Does the mere thought of an IRS audit send chills down your spine? Historically, small businesses have been audited by the IRS at double the rate of all filers. Although that rate is dropping, there are a number of practical reasons why small businesses are at greater risk of being audited, says Vicki L. Helmick, a CPA in Orlando, Florida.
"If you're a sole proprietor, have a home office or do your return by hand rather than using a computer program or a professional tax preparer, you increase your chances of being audited," Helmick says. Of course, you may be audited no matter what. There are a few things you can do when starting your business to make the experience less stressful.
The key, says Helmick, is in keeping good records from the start. "In the long run, it's easier-and you'll always be prepared for whatever happens, whether it's an audit or whether you need financial documentation for some other purpose."
Open a separate checking account for your business. "That way, you're not commingling personal and business funds where income or expenses can get lost or miscoded," Helmick says. "You'll capture your financial information correctly and in one place."
Get a business credit card or a separate card in your name that you use exclusively for business. Charging business expenses eliminates the risk of losing receipts for cash purchases. Also, Helmick says, if you carry a balance on a credit card that's used solely for business purposes, the interest is deductible; but if you mix business and personal charges on the card, the interest is not even partially deductible.
Set up a good computer-based accounting system, like QuickBooks, suggests Helmick. Then record your information on a timely basis-which is important not only for audits, but also for tracking your profits.
For your physical documentation, designate a filing cabinet for exclusive business use. Set up files by year so it's easy to pull information out by date. Have separate files for payroll, payables (you may want to set up individual files for each vendor) and receivables. Remember that for any files you maintain electronically, you must always have the program to access the data-that means keeping software even after you've upgraded.