Tips to avoid an Audit of a C-Corporation
Tips to avoid an Audit of a C-Corporation
With increasing pressure from the US Congress to accelerate revenue collections and encourage taxpayer compliance, the IRS would be increasing the number of audits it will perform of Corporations in Tax Year 2008. There are many situations that would trigger an IRS audit of a C Corporation. Here are some of the situations would tend to invite an IRS scrutiny of a Corporation Tax Return.
1.Auto expenses are high.
Corporations need to be careful and ensure that the only business portion of Auto expenses should be claimed.
2.Omitting to account for personal usage of a Leased vehicle.
When filing a corporation tax return involving a leased vehicle, the corporation should include the personal portion of the use of leased vehicle by an officer on his W-2.
3.Officer life insurance is expensed on the tax return with no M-1 adjustment.
This item of expenditure is not deductible and if this is paid by the Corporations, it is usually shown as an M-1 item.
4.Excessive meals and entertainment.
Meals and Entertainment expenses are really expenses that are incurred in course of normal business. These result in subsequent business, and must be paid entertaining other than Corporate Officer and their family! IRS will investigate unusually high level of these expenditures and will demand proof of which client or customer was entertained and how much business was generated from the related expenditure. Excessive amounts would definitely invite an IRS audit.
5. Loans to officers instead of payroll.
The IRS will closely compare the amounts of Officer Loans relative to the Officer’s Salary. Where there is little or no Officer Salary, and substantial amounts of loans are paid to the Officer, the IRS will view this as an abusive transaction to avoid payroll taxes. The IRS will then recharacterize these loans as payroll and assess delinquent filing of a payroll tax returns, and charge interest and penalty on the payroll tax liabilities due.
6.Corporation with retail business involving inventory, but have zero ending inventory!
Corporations that are in the business of selling products, that involve tangible inventory, but have little or Zero ending inventory are generally susceptible to an audit. The IRS would feel compelled to audit that business, because it is impossible to have zero ending inventories especially in the retail environment. By showing Zero ending inventory, the Taxpayer would be increasing the cost of goods sold and thus lowering the effective taxable income subject to Corporation tax. An Inventory adjusment could result in substantial penalties and interest as well as additional tax on the "adjustment" amount.
7.Profit margins are inconsistent with prior years.
The IRS generally would be able test the reasonableness of the Corporation tax return by reviewing the prior year’s ratios of profit margins and expense ratio’s. If the Corporation tax return tends to reveal ratio’s that substantially deviate from prior years, this could cause an interest to investigate this anomaly by the IRS.
8.The Corporation Balance Sheet does not balance.
This situation is pretty obvious, in that it shows that the books do not balance and hence the entries made on the corporation tax return will not balance. This shows a lack of attention to detail and hence it would seem the business could not possibly have records to substantiate expenses.
9.Retained earnings from prior period not properly rolled forward to current year.
Once again, this demonstrates a lack of attention to detail and sloppiness, and the IRS would want to investigate the return further to determine where else has the Business shown level of sloppiness. Again, the thinking being has the taxpayer got substantiation for expenses claimed elsewhere on the tax return.
10.The Form 1096 Annual Transmittal along with the 1099’s Misc. were not issued timely.
The filing of this form is required on an annual basis that reports all independent contractors paid over $600 for that calendar year. A late filing of this form clearly indicates a poor record keeping of the company’s financial statements. The IRS would be thinking whether or not this business is keeping it records on a timely basis as well as having a proper set of books.
11.No interest paid on officer loans or no interest received on officer loans.
Anytime the Balance sheet shows loans to or from an Officer, the IRS would be looking to determine whether the Corporation received “interest” on Loans made to Officer or paid “interest” on Loans received by the Officer. A 1099-Int would have to be issued to the Officer who was paid interest on the Officer Loan.
The absence of interest income by the Corporation would invite an IRS scrutiny as these bona fide loans to shareholders could be disregarded as loans and be recharacterized as “Salary” to the Officer. This would cause imposition of substantial penalties and interest on late payment of payroll taxes as explained on 5) above.
The absence of interest expense by the Corporation would also invite an IRS scrutiny as bona fide loans to the Corporations should result in interest income to the Officer making the loan. The IRS would impose penalties and interest on underreporting of interest income on the Officers tax return.
Hence, it is important to document all loans made by or paid to the corporations, and have a loan document outlining the payment terms, interest rate and duration of the loan. Furthermore, it is important to at least record the accrual of interest if the loan cannot be paid and at the end of the year and the proper 1099-Int be filed along with the Annual Transmittal Form 1096.