It’s something every business owner worries about – including contractors.
You file your taxes on time and believe they’re accurate but, several months later, you get that fateful letter in the mail. Getting the news you’re going to be audited is like seeing a ghost – shocking to the point where you may not even believe it at first.
But an IRS audit, though not entirely preventable, is more manageable than you might think.
Construction companies are document-oriented businesses. So if you manage those documents properly, you’ll likely be well on your way to defending whatever tax breaks you’ve claimed.
Let’s discuss some important points to keep in mind.
For a variety of reasons – a tax audit certainly being one of them – it’s important for contractors to keep good records.
Examples of important records include:
- Detailed accounts of daily business/project transactions
- Receipts for charitable donations
- Documentation for any investment losses
- Copies of invoices and purchase orders
Meticulous record keeping simplifies tax preparation and ensures that your returns will include all the deductions to which you’re entitled. Should it be required, good documentation can also help explain your position to the IRS.
Tax experts advise companies to carefully document travel, entertainment, medical and other business-related expenses. Expenses that are out of the ordinary, unexplained or excessive in the mind of a tax examiner can trigger further investigation.
IRS officials also warn contractors to be honest in how they classify their employees.
It may be tempting to categorize salaried workers as independent contractors to avoid payroll taxes, but that practice carries significant risk. Not only could you end up paying those back taxes anyway, but you could also be charged interest and other penalties to remedy potential violations of wage laws. Moreover, doing so could trigger an audit.
The distinction between employee and independent contractor typically is determined by the amount of control a construction company has over the way in which the person works and by the support given to that individual.
To steer clear of IRS trouble, explain your desired results to the independent contractor and provide a deadline. But leave the how, when and where the work is done to him or her. And be sure that the independent contractor uses his or her own transportation, equipment and supplies.
Keys to survival
Despite your best efforts, you may be subject to one of three types of audits.
First, the IRS could send you a letter, which usually seeks documentation to support certain deductions you’ve taken. This is the easiest audit you’ll face.
The next step up is an office audit, whereby the IRS asks you to take receipts and other documents to a local IRS office.
The most severe version, though, is the field audit that is conducted by the IRS at your office or home.
The keys to surviving an audit are knowing what areas the IRS will look at and being prepared to answer potential questions.
To get ready, collect and organize all relevant income and expense records. If any records are missing, you should reconstruct the information as accurately as possible, based on other documentation.
Having an accountant or other tax professional respond to the auditor’s inquiries and provide the necessary information is usually the best approach. The weaker your case, the more value a tax adviser can provide. In addition, IRS agents are often more comfortable dealing with professionals who understand tax law.
For better or worse, the construction business is wrought with complexities that can trigger an IRS audit.
The nature of your contracts, the status of your workers, the various tax breaks for which you may or may not qualify – these can all draw the attention of tax authorities.
That’s why staying on top of record keeping and continually looking for ways to make it more efficient and accurate are such important activities for a contractor.