Being prepared for an Internal Revenue Service (IRS) audit you hope never happens will nonetheless make the audit easier and less stressful. Erlin Weness, farm management educator with the University of Minnesota Extension Service, lists 12 tips in a new publication he's written:
1. Keep receipts to justify all deductible expenses and capital purchases, and keep them filed according to your expense ledger accounts.
2. Keep checks to verify all deductible bills paid. Write the purpose of the check in the memo portion of the check. Every memo should relate to a clear business or deductible personal expense. If you write "food," "life insurance," or "kid's allowance" on the check, don't expect it to be deductible.
3. Don't try to deduct capital items as current repairs. If any repair checks are for a large amount, expect the auditor to make you prove they're repairs rather than a capital purchase. It may be better to write numerous small checks for repairs.
4. File and keep all W-2 Forms, 1099s, K-1s and other informational returns sent to you by financial institutions, employers and other businesses at year-end.
5. Use proper terminology for all entries in your accounting program. Don't type or write in such things as "gift," or "used tractor" (if you are entering it in repairs).
6. Write checks for specific items. If you write one check for several items such as feed, fertilizer or repairs, it can be very confusing for an auditor. Weness says auditors like to see one check for every bill, not one check for several bills.
7. Write checks for all charitable contributions. Cash donations may not fly very well. If you give property to charities, have proper documentation and a receipt.
8. If you buy capital items such as machinery, list them as capital purchases and put them on your depreciation schedule. If listed as repairs, they will probably be ruled non-deductible and moved to your depreciation schedule.
9. Make sure you have a current, qualifying written employment agreement or rental agreement if you are employing or renting land from your spouse. The same goes for renting to or being employed by your corporation or if using the Sec. 105 medical plan. Weness says these are current "hot buttons" for the IRS.
10. Having an organized filing system for retrieval of important receipts can be a big help if you are audited. An audit is a demand for you to prove the legitimacy of your tax bill. If you can't prove an item, don't expect to deduct it.
11. Keep a journal of difficult or hard to understand transactions handled during the year. It's easy to forget your reasoning regarding accounting entries a year or two later. Write down unusual transactions to explain them while you understand them and include them with your documentation for the year. Commodity Credit Corporation and USDA transactions may particularly need explanations.
12. Don't take shortcuts when dealing with the IRS. If the proper thing is to write and exchange checks, do so instead of writing a "net" check. Document in writing any item pertaining to self or family deals. The IRS particularly scrutinizes family and controlled group transactions.
For more information, see the publication "Preparing for an IRS Audit" at http://swroc.coafes.umn.edu.