According to a recent report by the IRS, auditors are going to be stepping up their audits of sole proprietors, looking for unreported income and unfiled tax returns.

In addition to searching for unreported income, the IRS will be looking for sole proprietors who did not file required employment tax returns or information returns.

How to prepare your business in case the IRS comes knocking?  It all comes down to preparation and documentation:

• Improve your recordkeeping. Be prepared to back up every number on your tax return with complete documentation on the details and purpose of each expense.  If you do this with every expense at the time of purchase, you won’t be leaving yourself with hours of catch-up work at tax time.  Even worse, an audit that occurs in the fall of 2010 could be for expenses incurred in early 2008!
• Consider professional help. Even if you feel confident in preparing your own tax return, it’s worth your time and money to have a professional review your return every couple years.  Not only may they catch mistakes, but they may catch missed deductions or new tax-saving opportunities.  Two sets of eyes are always better than one!
• Don’t stick your head in the sand. If you hate bookkeeping so much that you just never get around to it, then consider hiring some outside help.  What might take you several late nights of agonizing stress might only take a couple of hours for a professional bookkeeper.  I help several sole proprietors and small business owners with ALL of their bookkeeping needs with only five to ten hours per month.  The bookkeeping gets done (properly!) and the business owner has an extra ten hours to spend on billable hours, business development, or whatever else is at the top of their priority list!

The IRS just published their IRS Enforcement and Service Results for their fiscal year 2009.  Based upon this new data, the higher your income, the more likely that you’ll receive a letter from the IRS asking for additional information or tax payments.  A correspondence audit of this kind is often triggered when you forget to report all of your 1099 payments, including “freelance” payments that were reported to you on a 1099-MISC.

The statistics released by the IRS show:

• Individuals with income over $200,000 had an audit rate of 2.89%
• Individuals with income under $200,000 had an audit rate of 0.96%

For businesses the results were:

• S-Corporations had an audit risk of 0.40%
• Partnerships had an audit risk of 0.38%
• Sole Proprietorships were not broken out from individual results

For upcoming audits, the IRS has already announced that Sub-S Corporations that are not paying shareholder/employees “reasonable compensation” will be at the top of their audit lists.