Buying A Retail Business For Sale
If you are thinking about buying a retail business, there is a lot that you must consider outside of the basic nuts and bolts of the business. There is an old saying that retail success hinges on three factors: "location, location, location." While this is true to a large extent, it’s not always the case. When looking at a retail business for sale, your number-one goal must be to determine what “drives” the customers to the store.
Location
If the business relies on its location then you’ll want to be certain:
The lease in place is transferable/assignable and is long-term. You must negotiate additional options to give yourself at least ten years of contract length.
Is there an anchor tenant that brings customers to the locale? If so, then you’ll want to know how long their lease is, and if they have any plans to relocate in the near-term. Also, be certain that this anchor tenant is solid financially - think about all the poor merchants who relied on K-Mart and General Cinema traffic. The stores surrounding these faced disastrous situations when they closed numerous locations.
Is there any planned road construction that can impact the business? Typically, major roads undergo some form of construction every ten years or so. Visit the city hall/planning office to see when the last work was done and what plans, if any, may be in place.
Above all, think about every possible situation that can impact the location and investigate it thoroughly.
If the operation is driven by its product offering you’ll want to be certain that you’re capable of continuing to identify the types of products that customers want. If this function is performed by an employee/buyer, you may want to have them own a stake in the business as well. However, if you’re not 100% comfortable with performing this function yourself, or are not the type that has an “eye” for product, you may not want to go down this road.
Marketing
For some retail businesses, it’s the marketing that brings in the customers, and location takes a back seat. These are destination locations. Furniture and specialty retailers are typical examples. They spend a fortune on advertising and promotion, and they get the people to the stores. Here again, if this is what drives the business then you’ll want to be certain that your greatest skill lies in this area.
Avoid Working 100 Hours Per Week!
The biggest issue that I discuss with clients who want to become retail merchants is for them to get a true grasp upon the actual workload that’s required in this environment. Retail hours can be hell, especially if you’re in a mall where you’re required to maintain certain hours. I meet far too many retailers who seem to work seven days a week. It does not have to be this way, as long as you set up the business to run properly without you having to be there every minute.
Hire great people! Getting good employees is an ongoing challenge. You shouldn’t be afraid to churn through employees until you get the right ones. Pay them well. Train them effectively. Put policies and procedures in place that allows them to get up to speed quickly. Work towards having a key manager in place that can relieve you of some of the daily burdens. Never, ever, tolerate stealing. Hire a mystery shopping company to do an assessment at least once a year. It’s a great way to learn what the customers are experiencing.
Implement the most effective technology you can afford. There are tremendous systems available today for point-of-sale tracking, inventory management, accounting modules, etc. Systematize everything so that you’re not beholden to being there every minute. One program that I’ve seen quite a bit of is RetailPro. It appears to be very robust and cost-effective. It’s well worth checking out. There are many others available as well.
Growing The Business
If your agenda is to make a lot of money, then it’s hard to do so with one location. Growth requires expansion. Many times, however, one successful location does not translate well into a second successful one. This usually happens because the owners cannot duplicate the business effectively. That’s why systems are crucial. It’s also why you need to have a crystal-clear view of what brings in the customers and then be able to duplicate it effectively.
The other reason why this happens is that the owner is the business and then ends up trying to be effective in two location. Guess what? It doesn’t work! Build the first one. Get the recipe in place that includes a top-notch manager. Then you can decide to either run the second one yourself or put in the manager from the existing location.
If you’re running a large-sized operation, you may want to consider opening a second one that may be a bit smaller, with an option to expand. This doesn’t always work, but should be considered.
Certainly when thinking about buying a retail operation, and growth is your objective, you have to decide if it’s even a possibility, or is it too specialized? If you buy a scuba diving store that’s on the ocean, well you cannot open up a second location in a rural area and expect similar results. The business itself may be restrictive from a growth perspective.
What’s A Retail Business Worth?
Just like any other business resale, there are no “golden rules” to establishing the value of a retail business. The main issue must always be how much the business is making. This is the key component that must dictate the purchase price. Inventory is one element that clouds many retail business purchases. You need the inventory to drive revenue. It may or may not be treated separately in the price.
