You may wonder how else you can avoid an audit. I know, I know: I shouldn’t expect the IRS to hand over its entire playbook. But according to the Internet site WorldWideWeb Tax, certain characteristics could likely raise a red flag with auditors. These include:

* You have large amounts of itemized deductions on your tax return that exceed IRS targets.

* You claim tax shelter investment losses on your tax return.

* You have complex investment or business expenses on your tax return.

* You own or work in a business which receives cash and/or tips in the ordinary course of business.

* Your business expenses are large in relation to your income on your tax return.

* You have rental expenses on your tax return.

* A prior IRS audit resulted in a tax deficiency.

* You have complex tax transactions without explanations on your tax return.

* You are a shareholder or partner in an audited partnership or corporation.

* You claim large cash contributions to charities in relation to your income on your tax return.

* An informant has given information to the IRS.

If you’re at all like me, chances are none of these areas should cause you any concern.  But talk about news some of us can use. Like: “Girls Gone Wild” founder Joe Francis, who claims the IRS is out to get him.

www.TaxesPlusUS.com

Cash method

If you use the cash method of accounting, you record income only when you receive cash from your customers. You record an expense only when you write the check to the vendor. Most individuals use the cash method for their personal finances because it’s simpler and less time-consuming. However, this method can distort your income and expenses, especially if you extend credit to your customers, if you buy on credit from your suppliers, or you keep an inventory of the products you sell.

Accrual method

With the accrual method, you record income when the sale occurs, whether it be the delivery of a product or the rendering of a service on your part, regardless of when you get paid. You record an expense when you receive goods or services, even though you may not pay for them until later. The accrual method gives you a more accurate picture of your financial situation than the cash method. This is because you record income on the books when it is truly earned, and you record expenses when they are incurred. Income earned in one period is accurately matched against the expenses that correspond to that period, so you get a better picture of your net profits for each period.

Pros and cons

The cash method is easier to maintain because you don’t record income until you receive the cash, and you don’t record an expense until the cash is paid. With the accrual method, you will typically record more transactions. For example, if you make a sale on account (or, on credit), you would record the transaction at the time of the sale, with an entry to the receivables account. Then, when the customer pays their bill, you will record the receipt on account as another transaction. With the cash method, the only transaction that is recorded is when the customer pays the bill. If you are using computer software to do your accounting, this is probably not a big concern, since the computer program automates much of the extra effort required by the accrual method, such as QuickBooks.

Another issue to be considered is the accounting method you use for tax purposes. For convenience, you probably want to use the same method for your internal reporting that you use for tax purposes. However, the IRS permits you to use a different method for tax purposes. Some businesses can use the cash method for tax purposes. If you maintain an inventory, you will have to use the accrual method, at least for sales and purchases of inventory for resale.

We recommend the accrual method for all businesses, even if the IRS permits the cash method, because accrual gives you a clearer picture of the financial status of your business. You probably need to keep a record of accounts receivable and accounts payable anyway, so you are already keeping track of all the information needed to do your books on the accrual basis. If you are using a computer program, there really isn’t much extra effort involved in using the accrual method.

* Appropriateness of the expense – was the expenditure ordinary and necessary for your business?

* Relation to a business activity – the IRS is keenly aware that taxpayers may be tempted to write off things as business expenses that are really nondeductible personal expenses. If the expense was only partly for business, you’ll need to allocate it between the business and personal portion.

* Do you have adequate records – in a tax audit, the IRS agent will ask you to show that the expense was in fact paid. This is where your recordkeeping routines come into play. If you have kept good records, proving your deductions won’t be a problem. Remember, on most tax matters, the IRS can require you to prove that your deduction (or other item on your personal or business return) is correct. If you can’t do this, the IRS will compute your tax liability based on its view of the question under dispute.

* What are some common deductible expenses – we provide a list of some of the most frequently used deductions, and some that you may have overlooked
* What are some common nondeductible expenses – while no list can be all-inclusive, we point out some items that are generally not deductible for most business owners.

