3 Ways to Prevent Your Company from Committing Tax Fraud

3 Ways to Prevent Your Company from Committing Tax Fraud

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Most businesses are started by people like Bill Gates CEO of Microsoft or Frank Vandersloot CEO of Melaleuca who are ambitious and enthusiastic about what their new business will make, sell, buy, or fix. They are not driven by the paperwork, laws, mandates, or codes. However, every business requires at least some basic knowledge of tax law. And, in the long run, this understanding along with good ethics can save you money and give you peace-of-mind when dealing with the IRS.

Detailed below are the top three ways to avoid tax problems.

1. Implement a Bookkeeping System

Operating a business without records is like flying a plane in heavy fog without instruments. Paperwork matters do not resolve themselves and can prove to cause big problems down the road. The only way to truly know the financial state of your company is by keeping accurate records. A record-keeping system is also extremely helpful when preparing your tax returns. And last but not least, records are a must if your company is ever audited by the state or IRS.

2. Understand the Common Reasons for Penalties

When the IRS issues your business a tax bill, it usually comes with penalties. These extra charges can be a nightmare-an old $4,000 tax bill could have $9,000 in penalties. Penalties for late payments are added automatically by their computers. IRS personnel may also slap on penalties if you violated any provisions such as filing late. Once penalties are added, if you don’t complain, it is assumed that you accept them.

Luckily, the IRS can remove a penalty as easy as it can add one. The best way to receive penalty relief is to show a reasonable cause for your failure to comply with tax law. A reasonable cause could be anything from "my house burned down" to "I was really busy and forgot." The most common reasons for penalties are inaccuracies, civil fraud, and late payments and/or late filings.

3. Know What to do When being Audited

An audit is an IRS look into your business and into your tax return. The goal of an audit is to verify that your tax return accurately states your income and deductible expenses. The probability of a small business being audited is four times that of wage earners. Computer scoring is often the first step towards becoming an audit candidate.

A computer program called DIF scoring scans every 1040 and gives it a number grade. The highest scores are then reviewed by a human for audit potential. If you are chosen for an audit, the tax law places the burden of proof on you to back up what’s in your return. This may or may not be easy. The IRS wins over 80% of all audits, often because people can’t verify data; not because of cheating, but because of poor record-keeping.

Before meeting with an auditor, review the tax returns being questioned. Be prepared to explain how your figures were reached. If you can’t, ask your tax preparer or another tax professional. Explain any problems you may have backing up income sources or expense deductions. If necessary, look up information on tax law. You’ll need to show in legal terms your right to claim any deductions.

Audit success means documenting everything. The process will be much easier if you can show that your tax return is based on good record keeping. It is best that proof be in writing, though oral explanations may be accepted by the auditor.

At minimum, you should be able to produce bank statements, books and records, electronic records, appointment books and logs, auto records, travel and entertainment records, and expenses for renting or buying property. If you have good reason to fear an upcoming audit, such as tax fraud, consult a tax attorney well before the date of your audit.

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