Notwithstanding this, the combination of the profit and inventory acquisition cannot over-inflate the price to the point where it’s not a feasible investment. Liquor stores, for example, may sell at a reduced multiple of earnings, but inventory is priced and purchased separately. Conversely, a clothing retailer may be sold at one fixed amount and includes all of the assets.
When it comes to inventory, your investigation must conclude if the product is saleable, and in what time frame. Specialty retailers usually have a ton of obsolete or slower-selling product. If there’s old inventory it must be discounted heavily in the valuation.
Ultimately, you will find retail businesses selling around the time times range (typically) plus an optimal level of inventory to operate the business. But again,I never endorse broad-brushed or generalized valuations so take this point only as a barometer.
What To Do Next?
Lots of people have made lots of money operating retail businesses. If you’re cut out for it, you can also be successful. But, you’ll want to weigh all of the factors to be certain that this type of business fits both your strengths and the lifestyle you want.
In most regions, there are always an abundance of retail businesses listed for sale. In addition to the business-for-sale Websites, check out the local business broker sites, and keep an eye on the classifieds as many retailers attempt to sell their businesses privately. Often times, a local merchant will foolishly hire a commercial real estate agent to sell their business and so you should review the multiple listing sites, as well. While many people think that it all comes down to location, the savvy retail business buyer knows there’s far more to consider in the equation. Have a great week
Posted by Richard Parker
Tuesday, October 13, 2009
Key Tax Changes for 2009
Key Tax Changes for 2009
As you prepare to work through your taxes for 2009, consider the following business changes. This year’s shifts may offer an opportunity to save money, so you, your accountant and/or your tax preparer should be prepared.
Section 179—The American Recovery and Reinvestment Act makes several important changes to the equipment write-off rules, but only for 2009. First, the maximum amount that can be written off under Section 179 is $250,000 and the investment limitation is $800,000 for tax years beginning in 2009. The maximum amount of equipment placed in service in 2009 was scheduled to fall to $133,000, a $117,000 decrease from 2008, when a temporary $250,000 ceiling was in effect, but the 2008 levels have been extended.
Bonus depreciation—The 50% bonus depreciation deduction for qualifying property has been extended an additional year and applies to property placed in service before January 1, 2010 (January 1, 2011 for certain other property, including that with a longer production period).
Bonus depreciation is only available for new property and only property depreciable under MACRS with a recovery period of 20 years or less. Bonus depreciation is automatic. You can, however, elect out of it. (You might consider doing so if 2009 is a particularly bad year and you expect to be in a higher bracket in future years.)
The luxury car depreciation caps for vehicles that qualify for bonus depreciation are increased by $8,000 for vehicles placed in service before January 1, 2010. Thus, the limit on cars is $10,960; the limit on trucks and vans is $11,060.
Depreciation of restaurants and retail stores—The current 15-year depreciation period for tenant and restaurant improvements is expanded to include buildings housing restaurants, and improvements made to retail stores that are placed in service in 2009.
Payroll tax changes—The maximum amount of wages subject to Social Security tax has increased to $106,800 for 2009, up from $102,000 in 2008. That means you should stop making (and paying) Social Security for employees once they reach $106,801 in eligible earnings in 2009. The tax rate remains 7.65% on employers and employees.
Self-employment tax contribution base increased—The maximum amount of self-employment income subject to Social Security taxes increases to $106,800 in 2009, up from $102,000 in 2008. The self-employment tax rate remains 15.3%.
Estimated tax relief for small business owners—If an individual’s Adjusted Gross Income for 2008 was less than $500,000, and more than half of gross income was from a business with fewer than 500 workers, the owner’s estimated income taxes for 2009 estimated payments can be based on the lesser of 90% of tax liability for 2008 or 2009. The usual estimated tax benchmarks of 100% or 110% of tax liability do not apply.