List of common deductible expenses:

• advertising
• bad debts from sales or services (for those using accrual accounting)
• bank fees on business accounts
• car and truck expenses
• commissions and fees
• cost of goods sold
• deprecitation
• dues for trade associations and other not-for-profit, business-related organizations
• employee benefits
• gifts to customers, suppliers, etc.
• insurance (casualty and liability)
• interest
• legal and professional services
• meals and entertainment
• office expenses
• pension and profit-sharing plans
• rent or lease expense
• repairs and maintenance
• services performed by independent contractors
• supplies and materials (not included in cost of goods sold)
• travel expenses
• utilities
• wages of employees

If you don’t see an item you’re interested in on this list, check our list of common nondeductible expenses as well.

Owning a small business is not just another job. It’s a totally different lifestyle. You have to ask yourself whether you’re ready for a complete commitment to the success of your business. Just as importantly, you have to ask your partner, if you’re in a relationship, whether he or she is completely committed.

As a small business owner, you’re going to have less time for your personal life and you’ll probably be using much of what you own as collateral to raise money for the business. If you are willing to make those sacrifices, then let’s move on to some of the advantages and disadvantages of owning your own business.

Pros:

• You have the chance to make a lot more money than you can make working for someone else.
• You’ll be your own boss and make the decisions that are crucial to your business’ success or failure.
• You may be the boss of other people.
• You’ll have job security — no one can fire you.
• You’ll have the chance to put your ideas into practice.
• You may participate in every aspect of running a business.
• You’ll learn more about every aspect of a business and gain experience in a variety of disciplines.
• You’ll have the chance to work directly with your customers.
• You’ll be able to benefit the local economy, such as by hiring other people to work for you.
• You’ll have the personal satisfaction of creating and running a successful business.
• You’ll be able to work in a field or area that you really enjoy.
• You’ll have the chance to build real retirement value (for example, by selling the business when you retire).
• You’ll have the chance to put down roots in a community and to provide a sense of belonging and stability for your family.

Cons:

• You may have to take a large financial risk.
• You will probably have to work long hours and may have fewer opportunities to take vacations.
• You may end up spending a lot of your time attending to the details of running a business and less time on those things you really enjoy.
• You may find that your income is not steady and that there are times when you don’t have much income coming in at all.
• You may have to undertake tasks you find unpleasant, such as firing someone or refusing to hire a friend or relative.
• You may have to learn many new disciplines, such as filing and bookkeeping, inventory control, production planning, advertising and promotion, market research, and general management.

Special pros and cons of the home-based business:

• Your startup costs will be lower.
• Your operating costs will be lower than they would if you were renting space and paying utilities.
• Your commute will be shorter.
• If your location is unimportant to your business, you can theoretically live anywhere and still operate your business.
• You may be more flexible in your schedule if your business can be conducted at your convenience or outside “normal” weekday business hours.
• On the other hand, you’re much more vulnerable to interruptions from family members, neighbors, and door-to-door salespeople.
• You may have trouble attracting qualified employees.
• You may be less accessible to suppliers.
• You may have an image problem, although with the growing popularity of home businesses, that’s less common.
• You may run out of space at home if your business grows.

What are some other Pros and Cons you can think of? Feel free to leave comments.

If you incur startup expenses, the IRS requires you to amortize and deduct the expenses over a period of at least 60 months, provided that you subsequently enter the trade or business to which the expenses relate. Expenses incurred after the business begins operation, however, are often deductible in the first year. Thus, it’s often a good idea to postpone some expenses until after your first customer arrives.

Which expenses must be amortized? The amortization only applies to expenses incurred after you decide to establish a particular business and before the business actually begins operation. It applies to expenses such as advertising; salaries and wages paid to employees who are being trained; travel expenses incurred in lining up prospective distributors, suppliers, or customers; and salaries and fees paid or incurred for executives, consultants, or similar professional services.

It does not, however, apply to expenses that would not be deductible if incurred after you start the business.

