Checklist · Tax
Setting Up Business Tax Compliance and Responding to an Audit: A Practical Checklist
26 U.S.C. § 446
- Type
- Checklist
- Jurisdiction
- National
- Date
- 2024-07-26
- Topic
- Tax
This checklist takes a business owner from formation through examination. It opens with the setup steps that must happen in the first ninety days, because nearly every later failure traces to a habit not established at the start. Separate sections cover estimated payments and the safe harbor that makes them predictable, entity selection and the reasonable compensation analysis an S corporation owner must document, and the payroll obligations that create the only tax liability an owner can never escape. Recordkeeping sections set out exactly what must exist and when it must be created. A full audit section covers what to do when an examination notice arrives, what to produce and what not to, how to handle interviews, and the deficiency and appeal deadlines that are jurisdictional. Further sections address worker classification, state and local registration, retirement plans, year-end planning, and closing or selling a business. Every item is written to be worked by an owner and relied on by counsel.
Setting Up Business Tax Compliance and Responding to an Audit: A Practical Checklist
Tax > Business and Self-Employment Tax | Published 26 July 2024 - Updated 26 November 2025 | UpLaw - uplaw.us
Business tax rewards habits over cleverness. Work section 1 in your first month and most of the rest becomes routine.
Items marked ⚠ are the ones where the natural instinct causes the most damage.
Section 1 — First ninety days
☐ Choose an entity for both liability and tax, recognizing they can point different ways. See starting and running a small business. ☐ Obtain an employer identification number, even as a sole proprietor. ☐ Open a business checking account. ⚠ Never run business money through a personal account. Commingling invites a bank-deposits analysis in which every deposit is presumed income. ☐ Open a separate tax savings account. ⭐ This single habit is the highest-value item in this checklist. ☐ Set a standing transfer of a fixed percentage of every deposit into that account, on receipt. ☐ Choose the accounting method — cash or accrual under 26 U.S.C. § 446 — and the tax year under 26 U.S.C. § 441. ☐ Set up accounting software connected to the bank feed. ☐ Adopt a written accountable plan so reimbursements are not treated as wages. ☐ Start the mileage log today. ⚠ It cannot be created later with any credibility. ☐ Consider qualified small business stock eligibility under 26 U.S.C. § 1202 — ⭐ it cannot be created retroactively. ☐ Document capital contributions under 26 U.S.C. § 351 or 26 U.S.C. § 721. ☐ Calendar the four estimated payment dates, payroll deposit dates, information return deadlines, and the entity return deadline. ☐ Schedule an October planning meeting — ⭐ while decisions can still be made.
Section 2 — Estimated payments
☐ Understand why the bill is larger than expected: you pay both halves of the payroll tax under 26 U.S.C. § 1401, and nothing is withheld. ☐ Compute the four installments. The penalty under 26 U.S.C. § 6654 is calculated period by period; corporations face 26 U.S.C. § 6655. ☐ ⭐ Use the prior-year safe harbor if income is unpredictable — it is a known number. ☐ Consider the annualized income method if income arrives unevenly. ☐ ⭐ If you or a spouse also has wages, increasing withholding late in the year cures an earlier shortfall — withholding is treated as paid evenly. ☐ ⚠ An extension to file is not an extension to pay — 26 U.S.C. § 6151, 26 U.S.C. § 6081. ☐ ⭐ File even when you cannot pay. The failure-to-file penalty under 26 U.S.C. § 6651 is many times the failure-to-pay penalty.
Section 3 — Entity and owner compensation
☐ Revisit entity form annually. ⭐ Profit changes the answer; an S election that made no sense at $60,000 frequently makes sense at $200,000. ☐ Model total cost, including payroll administration, return preparation, and state entity taxes. ☐ If electing S corporation status, confirm eligibility under 26 U.S.C. § 1361 and make the election under 26 U.S.C. § 1362. ☐ ⚠ Pay reasonable wages. This is the most examined issue in small-business tax. ☐ Document the compensation analysis contemporaneously, addressing duties, hours, industry and regional comparables, revenue and profitability, and replacement cost. ☐ ⚠ Do not select the number to minimize tax and construct support afterward. ☐ Track basis for loss and distribution limits — 26 U.S.C. § 1366, 26 U.S.C. § 1368. ☐ For partnerships, track outside basis including liabilities under 26 U.S.C. § 752, and distinguish guaranteed payments under 26 U.S.C. § 707. ☐ Watch built-in gains on conversion from C status — 26 U.S.C. § 1374.