Withholding changes—The IRS has announced changes in withholding rates for 2009 and 2010. These changes are the result of the Making Work Pay provision of the American Recovery and Reinvestment Act (ARRA), which provides a refundable tax credit of up to $400 for working individuals and $800 for married taxpayers filing joint returns. This tax credit will be calculated at a rate of 6.2% of earned income and will phase out for taxpayers with adjusted gross income in excess of $75,000, or $150,000 for married couples filing jointly. (See the new withholding tables for more information.)
Estimated tax payments for small business owners—There are several ways to avoid a penalty for failure to pay estimated taxes. Most taxpayers avoid the penalty by paying in at least as much as the liability on the prior year’s return. For example, your total tax liability for 2008 was $8,000. If you pay at least $2,000 per quarter in 2009, you’ll avoid any penalty. If your adjusted gross income on last year’s return was more than $150,000, you’ll need to pay at least 110% of last year’s liability. (If you expect your tax liability to be lower than in the prior year, you can pay estimates based on your annualized, actual income for the year. This involves more computations.)
For tax years beginning in 2009, the 100% (or 110%) requirement for a “qualified individual” is reduced to 90%. A qualified individual is one whose:
adjusted gross income shown on the individual’s prior year tax return was less than $500,000 ($250,000 for a married person filing separately), and
the individual certifies that more than 50% of the preceding year’s gross income was from a small business.
Increased retirement plan contributions—In 2009, small business owners have the opportunity to invest more tax-deductible money in their retirement savings accounts. New contribution limits are:
401(k) elective deferrals up to $16,500 (plus another $5,500 for those age 50 or older by the end of 2009). In 2008, the limits were $15,500 (plus another $5,000 for those age 50 or older by the end of 2008).
SEP and profit-sharing plan limit of $49,000 (up from $46,000).
Defined benefit (pension plan) limit of $195,000 (up from $185,000).
Increased deductions for Health Savings Accounts (HSAs)—You can contribute more in 2009 to business HSAs, with a 100% tax deduction up to a limit of $5,950 for a family, and $3,000 for an individual.
First-time buyers with home-based businesses—If you operate your small business from an office situated within a first-time home purchase, you can still qualify for additional tax incentives, if you purchased your home between April 9, 2008 and June 30, 2009.
Lower mileage rates—As expected, the IRS lowered the standard mileage rates for the business use of vehicles. Beginning on January 1, 2009, the standard mileage rate for the use of a car (also vans, pickups or panel trucks) is:
55 cents per mile for business miles driven
24 cents per mile driven for medical or moving purposes
14 cents per mile driven in service of charitable organizations
Maximum automobile value for using the cents-per-mile valuation rule—For 2009, an employer providing a passenger automobile for the personal use of an employee may determine the value of the personal use by using the vehicle cents-per-mile value rule if the vehicle’s fair market value on the date it is first made available to the employee does not exceed $15,000 for a passenger automobile other than a truck or van, or $15,200 for a truck or van.
Commuting and parking benefits for employees—Beginning in 2009, businesses can pay $230 a month in tax-free parking for employees, up $10 per month from 2008. The cap on tax-free transit passes rises to $230 a month. In addition, you can offer employees who prefer to cycle to work a new tax-free benefit of $20 per month to cover the cost of buying, maintaining and storing a bicycle for commuting purposes.
For Quick Reference
The chart below outlines a number of personal and business tax rate changes.
