How to Audit-Proof Your Business

By Collin Almeida

Police and auditors have one thing in common: they make even the most honest, law-abiding citizens nervous. After all, who hasn't felt their heart jump at the sound of a police siren close behind them even if they are obeying all traffic rules? Generally, the same feeling comes over people when the topic of an IRS audit arises.

Most taxpayers fear an audit because they don't know if they are adequately prepared. You may ask yourself: Did I save the right documentation? Are all my deductions legal? Can I answer all of the IRS's questions? For the home-based business owner, however, these questions are even more pressing, so waiting for an audit to test their preparation is not the best option. By following some easy guidelines, they can take the guesswork out of keeping records.

Obviously, every deduction claimed needs to be documented, but many taxpayers aren't clear on what is adequate proof. The IRS does require more than just a few jottings in a notebook, but not much more. First, each deduction must be recorded with a copy of an invoice or bill. For example, if you are claiming your utilities expenses as a deduction, you need to keep a copy of each month's bill. In addition to proving the expenses were incurred, you must also prove they were paid. So along with that utilities bill, you may want to staple the canceled check or credit card statement that covered the charges. Receipts, bank statements, and even invoices stamped "paid" also count as evidence that the expenses were have been taken care of.

Along with documenting business expenses, all deposits must also be adequately documented to prove that you are reporting your profit correctly. If the funds are from payment for a service or product rendered by your company, you should attach a copy of the payment to the invoice it covers. Not only will this serve as documentation for the IRS, it will also help you keep track of paid and outstanding invoices from customers. Loans and other sources of company income must also be accompanied by all related paperwork.

Additional documentation is also required when a home-based business owner keeps his or her children, spouse, or other relatives on staff in order to claim their wages as a tax-deductible company expense. For the record, always pay every staff member by check and have each person keep a written record of their work, including total number of hours, date of work, and type of activity accomplished. In addition, you should also request a written estimate from a professional for the same services. For instance, if your spouse maintains your company's web site, you need to find what a professional Webmaster charges in order to substantiate your spouse's salary.

Besides keeping track of expenses, income, and wages, you must also have proof that your company intended to produce a profit. A business plan can serve as evidence that you are serious about generating revenue with your company. The plan will also provide written documentation of the expenses you plan to incur and will help keep you organized.

Overall, the best way to ease your concern over an audit is through preparation. By keeping records and documentation on everything, you'll have nothing to fear if you are one of the .5% of taxpayers selected for an audit.

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