Reduce Your Audit Risk
You've probably already figured out that as a business owner your odds of getting audited by the IRS are much higher than they'd be if you were a corporate employee. We asked Jeffrey S. Levine, an accountant based in Newton, Mass., about the biggest personal-audit risks entrepreneurs face.
Consumer reality checks: In these audits, the IRS looks at your personal expenditures and investments to see if your lifestyle fits the income level you and your company are reporting. Business owners often get hit with these, because agents are concerned about the ways owners can hide cash.
What you can do: Make sure your personal spending habits jibe with what you're reporting to the IRS on the corporate front. Be prepared to explain anomalies.
Compensation and benefits: Did you know that the tax man can challenge you not only if you pay yourself too much but also if you pay yourself too little? (If you own an S corporation, the IRS may, for example, suspect that you're hiding money in the company to minimize taxes artificially.) In any compensation audit, expect the agent to consider industry norms and to compare your salary with others', based on factors such as sales volume. As for fringe benefits, Levine says it's unlikely that a single benefit will trigger an audit, but if the IRS has already launched one, close scrutiny of them is almost inevitable. So make certain your practices here will seem "reasonable and allowable" if an audit occurs.
What you can do: If you have a board of directors, include in meeting notes a discussion of the rationale for the owner's salary. If not, ask your lawyer to prepare a similar justification each year for the company records.
Compliance problems: If you call attention to your company by, say, falling behind on payroll taxes, you've raised the chances of receiving a corporate audit and, along the way, a personal challenge, too.
What you can do: Take all federal and state deadlines seriously--or risk the consequences.