Social Security/Medicare
2008
2009
Social Security Taxable Wage Base
$102,000
$106,800
Medicare Taxable Wage Base
No limit
No limit
Individual Retirement Accounts
2008
2009
Roth IRA
Lesser of $5,000 or 100% of earned income
Lesser of $5,000 or 100% of earned income
Traditional IRA
Lesser of $5,000 or 100% of earned income
Lesser of $5,000 or 100% of earned income
Roth and traditional IRA additional annual “catch-up” contributions for account owners age 50 and older,
$1,000
$1,000
Annual Qualified Plan Limits
2008
2009
Defined contribution plan dollar limit on additions to qualified plans, 403(b) plans and SEP plans
$46,000
$49,000
Defined benefit plan limit on benefits
Lesser of $185,000 or 100% of average compensation for highest three consecutive years
Lesser of $180,000 or 100% of average compensation for highest three consecutive years
Maximum compensation used to determine contributions
$230,000
$225,000
Elective deferral limits for 401(k) plans, 403(b) plans, 457(b) plans, and SAR-SEPs Unchanged for 2008
Lesser of $15,500 or 100% participant's compensation
Lesser of $16,500 or 100% participant's compensation
Additional catch-up contributions (individuals age 50 or older) for 401(k) plans, 403(b) plans, 457(b) plans, and SAR-SEPs
$5,000
$5,500
Elective deferral limits for SIMPLE 401(k) plans and SIMPLE IRA plans
Lesser of $10,500 or 100% participant's compensation
Lesser of $11,500 or 100% participant's compensation
Additional catch-up contributions (individuals age 50 or older) for SIMPLE 401(k) plans and SIMPLE IRA plans
$2,500
$2,500
Compensation defining highly compensated employee
$105,000
$110,000
Compensation threshold used to determine a key employee in a top-heavy plan
$1 for more than 5% owners; $145,000 for officers; $150,000 for more than 1% owners
$1 for more than 5% owners; $160,000 for officers; $150,000 for more than 1% owners
Compensation triggering Simplified Employee Pension (SEP) contribution requirement
$500
$550
Driving Deductions
2008
2009
Business mileage, cents per mile
50.5 (first half)58.5 (second half )
55
Charitable mileage, cents per mile
14
14
Medical and moving mileage, cents per mile
19 (first half)27 (second half)
24
Business Equipment
2008
2009
Maximum Section 179 Expense Deduction
$250,000
$250,000
Phase-out for Section 179
$800,000
$800,000
Qualified Transportation Fringe Benefit Exclusion
2008
2009
Commuter highway vehicle and transit pass, per month
$115
$230
Qualified parking, per month
$220
$230
Standard Deductions
2008
2009
Married filing jointly or surviving spouse
$10,900
$11,400
Single (and married filing separately)
$5,450
$5,700
Heads of Household
$8,000
$8,350
Itemized Deduction Phase-Out
2008
2009
Married filing separately
$159,650
$159,950
Personal Exemption
2008
2009
Amount
$3,500
$3,650
Sources: Internal Revenue Service, Small Business Tax Center, and IRS Small Business and Self-Employed Tax Center. Thanks to Martin G. Meyer, principal at B. Meyer Bookkeeping Services, for his help with the “For Quick Reference” list.
As you prepare to work through your taxes for 2009, consider the following business changes. This year’s shifts may offer an opportunity to save money, so you, your accountant and/or your tax preparer should be prepared.
Section 179—The American Recovery and Reinvestment Act makes several important changes to the equipment write-off rules, but only for 2009. First, the maximum amount that can be written off under Section 179 is $250,000 and the investment limitation is $800,000 for tax years beginning in 2009. The maximum amount of equipment placed in service in 2009 was scheduled to fall to $133,000, a $117,000 decrease from 2008, when a temporary $250,000 ceiling was in effect, but the 2008 levels have been extended.
Bonus depreciation—The 50% bonus depreciation deduction for qualifying property has been extended an additional year and applies to property placed in service before January 1, 2010 (January 1, 2011 for certain other property, including that with a longer production period).
Bonus depreciation is only available for new property and only property depreciable under MACRS with a recovery period of 20 years or less. Bonus depreciation is automatic. You can, however, elect out of it. (You might consider doing so if 2009 is a particularly bad year and you expect to be in a higher bracket in future years.)
The luxury car depreciation caps for vehicles that qualify for bonus depreciation are increased by $8,000 for vehicles placed in service before January 1, 2010. Thus, the limit on cars is $10,960; the limit on trucks and vans is $11,060.
Depreciation of restaurants and retail stores—The current 15-year depreciation period for tenant and restaurant improvements is expanded to include buildings housing restaurants, and improvements made to retail stores that are placed in service in 2009.