Please keep in mind there are additional rules that allow up to $5,000 to be deducted in the first year. For example, Company ABC was had start up expenses of $25,000. On the first years tax return the company is allowed to deduct up to $5,000 and $338.98 each additional year.

Unless your business is accounting or bookkeeping, keeping financial records is probably not what you do best. Most likely, you’d rather spend your time selling your product or service. However, if you are going to run a successful business, accurate and timely financial information is a must. Here are some of the reasons why you need a good financial recordkeeping system:

• Monitoring the success or failure of your business. It’s hard to know how your business is doing without a clear financial picture. Am I making money? Are sales increasing? Are expenditures increasing faster than sales? Which expenses are too high based on my level of sales? Do some expenditures appear to be “out of control?”
• Providing the information you need to make decisions. Evaluating the financial consequences should be a part of every business decision you make. Without accurate records and financial information, it may be hard for you to know the financial impact of a given course of action. Will it pay to hire another salesperson? How much will another production employee cost? Is this particular product line profitable?
• Obtaining bank financing. A banker will usually want to see financial statements; a balance sheet. income statement, and cash flow budget for the most current and prior years, as well as your projected statements showing the impact of the requested loan. A banker may even want to see some of your bookkeeping procedures and documents to verify whether you run your business in a sound, professional manner.
• Obtaining other sources of capital. If your business has reached the point where you need to take in a partner, any prospective partner will want to become intimately familiar with your financial picture. If you need capital and are thinking of taking in an outside investor, you will need to produce a lot of financial information. Even your suppliers and other creditors may ask to see certain financial records. Such information may be produced by your outside accountant, but it is based on your day-to-day recordkeeping.
• Budgeting. All businesses should use a budget for planning purposes. A budget will help keep your business on track by forecasting your cash needs and helping you control expenditures. In addition, if you are seeking bank financing or other sources of capital, a banker or prospective investor will probably want to see your budget as evidence that your business is well planned and stable. You must have solid financial information to prepare a meaningful budget.
• Preparing your income tax return. Whether your business is a sole proprietorsship, partnership, or corporation, you must file an income tax return and pay income taxes. With good records, preparing an accurate tax return will be easier and you’re more likely to be able to do it on time. Poor records may result in your underpaying or overpaying your taxes and/or filing late (and paying penalties). If your accountant prepares your income tax return, poor records will almost certainly result in your paying higher accounting fees. If your business is a partnership, not only will you have to prepare a partnership tax return, but partnership return amounts will pass directly to the tax return of each partner. So your recordkeeping will directly affect the tax return of each partner.
• Complying with federal and state payroll tax rules. If you have employees, you are aware of the myriad rules and regulations relating to payroll taxes. Payroll tax deposits must be made according to strict deadlines. Late payment of payroll taxes results in severe, and unnecessary, penalties. Also, you must file a payroll tax return every quarter, which you must reconcile with the payroll deposits made during the quarter. Then at the end of the year, you are required to give your employees and the government W-2 forms, which must agree with your quarterly payroll returns. Sound bookkeeping practices will make compliance with all these payroll rules easy. Poor records will make it impossible.
• Submitting sales taxes. If you collect sales tax from your customers, good records will make it easy for you to compute the tax due and prepare the required reports.
• Distributing profits. If your business is a partnership, you will need good records to determine the correct amount of profits to distribute to each partner. If you are operating as a corporation, you must determine the company profits that you will be paying out as dividends to the shareholders.

Many small companies believe that it is necessary to handle bookkeeping all by them selves in order to cut costs. However, the downside of managing the accounting books yourself is that it will reduce your potentials of being able to focus on the development of your business. In fact, in the long run, you will be spending more. The time spent for analyzing debits and credits can be spent on other more important things. Allowing a professional to handle the bookkeeping task for you will save you time, effort and money. Virtual bookkeeping professionals are equipped with the skills to do the work faster and more efficiently.

