IRS Business Audits: Everything You Need to Know

National income in the USA is on the rise, and so are the rates at which the Internal Revenue Service (IRS) is auditing businesses. In fact, they plan to increase their IRS small business audits by about 50% in the coming year!

So, what does that mean for small business owners like yourself? Well, it means that you need to be prepared in the event that your business is selected for an IRS business audit.

What is an IRS Business Audit?

An IRS business audit is a thorough system of checks and balances conducted by a tax professional known as an IRS auditor. They have complete authority to examine the totality of your business’ accounts to determine if you’re compliant with federal tax laws. If the auditor finds a mistake, either you or your business may have to pay a tax deficiency, as well as a penalty and interest on the deficiency.

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IRS Business Audits

How Does the Selection Process Work for IRS Business Audits?

Even if you’ve been as careful as possible when filing your taxes, it’s still possible for an IRS auditor to find a mistake during their business tax audits. To avoid having to pay a tax deficiency with additional penalties and interest, you should know what kinds of mistakes that you can make during your tax preparation that can trigger an IRS field audit.

Rounding Numbers in Your Account Books

As a general rule, most small business owners don’t do their bookkeeping themselves. They defer their bookkeeping to someone else.

However, if you decide to do your own bookkeeping, keep in mind that if the IRS sees that your income tax return lists several items that are all rounded to the nearest $100, that may set off a red flag and prompt an IRS audit on your small business.

Frequently High Deductions

Business meals and home office expenses are all reasonable deductions and perfectly allowable in the eyes of the IRS. However, expenses that are eligible for tax deductibility must meet a number of strict criteria.

Take meals, for instance. If you’re grabbing a cup of coffee or lunch down the street from your home office, that’s not a deductible expense. A dinner with clients and food you eat while travelling for business purposes, however, is. Just make sure to record the names of people in attendance for client meals and the business relevance as well.

For home office deductions on returns filed, you must prove that your office is used “exclusively and regularly” for your business.

If any of these expense deductions are out of order, it could trigger audits from the IRS.

Reporting Higher Income

Keep in mind that as your overall gross income increases, so does your potential of getting audited. As your small business grows, you want to make sure that the systems you are using to account for your receivables, payables and all of your business expenditures are scalable and can maintain the necessary records.

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What Happens When a Business is Selected for an IRS Business Audit?

As discussed above, certain conditions pertaining to your tax return can influence whether or not your business is the target of an IRS business audit, but more often not, the selections are random.

At its core, an IRS business audit is a second glance at your return for a specific year, and there are two main types of audits you should be aware of:

  1. Correspondence Audit
    This type of audit consists of the IRS notifying you by mail that you made a possible mistake on your return. In this case, you gather documentation to support your case and mail it in.
  2. Field Audit
    This is where an auditor shows up in person to conduct the IRS business audit and is much less common of an occurrence. 

In both of these cases, having a professional business tax specialist or attorney to represent you is always a great idea.

As for the audit itself, the IRS will give you a specific list of documentation and information they wish to examine. It’s important to follow these instructions to the letter. The auditor’s job is to make sure there are no errors on your return, and they have the ability to exercise considerable powers in pursuit of that goal.

IRS Business Audit

What are the Possible IRS Business Audits Outcomes?

Primarily, there are three main outcomes of an IRS business audit:

  1. The IRS Verifies that all of Your Information is Correct
    Obviously, this is the best-case scenario. In this scenario, the auditor has found there to be no errors or mistakes and thus no change to your tax return or any potential tax refund.
  2. The IRS Finds a Mistake, and You Agree
    Here, the auditor has found errors or mistakes on your tax return, and you accept them as they’ve been described and laid out. It’s possible you may be liable for additional tax payments and penalties plus interest. Or, it could be that there was a mistake in your favor, and you could get an even larger tax refund.
  3. The IRS Finds a Mistake, and You Disagree
    You have the right to disagree with the IRS’ findings post-audit. For this scenario, you have 30 days to file an appeal or contact the IRS Taxpayer Advocate Service, which is an independent organization within the IRS that helps taxpayers and protects their rights.