Payroll tax changes—The maximum amount of wages subject to Social Security tax has increased to $106,800 for 2009, up from $102,000 in 2008. That means you should stop making (and paying) Social Security for employees once they reach $106,801 in eligible earnings in 2009. The tax rate remains 7.65% on employers and employees.
Self-employment tax contribution base increased—The maximum amount of self-employment income subject to Social Security taxes increases to $106,800 in 2009, up from $102,000 in 2008. The self-employment tax rate remains 15.3%.
Estimated tax relief for small business owners—If an individual’s Adjusted Gross Income for 2008 was less than $500,000, and more than half of gross income was from a business with fewer than 500 workers, the owner’s estimated income taxes for 2009 estimated payments can be based on the lesser of 90% of tax liability for 2008 or 2009. The usual estimated tax benchmarks of 100% or 110% of tax liability do not apply.
Withholding changes—The IRS has announced changes in withholding rates for 2009 and 2010. These changes are the result of the Making Work Pay provision of the American Recovery and Reinvestment Act (ARRA), which provides a refundable tax credit of up to $400 for working individuals and $800 for married taxpayers filing joint returns. This tax credit will be calculated at a rate of 6.2% of earned income and will phase out for taxpayers with adjusted gross income in excess of $75,000, or $150,000 for married couples filing jointly. (See the new withholding tables for more information.)
Estimated tax payments for small business owners—There are several ways to avoid a penalty for failure to pay estimated taxes. Most taxpayers avoid the penalty by paying in at least as much as the liability on the prior year’s return. For example, your total tax liability for 2008 was $8,000. If you pay at least $2,000 per quarter in 2009, you’ll avoid any penalty. If your adjusted gross income on last year’s return was more than $150,000, you’ll need to pay at least 110% of last year’s liability. (If you expect your tax liability to be lower than in the prior year, you can pay estimates based on your annualized, actual income for the year. This involves more computations.)
For tax years beginning in 2009, the 100% (or 110%) requirement for a “qualified individual” is reduced to 90%. A qualified individual is one whose:
adjusted gross income shown on the individual’s prior year tax return was less than $500,000 ($250,000 for a married person filing separately), and
the individual certifies that more than 50% of the preceding year’s gross income was from a small business.
Increased retirement plan contributions—In 2009, small business owners have the opportunity to invest more tax-deductible money in their retirement savings accounts. New contribution limits are:
401(k) elective deferrals up to $16,500 (plus another $5,500 for those age 50 or older by the end of 2009). In 2008, the limits were $15,500 (plus another $5,000 for those age 50 or older by the end of 2008).
SEP and profit-sharing plan limit of $49,000 (up from $46,000).
Defined benefit (pension plan) limit of $195,000 (up from $185,000).
Increased deductions for Health Savings Accounts (HSAs)—You can contribute more in 2009 to business HSAs, with a 100% tax deduction up to a limit of $5,950 for a family, and $3,000 for an individual.
First-time buyers with home-based businesses—If you operate your small business from an office situated within a first-time home purchase, you can still qualify for additional tax incentives, if you purchased your home between April 9, 2008 and June 30, 2009.
Lower mileage rates—As expected, the IRS lowered the standard mileage rates for the business use of vehicles. Beginning on January 1, 2009, the standard mileage rate for the use of a car (also vans, pickups or panel trucks) is:
55 cents per mile for business miles driven
24 cents per mile driven for medical or moving purposes
14 cents per mile driven in service of charitable organizations
Maximum automobile value for using the cents-per-mile valuation rule—For 2009, an employer providing a passenger automobile for the personal use of an employee may determine the value of the personal use by using the vehicle cents-per-mile value rule if the vehicle’s fair market value on the date it is first made available to the employee does not exceed $15,000 for a passenger automobile other than a truck or van, or $15,200 for a truck or van.
Commuting and parking benefits for employees—Beginning in 2009, businesses can pay $230 a month in tax-free parking for employees, up $10 per month from 2008. The cap on tax-free transit passes rises to $230 a month. In addition, you can offer employees who prefer to cycle to work a new tax-free benefit of $20 per month to cover the cost of buying, maintaining and storing a bicycle for commuting purposes.
