The New Wave of IRS Audits- How Will It Affect Your Small Business

Have you gotten an audit letter from the IRS yet? For the first time in history, the IRS is auditing 2,000 companies this year at random as part of its Employment Tax National Research Project (NRP). If you aren’t thinking about a tax audit, you should be. They can be a nightmare even if you’re completely honest. Even if you come out ahead as a result of a business audit, it will still take away from your valuable resources of time and money.

It should come as no surprise that our government is strapped for cash. With the staggering federal deficit, the IRS is aggressively trying to close the $300 billion gap between what Americans pay in taxes and what the government thinks we should have paid.

If you haven’t received an audit letter, don’t celebrate too soon. The IRS plans to continue performing 2,000 random audits through 2012.

In an announcement last November, the IRS said, the audits will be "comprehensive." So what does "comprehensive" mean? Well, the focus of the IRS will be to "close the tax gap". The tax gap is the difference between the amount businesses owe and the amount they actually pay on time. Whether the gap is due to businesses not filing taxes, not paying on time, overstating deductions, or underreporting income, the IRS is ready to tackle the issues and increase tax collections. In fact, the IRS has developed their own strategies to identify some of these problem areas and stop the leaks.

So what does this mean for small business owners? Well, here are some of the key areas the IRS will be targeting for their upcoming audits that you need to prepare for:

Worker Classification: This IRS will continue to focus on determining whether workers are classified as employees or independent contractors. If you have independent contractors in your business, make sure you have the appropriate agreements and documentation to support their employment status. To help protect your business in case of an audit, make sure you have Form W-9s and independent contractor agreements from EACH of your contractors. Another step you can take is to check your Company policy and operating agreement to ensure the job description is that of a contractor’s position rather than an employee.

Executive Compensation: Audits will focus on reasonableness of salary and non-salary compensation, such as loans, deferred compensation and stock options. In order to protect yourself in case of an audit, make sure you have market comparables to substantiate the reasonableness of your compensation. Examples include market salaries, interest rates, and stock prices.

Fringe Benefits: These are the perks for executives and employees. The IRS will target these areas to make sure that the tax free and taxable fringe benefits such as cell phones, cars, and insurance are appropriately reflected. There are a lot of great TAX FREE fringe benefits that you can take advantage of as a business owner. However, there are also a lot of pitfalls and limitations that you need to watch out for. This is the best time to review your company policy and update it to be compliant for the 2011 year.

Payroll Taxes: The IRS will be looking closely at Forms 941 and Form 1099/W-2 for issues including withholding and next-day deposit requirements. Make sure you are working with a competent payroll service company to ensure all your filings and payments are made on time to avoid massive penalties.

As part of the new wave of increased audits, the IRS has warned that businesses being audited should be prepared to open all their records for examination. But whether or not your business gets an audit letter, it is nevertheless a great idea to get your ducks in a row in case of a potential audit.

So what should you be doing now? Start now to make sure your business is in compliance with the above target areas. Do an internal audit to ensure you have the right documentation in place. If you find anything questionable, take immediate steps to resolve the problem and put together the systems within your business to protect yourself from these shortfalls in the future.