When a return is selected for examination, the examiner assigned use the IRS Audit Techniques Guides (ATGs). ATGs clarify industry-specific examination techniques and contain common, as well as, specific industry problems, business practices, and terminology.
Guidance is also provided on the examination of income, interview techniques and evaluation of evidence designed for specific industries. Although ATGs main use is to provide guidance for IRS Employees, they are also beneficial to small business owners who work to stay tax compliant and IRS audit ready.
In this blog, we have summarized the key areas that IRS examines on the business consulting industry.
Business consulting is now a rapidly growing industry as a result of companies downsizing in the past decades. The employees who were downsized are now working as a contractor or have already put up their own businesses in collaboration with other professionals. And here are some of the things you need to be mindful of as you grow your consulting practice.
Travel
Traveling inside or outside the state are constant in the consulting field and on certain circumstances, the consultant travels with his family. For instance, the consultant is trying to balance work and life and have decided to have a vacation and travels together with the family to visit a client with the intention of spending the remaining days on break.
Why is this a red flag?
This is the usual perceived opportunity for consultants to lump in their personal expenses in their business purpose expenses. So, the IRS is very adamant regarding this because it causes to overstate the expenses hence overstating the claimable deductions and in turn understating the income subject to tax liability by a huge amount.
Meal and Entertainment Expenses
When there’s constant travel, there is a substantial amount of expenditure in relation to meals and entertainment. Not just during travels but also on the office premises during important occasions.
Why is this a red flag?
Like travel expense, this type of expense has the same potential as understating the income subject to tax liability.
Reimbursed Expense
Reimbursed expenses are the expenses which a consultant directly incurred and will later claim for reimbursement to the client. These can include travel, meals, printing cost, among others.
Why is this a red flag?
The IRS is very alert on the possible tax effect of the treatment of the related income or expense accounts in relation to the method of accounting used.
Reimbursed expenses are very common in the consulting industry and the IRS examiner determines as part of the audit, who is subject to the 50% limitation on business meals and entertainment.
On the income side, the area of close scrutiny is the deduction of the expense without reporting the reimbursement as income.
Activities Not Engaged in for Profit
There are cases when a consultant gives advice to someone personally thinking they have done it for business then started adding some personal expenses incurred during the undertaking as part of the business.
Why is this a red flag?
It is to be noted that large amounts of deductions claimed with little or no income raises questions as well as when losses are offsetting against other income. Therefore, it is important to determine the nature of your transactions because blindly claiming deductions would lead to future tax disputes.
Income
The income of a business consultant is dependent upon the contracts entered into with the client, how it is determined and when it is earned.
Why is this a red flag?
The business consultant may fail to recognize income when nonmonetary considerations are received as payment. The fair value of the property or services received as payment should be recorded in income as compensation and should be reported on Form 1099-MISC when received.
Independent Contractor VS Employee
The independent contractor versus employee is a pervasive issue not only in consulting but in many industries.
Many business owners in an effort to lower costs on payroll and employee benefits hire independent consultants.
Why is this a red flag?
An issue arises when the company that hires contractors is not qualified for the employer safe haven under Section 530. The IRS look into the aspect of behavioral control, financial control and the relationship of the parties.
Putting up a business can be a tedious task. But complying with all the rules and regulations could be a lot more difficult.
If you have more questions or things that you want to clarify, or if you are considering to outsource your bookkeeping tasks, as well as tax preparation for your practice, contact us today at cristy@fas-accountingsolutions.com or 832-437-0385.
