You’re working hard to build your business. You are a strong, upstanding, ethical person and you do everything you’re supposed to. But then you get that notice in the mail that you’re being audited. Does that send fear through your body?
Actually it didn’t for me. I am very particular about my books. I keep track of every expense and every penny that I’ve earned. I don’t fudge anything, mostly because I don’t know how to. I have never understood how some people take money under the table. How do they manage their books that way? How do they know how much they are making? How do they keep track of what to report and what not to?
So when I was audited, I wasn’t worried at all. I knew everything was in order. It was certainly inconvenient, and a little of a pain because I needed to stop working on my business long enough to get everything in order so it would be easy for the auditor to see everything.
So Richard and I showed up for our audit appointment alone, with as much of our business as we could put in a copy paper box, and carrying my laptop in case we missed anything. Getting into the IRS office was worse then the airport. We were screened very carefully. Also, there is no accommodation for you whatsoever once you are in there. To get to the restroom you had to go to another building, and in our case travel back through the heavy rain and be rescreened to get back in. (We were kept there for 3-4 hours). If you needed to access anything on your laptop, they offered no wifi for your use.
So we get in to the auditor’s office, and he smiles at us and shakes our hands, and the first thing he says is, “Just so you know, I don’t believe in Network Marketing”. That should have been our first flag. What goes through my head over and over these days is Maya Angelou’s quote – When someone shows you who they are, believe them. For some reason, I have such a hard time living that – in every area of my life – and that has bitten me over and over. But the auditor was friendly, and I knew that once he saw what we had, he would see that, in fact, we did have a solid business.
So we got down to business. He asked us about certain categories on our return, and we provided the receipts and/or documents he asked for. We had everything he asked for except for 1 thing. He wanted an itinerary of a convention that we had attended to prove that we were really working. We promised to get that to him by the next day.
He thanked us for having everything so organized. We had made his job so much easier and it took much less time than it usually does because we were so well prepared.
We left his office happy, thankful that it was over.
But as it turns out, that was not the case.
About a week or so later, we received a letter stating that according to the IRS, we did not qualify as a business – but instead we were considered to be a hobby – and that we were not smart enough to run a business (It actually said that!)! They had stripped our entire Schedule C from our return and wanted us to pay the IRS thousands and thousands of dollars. I didn’t know this at the time, but once we were declared a hobby, the IRS could now go back and strip the Schedule C’s from every one of our tax returns for the last 7 years, as well as not allow us to file them in the future as long as we were in the same business. Of course, they get to reap the benefits of our income, but not the expenses it took to earn that income.
Even without knowing all that yet, I was totally devastated. My entire identity ever since I started my business in 2001 was that I was a Network Marketing Professional. The government had effectively just stripped my entire identity! I went into a severe depression and spent the next 8-9 days sleeping, or binge watching the Thorn Birds, Downton Abby, and Game of Thrones, eating nothing but popcorn. I didn’t move off the couch for like 8 days. Richard didn’t know what to do with me.
Then my pastor recommended a Tax Attorney and suggested I at least meet with her. I felt at that point that I had nothing to lose, so I might as well find out just how bad it was.
I learned a couple of things about why I was audited.
First off, our government is hurting financially. They are looking for ways to bring in more money. They are currently auditing small businesses because they are easy targets. Big corporations have big lawyers, and the IRS doesn’t want to spend money in court. So they’re going after anyone who works for themselves – that could be Network Marketers, Realtors, Business or Personal Coaches, Dog Groomers, Pet Sitters, Fitness Coaches, Exercise teachers, Freelancers, Virtual Assistants, etc.
But it’s not only business people. My sister was audited and she’s never earned any money except for her earnings working in a grocery store. I have a friend who is a minister who was audited. Nobody is safe, and we all seem to get our turn.
