5 Questions Entrepreneurs Should Ask Their CPAs to Reduce Audit Risk
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To help reduce your fears of a government audit, February is the best time of year to meet with your CPA to review your tax strategy, review your documentation requirements and ask key questions about how to reduce your chances of an audit. What’s clear from my 35 years of experience as a CPA is that people fear a government tax audit more than death and public speaking combined.
The good news is you can sleep at night by being more proactive. The number one thing the government wants is compliance, so your job is to make sure you’re following the rules. Schedule a meeting with your CPA early this year, and ask these five direct questions to reduce your anxiety.
1. Are you afraid of the IRS?
Your tax preparer should be comfortable, willing and actually very engaged with the idea of handling an IRS audit. If they are afraid of the IRS and/or overly cautious, then find someone else to prepare your returns. People often share that their tax preparer advised: “Don’t take this deduction, even though it’s legitimate, because it might raise a red flag and get you audited.” Well, what that statement really says is that your tax preparer is afraid of the IRS.
2. If there is an audit, are you going to handle the IRS communications?
Your number one goal should be to have the best tax advisor who will interface with an IRS auditor, not you. You can even give your tax advisor power of attorney in the U.S. by completing a Form 2848. I cannot emphasize this point enough. You should never communicate directly with the IRS. It doesn’t matter whether it’s is a simple request for information or an extensive audit. The reality is that the IRS knows a lot more about taxes than you do, and your CPA should know even more than the IRS. So write this down: “I will never speak to a government tax authority.” Ask your CPA this question, and listen carefully to their response.
3. Have you ever handled an IRS audit for a client, and what happened?
Ask your tax preparer about their experience working with the IRS on audits for clients, and then ask for a few examples and the results (without giving names of course). There are many different scenarios, and you want to gauge their confidence level. After handling many audits over my 40-year career, I am most proud of losing my first audit because I calculated that it meant a huge refund for the client. I ran the numbers not just for the year of audit, because for the year of audit it would have meant a big tax payment from the taxpayer. What I figured out was in the year subsequent to the audit, it meant a huge tax refund if the auditor won. And in fact, when you combined the two years, the taxpayer was better off losing.
4. How do you build a relationship with an IRS auditor?
This relationship-management question is really important, because you want a CPA with good people skills to oversee your audit. When meeting with an IRS auditor, your tax preparer should make them feel comfortable and really do their best to help them. Auditors have a tough job, and building rapport can make a big difference in the results. Unfortunately, there are tax advisors who treat the IRS very poorly, and that’s not in your best interest.
5. What documentation do we both need to keep to minimize audit risk?
Keeping proper documentation of expenses for deductions on your tax return is critical. You want to keep physical copies of documentation ideally for seven years. You will probably not turn over documents to your tax advisor until and unless you get audited. As a result, ask for a list of what documents you need to keep. And then ask your tax preparer, “What information are you keeping that can help defend an audit?” Along with maintaining a copy of your tax return, the tax preparer should keep copies of your W2 wage statement, 1099, general ledger, balance sheet and income statement for your business. This documentation will be the basis for an audit, and it’s critical to keep good records.
By asking your CPA these five audit risk-mitigation questions, you will reduce a prominent and valid fear. Bottom line, you need three things to reduce audit risk: 1. the right tax advisor who handles all IRS communications for you; 2. great documentation and 3. a tax return prepared in way that's as audit-proof as possible. It’s then the CPAs job to make the IRS auditor feel confident in your tax returns and minimize any impacts. Good luck.