Be prepared for a tax audit

By

September 24, 2021

Photo: Waldemarus/iStock / Getty Images Plus/Getty Images

Photo: Waldemarus/iStock / Getty Images Plus/Getty Images

At press time, President Biden has asked Congress for $80 billion to help the IRS crack down on tax avoidance from wealthy Americans and big corporations.

The proposal seeks a boost in enforcement staffing, technology and additional bank reporting, measures that may generate an estimated $700 billion in tax revenue over the next decade. Obviously, this means more audits for certain small businesses, including those owned by pest management professionals (PMPs).

Getting the call for an audit may be nerve-racking for small business owners. But those following the rules should not be afraid of run-ins with Uncle Sam.

TAXPAYER’S RESPONSIBILITY

Essentially, you are responsible for providing taxing authorities with financial statements that summarize the results of your operations, to report tax liabilities as well as provide payment of taxes. Depending upon the type of legal entity you operate, you may be required to provide a balance sheet as well as a profit-and-loss statement. It is your responsibility to be able to support each number on your tax return with collaborating documentation.

The IRS does not have a prescribed recordkeeping system. You may choose any recordkeeping system that suits your needs, if it clearly shows your income and expenses. Your recordkeeping system should also include a summary of your business transactions. This summary is primarily the ledgers that are part of your accounting system. Most PMPs I work with use QuickBooks for their general ledger requirements. QuickBooks provides adequate detail when drilling into subledgers. If the transactional information is accessible, accurate and detailed enough to trace and agree to a source document, a PMP will fare well in the data presentation phase of an audit.

Assuming your ledgers are correct, each transaction needs to be supported by a source document, which can be physical or electronic. Purchases, sales, payroll and other transactions will generate supporting documents such as invoices, receipts and other supporting documents. It is important to keep these documents, because they support the entries in your books and on your tax return. You should keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.

SUPPORTING DOCUMENTS

It’s important to note that a record not only needs to be verifiable, but it must support a transaction that is includible in income or deductible as an expense as allowed by the tax code and regulations. In other words, just showing you paid an item is not sufficient. It must be necessary and reasonable in supporting a business purpose to be deductible.

Here are some basic records that substantiate the following items:

Gross receipts are the income you receive from your business. You should maintain supporting documents that show the amounts and sources of your gross receipts. Documents for gross receipts include:

  • Signed service tickets or invoices.
  • Bank deposit slips.
  • Credit card charge slips.
  • Forms 1099-MISC received from customers.

Purchases are the items you buy and resell to customers or materials you apply during your service visits. Your supporting documents should show the amount paid, and that the amount was for purchases. Documents for purchases include:

  • Vendor invoices for chemicals, supplies and equipment.
  • Canceled checks.
  • Credit card sales slips.

Expenses are the costs you incur (other than purchases) to carry on your business. Your supporting documents should show the amount paid, and that the amount was for a business expense. Documents for expenses include:

  • Canceled checks.
  • Legal agreements such as leases, note payable, mortgages, etc.
  • Account statements.
  • Credit card sales slips.
  • Vendor invoices.
  • Petty cash slips for small cash payments.

The tax enforcement ranks will be growing over the next few years, meaning more audits. A successful PMP needs to keep accurate and complete records that are supported by a well-maintained bookkeeping system. Doing so allows you to comply with any requests for records during an IRS audit, should you be called upon to prove your tax return is accurate.

About the Author

Dan Gordon owns PCO Bookkeepers, an accounting and consulting firm that caters to pest management professionals throughout the United States. He can be reached at dan@pcobookkeepers.com.

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