But for me personally… I was audited for the year 2012. From 2001 thru 2011 we had a thriving business with a Network Marketing Company. That company was HUGE and public, and their shareholders were many times more important than their representatives. Every time new top people came in, they changed their rules with what seemed to be no concern as to how it affects their representatives. In 2011 they made some changes that devastated our business. We actually had a store (big mistake, but that’s another story) at that point, and ended up having to liquidate everything and took a huge loss that year.
We were fed up with that company and left it when this happened. We then started with a new Network Marketing company fully expecting to be able to replace our income within a year. After all we were already established and already knew what we were doing. That was not to be. In fact, after 4 years, we still hadn’t replaced our income, so we finally cut our losses there and are now with an amazing company. But again, that’s all another story. 🙂
So we took a big loss in 2011, and then made much less in 2012, thereby triggering the audit. So now that we know what most likely brought it on, let’s look at what I learned.
Here are some general tips to protect yourself in the event of an audit. Hopefully you’re already doing most of these things. If you’re not, please do yourself a favor and implement them NOW:
1. Maintain a balance sheet.
I kept mine on an Excel Spreadsheet. Since my audit, I now do both that and Quick Books because that is what my Accountant is requesting. Every expense and all the money earned needs to be on this sheet so you know where you stand at all times.
2. Keep every receipt.
If you are taking someone out for dinner or coffee to make a presentation or show them your business, write their name on the receipt.
3. Keep a mileage log.
Update it every day. Every time you get in your car, make a note in your log of the mileage, and where you’re going. Keep track of all business miles.
4. Use your calendar.
Every appointment needs to be on your calendar. You are running a business right? This is what’s going to keep you on track. Also keep track of your conversations with prospects, follow-ups, etc. I use Big Contacts for this, but you can also use your calendar, and your contact manager. Most contact managers have a field for notes.
OK, so these are the basics. When my attorney went back to the appeal, these are some of what saved me. She showed the appeals person that my calendar matched my mileage log, which also matched my expenses… wow! What a concept. …Something the auditor should have seen in the first place. The activity was definitely there! I was showing my business, in actual appointments, an average of 2-3 times per day. I guess that would show that I’m really working my business!
So here are the things I wasn’t doing (or hadn’t done) that I’m on top of now, and what I would recommend for you.
1. Don’t do your own taxes.
Especially if you own a business. Even if you think you can’t afford a licensed accountant or CPA, trust me… you cannot afford not to. It’s one of the things the IRS looks at when they’re looking for the easy pickings. If you did your own taxes, you’re more likely to be audited.
2. If you do get audited, DO NOT attend the audit without representation.
You’re sitting ducks, and the auditor knows it. He’s actually excited that you are alone. It makes it that much easier for him to get more money out of you.
3. Have a Formal, Written Business Plan!
This is crucial. I didn’t have one. I mean… yes, I knew what I was doing, and I had a plan about how I was going to be successful in my business… but it wasn’t in writing. You need an actual business plan if you are in business. The IRS will look for that first thing. If you are on a PC, there is a great program called Business Plan Pro. I am on a MAC, so I use LivePlan.
I always thought you didn’t need a business plan unless you were looking for investors, but I was wrong. The IRS is going to use this to see how serious you really are about building a successful business.
Your plan can be fairly simple, but it needs to include at least the basics:
Executive Summary: Ideally the executive summary is short—just a page or two—and highlights the points you’ve made elsewhere in your business plan, so if you save it for the end, it will be quick and easy.
Company Summary: This section is an overview of who you are and what you do. It should summarize your vision and what you hope to deliver to your market, but it should also ground the reader with the nuts and bolts: when your company was founded, who is/are the owner(s), what state your company is registered in and where you do business, when/if your company was incorporated, and a bit about your recent sales and growth trajectory.
Products & Services: List and describe the products or services you sell. For each business offering, cover the main points, including: What the product or service is, How much it costs, What sorts of customers make purchases, and why, and What customer need does each product or service line fill? You don’t need to include every product or service in the list, but at least consider the main sales lines.
