The IRS Can Choose Form OR Substance - What that Means for Your Business

Have you ever heard of form vs. substance or the form over substance doctrine in the context of accounting or tax law? I wouldn’t be surprised if you have never heard of it. But it’s actually very important to understand for your small business. Knowing what it is and what it means can make the difference between avoiding or passing an audit with flying colors and being charged more money, penalties, or fees that take resources away from your company and customers.

What Is the Form over Substance Doctrine?

The substance over form doctrine essentially allows the IRS to ignore what the law actually says about a transaction or arrangement (form) and examine and make a judgement based on what happened in or the impact of a transaction or arrangement (substance).

Put differently, the IRS may authorize or prohibit attaining tax benefits or write-offs based on either the legal form of the transaction or its actual substance. The substance over form doctrine allows the IRS to ignore an arrangement’s legal form and examine its actual substance, with the goal of preventing artificial structures from being used to avoid paying taxes.

How Form over Substance Affects Your Business

The problem is that the courts have generally allowed the IRS to pick and choose which aspect they want to adhere to or focus on, form or substance. Essentially, they’ll choose whichever route most benefits their case against you. That can lead to problems for your business if your form and substance don’t match.

In terms of your business, the form of your transactions are receipts and tax documentation, and the substance of your transactions are your books.

The only way you can overcome uncertainty of form vs. substance and ensure that the IRS does not have a successful audit if they look into your business is to make sure your documentation is done correctly (form) and your books are in order (substance).

Make Your Business Audit Proof

The last thing that you want is to be audited by the IRS. First off, they presume your guilt. Second off, 93% of IRS audits find discrepancies. By ensuring that your form and substance match each other, you can greatly reduce the chances that an IRS audit will find any irregularities with your company’s transactions.

The steps you have to take to make sure the two match up are really the same tax planning steps that you should be taking throughout the entire year.

·???????Keep meticulous records of your income, expenses, losses, and deductions over the course of the year.

·???????Use a bookkeeping software in order to keep your records neat, organized, up to date, and easy to retrieve.

·???????Utilize a payroll service to avoid discrepancies between payments and payroll tax withholdings (the common red flags for the IRS).

·???????Use credit over cash to help you better track all business transactions.

·???????Always separate business from personal expenses by using different bank accounts and credit cards for each.

·???????Correctly classify your company. Different types of businesses, such as C corporations, LLCs, S corporations, partnership LLCs, etc. have different rules governing their taxes.

If you’d like help understanding the form over substance doctrine or with making your business audit proof, then please reach out today. We can help!?