The last thing a medical practice wants to face is an IRS audit. Fortunately, audit rates are low — around 1 percent — making IRS audits the exception rather than the rule. However, if your practice is unlucky enough to be audited, there are three important points to remember.
Excellent Books and Records Are Essential
Well-documented bookkeeping and records are going to be your best assets if your practice is selected for audit. If an IRS agent sees an organized set of books, he or she is likely to perceive that your practice is more compliant, which may cause the examination to be curtailed. Conversely, a messy set of books will be more difficult for the agent to follow and create a real or perceived belief that additional examination is needed.
Through an IRS audit, taxpayers are required to provide supporting documentation (typically for expenses) for their bookkeeping. It is certainly helpful to have canceled checks to document your various payments to vendors and suppliers. However, do your records also include items such as purchase orders, bills of lading and receipts? If not, the IRS agent may understand that you have made payments but does not know why the payments were made and attempt to deny the associated deductions. It is, therefore, essential that your practice maintain not only bank records, but also other supporting documentation that corroborates the bookkeeping entries. In fact, IRS agents are willing to overlook an unsupported deduction here and there if they see that most of the other deductions are well-supported.
Another important point to note is that certain expenses are treated differently for income tax purposes. For example, life insurance is typically a nondeductible expense for income tax purposes. If the practice’s books simply report “Insurance Expense” with no breakout, then the income tax return may be inadvertently deducting nondeductible life insurance payments.
If the bookkeeping and record-keeping processes in your practice are deficient, action should be taken to resolve these weaknesses. Otherwise, your practice may be scrambling to repair books on the eve of an examination and trying to find supporting documentation that is no longer available.
Travel, Meals and Entertainment
Travel, meals and entertainment are seen by the IRS as an area with high potential for taxpayer abuse. Not surprisingly then, a special Internal Revenue Code provision (Section 274) exists to combat potential abuse and requires taxpayers to substantiate deductions through adequate records with the amount of the expense, the time and place of the expense, the business purpose, and the business relationship of the person(s) associated with the travel, meals and entertainment. For example, a medical practice pays for hotel costs of several of its physicians to attend an out-of-town conference. A credit card statement showing the payment to the hotel would not be adequate evidence. Instead, a bill from the hotel showing the various components of the hotel charges is required. The key point with travel, meals and entertainment is that the documentation requirements are more stringent and require those who maintain the records to adequately understand the rules.
Appointing a Third Party to Represent You
Taxpayers have the option to have a third-party representative conduct the audit on their behalf. A third-party representative is authorized by presenting a completed and signed Form 2848, Power of Attorney and Declaration of Representative, to the IRS. Considering the stress that an audit can have, it is generally a good idea for a taxpayer not to handle the examination directly. In most cases, a practice’s CPA can assist with an examination, and it is typically best to have the CPA work on the examination from the start. A CPA help can help present the available information in the best light and also take the emotion out of the examination process.
Although rare, an IRS audit is still an ever-present and daunting reality for medical practices. With good books and records, especially for travel, meals and entertainment, and strong professional CPA representation, your practice can make the best of a difficult situation.
Bennett Allison, CPA, CFP, is a shareholder at Sol Schwartz & Associates P.C. (email@example.com). He has over 20 years of public accounting experience serving individuals, corporations, S corporations, partnerships, trusts, estates and nonprofit organizations. In addition, Bennett works with a high concentration of physician practices and high-net-worth individuals. Contact him at 210-384-8000, Ext. 138.