Keeping Tabs Going through an audit usually alters a company’s perspective about itself. Several contractors interviewed for this article spoke of their recommitment to better filing systems and more precise record keeping. Others say they now engage their accountants and CPAs on a regular basis to keep tabs on their financial reporting and to spot inconsistencies.
“Companies need to realize that as they become bigger, it’s more likely they’ll be on the IRS’s radar screen,” Yoho says. Indeed, as Alenco has grown — its annual sales, according to Petz, are now “just north of $9 million” — the company has improved its accounting procedures by keeping files on each vendor, supplier, and subcontractor, and by updating its accounting software program every year.
Several companies have changed their tax status by becoming S corporations, which helps prevent them from getting snagged on one of the thornier issues that can trigger an audit: the extent to which owners are remunerated with dividends versus salaries. Yoho points to a New York home improvement operation, the owner of which lent his company money to meet payroll. The problem? He did it without a paper trail that recorded the transaction. He ended up getting socked with a $480,000 tax bill when the IRS ruled that the repayment of that loan was a dividend.
Being an S corporation, says Don Bruce, “is better for the owner because it eliminates the dividend issue. Now I’m paying 50 cents on the dollar in taxes and the IRS gets all of its money at the end of each year.” As far as compensation is concerned, Van Cura says that the rule of thumb he follows is that the owner “has to be paid at least what the highest-paid employee gets.” —John Caulfield is a freelance writer and editor based in New Jersey.
Words From the Wise Contractors and tax experts offer the following tips to help you be better prepared for an audit.
Know the rules. The tax code is never static, but many contractors don’t stay current on its revisions. Consequently, small-business owners are prone to deduct more expenses than they’re entitled to, observes Tom Ochsenschlager, vice president of taxation for the American Institute of Certified Public Accountants. Rick Duggan of America’s Best Home Remodelers advises having good accounting software that can be regularly updated for changes in tax code and laws. Document everything. Small businesses often wind up paying back taxes and penalties because their documentation is lax, incomplete, or haphazardly filed. An audit by the state of Illinois last year “renewed my fanaticism about our record keeping,” says Don Van Cura, owner of Van Cura Construction, in Chicago. After that audit, Van Cura went to his local office supply store and bought several hundred dollars worth of plastic file folders to better organize his documents. Duggan says his company keeps files on every subcontractor, including photos of the signage on their trucks and their company logos. That’s to prove they aren’t his employees. Seek professional guidance. Consultant Dave Yoho says he still encounters too many contractors who follow “I think so” advice. He and other experts advise contractors to work with professional accountants or CPAs — and not just at tax time — to understand what information their companies should be capturing and to navigate an audit’s sometimes foggy shoals. “Auditors will ask for something that may seem trivial to an owner, but the professional will recognize immediately that the agent is going in a particular direction,” AICPA’s Ochsenschlager says. Don’t play audit roulette. Anyone who thinks the chances of their company being audited are slim is gambling against the house that wants its money back. In February, the state of Illinois disclosed that it was hiring 105 more tax auditors, at a cost of $4.7 million. Ochsenschlager noted that the IRS was one of the few federal agencies to escape cuts in President Bush’s latest budget proposal. “And that entire 4% increase would go toward enforcement,” he says.