No one likes to be audited by the IRS. It costs time and, thus, money — even if no additional tax, interest or penalties are assessed — and it’s stressful. So, what can your dealership do to avoid an IRS audit in the first place? It’s simple: Don’t attract unfavorable IRS attention. Reviewers can’t audit every return, so they rely on key indicators to narrow the scope.
Plan “A” — Careful Preparation
To reduce your chances of being audited, you need to examine your business practices and your dealership’s return while thinking like an IRS agent. Be accurate and consistent with the information you provide, and pay special attention to:
Compensation.
Because most dealerships are family-run businesses, the IRS keeps an eye out for unreasonable compensation. Align your salaries with industry benchmarks. Accurately record hours worked, unique contributions from high-salaried employees, and any other factors that influence pay spikes to executives or officers.
Cash transactions.
The IRS is much more likely to audit businesses with frequent cash transactions. Most of these occur in your parts department. Report these transactions properly by making sure the transaction is recorded in your accounting records with a proper paper or electronic trail.
The size of business loss deductions.
Large business loss deductions are red flags to an IRS reviewer. Document each loss and keep receipts. Be able to prove your intent to make a profit, even if you’re temporarily losing money.
Travel deductions.
Keep detailed auto expense logs and be able to justify the business-use percentage. Alternatively, you can employ the standard deduction rate of 54 cents per mile driven in 2016.
Nondeductible contributions.
Contributions to political action funds aren’t deductible for income tax purposes, including the portion of your NADA and state auto dealer association dues that fund political action committees (PACs). Give your CPA the annual statements provided by your associations indicating the portion of dues that fund PACs so that the matter can be handled properly on your tax return.
Business credits.
If you think one of your dealership’s credits might come into question, attach an explanation to the documentation. Show the IRS reviewer that you understand the rules.
Meals and entertainment.
Keep receipts for any expense totaling $75 or more. Include the name and location of the meeting facility. To avoid penalties if you are audited, keep detailed descriptions of events, who attended, business relationships and business discussed.
LIFO.
Keep accurate records of your previous years’ LIFO invoices. Despite the three-year statute of limitations for auditing tax returns, your current year’s LIFO reserve can be affected by several years of built-in layers. Thus, LIFO workpapers and calculations should be kept permanently.
Related-party receivables.
Keep documentation of related-party loans. There should be a signed loan agreement between the parties with a stated interest rate. Typically loans greater than $10,000 need to have interest paid between the parties. The minimum interest rate should be the applicable federal rate in effect at the time the loan is made.
Variances.
Do a high-level review of your tax return. If items are grouped differently from the previous year, it could draw IRS attention. An example: You classified your rental vehicles as part of your property and equipment in Year 1. Now, in Year 2, you classify them as “other assets.”
Plan “B” — Professional Assistance
No one wants an IRS audit. If you are conscientious about the records you keep and wise about the tax decisions you make, you can avoid waving the red flags that might trigger one.
But if, despite your best efforts, the IRS requests an audit, enlist the help of your CPA promptly and cooperate with the agency fully. Your CPA can perform a pre-audit, which includes reviewing the more complex areas of your tax return as well as any areas singled out by the IRS.