Section 4 — Payroll
☐ Set up payroll properly before the first paycheck, not after. ⚠ Deposit obligations begin immediately. ☐ Withhold income tax — 26 U.S.C. § 3401, 26 U.S.C. § 3402; employer liability at 26 U.S.C. § 3403. ☐ Withhold and match — 26 U.S.C. § 3101, 26 U.S.C. § 3111; wage definition at 26 U.S.C. § 3121. ☐ Pay federal unemployment tax — 26 U.S.C. § 3301. ☐ Deposit on the required schedule. ⚠ Penalties escalate quickly and apply even where the return is correct. ☐ Report wages under 26 U.S.C. § 6051 and tips under 26 U.S.C. § 6053; regulations at 26 C.F.R. part 31.
⭐ The absolute rule
☐ ⚠ If cash is short, pay the payroll taxes before rent, before the bank, before yourself. ☐ Under 26 U.S.C. § 6672, any responsible person who willfully fails to pay over withheld taxes is personally liable. ☐ "Responsible" reaches owners, officers, controllers, and bookkeepers — anyone deciding which bills get paid. ☐ "Willful" does not require bad intent; ⚠ knowing the taxes were due and paying others instead is enough. ☐ The liability survives dissolution and is not dischargeable in bankruptcy. ☐ Criminal exposure at 26 U.S.C. § 7202. ☐ See when a business cannot pay.
Section 5 — Records that survive examination
☐ Monthly bank reconciliation, without exception. ☐ Receipts organized by category, retained through the period at 26 U.S.C. § 6501 and longer for assets. ☐ Contemporaneous mileage log — date, destination, purpose, miles. ⭐ The most commonly disallowed deduction in small-business examinations. ☐ Meal and travel documentation meeting 26 U.S.C. § 274: amount, time, place, business purpose, business relationship. ☐ Home office — photograph the space, measure it, document exclusive and regular use. ☐ Vehicle records under the limits at 26 U.S.C. § 280F. ☐ Payroll records and deposit confirmations. ☐ Fixed asset schedule with dates, cost, and method — 26 U.S.C. § 167, 26 U.S.C. § 168, 26 U.S.C. § 179. ☐ Inventory counts where required by 26 U.S.C. § 471. ☐ Material participation hours where 26 U.S.C. § 469 applies. ☐ Written related-party agreements priced at arm's length. ☐ ⭐ Reconstruct nothing. Records made at the time carry weight that records made for the audit never do.
Section 6 — Information returns
☐ Collect taxpayer identification numbers before paying any vendor. ⭐ Chasing them after year end rarely works, and refusal triggers backup withholding. ☐ File contractor information returns on time; ⚠ penalties apply per return for both failure to file and failure to furnish. ☐ Report other business payments under 26 U.S.C. § 6041; broker and barter transactions under 26 U.S.C. § 6045. ☐ Reconcile payment card reporting to your own revenue. ⚠ The reported figure is gross of fees and refunds and will not match your books. ☐ Furnish owner schedules on time for partnerships and S corporations — penalties at 26 U.S.C. § 6699. ☐ Confirm entity filing obligations — 26 U.S.C. § 6011, 26 U.S.C. § 6012, 26 U.S.C. § 6031, 26 U.S.C. § 6037, with deadlines at 26 U.S.C. § 6072. ☐ ⭐ Spend one afternoon in December collecting missing identification numbers. It prevents most penalties in this section.
Section 7 — When an examination notice arrives
☐ Read it carefully to identify the type — correspondence, office, or field — the years at issue, and the items selected. ☐ Calendar every date stated, and calendar them again with counsel. ☐ Engage representation before responding. ⚠ The person who prepared the return is not always the right person to defend it. ☐ Do not call the examiner informally. Everything said is a statement about the return. ☐ Assemble the records requested — and only those requested. ⭐ Producing more than was asked expands the examination. ☐ Reconcile before producing. Know what the records show before the examiner does. ☐ Do not create documents that did not exist. ⚠ A reconstructed log presented as contemporaneous is far worse than no log. ☐ Prepare a written narrative explaining the business, its records, and any unusual items. ☐ Consider whether the interview should happen at all, and if so, whether the taxpayer should attend or be represented. ☐ Invoke 26 U.S.C. § 7605 where a second examination of the same year is proposed. ☐ Understand summons authority at 26 U.S.C. § 7602. ☐ ⚠ Assess criminal exposure before saying anything. 26 U.S.C. § 7525 practitioner privilege is narrower than attorney-client privilege and does not apply in criminal matters — ⭐ where exposure exists, counsel should engage the accountant. Relevant offenses: 26 U.S.C. § 7201, 26 U.S.C. § 7203, 26 U.S.C. § 7206.
