Some audits are routine and relatively painless. Other audits are worse than a root canal and proctology exam at the same time. It depends on the authority that is conducting the audit, the temperament of the auditor and of course, the completeness and organization of your records.
The worst and most costly audits are IRS.
From my years of experience in restaurant audits, I have developed the top 10 areas the IRS will concentrate their attention.
1) Deposits as compared to sales.
This is a rich area for auditors because in many cases, the deposits that go into your bank account are more than what is reported as sales on your tax returns. This is a clear indication of under-reported sales. If your sales is not reconciled to deposits as part of your accounting procedures by us, then we encourage you to talk to your bookkeeper to set up that procedure.
2) Bank account activity.
Are unexplained deposits coming into your business or personal accounts? Are there transfers being made out to unexplained sources? Do the amounts of deposits match with income reported on your returns?
3) Vendor and other payments used for personal expenses.
It is fairly easy for restaurant owners (and other business owners) to sometimes pay a personal expense and run it through the business to get the deduction. IRS will question and demand proof of large samples of your expenses looking for non-business items.
4) Tip reporting.
This is a lucrative area for the IRS. It is simple for them to examine your credit card charges and compare the tips reported there to tips reported on form 8027. If your employees are under-reporting tips, you are the one who pays the tax and the taxes could be huge.
5) Hidden bank accounts.
This is another area that has expanded in recent years. You can be sure if there is a bank account that you have not reported and they find it – you are in big trouble.
6) Auto mileage.
Because this is a deduction that is abused by many business people, more and more audits are demanding proof of business use of an automobile. The proof required is a logbook showing odometer readings on each business trip, description of the purpose of the trip along with 3rd party odometer confirmation (oil change receipts with odometer mileage on the receipt).
7) Gambling winnings and losses.
IRS has learned many taxpayers under-report their winnings and over-report their losses. The laws are strict on losses. They must be proven with receipts or casino records.
8) Credit card purchases.
Many restaurant owners like to pay expenses using credit cards for convenience and because of the value of the points. Unfortunately, if that is your practice, you can be assured, IRS auditors will examine those purchases closely for personal items. And please be aware, the statements themselves showing the purchase is not sufficient proof. They will require actual bills
9) Passive vs non-passive deductions and limitations.
This is a technical and complicated area of tax law that your accountant or tax advisor needs to monitor. If done improperly, can cost you tax dollars
10) Shareholder and partner basis issues.
This is another technical and complicated area of tax law that IRS will look at and is an area your tax advisor needs to monitor and explain. Basically, it requires your accountant to maintain records of the money you invest and the money you take out of the business.