Discover The Secrets Of Auditors

What's In It For You

Although the guides were designed for IRS auditors, entrepreneurs can use them to their advantage. They're readily available to the public, and those who review the guides are certain to do a better job complying with the tax laws, says Mark H. Ely, national partner in charge of tax-controversy technical services for KPMG.

Unfortunately, the easy availability of the MSSP guides is often overlooked by small-business owners, Ely says. "Smaller companies haven't taken the opportunity to make use of the guides as much as they should."

Not only do the guides explain how the IRS expects you to operate your business from a tax standpoint, they also include information about IRS examination techniques, common and unique industry issues, specific business practices and terminology.

A good number of the guides focus on businesses that deal with cash. By giving auditors clues on how cash comes into a business, they can better determine if it is being properly reported so the IRS gets its share. The guides are particularly thorough and should be read carefully, says Ely.

Take the MSSP guide on car washes, for instance. It alerts auditors to the fact that many of these establishments are cash-oriented and have weak internal controls. As a result, auditors are on the lookout for unreported income. They may even want a tour of the business site to search for unreported income from things like vending machines from other parts of the building.

If you operate a pizza restaurant, know that the MSSP guide tells auditors that restaurant suppliers' invoices and the amounts of ingredients purchased may be compared to the pizzerias' menus and records. If necessary, the IRS will analyze the pizza in labs to determine the recipe used.

If you run a bed-and-breakfast, you'll need to demonstrate that you're not using your business to pay for and deduct personal expenses. If an auditor makes a visit, it's important to be able to show, for example, that your business isn't paying for the groceries you buy for your own personal use. A good way to avoid problems in this area is to keep two checkbooks-one for your business and one for yourself-and write separate checks for your personal expenses and those related to your business.

For manufacturers, employment taxes are likely to get the auditor's attention. He or she will ask the reasons for treating workers as independent contractors. If you request an opinion letter from an attorney on this issue after the IRS starts its examination, the agent is less likely to be persuaded that the individuals in question are actually independent contractors. A better idea: Request the letter when you first hire individuals as independent contractors.

Construction contractors are advised to carefully read the guide on their industry. The IRS wants contractors to treat the materials of their trade, such as plywood and drywall, as "inventory" and use the accrual method of accounting. This is preferable to treating the materials as supplies and using the cash method, the guide maintains. Auditors will also be looking for double-deduction abuses in single-entry bookkeeping systems, such as costs that are both capitalized and expensed in the current period.

If you find sections of the guides difficult to understand because of the technical nature of the information, ask your accountant for help. Check to see if you need to change any procedures to achieve better compliance.

Most important, finding out what the IRS identifies as key issues for your industry or profession can "help reduce the possibility that you'll be next in line for an audit," says Jacksack. In addition, if you're just starting a business, the guides can be especially useful with regard to the types of records you need to keep, she points out.

Even if a guide doesn't exist yet for your industry, Jacksack says it pays off to review those in similar industries to garner useful tax information: "By analogy, you can draw some useful conclusions."

Be sure to check out "Discover The Secrets of IRS Auditors, Part 2" on Friday, Jan. 12

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This article was originally published in the July 2000 print edition of Entrepreneur with the headline: Discover The Secrets Of Auditors.

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