Posts made in March 2017

8 tips for avoiding an IRS audit

The Denver Post | BUSINESS

By Gary Miller/GEM Strategy Management

POSTED: March 19, 2017, AT 5:29 AM

Gary Miller

Do not round out your numbers, the IRS views this as “sloppy” reporting

It’s tax season. Most business owners have either filed a 1040 tax return or an extension. Still, the question looms: Is this the year I get audited?

Every year the IRS sends notices to thousands of taxpayers informing them they have been selected for an audit. An audit can be a scary situation, one most small business owners try to avoid. Audits involve the government prying into your personal financial affairs, requesting sensitive financial information, and at times making you feel as if you’ve done something wrong. Audits are time-consuming and can be expensive — you may have to pay penalties and interest assessed on a tax liability and the cost of professional tax counsel to help you through the process.

How can you minimize your chance of being audited? It helps to understand how returns are selected. Since the IRS doesn’t have the budget to audit everyone, the agency assigns a numeric score from two scoring systems to every tax return. It is looking for under-reported income and overstated deductions. The higher your score, the higher your chances for an audit. Here’s how it works.

All tax returns are entered into a computer. The IRS uses one computer program called the Discriminate Inventory Function system and another program called the Unreported Income Discriminate Index Formula to determine the probability of inaccurate information and under-reported income. Each score is evaluated in conjunction with the other.

Different formulas are used for different types of tax returns. The IRS does not reveal the exact criteria and formulas used to score tax returns, but some information is known. It is important to note that complex tax returns have a higher chance of being audited – because complex tax returns usually are filed by high-income earners.

There are eight common audit triggers that you should keep in mind as you work on your tax return.

  1. Higher than average income.Taxpayers with incomes exceeding $200,000 have a greater chance of being audited that taxpayers of average income. If this applies to you, keep meticulous financial records in case you are audited.
  2. Disproportionate deductions.The IRS uses schedules to determine how much is too much for various income brackets. For example, if you claim charitable deductions that are out of line with your income bracket, watch out. The IRS will want proof.
  3. Rounded or averaged numbers.If your total deductions are $15,998, don’t report the deduction as $16,000. The IRS agent reviewing your return tends to believe that rounded or averaged numbers are “sloppy” and that the rest of your return may contain inaccuracies.
  4. Home office deductions.These are often abused by business owners. Even though the IRS has simplified the home office deduction method, requirements necessary to take the deduction have not been relaxed. You can still only claim a portion of your home office if it is exclusively dedicated to your business.
  5. Claiming business losses year after year.The agency knows some people claim hobby expenses as business losses, and under the tax code, that’s illegal. If your business claims a net loss for too many years or fails to meet other requirements, the IRS may classify it as a hobby, which would prevent you from claiming a business loss. If the IRS classifies your business as a hobby, you’ll have to prove that you had a valid profit motive if you want to claim those deductions.
  6. Filing a Schedule C.The IRS looks closely at this form. A Schedule C (Form 1040) is used to report income or losses from a business you operate or a profession you practice as a sole proprietor. An activity qualifies as a business if your primary purpose is for income or profit.  You have to be involved in the activity with continuity and regularity. Make sure that you have careful documentation to justify all of your deductions.
  7. Excessive deduction for business entertainment.We all know stories about someone who takes friends out to dinner and then writes it off as a business expense. So does the IRS. Don’t take your family on a business trip and try to write off their expenses. If your return has higher-than-average entertainment expenses compared to your income, you could find yourself sitting across the table from an IRS agent. You will need receipts for all expenses greater than $75 when traveling for business.
  8. Claiming your vehicle as 100 percent business use.Deducting both the IRS standard mileage rate and actual vehicle expenses will cause the IRS to come knocking. In addition, if you claim 100 percent business use on the depreciation form for your vehicle, you’ll need precise records that include mileage logs, dates and the purpose of every trip.

Your best defense against these eight triggers is keeping complete and detailed records. If you have questions about filing your return, seek tax counsel or ask a professional tax preparer. If you have already filed your return and think there could be problems with it, consider amending your return.

Gary Miller / GEM Strategy Management

Gary Miller is the CEO of GEM Strategy Management, Inc., an M&A consulting firm, advising middle-market private business owners prepare to raise capital, sell their businesses or buy companies. He is a sought-after business consultant and speaker on M&A issues, strategic business planning, business valuations, exit planning, what buyers are looking for in acquisitions and how to prepare for due diligence. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.

 

Headed for a crash? 50 Leading indicators

By Bob Vanourek, Senior Consultant, GEM Strategy Management, Inc.

Posted March 6, 2017

Why is it that a corporate financial crash seems obvious in hindsight? The “Monday morning quarterbacks” cite the warning signs that were brewing. But why weren’t those signals heeded beforehand? Is your organization headed for a financial implosion?