Section 8 — Deficiency, appeal, and collection
☐ Review the examination report and identify each proposed adjustment and its basis. ☐ Request an appeals conference where adjustments are contested; it is faster and cheaper than litigation. ☐ ⚠ When a notice of deficiency issues under 26 U.S.C. § 6212, the petition deadline under 26 U.S.C. § 6213 is jurisdictional and cannot be extended for any reason. Calendar it the day the notice arrives. ☐ Check the assessment period under 26 U.S.C. § 6501; United States v. Home Concrete & Supply addressed the substantial-omission extension. ☐ ⚠ Think carefully before signing a consent to extend the assessment period. It is sometimes wise and sometimes not. ☐ Contest penalties separately — accuracy-related under 26 U.S.C. § 6662, late filing and payment under 26 U.S.C. § 6651. Reasonable cause is a real defense and is frequently not asserted. ☐ File protective refund claims where appropriate — 26 U.S.C. § 6511. ☐ On collection, understand the lien under 26 U.S.C. § 6321 and 26 U.S.C. § 6323, the levy under 26 U.S.C. § 6331, and exemptions at 26 U.S.C. § 6334; procedures at 26 C.F.R. part 301 and 26 C.F.R. part 601. ☐ See tax controversy for individuals, the letter from the IRS, and responding to an IRS notice, audit, or collection action.
Section 9 — Worker classification
☐ Analyze the relationship, not the paperwork. ⚠ Issuing an information return does not create contractor status. ☐ Understand where the exposure falls — on the business, as back taxes, penalties, and interest. ☐ Check relief provisions for a reasonable basis and consistent treatment. ☐ Treat similarly situated workers consistently; inconsistency defeats most relief. ☐ Document the analysis at the time the relationship begins. ☐ See worker classification, employee or contractor, and assessing and challenging a worker classification.
Section 10 — State and local
☐ Register for state income tax withholding and unemployment in every state where an employee works — ⚠ including a single remote employee. ☐ Analyze sales tax — taxability, sourcing, and economic nexus thresholds. ☐ ⚠ Sales tax collected and not remitted is a trust fund obligation in most states, with personal liability parallel to 26 U.S.C. § 6672. ☐ Check for local business licenses, gross receipts taxes, and occupational taxes. ☐ Note franchise or entity taxes owed even in a loss year. ☐ File business personal property renditions where required. See property tax assessment and appeals. ☐ ⚠ Do not register where you have no obligation — registration creates ongoing filings until formal withdrawal. ☐ ⭐ Before hiring in a new state or shipping into one at volume, ask what obligations that creates.
Section 11 — Year-end planning
☐ Project the year's profit and resulting tax in October. ☐ On the cash method, decide timing — accelerate expenses or defer billing. ⭐ The most accessible planning tool available. ☐ Evaluate equipment purchases against 26 U.S.C. § 179, noting the taxable income limit. ⚠ Never buy equipment primarily for the deduction. ☐ Fund a retirement plan — ⭐ usually the largest legitimate deduction available, and it builds wealth rather than deferring a bill. Confirm establishment deadlines by plan type. See employee benefits and ERISA. ☐ Confirm the tax savings account holds enough. ⭐ Know that in October, not April. ☐ Review reasonable compensation for the year and adjust before it closes. ☐ Collect missing vendor identification numbers. ☐ Confirm all payroll deposits are current.
Section 12 — Selling or closing
☐ Allocate purchase price under 26 U.S.C. § 1060; ⚠ buyer and seller have opposing interests and must be consistent. ☐ Model asset versus stock treatment — recapture at 26 U.S.C. § 1245 and 26 U.S.C. § 1250, character at 26 U.S.C. § 1231, gain at 26 U.S.C. § 1001. ☐ Check qualified small business stock eligibility under 26 U.S.C. § 1202 — ⭐ frequently the largest item in a sale, and only if structured years earlier. ☐ File final payroll returns and deposits. ⚠ Closing does not extinguish liability under 26 U.S.C. § 6672. ☐ File final information returns. ☐ Formally withdraw state registrations. ☐ Retain records well beyond closing — ⚠ a closed business still gets examined. ☐ See owner disputes and business dissolution.
