bmcper 
CEO/Auditor
Posts: 56
(12/4/00 11:50 am)
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Are You Prime For An Audit???
Money Matters/Joseph Anthony
What the IRS knows about your industry
Every so often, someone asks me, "I know it's legal for me to take _____ (insert your favorite tax deduction or strategy here). But will having it on my return trigger an audit from the IRS?"
If you own a small business, you may be looking ahead to 2001 at the same time you are celebrating the end of 2000. In an upcoming column, Money Matters columnist Joseph Anthony will be writing about New Year's Resolutions for Better Business. What would you like to do next year to make your business more profitable, successful — or just plain more enjoyable? In short, what are your business resolutions for 2001?
I'm sorry, but I don't know. I really don't. Nobody knows exactly what will trigger an IRS audit. The Internal Revenue Service closely guards the guidelines and formulas it uses for determining who will be audited, which makes sense. Sure, tax pros can make educated guesses about what returns might be more likely to draw the IRS' attention. But none of us can say with certainty that something will or will not lead to an audit.
However, one thing I do know is that the IRS is getting more and more sophisticated when it comes to training its auditors about how businesses operate, and in identifying areas of opportunity for, um, increased government revenues.
The most visible evidence is called the "Market Segment Specialization Program" (MSSP). This is an ongoing effort by the IRS to arm examiners with detailed information on common practices, standards and ratios for a host of industries. The idea is that if the examiner knows how businesses in an industry typically operate, he or she can more quickly and thoroughly audit a specific company within that industry.
The IRS has been developing MSSPs for years, and currently there are 59 industry guides. Among the industries covered: attorneys, bed-and-breakfast establishments, used car dealers (insert your own joke here), architects, bars and restaurants, auto body shops, beauty shops, ministers, the cattle industry, garment manufacturers, tour buses, drywallers, child care providers and sports franchisers.
These "Audit Techniques Guides," as the IRS calls them, aren't little leaflets or one-page summaries — they can run to 30 or more pages of single-spaced type. By reading one, you can learn a lot about the approach an auditor may take in doing a detailed examination of a business. And the detail can be amazing.
Some examples:
Artists and art galleries: This guide discusses typical revenue splits between artists and galleries, and even gives one-sentence summaries of abstract, cubism, pop, post-impressionism and other art movements.
Among the recommendations for the auditor: Ask for all records of consigned art received, returned and sold in the year, as well as for all shipping records and canceled checks. (The canceled checks might lead to research into returns of specific artists.)
Interesting understated quote: "This MSSP Guide concentrates on the use of 'third party' contacts in proving income, since the use of cash can be an integral part of the artist's lifestyle."
The wine industry: This MSSP paper takes auditors through the process of making wine, beginning with the initial land clearing for planting and developing the vineyard. The guide also discusses costs per acre to establish a vineyard and produce grapes; the equipment, investment, and business overhead costs, and details about bench grafts, trellising, irrigation and other factors involved in wine production.
Among the recommendations for the auditor: Verify grape sales by checking out the weight tickets required by the federal Bureau of Alcohol, Tobacco & Firearms. Confirm that all costs associated with manufacturing during the production period — including costs incurred during the aging process — are capitalized rather than expensed.
Interesting understated quote: "Wineries will often pre-release wines to wine writers or for other promotional purposes. This is done for marketing reasons and does not terminate the aging process for that lot of wine."
The music industry: Auditors get an overview of how the music industry is structured, how records are produced, the major unions for musicians, the role of promoters in concert tours and other key factors.
Among the recommendations for the auditor: Find out if the songwriter belongs to any music industry unions — the unions often keep records of the income earned by musicians. Get royalty statements from third parties like ASCAP, contracts with all publishers and collaborators, and other related statements. Auditors dealing with "star" performers will probably find that these individuals are excellent sources of information about their work itself — when, where, how and with whom they work — but don't know a great deal about how their tax return is prepared.
Interesting understated quote: "There are many checks and balances in the industry on income reporting, but some activities such as playing small clubs for the door receipts, love offerings at concerts and churches, and concession sales at the small locations, etc., present situations where income may go unreported."
Bonus interesting understated quote: "Vacation homes [may be] used by songwriters as a retreat and a place to think. This is not allowable as an ordinary and necessary expense."
Check out the audit guide for your industry
Here's the great thing about these guides: They're public documents. The IRS even has posted most of them on its own Web site. Want to see if the IRS has something to say about your industry? Click here.
** Joseph Anthony advises small businesses and sole proprietors as part of his tax preparation and planning practice in Portland, Ore. He is an enrolled agent authorized to represent taxpayers before the IRS, and has written and spoken on taxes and personal finance issues for many publications and before numerous organizations.
Edited by: bmcper at: 12/4/00 10:52:37 am
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