If you do decide to officially argue with the IRS’ findings, it’s important to have a reputable tax accountant to represent you.

How to Get Through IRS Business Audits: Best Practices

Whether you’re worried about IRS estate tax audits or hold a tax-exempt status, it’s always good practice to prepare ahead of time and do everything you can to ensure the audit is complied with and results in a favorable outcome for you.

Keep Airtight Records

Everything from income and losses to expenses and deductions, the more accurate and collected your records are, the better chance you’ll stand at making it through an IRS business audit unscathed.

Prepare Ahead of Time

You’ll be notified in advance, in writing, by the IRS of your audit date and the tax year they plan to examine. Take that time to make sure you’ve got all of your records compiled and ordered neatly.

Have Your Tax Professional On-Hand

The best tool to have at your disposal during an audit is a certified tax professional who knows all your tax information. 
Talk to HKMP  today about any accounting concerns you may have, and let’s work together to figure out the best strategies for your small business.

Cost of Small Business Accounting Services | HKMP

Small business owners recognize that accounting and tax services are necessary to operate their business and comply with government tax laws. Unfortunately, given the difficulties many small businesses face day to day, business owners consider paying for accounting and tax services as just another cost of doing business. 

This cost is not viewed as one that could lead to increased revenues, lower expenses, and increased profits. In addition, the business’ expansion potential by utilizing additional cash flow or outside business financing is never brought to the table. 

In stark contrast to that, proactive/best in class accounting and tax services can provide small businesses with an impressive ROI (return on their investment) in addition to the standard bookkeeping and tax filing. 

While the average cost for accounting services can run you anywhere from $75 to $500 per hour (depending on the type of services needed and the scope of work) how do you measure the cost, value and ROI of accounting services for your small business?

Measuring the Cost of Accounting for Small Businesses – Is it Worth It?

Many small business owners perform their own bookkeeping services. Recording transactions and managing their financial data utilizing accounting software, such as Quickbooks. Why? Often seen as the most knowledgeable about the business, who better than the owner to record the financial transactions. 

However, the question to ask is whether that is the best use of the small business owner’s time? In most instances, the answer is No. Usually it is better for the owner to use outsourced accounting services or hire a part time employee. 

Thus freeing up the owner’s time to focus on growing and managing the business. Outsourced accounting services utilize per diem bookkeepers, accounting and bookkeeping firms or CPA firms. Your firm can choose to be billed via hourly rates or with a flat monthly rate.

What to Expect From Your Accounting Professional?

Conducting proper bookkeeping in your accounting software is always the first step. Reviewing financial statements is the critical and next step. The numbers within these financial reports tell a story about how well the business is performing or where the business is lacking. 

Digging into the details behind the numbers is invaluable to a small business owner. Small business owners need to spend time reviewing these reports. This is where hiring an accountant, preferably a Certified Public Accountant comes into play. Your CPA can assist you in evaluating your financial statements. 

As a small business owner, items a CPA can review with you are:

  • Whether the price of your product or service is too low
  • Utilizing cost accounting, if your costs of product labor for a service is too high when compared to other businesses in your industry.
  • Using cash flow, do you have the ability to finance debt to make an acquisition, helping your business grow or invest in a new revenue stream

A CPA can assist in making timely business decisions to achieve the goals of the small business owner. The guidance of the accountant/CPA does come at a cost. And what the accountant charges will vary depending on the extent and level of the service provided.

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Compliance with tax laws and filing requirements is another area in which small business owners seek assistance from an accounting/tax professional. This is an area in which many small business owners are misinformed. 

Generally, they follow a reactive approach to tax returns by consulting with a tax professional, prior to the tax deadline, but after the fiscal year is completed. This is usually within 2 ½ months after the close of the fiscal year. This is not the best way to approach tax compliance and planning. Your firm should switch to a proactive approach.