The most common reason why companies outsource bookkeepers is to cut costs. Most companies look for a bookkeeping company that can deliver to them the kind of work that they expect at a reasonable value. Virtual bookkeepers are well-versed on business and accounting concepts. Since the company no longer has to hire an in-house bookkeeper, it means less training and hiring costs for the company. It also makes a company save on office space and equipments. Also, since the company will not be responsible for the medical benefits and other additional needs of the virtual bookkeeper, more savings are incurred.

Studies have shown that a company can actually save up to 50% from hiring a virtual bookkeeper than hiring an in-house bookkeeper. This gives a company more money to invest on other things for the growth of their business.

A telecommuting bookkeeping firm delivers a weekly or daily (according to your preference) reports of your company. When interpreted, these figures can point out to how the business is doing and the required steps to keep the business on track. These financial statements can provide essential information regarding the company’s liabilities, assets and profitability at a given period of time.

A bookkeeper who works for a good telecommuting bookkeeping company will be able to identify the competition and trends faced by a certain product in the market. A professional virtual bookkeeper can give the best advices on financial structures and how to lessen annual tax obligations and other expenses. Also, he/she should be able to identify any changes in customer preferences and behaviors to be able to determine timely and effective marketing strategies that will boost revenue and sales.

Every business should be able to preserve precise financial records to maintain transparency in all business dealings. It is mandatory for a company to comply with several government policies such as sales tax and income tax. Thus, instead of doing the bookkeeping task all by yourself, it would be wiser to pass on the burden to a competent bookkeeper.

There is no surefire way to audit-proof your tax return. Nevertheless, there are numerous steps you can take to reduce your audit risk:

• Prepare your tax return by computer. A neat, computer-prepared return looks more official to the IRS classifiers and fits the IRS bias favoring computer processing. Most professional tax preparers now use computers. There are some good PC and Macintosh programs, such as Intuit’s TurboTax and MacInTax, that you can use to prepare your own return. You can prepare your return online by using TurboTax for the Web atwww.turbotax.com.
  If for some reason it isn’t possible for you to use a computer, be certain to print carefully. A messy return — cross-outs, sloppy handwriting, smudges — almost screams “audit me!” It tells the IRS that you are careless and disorganized.

• Don’t use round numbers for deductions — for example, $1,000 or $12,000 instead of $978 or $12,127. It’s an indication that you are estimating things rather than keeping good records.

• If you claim large deductions for unusual items, such as an earthquake, flood, or fire loss, attach documentary proof to the back of your tax return. Copies of repair receipts, canceled checks, insurance reports, and pictures are advisable. This won’t stop the IRS computer from flagging your return, but the documents should catch the attention of the IRS classifier who next screens computer-picked returns for audit potential. If she thinks your documentation looks reasonable, you won’t get audited.

• Avoid filing an income tax return with Schedule C, Profit or Loss for Business, that reports a net loss from a small business venture. IRS auditors go after these returns like bees toward honey.

• Report side-job income as other income on line 22 of your tax return. Try this only if the income is relatively small, and you are not claiming any business deductions against it. Technically, side-job income is usually reported on Schedule C, Profit or Loss from Business. But filing a Schedule C undoubtedly increases your audit chances.

• Don’t use electronic filing or the IRS preprinted address label on your tax return. These enable the IRS to get your return into the processing cycle, including the audit cycle, more quickly than otherwise would happen. Anything that slows down the IRS machine can’t be bad. On the flip side, however, using electronic filing or the label usually means that any refund will come faster. If you expect a refund but fear an audit, you’ll have to weigh the pros and cons.

• Live in a low audit area. Your audit chances are radically different depending on where you live. For example, Nevada taxpayers are audited four times more than people in Wisconsin. While moving your official address to reduce your chance of audit is extreme, it might make sense if you travel most of the time or have addresses in several areas. If you have flexibility in choosing your tax reporting address, choose the one with the lower audit rate. If you’re really interested in this, ask your tax pro or visit the IRS local office information reading room.