Market Analysis Summary: Explain here how Network Marketing works (or whatever your profession is). You’ll also want to spell out who your competitors are in your specific industry.
Financials: You’ll need to be able to show your expected earnings, and how long it will take you to get into profit. If you are in Network Marketing, use your company’s Fast Start programs to help you with this. Also, determine what you earn off an average Distributor or Customer, as this will also help you determine how many you need to be in profit.
Milestones: You’ll need to set milestones to help you know if you are on track. (This is important to the IRS too). Your Fast Start program is also a great place to start with this. Figure out where you will be in 30 days, 90 days, 6 months, 1 year, etc. This was a big mistake I made. If I had set up milestones, I wouldn’t have stayed with my 2nd company for four years. It would’ve made me make some serious decisions much sooner.
4. Keep a Journal.
I’m now keeping a journal. I update it every day with details of every conversation I had with a client or prospect. I note how many follow-ups I did, or every thing I did that day for my business. Now if the IRS wants to know what I talked about with John at our meeting on XX date, I can easily show him. It also helps me to go back and see what I did over the past weeks or months.
I’m sure there is a lot more, and I will have a few more below that you may find helpful. We won the appeal! We are officially a business in the eyes of the IRS. However we are still in negotiations with them. They took the time to audit us, so they want to make it lucrative for them whatever it takes.
Here are a couple of the points they are nailing us on that we are still in negotiations for, that might help you in the future.
1. Richard cannot be part of my business at this time.
Basically the reason for this is that the government wants both husband and wife to be paying self-employment taxes instead of just me paying them. That means that Richard needs to have his own Distributorship, or needs to be on my payroll so that he is earning income separately. At some time down the road, we will incorporate, and will have us both on a payroll, but that is not how we are setup at this time.
So that means I am not allowed to write off Richard’s travel expenses. That is a big deal for us because we travel at least 4-5 times each year.
On a side note, for those who have wondered about the MLM Cruise… The IRS had no problem with the MLM Cruise as long as I had an itinerary showing that we indeed were in training. So keep that itinerary with your taxes. The only problem they had is I cannot pay for Richard’s cruise and call it an expense.
If he is at an appointment with me, his meal cannot be included in the expense. His mileage cannot be counted, etc.
So yes, that really hurts us, but for now, while we are under the microscope, we’ll have to live with it.
2. Be very careful about the company name of people you do business with.
We hired a business coach during that year. Not a problem. But unfortunately, the coach’s company name was _____ Healing Center. (I don’t want to call them out here). The IRS says that sounds like a religious or personal name, and so we cannot write off that expense. So business coaches, please be very careful what name you choose for your business. Even if you are “conscious” or “woo woo”, your name needs to be business professional. Just fyi. 🙂 We’re working on finding proof that our coaching sessions were, in fact, business coaching to make the auditors happy.
3. They want to fine us heavily for “Nondisclosure(?)” (their word for fraud) because we “should have known better” than to have Richard be in our business. Not sure where that’s going to end up.
4. And of course, they have all kinds of penalties and late charges, etc.
So… sorry that was so long. I hope you found something here that is helpful to you in your business. Not everyone is going to get audited. Sometimes it’s just the luck of the draw. But being ready, and taking care of all of these things now will help save you should you be audited in the future.
I wish you all the best in your business. Let’s all go out there and build huge businesses and pay lots of taxes. Because paying lots of taxes means we’re making lots of money. 🙂
<—— Did this article help you? If so, it would mean a lot to me if you would share it with others!!! And, share your comments below! I would LOVE to know more about you and your thoughts on this subject!
Let’s have some conversation!
By Lynn Huber
p.s. Don’t spend all day on Facebook. Use an app like Push Button Power Leads to plan out a week or month’s worth of posts in advance. Then get off the computer and enjoy your life!
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