The last thing you want is the IRS on your doorstep, set on conducting a compliance check.
But with the IRS collecting a reported $458 billion less per year in taxes than what Americans actually owe, there’s a fair chance they might come knocking.
Here’s how to get prepared – and how to make sure you avoid a visit from your friendly neighborhood tax collectors.
What is a Compliance Check?
But first, the basics: what even is a compliance check?
Well, for starters, it’s not actually an audit (yes, we know, you’ve been dreading the a-word). It’s not an investigation either.
It’s a review conducted by the IRS to make sure that a business owner is complying with the appropriate recordkeeping and information recording requirements.
Whoa. That sounds way less scary than you thought, doesn’t it?
Basically, the point is to educate business owners about their reporting requirements so that it’s easier for them to comply voluntarily.
Compliance Check vs Examination: What’s the Difference?
You also shouldn’t confuse a compliance check with an examination.
Actually, checks are meant to be an alternative to examinations. Something that’s less burdensome for the taxpayer in question.
In fact, you can usually complete a check in one or two visits.
But before you get too excited: you should still make sure you follow through with the check. While technically you can refuse to participate without penalty, the IRS still retains the right to open an investigation whether or not you cooperate.
Then you might actually be in hot water.
What Happens in a Compliance Check?
Well, we said it isn’t an audit or an examination. So what actually happens?
The IRS won’t ask to go through your books or records during a check, nor will they ask questions related to tax liability. Those are typically reserved for an audit.
During a compliance check, the IRS is reviewing the forms you’re required to maintain for tax purposes, as well as asking questions about whether you understand the forms or have any questions. They may also ask if you’ve filed the proper forms for workers they’ve paid during the tax year.
If a form is missing, the IRS may ask you to file them voluntarily. If you don’t, the IRS may prepare substitute returns or start an examination. Or a full audit.
Why Do Compliance Checks Happen?
Long story short: they’re trying to make sure that you do your taxes right the first time.
While the exact formula remains within the IRS, here’s more or less what happens to make your number come up.
You file a tax return, right? Each return the IRS receives is given a numerical score determining how far above or below the average each of your deductions is.
Things that can raise red flags include a low gross profit margin, high travel and entertainment costs, little or no profit from business operations, high auto expenses, etc.
Basically, signs that your tax number and the amount you pay in taxes every year don’t quite line up with each other.
The higher the number, or the more deductions you have than the norm, the more likely it is that the IRS will flag you for a compliance check.
And really, everyone’s lives are easier if you can avoid dealing with checks altogether.
Why are You Being Checked?
So, let’s say the IRS checks your taxes and flags you. Why are you getting checked out of everyone else?
There are a few reasons why you might get checked. It’s not an audit, but it’s on the road to one, so it’s important to make sure you figure out why you’re getting flagged so it won’t keep happening every tax season.
As we noted above, your taxes can be flagged based on numerical calculations – how far you are from average. Your returns can also be selected if your returns are connected to transactions with other taxpayers, including business partners or investors, whose returns were flagged for an audit.
Of course, there’s also the chance that you ran into bad luck – statistically, your numbers are farther from the norm than the IRS would like, even if you didn’t do anything wrong.
Remember: it’s always your prerogative to ask the IRS why you’re being checked or audited.
How are You Notified?
If you’re selected for a compliance check or an audit, you’ll be notified by mail. The IRS won’t initiate a check by phone, so steer clear of anyone calling who says they’re from the IRS.
It’s also worth keeping in mind that you can be checked or audited as often as the facts warrant it. A high frequency of checks may mean there’s something up with the way you’re doing your taxes.
IRS Targets Schedules A, C, or E
Keep in mind that when the IRS checks or audits you, they’re making sure that you’ve paid as much in taxes as you’re supposed to.
As such, they’re going to be paying the most attention to certain forms (small business owners, we’re looking at you).
Specifically, they’re going to be looking especially closely at Schedule A (Itemized Expenses), Schedule C (Business Expenses), and Schedule E (Supplemental Income).
Which isn’t to say you shouldn’t pay attention to all of the forms. You should. Like the form 1099.
Simplifying a Compliance Check
Of course, there are ways to make your life a lot easier when tax season rolls around.
Not the least of which is an accounting service.
Seriously though. There are ways to make dealing with a check or an audit that much easier and ways to avoid them altogether.
And why wouldn’t you want to make things easier?
Before You Get Audited, Minimize Risk
You can’t guarantee that your returns won’t get randomly selected (or fall on the unlucky side of the average) but you can do whatever you can to minimize your risk.
The most important tenet here is careful, thorough recordkeeping and return preparation (and if you’re not that great with bookkeeping, invest in a service that will make your life easier).
Careful recordkeeping and information checks will make it easier to spot when submitted information is incorrect. If this happens, ask the issuer to correct the problem.
The IRS computer will flag any mismatches it finds between your forms, so if you have several corrections, report each of them separately on your tax return – the computer won’t flag them that way.
Options for Handling a Compliance Check
If a check does come up, you have a few options for handling it.
You can ride it out on your own, or you can enlist a representative to make sure everything goes smoothly.
Regardless of what you choose, keep in mind that there is no such thing as an idle question from an IRS agent – their job is to find out about your taxes.
But once you’re in the process, there are a few things you can do to make your life easier (and a few things you should avoid like the plague).
Check all your arithmetic. It sounds like a basic mistake that you definitely wouldn’t make…until you definitely did.
And while you’re at it, check all of the Social Security numbers on all of your forms. Again, it sounds like the most basic thing in the world – everyone knows their Social Security number, right? Except, this is where people often make foolish mistakes because they think they’ve got it covered.
Oh, and make sure that you signed everything where you were supposed to sign things. Sounds like a mistake you wouldn’t make, right? Check anyway. Just in case.
With those little things out of the way, you can shift your attention to bigger housekeeping issues, like making sure your tax returns are entirely correct from start to finish.
Remember, if you turned in everything you were supposed to and filled out everything correctly, you won’t have anything to worry about from your friendly neighborhood tax collector.
Don’t give the IRS agent more or less information than they requested. Either option will make the whole process take longer, which nobody wants.
Don’t ever give the IRS the only copy of a document. Sounds like too dumb a mistake to make, until you get careless and forget to make copies.
And on that note, don’t leave original documents with the IRS. You need those for your own business, and if you leave them, there’s a fair chance that they’re lost forever.
You should also ask for copies of all the information they have in their files before you agree to sign anything. And while you’re at it, make sure you get copies of any paperwork that you sign.
And above all: stay calm. Being belligerent with an IRS agent will only make the process more unpleasant for everyone.
Making Sense of Your Small Business Money
Making sense of your money (and your taxes) is no small process.
Let’s make that process a little bit easier.
For your first steps to making sense of this year’s taxes, try this 2017 tax filing guide.
But if you’re ready to take the next step to make finances and accounting easier for your business, request a demo today.