© by Greta P. Hicks, CPA

There are some mistakes or oversights that will fly past the IRS computers and eyes of suspicious employees and there are other what may seem to be little errors that can cause major problems with the IRS rules. Small business people who avoid this "little errors" during the preparation of their return or for those being audited, will have more time to manage their business and less time tangled in IRS traps. Two of the most common traps small businesses fall into are complacency and trying to beat the "audit lottery."

Complacency And Audit Lottery Trap

"I haven’t ever been audited so I don’t have to worry about it." Maybe yes. Maybe no. The IRS audits about 4% of the self employed business and recently they are concentrating on auditing mom and pop, cash based businesses such as bars, restaurants, mobile food vendors, construction workers, laundromats, and retail stores.

The chances of being audited go down dramatically to .05 if the business is a partnership or S Corporation. Incorporating solely to reduce the risk of an IRS audit is usually not good planning. Consider all favorable and unfavorable facts prior to incorporating. For more details see ASBA Today, ___

"So why worry about it?" If you have poor or little records when the tax man cometh, the cost of reconstructing records, of lost time, and of legal and accounting fees will be staggering. Those of us in the business know that it is less expensive to maintain good records that it is to create records from bits and pieces of records that are two or three years old.

Tax Preparation Trap

"I’m smart enough to read the instructions and do it myself. After all, I now have Turbotax." The first rule to avoiding an intrusive IRS audit, is to prepare a return that is accurate that  will not set off the bells and whistles of the IRS computer. Common mistakes on returns that cause the IRS to audit the complete return.

1. Failure to list all Forms 1099-INT, Interest Income, on Schedule B, in such a way that the computer or unskilled IRS worker could find the interest income on the return.
2. Failure to list all Forms 1099-B, Sale of securities, on Schedule D. The most common error in this department is the failure to report the transfer of moneys from one mutual fund to another mutual fund.
3. Failure to list all Forms 1099-DIV, Dividends, at gross dividends on Schedule B and deduct the nontaxable distributions and capital gains distributions.
4. Failure to report all Forms 1099-MISC, Miscellaneous Income, on the appropriate schedule. Listing non-employee compensation with wages and failing to complete a Schedule SE, Self-employment earnings.

Failure To Keep Records Trap

Most traps arise due to the mixed personal and business use of certain assets and deductions. The IRS presumes all assets and deductions are personal unless the taxpayer has the records to prove otherwise.

The typical mixed-use assets are cars, mobile phones, home computers, boats, hunting leases, and vacation homes. Each mixed-use asset carries with it stringent, detailed record keeping rules. Other deductions that the IRS looks upon as personal unless proven other wise are meals, entertainment, travel, and customer gifts. The typical trap the taxpayer falls into is that when audited, the taxpayer does not have the detailed required records to prove to the IRS the amount of the business versus personal use.

During an audit, the IRS will request not only canceled checks and paid receipts or invoices, but also copies of insurance policies, contracts, calendars, logs, travel and conference agendas, journals, and diaries. Section 280F, 280A, and 274 of the Internal Revenue Code require automobile logs, logs of vacation home use, and who, what, where when and why of all travel, meals and entertainment. The IRS will want to see the actual hotel bill not just the credit card receipt. Credit card statements and canceled checks need to be further supported by the actual receipts

You say, "Too much!" I agree but how many deductions are you willing to give up? For every $100 of deduction lost, the tax bite is from $14 to $54.80.

You say, "I’ll just wait to see if I get audited." Ok, some auditors will allow you to reconstruct logs, etc. but others stick to the letter of the law which requires these types of records to be "contemporaneous."

You say, "What about the new rule that you don’t have to have a receipt for an expenditure under $75?" BUT, you still have to write down detailed information, such as: The date, time, place, name, and business purpose of the expenditure. I ask, "Which is easier, writing the name of the personal entertainment and the business purpose of the discussion on a credit card bill, or writing all the details on your calendar, diary or journal? The law says no receipt required but contemporaneous record required. The auditor says, "No receipt. No deduction."

Having your deduction disallowed because of poor records is a trap you can easily avoid by maintaining a log on your business car and writing the name of the person and business relationship on all credit card charges.

The Barber Shop Law Trap

Many taxpayers get trapped into thinking that the tax hints they receive from their barber, golf buddy, manicurists, neighbor, or co-worker are "the law." The most common tax law trap is in the buying and selling of real estate.

Common Trap Number One.

"If I sell a piece of property, I have two years to reinvest the money." Yes, if you sell your primary residence, you have two years to replace that residence with a new primary residence. No, on any other property unless you are involved in a "like kind" exchange or an "involuntary conversation." An example of like kind exchange is you swap your real estate for real estate owned by another person or business. A loss due to an involuntary conversion, such as hurricane, flood, earth quake, can be replaced with in like kind property. You usually will need to consult an attorney and/or a certified public accountant when you are planning a like kind exchange transaction.

Common Real Estate Trap Number Two.

"I can sell property and carry the note and no taxes are due until I collect the money." This is true but there are tax traps. If you sell property that has been depreciated using an accelerated depreciation method, you may have to recapture part or all of the depreciation taken in prior years. In an installment sale transaction, income taxes are to be paid on all depreciation recapture in the first year of the sale. The solution is to get a very big down payment so that you will have the money to pay the taxes in the first year.

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GRETA P. HICKS, CPA and former IRS manager, concentrates in solutions to IRS problems and advises business and tax professional on IRS policies and procedures. Ms Hicks is owner of TAX SOLUTIONS, Inc., a company providing educational materials and programs on solutions to IRS problems and is a nationally known speaker and writer on solutions to IRS problems. To arrange for consultation contact: Greta's web site: http://www.gretahicks.com

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