Five Red Flags Law Firms Should Consider to Avoid an IRS Audit

MIAMI, Feb. 06, 2012 – Miami accounting firm Kaufman Rossin, one of the largest independent accounting firms in Florida, is providing law firms with advice on how to avoid an IRS audit.

While many think the IRS selects tax returns randomly for audit, that’s far from true.  The IRS chooses those with the highest potential return on the time and energy they expend.  The most common things they look at are clerical errors, obvious overstatements of deductions or understatements of income.

To mitigate the risk of a law firm being audited, Scott Berger, CPA, tax principal with Kaufman Rossin offers the following five red flags for consideration:

1. Is the firm an S Corp.? If so, look at the compensation for stockholders.

Is the compensation paid to firm shareholders reasonable and justifiable? Officer’s compensation is one of the first things that the IRS looks at when reviewing a return.  If a shareholder earns a salary far below the market average or none at all this is a red flag.

2. How does the firm handle expense reimbursements?

It’s imperative that the firm has a policy and addresses the way expenses will be reported.  Attorneys shouldn’t characterize personal expenses as business expenses and vice versa.  Be sure to adequately document both the reimbursement policy and expense reimbursements.

3. Was all that money spent on meals and entertainment truly for business purposes?

Given the financial condition of the government at the federal, state, and local level, the enforcement of tax rules has gotten tougher.  Where it may have been possible to get away with vague presumptions in the past, the IRS is now cracking down. Make sure the firm has support for these claims – best guess estimates and missing receipts won’t suffice.

Firms may have to provide detailed information regarding the purpose of these expenses, such as who they were entertaining, and what was the business purpose, especially if it gets to the audit stage.

4. Are firms properly handling client costs?

Law firms should keep precise records and accurately allocate the expenses incurred on behalf of each client.

5. Large trust account balances should not be shown on the balance sheet.

If the firm has trust accounts for escrow funds, etc., the way it reports this money will certainly be scrutinized by the Bar Association and IRS. Properly record and reconcile all trust account transactions and ensure any income is properly recognized as well.

Law firms should plan ahead to identify issues and get the documentation they need. The stress of scrambling to produce all records at the last minute often leads to inaccuracies and cutting corners.  While it’s on their mind now, firms should make an effort to allocate a central location for all tax related documents year-round. Being thorough and accurate now will pay off when they’re unable to avoid the hassles of an IRS audit.

About Kaufman Rossin

Kaufman Rossin maintains offices in Miami, Fort Lauderdale, and Boca Raton. The firm has represented Florida businesses for nearly 50 years and serves international clients in more than three dozen countries.  It offers a complete array of traditional accounting services, as well as consulting services specially tailored to clients’ needs.   The firm has twice been named the Best Accounting Firm to Work For in an independent survey sponsored by Accounting Today.   With 300 members, the firm is large enough to provide versatility, but able to render the personal service upon which its reputation is based. For more information, visit www.kaufmanrossin.com.