It finally happened, the ever-dreaded IRS audit. We knew that after 15 years in business it would happen sooner or later, but it just so happened to occur at the worst possible time.
We had just sold our house and everything was in storage. We changed out address but didn't have a mail box yet. Everything happened at once, and although I felt very unprepared and overwhelmed, I took it head on.
So, in case you have never been audited, this is how it goes:
You get a letter in the mail saying that you have 30 days to provide them with the information requested. In our case, they scheduled a phone call. Sometimes they request that you appear at their office or schedule a video chat. I thought this would be a breeze, but this is where what I learned what comes in to play.
1. When they ask you to explain your business, such as what do you make and sell or what services do you provide, list every single thing.
Why, you ask? Because when they go through the receipts and documents you provided, any material that does not relate directly to your business will be thrown out.
I did not know this. When they asked what I made in my homemade business, I said that I made cabbage patch wigs and shirts. So all wood, beads, or any item that was not yarn or shirt material was thrown out, and we had to contest it.
2. Copy all receipts front and back.
I know this seems silly, but they will throw out any utility bills out that do not have the service address listed. They will throw out any receipts that do not have all the items listed. Make sure that if you purchase something for business use and something for personal use in the same transaction that you have the business expense circled and amount written on the receipt.
3. When receiving loan funds, make sure you are noting the deposit and every check that is written with those funds.
One thing we didn't expect, because it was not part of the requested information, was proving that deposits were loan proceeds. I never thought about providing loan information until they had added the loan proceeds for my husband equipment to our information.
We had to prove that those deposits were loan proceeds. You would think that it would be easy, that you show them the documents and done. No, it didn't quite go that way. We had to go to tax court to prove that what they were claiming was income was in fact a loan. It required check images from the deposits, check images for the equipment processes, and a paper trail put together by the bank. This was the hardest part.
4. Make note of all account transfers, owner withdrawals, and deposits.
When moving money from one account to another, make sure you are noting this on the deposit slip and the memo line of the check. We made the mistake of withdrawing cash and putting it in a lock box. We took the money out of the lock box and put it in our checking account to pay for a car. This worked well for us as a way of saving money, but in the case of the audit, it was a nightmare. We again had to show every withdraw for cash. My advice is to not do this.
5. Hire an enrolled agent, CPA, and tax attorney immediately, even if you feel like you have it handled.
They do this regularly, and they know what to say and what not to say. They know what information you should provide and in what form. They are costly, yes, but this will save you in the long run.
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