Filing amended tax returns falls somewhere just below getting a cavity drilled on the “things you’d rather not be doing” scale. Amended returns are tedious and time consuming enough for individuals, let alone companies with many sources of income.
Every business owner dreads the letter from the IRS asking for clarification or proof of income. And many times, it’s not that the income wasn’t reported, it’s that the income wasn’t reported correctly. That’s why it’s important for businesses to keep all of their financial data organized and at the ready, and have a thorough understanding of how the IRS classifies business income.
By staying organized and up to date on your records, your company will be prepared if the IRS comes knocking — and you stand a greater chance of filing a correct return in the first place. Here are some things to remember.
Don’t mingle different types of income
The IRS draws a distinction between income that was generated directly by the operation of a business — in other words, gross receipts — and income that was not.
Recently, I had a client company that received a $6,000 workers’ compensation refund check from Ohio BWC.
BY STAYING ORGANIZED AND UP TO DATE ON YOUR RECORDS, YOUR COMPANY WILL BE PREPARED IF THE IRS COMES KNOCKING — AND YOU STAND A GREATER CHANCE OF FILING A CORRECT RETURN IN THE FIRST PLACE.
and recorded it on its tax return under gross receipts. The problem is, workers’ comp refund money isn’t gross receipts from the operation of the business, so the income needed to be filed as other income on the company’s federal tax return.
The recording mistake triggered a letter from the IRS requiring that the company supply proof of its original income for the tax year. In actuality, the company could have filed an amended tax return if the coding error had been caught by the client before the IRS reconciliation with the Ohio BWC 1099 for Other Income.
In the short term, it caused some headaches that could have been avoided.
The bottom line is, separate your gross receipts from other income as if they were oil and water. For taxation purposes, money generated by the operation of the business has nothing to do with money received via any other means.
Reconcile all forms of payment
In December and January, you are likely flooded with statements from all of your payers, declaring how much money they paid to your company over the previous year. Collect those statements and check them against your own records. If what you say they paid you doesn’t match what they say they paid you, you need to reconcile the difference.
Get in touch with payers that have a discrepancy with your own records, be they vendors, insurance companies, banks paying interest on your accounts, or government entities. Document your attempts to resolve the issue. If there is a difference in reported income, the IRS will take note of it and ask you to provide proof of income. The burden is on you to explain the discrepancy, and at that point, the paper trail will come in handy.
Keep your records
It can take one to three years for the IRS to discover a filing mistake, so your business needs to be prepared with records that date back at least that far. In 2016, the IRS could still come calling about a filing mistake made on 2012 income tax returns.
File, organize and save your income records going back at least three tax years, if not longer. Just because you filed away the previous year’s taxes and forgot about them doesn’t mean the IRS has. An old tax filing can always return from the dead.
Though it might not always seem that way, the process of filing a tax return is much simpler than it used to be. Thirty years ago, we were still in an era of handwritten tax forms, when common mistakes included things like transposed digits on a Social Security number
— which would trigger a need for an amended return. Mistakes that basic have largely been eliminated thanks to computers, and the most prevalent mistakes now involve misreported income. Unfortunately, preventing and correcting those mistakes isn’t as simple as glancing at your Social Security card. It takes detailed recordkeeping and organizational skills to file a clean, mistake-free tax return in the modern era.