Running a small business requires you to manage customers, employees, finances, and countless daily responsibilities. The last thing most business owners want to think about is receiving a letter from the IRS.

An IRS audit is an examination of a tax return or related financial information to determine whether the information reported is accurate and whether the correct amount of tax was paid.

For a small business, an audit may focus on specific items, such as income or deductions, or it may involve a broader examination of the business's tax return and supporting records.

An audit does not automatically mean that you did something wrong. The IRS selects some returns because information appears inconsistent or requires additional review, while other returns may be selected through statistical or random processes.

Understanding how audits work can help business owners respond appropriately if they receive an IRS notice.

What Can Trigger a Small Business Tax Audit?

There is no single factor that guarantees an audit. The IRS uses various methods to identify returns that may require examination.

Some situations that can attract additional attention include:

Large or unusual deductions

Business expenses should be reasonable, properly documented, and connected to the operation of the business.

Large deductions for areas such as vehicles, travel, meals, or other expenses may receive additional scrutiny when they appear inconsistent with the business's income or activities.

This does not mean that claiming a large legitimate deduction automatically causes an audit. The important issue is whether the deduction is properly supported and meets the applicable tax requirements.

Income that doesn't match IRS records

The IRS receives information from employers, financial institutions, payment processors, and other third parties.

If the income reported on a tax return doesn't match information reported to the IRS on forms such as Forms W-2 or 1099, the discrepancy can lead to an IRS notice or further examination.

Repeated business losses

A business can legitimately lose money, particularly during its early years. However, consistently reporting losses can raise questions about whether the activity is being operated as a business with a profit motive or is instead a hobby.

Business owners should maintain records demonstrating the purpose and commercial nature of their activities.

Unusual patterns compared with similar businesses

The IRS uses information and statistical tools to identify returns that may warrant further examination.

A return with deductions or financial results that appear unusual compared with similar businesses may receive additional attention.

Again, this doesn't mean that an unusual result is automatically incorrect. Proper documentation and accurate reporting are what matter.

What Are the Main Types of IRS Audits?

IRS examinations generally fall into several categories. The type of audit you receive can affect how the examination is conducted and what information you need to provide.

1. Correspondence Audit

A correspondence audit is conducted primarily through written communication.

The IRS may send a notice requesting documentation or clarification regarding a particular item on a tax return.

For example, the IRS may ask for documentation supporting:

·         Business expenses

·         Income

·         Tax credits

·         Charitable contributions

·         Other deductions

·         Information reported by third parties

The notice should explain what information the IRS needs and provide instructions for responding.

If the taxpayer provides adequate documentation and the IRS agrees with the explanation, the examination may be resolved without an in-person meeting.

2. Office Audit

An office audit generally takes place at an IRS office.

The taxpayer may be asked to bring specific financial records and supporting documents. Depending on the issues involved, these could include receipts, bank statements, accounting records, invoices, expense documentation, and tax returns.

An office audit can cover more than a single question, although the scope of the examination is determined by the IRS.

3. Field Audit

A field audit is generally the most comprehensive type of IRS examination.

An IRS revenue agent may conduct the examination at the taxpayer's business, office, or another appropriate location.

Because field audits can involve more extensive business records and financial information, they may take longer and require more preparation than a correspondence examination.

How Will You Know If the IRS Is Auditing You?

A legitimate IRS audit begins with official IRS communication.

Business owners should be particularly cautious about unexpected phone calls, text messages, or emails claiming that they are being audited and demanding immediate payment.

The IRS generally initiates an audit by sending an official notice. The notice should explain the reason for the examination, the tax year or return involved, the information being requested, and how to respond.

If you receive an IRS notice, don't ignore it.

Pay close attention to the response deadline and keep a copy of everything you submit.

What Should You Do If Your Business Is Audited?

The first step is to read the IRS notice carefully.

Determine:

1.    Which tax year is being examined?

2.    Which tax return or items are involved?

3.    What documents is the IRS requesting?

4.    When is your response due?

5.    Where and how should the documents be submitted?

Next, gather the requested records.

Depending on the audit, you may need documents such as:

·         Bank statements

·         General ledgers

·         Profit and loss statements

·         Invoices

·         Receipts

·         Payroll records

·         Mileage records

·         Business credit-card statements

·         1099s

·         W-2s

·         Prior tax returns

·         Asset and depreciation records

Don't send unrelated documents simply because you have them. Focus on the information requested by the IRS and make sure your records are organized and easy to understand.

What Can Happen After an IRS Audit?

An audit doesn't necessarily result in additional taxes.

There are several possible outcomes.

No changes

If the IRS determines that the tax return was properly reported and the documentation supports the items examined, the audit may be closed without changes.

Agreed changes

If the IRS determines that adjustments are necessary and you agree with the proposed changes, the examination can generally be resolved by accepting the changes and paying any resulting tax, penalties, and interest according to the applicable procedures.

Disagreement with the IRS

You generally have rights if you disagree with the IRS's proposed adjustments.

Depending on the circumstances and the amount involved, you may have opportunities to discuss the matter with the examiner or request an administrative appeal.

Taxpayers should carefully review the IRS notice and applicable appeal procedures because deadlines can apply.

Keep Good Records Before an Audit Happens

The best time to prepare for an audit is before you receive one.

Maintain organized financial records throughout the year instead of waiting until tax season.

A strong bookkeeping system can help you quickly locate:

·         Income records

·         Business expenses

·         Bank transactions

·         Payroll information

·         Contractor payments

·         Asset purchases

·         Tax documents

·         Supporting documentation for deductions

Your bookkeeping records should also agree with the information reported on your tax returns.

When Should You Get Professional Help?

Some IRS examinations are relatively straightforward, while others can become complicated.

Consider obtaining professional assistance if the audit involves substantial amounts of money, multiple tax years, complicated business transactions, unfiled returns, significant deductions, payroll tax issues, or disagreements with the IRS.

A qualified tax professional may be able to communicate with the IRS on your behalf when properly authorized and help you organize the documentation needed to address the examination.

ContNow Tax Preparation LLC can assist small business owners with tax preparation, bookkeeping, financial records, and IRS-related tax matters. If you receive an IRS audit notice, getting professional guidance early can help you understand what the IRS is requesting and respond within the applicable deadline.

An audit can be stressful, but receiving an IRS notice does not automatically mean your business has done something wrong. The most important steps are to stay organized, respond on time, provide accurate documentation, and understand your rights throughout the examination process.

 

 

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