Conducting tax planning throughout the year will yield the highest returns. Making informed decisions during the year will impact the small business owner’s tax bill at the end of the year. 

This proactive approach provides the small business owner with opportunities to make changes during the tax year that can save/defer taxes that would be due after the close of the year. Unfortunately, once the year is over, the majority of these opportunities are lost. A proactive approach may come at an additional cost over the reactive approach. 

However, a tax professional can provide a cost / benefit analysis for the small business owner prior to beginning the engagement to demonstrate the effectiveness of the proactive approach.  

Accounting Cost For Small Business: Conclusion

As the business owner, you cannot measure the average cost for your accounting services for your small business solely by the amount you pay. You need to factor in the following:

  • Uncovered opportunities to grow the business
  • Increase in the ability to make informed and timely decisions
  • Realization of saved tax expenditures or revenue

A small business owner must change the mindset that accounting and tax services are just a cost of doing business. Instead, the owner needs to tap their entrepreneurial spirit and consider it an investment in the future of their business.

Sales and Use Tax For Online Sellers After the Wayfair Case

It has been nearly three years since the U.S. Supreme Court decision was handed down that changed sales and use tax rules for online sellers. Known as South Dakota v. Wayfair, Inc., or simply as the Wayfair case, the ruling removed the physical presence requirement for sales tax nexus.

As a result, states can now require businesses to collect sales tax on goods and services sold in the state even if the business has no physical presence in the state. The ruling primarily affects online businesses and companies that sell via mail or telephone order (sometimes referred to as MOTO businesses).

Surprisingly, many companies have yet to adapt to the ruling. Often companies have heard of Wayfair but haven’t done anything about it.

Here are some of the most common questions clients have about how they can keep up with their sales and use tax obligations.

How does a company know where to file sales and use tax?

To know if it has a filing responsibility, a company needs to understand state law and how it applies to the company’s activities in the state.

Wayfair expanded states’ ability to require out-of-state companies to collect the state’s sales tax. Now, states can require out-of-state companies to collect the state’s sales tax if the company has sufficient “economic presence” in the state.

The most common economic threshold for a sales tax requirement is $100,000 in sales or 200 transactions in a state. The traditional parameters, however, such as whether a company has an employee presence or physical locations in the state, still apply. Complicating the situation, each state has its own parameters for determining when sales and use tax needs to be collected.

How can companies be sure they’re calculating sales and use tax correctly?

Calculating sales and use tax requires an analysis of state law and an understanding of the state’s sourcing rules. Depending on the state, some transactions are taxed all the time while some are circumstantially exempt.

Typically, a state will source a sale to the jurisdiction where the good is sold or delivered. Identifying that particular jurisdiction, however, can be tricky. Most states have a tax rate lookup system that enables companies to search for the correct jurisdiction and rate. However, it can be daunting when a company has thousands of customers with different addresses. Complete accuracy would require a check of every single transaction.

Alternatively, a company can invest in sales tax automation software. Whether that software produces the correct result depends on whether the correct information was input at the start.

What are the greatest challenges for companies that want to handle sales and use tax compliance in-house?

These companies face three main challenges: personnel, cost and risk. Calculating sales tax in-house requires at least one individual who is more than just knowledgeable about sales taxes. Companies that invest in such a person risk that person moving on and taking their knowledge with them. Also, calculating sales tax isn’t really a full-time job. Returns are typically due around the 20th of the month, so there’s a lot of downtime for an inhouse sales tax expert.

In addition, compliance and research software costs may be associated with handling sales and use tax in-house. Finally, if the person handling sales tax doesn’t rise to the expert level, there’s increased risk that the decisions made will turn out to be incorrect. This may lead to taxes, penalties and interest upon audit.

What tools can companies use to help with sales and use tax compliance?

Software can help, but the more complicated the software, the more expensive it gets. Also, software needs to be set up correctly and checked often to ensure its accuracy. This requires an expert.

