The number of IRS audits increased in 2007. See my recent article "IRS Ramps Up Audits" to read more about what is causing this increase and who is targeted. What can you do to be prepared?
#1 Build a defense for your rental real estate losses.
While the IRS has not specifically targeted returns that deduct rental real estate losses, if you are selected for audit, your rental real estate losses will be questioned. If you claimed real estate professional status, the IRS will ask you to prove that you qualify. If you claimed the $25,000 loss exception, you will be asked to prove that you meet the "active" threshold.
Here's what you can do:
First, make sure you clearly understand the rules for taking your rental real estate losses. You can deduct rental real estate losses to reduce you taxes but the rules are very specific. Knowing these rules inside and out will increase your chances that your audit will result in no adjustments to your rental real estate losses.
Second, document your real estate activities. Proper documentation is the number one defense you have. The IRS wants to see not only the number of hours but also the activity you were doing and for which of your properties or businesses. Need help? I'm here to help you!
#2 Clean Up Your S Corporation
The number of S corporation audits jumped in 2007. The IRS is looking at specific items; here are a few of those items you need to be aware of:
- Your salary -
How much did you receive as salary and when did you receive it? As an owner, if your salary is too little, you could be in trouble. But from a tax planning standpoint, if your salary is too much you will be overpaying your taxes! There is a balancing point to master here.
The timing of when you receive your salary is important as well. Big lump sum payments made once or twice don't look like salary and could be drawn into question.
- Your distributions -
How much did you receive as distributions and when did you receive them? Smaller distribution amounts that are paid more frequently than quarterly don't look like distributions. These amounts will be scrutinized!
Here's what you can do:
Your #1 defense is documentation. How did you come up with your salary amount and your distribution amount? How did you determine when you would pay your salary and when distributions would be made? Once you have this documented, you need to make sure what your S corporation is paying is reasonable. So, take another look at your salary and distributions and ask yourself if it makes sense for a business to pay these amounts.
Not sure what your S corporation should be doing? Then you are in the majority, that's why the IRS is having a field day with these audits! I can help walk you through the exact steps you need to take to determine your salary amount, your distribution amount and how to document both so you are ready for an IRS audit.
#3 Support Your Expenses
There are certain expenses the IRS will always look at in an audit. These expenses are travel, meals and entertainment.
The #1 thing you can do is to make sure you can support these expenses. The IRS will want to see the who, what, when, where and why of each of these expenses. Who was there, what was the business purpose, when was it, where was it and why was this an ordinary or necessary expense for your business.
Not sure if your documentation will pass an IRS audit? I can help!
By now, you realize the key to surviving an audit without any adjustments is proper documentation. If you are among the many who do not document as you should, it's not too late! Even if your documentation has not been ideal in the past, make a new start right now! Understand what you need to document and then on a daily, weekly or monthly basis, make sure your documentation for that day, week or monthly is in order. Once you have the hang of it, go back and start to document what you didn't in the past. Remember, the IRS can audit a return 3 years after it has been filed (and 6 years if the tax return filed was considerably incorrect).
Tom Wheelwright is not only the founder and CEO of Provision, but he is the creative force behind Provision Wealth Strategists. In addition to his management responsibilities, Tom likes to coach clients on wealth, business, and tax strategies. Along with his frequent seminars on such strategies, Tom is an adjunct professor in the Masters of Tax program at Arizona State University. For more information, please visit http://www.provisionwealth.com
Three (3) Things You Can Do To Be Prepared For An Audit