Sometimes major external shifts cause a company to go under – shifts such as a major industry crisis or technology transformation. More frequently, a company implodes because of internal deficiencies that leaders ignore. But internally driven crashes don’t occur without emitting warning signs. These warning signs are not financial signals, such as revenue declines, shrinking margins, slowing inventory turns, deteriorating working capital ratios, and falling profits. Those metrics are lagging indicators.

Leading indicators are more important to watch because leaders can address them before the financials go south. What are some early warning signals of a potential crash? Based on my experience as a leader in eight industries and as the CEO of five very different companies, here’s my list of 50 red-flag indicators covering a wide variety of signals. I list 50 leading indicators because, even though some are louder warnings than others, all are important to understand the future of your business

You and some trusted colleagues can score your organization on these warning signals.

 50 Early Warning Signals of an Organizational Crash

Scoring system:

5 points = this happens often

3 points = this happens occasionally

1 point = we don’t have this problem

 

  1. Not holding people accountable for results.
  2. Not paying attention to how results are achieved (sometimes they are achieved unethically, leading to a future blowback).
  3. Tolerating abusive, egotistical superstars.
  4. Seeing complacency in people’s work.
  5. Sacrificing the long-term good for the short-term expedient.
  6. Neglecting integrity, cultural fit, and emotional intelligence in hiring and promotions.
  7. Failing to invest in developing people.
  8. Not listening to people.
  9. Lack of clarity in why the organization exists (is your organization’s purpose inspirational, or is it all about making money for you?).
  10.  Lack of commitment to mutually developed shared values to guide the behavior of people.
  11.  Leaders not flexing between the hard (steel) and soft (velvet) edges of leadership depending on the circumstances.
  12.  Excessively tight controls that stifle creativity.
  13.  Leaders being too easy-going because they want to be liked.
  14.  Excessive deference to the top leader(s).
  15.  Leaders making virtually all the decisions (not empowering others).
  16.  Failing to tap into the capabilities of people.
  17.  Weak, inadequate board of directors or advisors.
  18.  Constantly changing priorities
  19.  Poor communications and secrecy.
  20.  People operating in independent silos.
  21.  Insufficient understanding of how departments are interrelated.
  22.  Lack of discipline to execute well.
  23.  Lack of trust between people.
  24.  Treating people disrespectfully.
  25.  Leaders having favorites among people.
  26.  Excessive employee turnover.
  27.  Incidents of internal sabotage or theft.
  28.  Lack of rigorous, honest feedback from customers.
  29. Lack of rigorous, honest feedback from vendors.
  30. Lack of rigorous, honest feedback from employees.
  31.  Failure to cut unprofitable products or services.
  32.  Failure to understand new market trends.
  33.  Failure to invest in new products and services.
  34.  Excessive debt and interest expense.
  35.  Insufficient capital.
  36.  Lack of reasonable financial controls.
  37.  Excessive dependence on a single, or very few, customers.
  38.  Excessively high or low compensation and benefit levels.
  39.  Excessive travel and entertainment spending.
  40.  Owners taking excessive funds out of the business.
  41.  Leaders not knowledgeable of financial details.
  42.  Lack of rigorous financial planning and budgeting.
  43.  Exploiting vendors with excess pressure to lower costs.
  44.  Giving insufficient attention to local community needs and issues.
  45.  Insufficient policies, systems, and procedures to guide people’s work.
  46.  Poor quality products or services.
  47.  Unaddressed safety issues.
  48.  Excessive stress levels among people.
  49.  Constant surprises.
  50.  Leaders in denial about what’s really going on in their business.

To ensure you have an objective assessment, have one or two trusted colleagues also score your organization, even if they have to make some guesses at some answers. Assure them they will not be penalized for an honest assessment – you are trying to avoid a disastrous crash.

If your organization scored:

·         50-125 points: Congratulations, you are unlikely to crash and burn.

·         126-200 points: There could be trouble ahead. Some changes are needed.

·         201-250 points: Disaster looms.

Practical Applications:

Review and discuss any metrics with a 1 or 3 rating. Then you and your team can brainstorm solutions and prioritize action plans. You’ll unleash their creativity and heighten their engagement.

There is no reason for you to be blindsided by an organizational crash. Pay attention to the warning signs of leading indicators.

Bob Vanourek is a senior consultant with GEM Strategy Management and is the former CEO of five companies and a frequent speaker, consultant, and coach on organizational leadership. He is the co-author of the award-winning book, Triple Crown Leadership: Building Excellent, Ethical, and Enduring Organizations. Bob’s latest book is Leadership Wisdom: Lessons from Poetry, Prose, and Curious Verse http://tinyurl.com/zr2peng You can see Bob’s entire profile on http:gemstrategymanagement.com or reach him at 970.390.4441.