Want to find out what IRS auditors know about your business industry?

Posted on September 2, 2021September 2, 2021 by CCG

In order to prepare for a business audit, an IRS examiner generally does research about the specific industry and issues on the taxpayer’s return. Examiners may use IRS “Audit Techniques Guides (ATGs).” A little-known secret is that these guides are available to the public on the IRS website. In other words, your business can use the same guides to gain insight into what the IRS is looking for in terms of compliance with tax laws and regulations.

Many ATGs target specific industries or businesses, such as construction, aerospace, art galleries, architecture and veterinary medicine. Others address issues that frequently arise in audits, such as executive compensation, passive activity losses and capitalization of tangible property.

Unique issues

IRS auditors need to examine different types of businesses, as well as individual taxpayers and tax-exempt organizations. Each type of return might have unique industry issues, business practices and terminology. Before meeting with taxpayers and their advisors, auditors do their homework to understand various industries or issues, the accounting methods commonly used, how income is received, and areas where taxpayers might not be in compliance.

By using a specific ATG, an auditor may be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the business is located.

Updates and revisions

Some guides were written several years ago and others are relatively new. There is not a guide for every industry. Here are some of the guide titles that have been revised or added this year:

Retail Industry (March 2021),
Construction Industry (April 2021),
Nonqualified Deferred Compensation (June 2021), and
Real Estate Property Foreclosure and Cancellation of Debt (August 2021).

Although ATGs were created to help IRS examiners uncover common methods of hiding income and inflating deductions, they also can help businesses ensure they aren’t engaging in practices that could raise audit red flags. For a complete list of ATGs, visit the IRS website here: https://www.checkpointmarketing.net/newsletter/linkShimRadar.cfm?key=89521181G3971J9375406&l=72457

Recordkeeping DOs and DON’Ts for business meal and vehicle expenses

Posted on June 7, 2021June 7, 2021 by CCG

If you’re claiming deductions for business meals or auto expenses, expect the IRS to closely review them. In some cases, taxpayers have incomplete documentation or try to create records months (or years) later. In doing so, they fail to meet the strict substantiation requirements set forth under tax law. Tax auditors are adept at rooting out inconsistencies, omissions and errors in taxpayers’ records, as illustrated by one recent U.S. Tax Court case.

Facts of the case

In the case, the taxpayer ran a notary and paralegal business. She deducted business meals and vehicle expenses that she allegedly incurred in connection with her business.

The deductions were denied by the IRS and the court. Tax law “establishes higher substantiation requirements” for these and certain other expenses, the court noted. No deduction is generally allowed “unless the taxpayer substantiates the amount, time and place, business purpose, and business relationship to the taxpayer of the person receiving the benefit” for each expense with adequate records or sufficient evidence.

The taxpayer in this case didn’t provide adequate records or other sufficient evidence to prove the business purpose of her meal expenses. She gave vague testimony that she deducted expenses for meals where she “talked strategies” with people who “wanted her to do some work.” The court found this was insufficient to show the connection between the meals and her business.

When it came to the taxpayer’s vehicle expense deductions, she failed to offer credible evidence showing where she drove her vehicle, the purpose of each trip and her business relationship to the places visited. She also conceded that she used her car for both business and personal activities. (TC Memo 2021-50)

Best practices for business expenses

This case is an example of why it’s critical to maintain meticulous records to support business expenses for meals and vehicle deductions. Here’s a list of “DOs and DON’Ts” to help meet the strict IRS and tax law substantiation requirements for these items:

DO keep detailed, accurate records. For each expense, record the amount, the time and place, the business purpose, and the business relationship of any person to whom you provided a meal. If you have employees who you reimburse for meals and auto expenses, make sure they’re complying with all the rules.

DON’T reconstruct expense logs at year end or wait until you receive a notice from the IRS. Take a moment to record the details in a log or diary or on a receipt at the time of the event or soon after. Require employees to submit monthly expense reports.

DO respect the fine line between personal and business expenses. Be careful about combining business and pleasure. Your business checking account shouldn’t be used for personal expenses.

DON’T be surprised if the IRS asks you to prove your deductions. Meal and auto expenses are a magnet for attention. Be prepared for a challenge.

With organization and guidance from us, your tax records can stand up to scrutiny from the IRS. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions (“the Cohan rule”), if your records are lost due to a fire, theft, flood or other disaster.

Journal entries may signal financial statement fraud

Posted on August 17, 2020August 17, 2020 by CCG

With a median loss of $954,000, financial statement fraud is the costliest type of white-collar crime, according to the Association of Certified Fraud Examiners. Fortunately, auditors and forensic accountants may be able to detect inflated income and other financial manipulation by testing journal entries.

Unearthing suspicious entries

Financial statement frauds come in many forms. For example, out-of-period revenue can be recorded to inflate revenue. Repair costs can be improperly capitalized as fixed assets to boost earnings. Accounts payable can be understated by recording post-closing journal entries to income. Or expenses can be reclassified to reserves and intercompany accounts, thereby increasing earnings.

To detect these types of scams, auditors:

Learn about the company’s financial reporting process and controls over journal entries,
Identify and select journal entries and other adjustments for testing,
Determine the timing of the testing, and
Interview individuals involved in the financial reporting process about inappropriate or unusual activity relating to the processing of journal entries.

Financial statement auditors may call on forensic accounting experts when they notice significant irregularities in a company’s financial records.

Testing journal entries

There generally are several common denominators among fraudulent journal entries. Experts look out for entries that are made:

To unrelated, unusual or seldom-used accounts,
By individuals who typically don’t make journal entries,
At the end of the period or as post-closing entries that have little or no explanation or description,
Before or during the preparation of the financial statements without account numbers, and
To accounts that contain transactions that are complex or unusual in nature and that have significant estimates and period-end adjustments.

Other red flags include adjustments for intercompany transfers and entries for amounts made just below the individual’s approval threshold or containing large, round-dollar amounts.

Technology tools are critical. Computerized testing enables auditors to evaluate entire datasets, thus reducing the risk of overlooking critical evidence. Such testing also allows fraud experts to devote more time to other aspects of an investigation, such as gathering information about the business and interviewing employees. Computerized testing can prove particularly helpful in situations where manual testing is largely ineffective — for example, when entries exist only in an electronic format and the desired data must be extracted.

Technology and expertise

Computer-assisted journal entry testing doesn’t replace a skilled auditor or fraud expert. Instead, these tools free up the expert’s time. Contact us about examining your company’s financial statements for signs of fraudulent activity.