For Quick Reference
The chart below outlines a number of personal and business tax rate changes.
Social Security/Medicare
2008
2009
Social Security Taxable Wage Base
$102,000
$106,800
Medicare Taxable Wage Base
No limit
No limit
Individual Retirement Accounts
2008
2009
Roth IRA
Lesser of $5,000 or 100% of earned income
Lesser of $5,000 or 100% of earned income
Traditional IRA
Lesser of $5,000 or 100% of earned income
Lesser of $5,000 or 100% of earned income
Roth and traditional IRA additional annual “catch-up” contributions for account owners age 50 and older,
$1,000
$1,000
Annual Qualified Plan Limits
2008
2009
Defined contribution plan dollar limit on additions to qualified plans, 403(b) plans and SEP plans
$46,000
$49,000
Defined benefit plan limit on benefits
Lesser of $185,000 or 100% of average compensation for highest three consecutive years
Lesser of $180,000 or 100% of average compensation for highest three consecutive years
Maximum compensation used to determine contributions
$230,000
$225,000
Elective deferral limits for 401(k) plans, 403(b) plans, 457(b) plans, and SAR-SEPs Unchanged for 2008
Lesser of $15,500 or 100% participant's compensation
Lesser of $16,500 or 100% participant's compensation
Additional catch-up contributions (individuals age 50 or older) for 401(k) plans, 403(b) plans, 457(b) plans, and SAR-SEPs
$5,000
$5,500
Elective deferral limits for SIMPLE 401(k) plans and SIMPLE IRA plans
Lesser of $10,500 or 100% participant's compensation
Lesser of $11,500 or 100% participant's compensation
Additional catch-up contributions (individuals age 50 or older) for SIMPLE 401(k) plans and SIMPLE IRA plans
$2,500
$2,500
Compensation defining highly compensated employee
$105,000
$110,000
Compensation threshold used to determine a key employee in a top-heavy plan
$1 for more than 5% owners; $145,000 for officers; $150,000 for more than 1% owners
$1 for more than 5% owners; $160,000 for officers; $150,000 for more than 1% owners
Compensation triggering Simplified Employee Pension (SEP) contribution requirement
$500
$550
Driving Deductions
2008
2009
Business mileage, cents per mile
50.5 (first half)58.5 (second half )
55
Charitable mileage, cents per mile
14
14
Medical and moving mileage, cents per mile
19 (first half)27 (second half)
24
Business Equipment
2008
2009
Maximum Section 179 Expense Deduction
$250,000
$250,000
Phase-out for Section 179
$800,000
$800,000
Qualified Transportation Fringe Benefit Exclusion
2008
2009
Commuter highway vehicle and transit pass, per month
$115
$230
Qualified parking, per month
$220
$230
Standard Deductions
2008
2009
Married filing jointly or surviving spouse
$10,900
$11,400
Single (and married filing separately)
$5,450
$5,700
Heads of Household
$8,000
$8,350
Itemized Deduction Phase-Out
2008
2009
Married filing separately
$159,650
$159,950
Personal Exemption
2008
2009
Amount
$3,500
$3,650
Sources: Internal Revenue Service, Small Business Tax Center, and IRS Small Business and Self-Employed Tax Center. Thanks to Martin G. Meyer, principal at B. Meyer Bookkeeping Services, for his help with the “For Quick Reference” list.
Sellers, In the case of an audit...
What IRS Auditors Look for When Examining a Business
In the case of audit, be aware that the IRS training manual tells its auditors that they are examining you, not just your tax return. The auditor wants to see how you match up with the income reported on your return, or what the IRS terms “economic reality.” According to Frederick W. Daily, tax attorney and author of Stand Up To the IRS and Tax Savvy for Small Business, if your business is audited, the IRS is likely to investigate the following issues:
Does your lifestyle square with your reported income? “An auditor sizes you up for dress, jewelry, car and furnishings in your home or office, if given a chance to make these observations. Someone who looks like a Vegas high roller, with the tax return of a missionary, will cause any auditor to dig deeper,” Daily says.
