The risks of the IRS selecting your return for audit are low. The IRS examines just over .6% of individual income tax returns. About .9% of those returns show gross receipts under $200,000. The higher your income, the greater the risk of examination.
The IRS has many methods of selecting returns, including third-party documentation, such as information return like Forms 1099 and W-2, and other sources of potential noncompliance, including newspapers, public records and individuals.
Red flags may trigger an audit. Among these red flags are large deductions for such items as charitable contributions, home office deductions, car and truck expenses, travel, meals and entertainment, hobby losses, rental losses, and suspicious activity (e.g., multiple deposits under $10,000).
TCMP is the IRS’ 1995 Taxpayer Compliance Measurement Program designed to estimate compliance with tax laws and revenue lost from noncompliance. Random in-depth audits are performed and data used for audit selection strategy. Then a computer program, called the Discriminant Inventory Function System (DIF), assigns a score to each return after they are processed. Selection based on a high DIF score generally results in a change to income tax liability.
Proper recordkeeping is crucial to monitor the progress of your business, prepare your financial statements, identify source of receipts, keep track of deductible expenses, prepare tax returns, and maintain supporting items reported on tax returns. The law does not require any specific kind of records. You can choose any recordkeeping system suited to your business that clearly shows your income and expenses. A good recordkeeping system includes a summary of your business transactions.
Keep supporting documents, such as sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks; invoices, receipt books, bank deposit slips, cash register tapes, documents showing the amount paid for inventory, and information about assets.
One of the first things you should do when you start a business is open a business checking account. Business checking records should be separate from personal checking accounts.
You must develop a bookkeeping system. This may be single entry, based on the income statement (profits or losses), including records the flow of income and expenses, or double-entry using journals and ledgers in which transactions are entered in a journal and posted to ledger accounts.
Barry A. Furman is Of Counsel to Fineman Krekstein & Harris, P.C., and a Mid-Atlantic law firm located in Philadelphia, Pennsylvania. Prior to entering private practice, Barry served as law clerk to a United States District Court Judge. He followed his clerkship with six (6) years at the Chief Counsel’s Office of the IRS, Department of the Treasury, where he was a Senior Trial Attorney. While at the Chief Counsel’s Office, he frequently advised the Commissioner of Internal Revenue on high profile, sensitive matters. Barry followed his IRS experience with private practice, representing a wide range of business clients in taxation, estate planning and administration, and corporate, healthcare, employment and real estate law for over forty years. Barry advises clients on a broad range of business matters and tax consequences and he continues to handle tax controversy matters, including tax litigation. His peers have repeatedly given him an esteem rating in competence and ethics. Barry has been a frequent lecturer and has written many articles for both attorneys and lay persons.