Independent Contractor Compliance Blog

Continuing our series on “things tax auditors may not tell you” we’ve now arrived at the moment of truth. This is the infamous day. The auditor is showing up for the first time to examine your “books and records” (auditor talk) and determine if you have properly classified your IC’s (grief for you unless you have been following my advice).

Are you ready?

Your accountant and/or tax attorney may be handling the audit.  If so, then you are probably going about your normal business routine and will not be too distracted. That’s what you’re paying the professional for – to take care of this distraction. So just wait it out and focus on your business operations.

The auditor is coming to the business. You should have a quiet room ready and the requested records available. 

First Rule: Always be polite and professional. It never helps to be polarizing in the beginning. The government has too many tools at their disposal to deal with businesses that will not cooperate. 

Definitely don’t drag out the Constitution, or other materials, claiming the auditor has no authority. The business will always lose this battle. Judges almost never side with a business that is labeled a “Tax Protester.”  One reason could be that judges are paid from taxes too, but the real reason is there are decades of case law that says the government does have the authority to examine your records during normal business hours. “Tax Protesters” accounts are “Flagged” on the government’s database which sets the government’s tone and attitude when dealing with these individuals. This means the auditor will bypass reasoning and explanations and be quicker to drag out the subpoenas, search warrants and issue grossly elevated estimated tax assessments, with terrifying penalties normal taxpayers never see.

So stay friendly, be reasonably cooperative, but don’t be a pushover.

The “Entrance Interview.” Different agencies may use different terms for this meeting, but most auditors will sit with your contact person before looking at any records and have a conversation, or interview.  This interview is a double edged sword. 

1. The front edge is to explain the purpose of the audit, its scope and answer questions you may have about the audit process. The auditor’s intent at this point is to create a more trusting atmosphere and to reduce the tension you may be experiencing.

2. The back edge is to learn more about your business, so the auditor can literally “cut to the chase” during the audit. He/she will be asking you such questions as:

• What type of legal entity is your company?
• May I see the Articles of Incorporation, Partnership Agreements, etc?
• Was there another form of ownership or entity prior to this one?
• What does you company do?
• When did you begin business?
• Do you have branch locations?
• Do you operate in other states or countries?
• Where?
• What kind of accounting system do you have?
• Is it automated, manual, a combination…?
• What type of employees and personal services do you employ?
• What type of contract or temporary services do you use?
• Do you consider them to be IC’s? (Many times the auditor will not ask why they are IC’s at this stage. He/she will wait until later in the audit process to do this because auditors know many employers become defensive once they are required to justify or explain the IC classifications. Defensiveness leads to polarization, which leads to cutting off the flow of information…)
• How are the IC’s listed in your accounting records?
• May I have a listing of the accounts in your accounting system for your Expense Ledger, Disbursements Journal, General Ledger, all Check Registers…? (The list goes on and on…)
• May I have a tour of your business (depending on the type of business)?
• If the audit was initiated because of a specific reason the auditor may discuss that topic and attempt to resolve it then-sometimes not.

In today’s internet world, the auditor has probably already obtained much of this information from your website and from other research websites. But a competent auditor will verify the details anyway. 

I think you see the true reason for the entrance interview. Auditors are not super-human sleuths who can independently dig out any and all items. The Entrance Interview is primarily designed to educate the auditor on your business and provides hints where the audit should be focused. You may want to keep that in mind…

Off to work the auditor goes. After the entrance interview the auditor will typically retire to the quiet room you have reserved for the audit. He/she will probably set up a laptop computer and begin the tedious work that accountants are generally good at and sometimes actually enjoy. The rest of us would rather go to the dentist than spend the day looking through a set of dusty accounting records, scratching for obscure entries that may or may not reveal potential unreported wages (another auditor term). 

Leave the auditor alone. I have never found it valuable to bother the auditor. It will just begin the polarizing process which is something you want to avoid during the early stages of the audit process. Polarizing may happen later, but by that time you will probably have called in your attorney* anyway and he’ll handle it for you.

*If and when you do call in an attorney, make sure it someone who is an experienced employment tax expert.

For now just smile and go about your other business. Once in a while drop by and ask “How’s it going?”  (You won’t get a real answer, so don’t expect one) and leave again. If the auditor has a question you’ll know. 

What’s next? 

What is the auditor doing locked up all day with your accounting records, humming to himself?