Tax audits (click here) typically start off with something like, “Please provide us with your 1099 forms, your business credit card statements, your mileage logs, and a copy of your prior year’s tax return.” But for a Raleigh physician or self-employed professional, the scope of the inquiry may grow considerably. A hotel bill for a trip to attend a physician convention could be listed alongside a family vacation, and inter-entity transfers could contain confusing memo lines, like “owner draw.” What at first appears to be a simple document request may quickly escalate to a meeting or a written explanation.
When a Consultant Is Enough
A tax consultant, accountant, or bookkeeper can assist in many situations where a tax audit is limited to reconciling records. They may help reconcile deposits to a practice account against the income reported on a 1099, organize your piles of receipts, or help you locate a missing employment tax return. A spreadsheet that links your credit card charges to a receipt, date, and description of business purpose can go a long way toward simplifying your response to a tax audit.
Some examples of tasks you can complete with a tax consultant include:
- Reconciling 1099s to your deposits as reflected in your bank statement
- Organizing your calendar of appointments, conferences, and travel
- Locating your payroll reports and your quarterly employment tax filings
- Sorting out your business purchases from your personal expenses
This kind of work is important, but you should avoid any effort to guess the reason for a given transaction. It is risky to write on the back of a restaurant receipt, weeks after the fact, explaining that you were entertaining clients – especially when your calendar has an appointment elsewhere on the same date or when your credit card was charged in a different city.
The Interview Request Changes the Stakes
It is important to carefully consider an interview request before returning the examiner’s call. He or she may want to discuss why an S-corporation paid only a small salary to the owner, who took larger distributions, or why there was income flowing through multiple entities. It would be hazardous to give a casual reply along the lines of “that’s just how we usually do things,” especially when the payroll records tell a different story.
At that point, a Raleigh Tax lawyer should step in. Your attorney can analyze the topics that have been raised, prepare you for the likely questions, and advise whether the interview should be restricted, delayed or conducted via an attorney representative. This may be an issue of civil tax adjustments only, but your interview may also touch on underreported income, fraudulent deductions, payroll reporting and altered records, which are issues that carry the potential for penalties and criminal prosecution.
Whether the interview is in person or by phone, every word you say goes into the official file.
In the case of an S-corporation (https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations), a key consideration is the degree to which the owner personally performed services, relative to the salary the entity reported on its employment tax filings. If the owner provided patient care, executed contracts, managed employees, or otherwise performed the services that brought in most of the entity’s revenue, then the distinction between wage payments and owner distributions becomes critical. This involves looking at the W-2, payroll tax returns, bank transfers, your calendar, and your history of compensation. What if the entity paid for a personal trip to Charleston, but you deducted the entire amount as an education expense?
Why Can a Written Explanation Backfire?
You may want to send a short letter to clarify the situation. That draft might say, “My travel was all for business,” but your calendar may reveal that you attended a conference for two days and spent the next four days with no appointments. Your tax consultant can help you assemble the hotel bill, the plane ticket, and the conference registration. But it is essential that a tax attorney review the wording of your explanation.
The attorney should also assess whether the records reveal issues other than the deduction in question. Perhaps your 1099s reflect income that went through several entities, and the transfers between the entities are just shown as bank wires, with no explanatory memo line. A written explanation should address the specific records requested and avoid generalizations that may be hard to substantiate.
Preserve the Original Records Before Responding
Before rearranging your records, save the originals. Save an unedited printout of your calendar, your original credit card statements, your payroll filings, your 1099s, your bank transfer records, and the audit notice with the due date for your response. Do not add labels to your old receipts or change the description of transactions after you receive the request.
If you have already received an interview request or have prepared a draft explanation, bring those documents to your tax attorney for review before responding.
