Business Matters Oh, No! I’m being audited

Oh, No! I’m being audited!

By Carol Gordon, CPA

If I asked each of you to make a list of 5 things that you really want to do in the next 5 years, it would be VERY unlikely that any of you would choose to experience an IRS audit. But for 1 out of every 44 of you (over a 5-year period, based on 2019 statistics), you will have that unlucky experience. And if you file a Schedule C, your chances of being audited are multiplied by almost 3 times. Some of being selected for an audit really is (bad) luck but there are some things that you can do to minimize your risk. And if you are selected for an audit, there are some things that you can do to minimize the time and pain involved.

5 things you can do to minimize your risk of an audit: 1. Report ALL of your taxable income. IRS auditors have access to detailed industry information for every area of the country.

So, they will know the average annual cost of care of a horse. If you report expenses for the care of 10 school horses and only report income equivalent to lessons on 5 horses, that will raise a red flag on your return. One red flag doesn’t necessarily trigger an audit but it’s definitely a cause for concern. 2. Provide 1099 Forms to all of the applicable vendors and submit the forms to the vendors and IRS on a timely basis. If one of your vendors reports income from you, for which you should have provided them a 1099 but did not, that’s another red flag.

You may believe that a particular vendor does not report some of their income, but it would be a shame to find out the “hard way” that you were wrong. 3. Pay to have your return prepared. Your job is being an instructor, barn owner, trainer (how many hats is that?). It’s a full-time

job. You are not a tax preparer, just like you aren’t an electrician. Please – don’t do your own electrical work or prepare your own tax return. 4. Make every effort to run your business as a business. The IRS guidelines for distinguishing between a business and a hobby are below. The tax consequences of one vs. the other are very significant.

Question How do you distinguish between a business and a hobby?

Answer In making the distinction between a hobby or business activity, take into account all facts and circumstances with respect to the activity. A hobby activity is done mainly for recreation or pleasure. No one factor alone is decisive. You must generally consider these factors in determining whether an activity is a business engaged in making a profit: • Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records. • Whether the time and effort you put into the activity indicate you intend to make it profitable.

Whether you depend on income from the activity for your livelihood. Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business). Whether you change your methods of operation in an attempt to improve profitability. Whether you or your advisors have the knowledge needed to carry on the activity as a successful business. Whether you were successful in making a profit in similar activities in the past. Whether the activity makes a profit in some years and how much profit it makes. Whether you can expect to make a future profit from the appreciation of the assets used in the activity.

5. Keep very detailed records. This is important if you are audited but it is also important as you compile the information that your tax preparer will use for your returns. And it’s really effective in making sure that you receive credit for all of the deductions due to you.

5 things you can do to minimize the effects of an audit: 1. You will receive notification via mail from the IRS that they require information or that you have been selected for an audit.

The IRS does not provide this initial notification via email or phone call. When you receive the notification, it’s tempting to put it aside. But if you don’t respond in a timely manner, the IRS may adjust your tax liability and the next correspondence that you receive from them may be a tax bill. So “bite the bullet”, read the notice and respond accordingly. 2. Review those detailed records that you kept so you are confidently familiar with everything there. For every audit, there is a minimum scope that the auditor will cover. But the auditor may enlarge that scope if they find something of concern. The best thing that you can bring to an audit is a solid understanding of the return and the documents supporting it. If you can answer the auditor’s questions accurately, you are demonstrating that you are knowledgeable about the return. 3. Answer the questions that the auditor asks completely, but do

NOT provide information that does not directly answer their question.

For example:

AUDITOR: “What is this cash disbursement in July of 20XX for $10,000?”

RIGHT ANSWER: “I bought a horse, Sparky, to use as a school horse.”

WRONG ANSWER: “That was for Sparky. He’s one of my school horses. He’s been lame lately. I’ve had the vet out twice and it’s cost me a bundle.”

During an audit, you must spend a large amount of time providing the auditor with documentation and answering questions.

It’s time away from your business, a major source of income for During an audit, you must spend a large amount of time providing the auditor with documentation and answering questions. It’s time away from your business, a major source of income for you. Whenever you provide the auditor with information beyond the scope of their question, you provide them with an opportunity to ask another question that they wouldn’t have asked otherwise – which will take even more of your time. From hearing Wrong Answer, they might now ask you what you do with horses that do not regain soundness or how much your total veterinary expense was for the last 5 years.

you. Whenever you provide the auditor with information beyond the scope of their question, you provide them with an opportunity to ask another question that they wouldn’t have asked otherwise – which will take even more of your time. From hearing

Wrong Answer, they might now ask you what you do with horses that do not regain soundness or how much your total veterinary expense was for the last 5 years. 4. Answer questions from the auditor honestly. If you don’t know the answer, say that you don’t know but will find out. Then find out the answer and provide it to the auditor on a timely basis. 5. Provide the auditor with copies of documents, not the originals.

Most audits now are “desk audits”, meaning that the audit is conducted via email and phone calls, rather than in-person visits. So, you would be providing either scanned or photocopied documents.

I hope that you each experience all of the items on your “want to do” lists and that you are never selected for an IRS audit. But just like learning emergency dismounts, it’s always good to be prepared.

About the author: Carol Gordon is a CPA with an MBA from Boston College and the owner of Carol Gordon, CPA, which provides consulting services to equine-based businesses. You can contact her at cgordoncpa@gmail.com. If you have any questions that you’d like covered here, please email her with your suggestions.