Section 13 — Quick reference
| Your situation | Do this first | Watch out for |
|---|---|---|
| Just started | Open two accounts and start the mileage log | ⚠ Commingling |
| First tax bill was a shock | Adopt the prior-year safe harbor | Both payroll halves |
| Income is unpredictable | Transfer a percentage on every deposit | Nothing is withheld |
| Profit is growing | Revisit entity form | S election threshold |
| S corporation owner | Document reasonable compensation | ⚠ The most examined issue |
| About to hire | Set up payroll before the first check | Deposit obligations begin at once |
| Cash is short | ⭐ Pay payroll taxes first | 26 U.S.C. § 6672 is personal and permanent |
| Considering a contractor | Analyze the relationship, not the form | Exposure falls on the business |
| Hiring remotely | Check that state's obligations | ⚠ One employee creates them |
| Buying equipment | Model the taxable income limit | Deductions do not create income |
| Profitable and no plan | Fund a retirement plan | ⭐ The biggest missed deduction |
| Examination notice | Engage representation before responding | ⚠ Produce only what was asked |
| Notice of deficiency | Calendar the petition date | ⚠ Jurisdictional; cannot be extended |
| Selling the business | Model the allocation | Buyer and seller diverge |
| Closing | File finals; withdraw registrations | Trust fund liability survives |
☐ Print this and keep it with the tax file. ⭐ Two habits prevent most of what goes wrong: separate the money, and make the record at the time.
Section 14 — Worked example: a first year done right
Priya leaves a salaried role in February to consult. She expects to bill about $130,000 in her first ten months.
Week 1. She forms a single-member LLC for liability separation, obtains an employer identification number, and opens two accounts: business checking and a tax savings account. She sets a standing rule — 30 percent of every deposit moves to the tax account the day it clears. ⭐ She never looks at the tax account balance as available money.
Week 2. She connects accounting software to the bank feed, adopts the cash method under 26 U.S.C. § 446, and begins a mileage log in her phone the first day she drives to a client.
Month 2. She meets an accountant — ⭐ not in filing season. They calendar the four estimated payment dates. Because there is no prior year of self-employment, they estimate conservatively and agree to revisit in June.
Month 4. She hires a contractor for design work and collects the taxpayer identification number before paying the first invoice.
Month 7. Profit is running higher than projected. The accountant models an S election for the following year and concludes it will pay for itself; they defer it rather than making a mid-year change.
October. Projection meeting. Profit will be about $104,000. They confirm the tax account holds enough — it does. She opens a solo retirement plan and funds a substantial contribution, ⭐ which is the single largest deduction available to her and converts tax into her own retirement assets. They decide to defer December billing into January and to prepay her January insurance in December.
December. She collects two missing vendor identification numbers and confirms the fixed asset schedule.
April. The return is filed. There is no penalty, no surprise, and the balance due is roughly what the tax account holds.
⭐ Nothing here was clever. Two accounts, a standing transfer, a log kept as she drove, an October meeting, and a retirement plan. That is the whole system, and it outperforms sophisticated planning built on mixed accounts and reconstructed receipts every single year.
⚠ Compare the version without the second account: the money gets spent as it arrives, April brings a bill she cannot pay plus an estimated tax penalty, and she begins year two already behind — which is how most first-year businesses actually experience this.
Section 15 — Planning techniques, honestly assessed
☐ Timing on the cash method — ⭐ legitimate, free, and the most accessible tool available. ☐ S election with reasonable wages — legitimate above a profit threshold; ⚠ dangerous if the wage figure is not defensible. ☐ Retirement contributions — ⭐ the largest legitimate deduction most owners can access. ☐ Hiring family — legitimate if the work is real and pay is reasonable; ⚠ a child on the payroll who does nothing is an adjustment plus a penalty. ☐ Accountable plans — free, simple, routinely omitted. ☐ Section 179 and bonus depreciation — legitimate but income-limited under 26 U.S.C. § 179. ☐ Home office — legitimate with exclusive and regular use. ☐ Vehicle deductions — legitimate with a contemporaneous log; the most commonly disallowed item. ☐ Renting your home to your business — a narrow provision, ⚠ routinely oversold and rarely documented adequately. ☐ Captive insurance and similar arrangements — ⚠ heavily scrutinized; several structures marketed to small businesses have been treated as abusive, with penalties and reporting obligations. ☐ Running personal expenses through the business — ⚠ not a technique. It is a disallowance, a possible constructive distribution, and evidence that undermines the entire return. ☐ ⭐ The filter: would this survive being described plainly to an examiner? If it depends on going unnoticed, it is not planning.
Section 16 — Choosing an accountant
☐ Engage before the first year ends, not in filing season. ⭐ An accountant met in March can only report what happened; one engaged in month two can change it. ☐ Clarify which services they provide — bookkeeping, preparation, planning, and representation are distinct. ☐ Ask whether they represent clients in examinations, and how often. ☐ Agree explicitly who reconciles the accounts. ⚠ The common failure is each side assuming the other does it. ☐ Ask for an October projection, every year. ☐ Ask them to revisit entity form annually. ☐ Ask about retirement plan options before year end. ☐ Understand privilege limits — 26 U.S.C. § 7525 does not reach criminal matters. ☐ ⭐ Ask this question every year: "What am I doing that would be hard to defend in an examination?" A good accountant will have an answer.