WILL HIGHFIELD BOOKKEEPING AND TAX
603 E. Emma St., Lafayette, CO 80026 720-251-2249
Income Tax Preparation for
Single Member LLCs
The IRS and You
The IRS has undergone some profound changes. One
is that they are now completely computer oriented. They
are able to track most, if not all, of your wages, your
withholdings, your school payments, you interest, your
subcontractor income, and your tax history.
However, they have a blind spot with many small
businesses. Very often the income earned by business
owners cannot be tracked by the IRS. Instead it must be
reported on your Schedule C. Your expenses are also not
known to the IRS until you report them. This leaves the
IRS at a disadvantage and you can be sure that they have
devised ways to know approximately what a kind of
income and expenses a person in your kind of business is
likely to have. When you file your tax return it will be
compared to others of similar businesses. Most of their
audits occur when the information, contained in a person’s
tax returns, does not match up with the profile for a
business which the IRS has on file.
A more recent change is the budget cuts forced on
them by Congress. This affects you because there are
fewer people to answer the phones and give you help.
Would it surprise you to know that even tax professionals
have difficulty getting the IRS to answer a phone call?
This means that most audits are done completely by mail.
Communication with the IRS in a timely way by mail has
become extremely important. Anybody can be audited.
Never ignore a letter from the IRS.
Things like too little income or too many
inappropriate expenses can trigger an audit. Audits will be
discussed a little later on this page.
The IRS makes mistakes. They lose information.
Sometimes something in a taxpayer’s return raises a red
flag and they decide to investigate. Sometimes they just
get it wrong. These mistakes can be corrected during the
audit process. The very worst thing you can do is ignore
letters from the IRS. Open the letter and then bring it to
me if you need help. I am your representative before the
Red Flags! Schedule C businesses, which are the type
that I serve, are the most highly audited of all businesses.
They are most prone to have mistakes in their tax
preparation. Some of the mistakes people make that catch
the eye of the IRS computers are • trying to disguise
expensive personal purchases, such as autos or boats, as
business deductions • not reporting all income • exaggerating
expenses • having a business profile which does not match
up with similar businesses in the IRS data base.
Most of tax law is set by Congress. Although some is
set by the other branches of government, most is set by
congress. The IRS interprets and administers these tax laws.
If you don’t like their interpretation of what you owe, and
you can’t get satisfaction using the means available within
the IRS system, there are options available to you. There is
an appeal agency which operates independently from the
IRS, and there is always the U. S. Tax Court. Most of you
will not have these kinds of issues and will be able to resolve
your audit issues by mail. But it is important to know the
procedures of the IRS when it comes to organizing your
business and submitting your taxes.
The 4 types of audit are:
• correspondence audit - the most common type. It
requests more information about a part of your tax return.
You will be required to substantiate the income and
deductions in question.
• office audit - a more serious audit during which you
will be asked specific questions requiring specific answers.
These usually are done in a day. If more questions are asked
you will be given time to prepare your answers.
• field audit - the most serious audit. You will be
visited at your home or business by an IRS field agent. You
should have representation because they are looking for
• random audit - the IRS examines a return randomly,
with no particular area of focus. It is designed to keep you
on your toes. The best solution is for you to keep good
books, save all your receipts, and file an accurate return.
There are two basic accounting methods, and a third
which is a combination of the first two.
The cash method is the most common and is perfectly
acceptable for most of the businesses I serve. With the cash
method income and expenses are recorded when they happen,
with the exception of certain pre-paid expenses.
The accrual method enters income and expenses when
they are incurred rather than when the transaction actually
takes place. For instance, you might complete a contract and
yet not be paid until some time later. The income is recorded
when you finish the work, not when you are actually paid. It
is similar with expenses. They are recorded when they are
incurred, not when they are actually paid. This method of
accounting is used when financial reports are required by
financial institutions who have an interest in your business. It
is also required if you keep an inventory and have gross
receipts over one million dollar and are prohibited from using
I use Quickbooks for my bookkeeping. It is very
accurate and fast and is used by nearly 95% of bookkeepers.
However, you can use a spreadsheet if that is your
preference. Setting up the books with a logical chart of
accounts allows a straightforward transfer of income and
expenses to your Schedule C. If you want I can set up your
books with a minimum of fuss.
You must keep records of income and epenses to justify
the entires in your books. The IRS is very specific about the
types of records it accepts, and how long you have to keep
them. In case of an audit if you do not have proof they will
discredit your deduction. Keep your receipts!
Turn a Hobby Into a Business
There are few tax benefits from having a hobby, but a
profitable business allows a great many tax benefits. These
include • deductions for business use of the home • the
deduction of "ordinary and necessary" business expenses •
you can claim a business loss • the deduction of some start-up
and organizational costs • some mileage, meal and
If you have decided to go to work for yourself, or have a
profitable hobby and would like to increase your tax
deductions, keep in mind that the IRS wants you to make a
profit. If you show a loss for too many years they will
question your “profit motive.” The following eight items are
are strong indicators of a profit motive even if you are
1) Does the time and effort put into the activity indicate
an intention to make a profit?
2) Does the taxpayer depend on income from the
activity? A dependency on this source of income is an
indicator of a good profit motive.
3) If there are losses, are they due to circumstances
beyond the taxpayer’s control or did they occur in the start-up
phase of the business?
4) Has the taxpayer changed methods of operation to
5) Does the taxpayer or his/her advisors have the
knowledge needed to carry on the activity as a successful
6) Has the taxpayer made a profit in similar activities in
7) Does the activity make a profit in some years?
8) Can the taxpayer expect to make a profit in the future
from the appreciation of assets used in the activity?
If you begin a business without plannning for its
success you cannot expect it to make money. The IRS wants
to see a profit three of the last five years for most businesses,
so it is in your best interest to constantly improve it, keep
good records, and show an increasing knowledge of the type
of business you are operating. A business which does not
meet this criteria stands the chance of being declared a
hobby by the IRS. If this happens many of your tax benefits
will be lost and you may end up owing back taxes. It just
makes sense to do everything you can to run a profitable
The IRS affects you and your
business in many ways. This page
discusses some of the basics, such
The IRS and You
Turning a profitable hobby
into a business