Over the past few years the small business sector has grown by leaps and bounds. According to IRS statistics, small business formation and tax filings increased by 15% percent between 2007 and 2011; they continue to grow at a record pace.
I service the small business market, which includes arts and entertainment. While this news is no surprise, it may be cause for concern for small business owners. As a result of this record increase, an IRS spokesperson reported, “Our largest increase of audits were of flow-through entities in fiscal year 2012.” A “flow-through,” or “pass-through,” entity is a business that is set up to pass the income, expenses, profits, losses and tax liabilities onto the individual business owner(s). This applies to sole-proprietorships, S-Corporations, LLCs and some Partnerships. The likely reason why the IRS is turning its focus to these types of businesses is that they feel there may be a possibility that these business owners are cheating the system—writing off personal expenditures as business expenses.
Dealing with a lot of cash is the quickest way to get the IRS’s attention.
As for those of you who are new to the small business world, following are the top three tips I give to business owners to help avoid—or navigate—an IRS audit.
Keep everything personal completely separated from business as much as possible.
Establish two or more bank and/or credit card accounts: one for personal and one for business. Make sure that these accounts are used only for those purposes. As small business owners, we have grey areas such as home office expenses and using the family car for business trips, but those circumstances are much easier to explain then why your business paid for a family trip to Disney World.
Keep detailed records of all income and expenses.
If you have separate personal and business bank accounts, this tip should be relatively easy. With separate bank accounts and credit cards for business and personal use, you will not have to worry about the IRS going through your personal finances to evaluate if they were business expenses. This tip also means keeping copies of the invoices you send out and holding on to the receipts for your expenses.
Invest a small amount of money into accounting software such as QuickBooks or Sage 50 (formerly Peachtree) to assist you in keeping track of your business finances. This will also make it much easier on you and your tax preparer at the end of the year.
AVOID CASH AT ALL COSTS.
I know this is easier said than done as some businesses are more cash transactional then others, but dealing with a lot of cash is the quickest way to get the IRS’s attention. As long as you follow steps one and two, you should be in good shape: you will have all the necessary records to explain where the cash comes from and where it goes.
Barry Cooper II is an accountant who has worked with artists and independent business owners for five years in Chicago, Nashville and Los Angeles. He graduated from Robert Morris University with a bachelor’s degree in accounting and is an accomplished musician and producer. His firm, Limelight Accounting, is dedicated to working with artists and creative professionals of all calibers.
Barry Cooper II