Another option is to outsource the function or employ a hybrid solution. For example, a company could work with a sales tax expert on a quarterly basis to make sure filings are occurring in the right states, tax is being charged when it should be, and tax is being calculated correctly and for the right jurisdiction.

Although sales tax is often the smallest item on the invoice, companies should take it seriously. States will be motivated to go after out-of-state companies that haven’t been filing when they should have.

Contact us if you’d like assistance getting a handle on your sales and use tax obligations.

5 Questions All Leaders Should Ask To Assess Cybersecurity Risk

The Cost of a Data Breach

A study conducted by IBM last year, The 2020 Cost of a Data Breach Report, put a price tag on data breaches. According to the study, the average cost of a data breach is $3.86 million. Also, 80 percent of data breaches resulted in the exposure of customers’ personally identifiable information, which is the most expensive type of breach to remedy.

Stolen or compromised employee credentials and cloud misconfigurations are the most common causes of data breaches, with 40 percent of breaches caused by these incidences. Misconfigured cloud networks increased data breach costs by half-a-million dollars, according to the study.

Cybersecurity Starts at the Top

Statistics like these make it clear that cybersecurity should be an important part of every organization’s operating plan. Ensuring a well-protected network starts at the top.

Here are five key questions leadership should ask to assess cybersecurity risk:

Question #1: Is your executive leadership informed about cyber risks that threaten the company?

Cybersecurity is about managing risk. A breach can have dire consequences. This makes managing cybersecurity risk a critical part of an organization’s governance, risk management and business continuity framework. Early response actions can limit or even prevent possible damage. Accordingly, timely reporting to leadership should be built into the strategic framework for managing the enterprise. The CEO, CIO, business leaders, continuity planners, system operators, general counsel and public affairs should be part of the chain of communications.

Question #2: What is our exposure to cyber risk, the potential impact of a breach and our plan for addressing both?

Identifying critical assets and associated impacts from cyber threats is critical to understanding your specific risk exposure. These will most likely be a combination of financial, competitive, reputational ando/or regulatory risks. Risk assessment results are key to identifying and prioritizing specific protective measures, allocating resources, informing long-term investments and developing policies and strategies to manage cyber risks at an acceptable level.

Question #3: How does our cybersecurity program apply industry standards and best practices?

A comprehensive cybersecurity program leverages industry standards and best practices to protect systems, detect potential problems and enable timely response and recovery. Compliance requirements help to establish a good cybersecurity baseline to address known vulnerabilities. However, they do not adequately address new and dynamic threats or sophisticated adversaries. Using a risk-based approach to apply cybersecurity standards and practices allows for more comprehensive and cost-effective management of cyber risks than compliance activities alone.

Question #4: How many cyber incidents is normal for us? At what point should executive leadership be informed?

Executive engagement in defining the risk strategy and levels of acceptable cyber risk enables close alignment with the business needs of the organization. Regular communication between leaders and those held accountable for managing cyber risks provides awareness of current threats, security gaps and associated business impact. Analyzing, aggregating and integrating risk data from various sources and participating in threat information sharing with partners helps organizations identify and respond to incidents quickly. Ensuring that protective efforts are commensurate with risk.

A good way to establish updated security protocols is to have an assessment of your network. This can show you where you stand and provide insights to a solid plan of action.

Question #5: How comprehensive is our cyber incident response plan? How often is it tested?

Even a well-defended organization will experience a cyber incident at some point. When network defenses are penetrated, the leadership group should be prepared with a Plan B. Documented cyber incident response plans that are exercised regularly help enable timely response and minimize impacts.

Devise a Cybersecurity Plan Now

When it comes to cybercrime and data breaches, it’s not a question of if, but when. Now is the time to devise a plan for how your organization will deal with a data breach when one occurs.

Meet with your key leaders use the questions to assess cybersecurity risk. If you don’t have adequate answers, commit to doing whatever it takes to get answers before your organization is the victim of a data breach.