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Deviate from the norm and your
company will likely be visited by an IRS auditor
By Cora M. Barnhart •
Bankrate.com
As we do our taxes, many of us
occasionally wonder if an inadvertent mistake could mean we'll be
hearing back from the Internal Revenue Service. Business owners
in particular may agonize over whether an auditor will be focussing
on their returns.
Although the IRS has audited only about
1 percent of individual tax returns in recent years, it has recommitted
itself to tracking down cheaters. The agency is again conducting
random
audits to gather information on taxpayer habits. It's also looking
especially hard at companies and individuals who try to hide earnings
in foreign (AKA offshore) bank accounts.
So just what prompts an IRS agent
to take another look at a return?
How
the IRS analyzes your return
When income tax returns arrive at an IRS Service Center, the staff
enters the information on the return into a computer. The IRS computer
analyzes the return with a complex "discriminant function"
formula. The analysis compares entries on the return to averages
based on taxpayer norms.
The program permits a certain level of deductions
for a particular income level. Unfortunately for us, this level
is secret.
The return then receives a numerical score.
The score depends on how much the deductions on that return vary
from the average. Every deduction that varies from the norm is added
together and the total amount determines the return's numerical
score.
The IRS doesn't publicize its scoring system.
Certain factors will increase the score, though.
Greta
Hicks is a CPA and a former auditor for the IRS. According to
Ms. Hicks, many of the factors likely to bump up a return's score
have to do with deductions for certain business expenses, such as
cars.
Avoiding
the top score
What are the deductions most likely to bump up a corporate return's
score? They include high auto expenses, high business
use of autos and the number of autos used in the business. Another
high scoring factor is high travel and entertainment expenses.
Low gross profit margins and claiming little
or no profit from business operations are other ways to increase
the score. In fact, the law center at Nolo.com actually
advises against filing an income tax return with Schedule C,
Profit or Loss for Business that reports a net loss from a small-business
venture. As the site puts it: "IRS auditors go after these
returns like bees toward honey."
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