Does your business handle a lot of cash? If your business handles a lot of cash, expect the auditor to suspect skimming, or diverting income into your own pocket, without declaring it.
Did you write off auto expenses for your only car? Personal use of your business-deducted set of wheels is so common that auditors expect to find it. That doesn’t mean they’ll accept it, however. Auditors don’t believe you use your one-and-only auto 100% for business and never to run to the grocery store or the dentist. If you operate your car for both business and pleasure and claim a high percentage of business usage, keep good records (preferably a mileage log).
Did you claim personal entertainment, meals or vacation costs as business expenses? Travel and entertainment business expenses are another area where the IRS knows it can strike gold. Document all travel and entertainment deductions. Taking buddies to the ball game and calling it business won’t fly if you can’t explain the business relationship in a credible fashion.
Did you “forget” to report all of your business sales or receipts? If you failed to report significant business income—$10,000 or more—strongly consider hiring a tax pro to handle the audit. Remove yourself from the process altogether.
If the auditor finds evidence of large amounts of unreported income, and it looks intentional, he may call in the IRS criminal investigation team.
If you have employees, are you filing payroll tax returns and making tax payments? Employment taxes are a routine part of every audit of a small enterprise.
And last but not least, if you hire people you call “independent contractors,” are they really employees? The IRS routinely conducts audits of businesses that hire independent contractors, because of the tax savings associated with hiring contractors instead of employees.
This list is by no means complete. These are just the most likely things an IRS auditor will look for, Daily notes. If your small business is being audited by the IRS, speak with your accountant, tax preparer or tax attorney about the steps you need to take to prepare.
In the case of audit, be aware that the IRS training manual tells its auditors that they are examining you, not just your tax return. The auditor wants to see how you match up with the income reported on your return, or what the IRS terms “economic reality.” According to Frederick W. Daily, tax attorney and author of Stand Up To the IRS and Tax Savvy for Small Business, if your business is audited, the IRS is likely to investigate the following issues:
Does your lifestyle square with your reported income? “An auditor sizes you up for dress, jewelry, car and furnishings in your home or office, if given a chance to make these observations. Someone who looks like a Vegas high roller, with the tax return of a missionary, will cause any auditor to dig deeper,” Daily says.
Does your business handle a lot of cash? If your business handles a lot of cash, expect the auditor to suspect skimming, or diverting income into your own pocket, without declaring it.
Did you write off auto expenses for your only car? Personal use of your business-deducted set of wheels is so common that auditors expect to find it. That doesn’t mean they’ll accept it, however. Auditors don’t believe you use your one-and-only auto 100% for business and never to run to the grocery store or the dentist. If you operate your car for both business and pleasure and claim a high percentage of business usage, keep good records (preferably a mileage log).
Did you claim personal entertainment, meals or vacation costs as business expenses? Travel and entertainment business expenses are another area where the IRS knows it can strike gold. Document all travel and entertainment deductions. Taking buddies to the ball game and calling it business won’t fly if you can’t explain the business relationship in a credible fashion.
Did you “forget” to report all of your business sales or receipts? If you failed to report significant business income—$10,000 or more—strongly consider hiring a tax pro to handle the audit. Remove yourself from the process altogether.
If the auditor finds evidence of large amounts of unreported income, and it looks intentional, he may call in the IRS criminal investigation team.
If you have employees, are you filing payroll tax returns and making tax payments? Employment taxes are a routine part of every audit of a small enterprise.
And last but not least, if you hire people you call “independent contractors,” are they really employees? The IRS routinely conducts audits of businesses that hire independent contractors, because of the tax savings associated with hiring contractors instead of employees.
This list is by no means complete. These are just the most likely things an IRS auditor will look for, Daily notes. If your small business is being audited by the IRS, speak with your accountant, tax preparer or tax attorney about the steps you need to take to prepare.
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