Learning your small business has been selected for a tax audit can be intimidating. It’s unusual for small companies to get selected for an audit, but that doesn’t mean you can’t be chosen. Whether you manage your accounting or outsource it to a tax professional or bookkeeper, making sure you’re adequately prepared and knowledgeable of the small business tax audit process can save you a lot of hassle and time.
What Is an IRS Audit?
If you own a business, it’s not unusual for the IRS to send an auditor to review and examine your company’s accounts and financial information like SBA loan information to ensure all data is reported correctly under tax laws. In most cases, being selected for an audit happens at random, so it doesn’t always suggest that an issue has occurred. If a problem or transaction has happened with a business partner or investor whose return is already being audited, your small business will likely be required to participate as well. If you’ve been selected for an audit, the IRS will notify you by mail.
Your chances of being chosen for a tax audit are slim, especially as a small business owner. It’s encouraged to become familiar with the various actions that could trigger your business for a tax audit. Once aware, it’s recommended to ensure that you and your chosen tax preparer avoid the following tax audit triggers as best you can:
- Claiming losses year after year. It’s not uncommon for small businesses to claim a loss in the first few years since you’re getting your new company underway. It’s vital that you’re conscious of the frequency in which losses are claimed as the IRS may question claimed deduction eligibility or suspect hobby expenses are utilized to claim a business loss.
- Failure to report all income. Any form of income you receive through your company should be reported in full, whether cash, credit card, or third-party. If the IRS suspects your income may be different than what is reported, you’ll likely receive an audit.
- Excessive expenses. All expenses (meals, entertainment, etc.) should be recorded accurately with thorough notes detailing the nature of the expenses, such as business relevance and who was present. The IRS may choose you for an audit if your expenses are outsized from your income.
- Rounding numbers. Owning and managing a small business can take a lot of your time, meaning bookkeeping is likely put on the back burner. It can be helpful to outsource bookkeeping for your company, so all numbers are accurate and rounded numbers are avoided unless applicable.
Understanding the Process and Outcomes
The IRS selects a certain amount of tax returns each year to audit, meaning all businesses are chosen randomly. Typically, audits are initiated within two years of filing your tax return; however, if the IRS suspects an issue in years prior, it is possible to go back further. You will be notified you’ve been chosen for an audit initially by mail, and from there, further direction will be given to complete the audit by mail or in-person. Audits by mail are quite simple and require you to respond in writing with documentation that supports your case. In-person or field audits occur at your place of business, a local IRS office, or your tax professional’s office but are much less common comparatively.
Your audit notice will include all pertinent information as well as a list of financial information the IRS wishes to have examined. It’s vital that you follow all steps accordingly, as this will make the process go smoothly. Whether by mail or in-person, the tax return for the year in question will be compared to your company’s books. You’ll likely be required to provide relevant financial statements, invoices, receipts, and bank statements, so the auditor can get a clear picture of the year being audited. Once your audit is complete, three primary outcomes can result:
- All information is correct. You won’t be required to owe additional taxes or changes being made to your tax return if the auditor finds all information on your tax return to be correct.
- An agreeable mistake is discovered. At times, an auditor may find errors on your tax return. While this may mean you could be held liable for additional taxes, penalties, and interest, the error might also be in your favor. In this case, a refund from the government will be issued for any overpaid taxes.
- A disagreeable mistake is discovered. If the acting auditor finds an error on your tax return, and you disagree, you must file an appeal with the IRS within 30 days.
Quick Tips and Suggestions
As a small business owner, the likelihood of being chosen for an audit is slim. However, it’s not guaranteed that you’ll never be required to participate in one. Owning a business comes with responsibilities, and there are active steps you can take so you’re adequately prepared if you learn you’ve been selected for a small business audit.
Keep Organized, Extensive Records
Audit selection is random, making it vital to keep physical or electronic documentation of all records. Many tax professionals recommend keeping records for seven years so that you can be prepared at any time. It’s helpful to keep records organized by year and regularly track down any missing documents for each tax year. Always have copies on hand, so you don’t have to give the auditor any original documents. Below are a few examples of documents and records you should have organized for each tax year:
- Legal papers
- Mileage logs
- Receipts and bills
- Proof of employment
- Medical documents
- Loan agreements
Take Time to Prepare
The IRS will notify you of selection for an audit well in advance, and it’s essential to take the time leading up to the scheduled date to prepare. Your mailed notification will include your audit date and the year being examined. It’s recommended to prepare all necessary information and records as this will ensure the process goes seamlessly. Many business software programs allow you to download yearly documents individually, and this is an excellent way to have your accounting records for the year being examined, organized, and readily available for the auditor.
Don’t Do It Yourself
Learning your business has been selected for an audit can be alarming but remember you don’t have to go through it alone. Upon receiving your audit notice, it’s recommended to inform your business lawyer, tax professional, and bookkeeper, so these individuals can be present at the field audit or help you gather all documents for your mail-in. Having these individuals present makes answering any questions simple and will likely speed up the audit process.
Be Courteous, Concise, and Precise
The auditor assigned to your case is there to complete their job, but often, many taxpayers become defensive. By rule of thumb, it’s helpful to remain courteous and cheerful throughout your audit, which will help the process go smoothly. Offer information willingly, but not anything the auditor does not explicitly ask of you. All provided documentation should be truthful and detailed as this will instill more confidence in the overall audit process. It’s recommended to keep any casual conversation surface level, so the auditor can focus on the task at hand and nothing surfaces that may encourage unnecessary incrimination.
Know Your Rights
It’s vital that you familiarize yourself with your rights as a taxpayer because this information will help you along in the audit process. If you notice your auditor doing anything out of the ordinary, you will know how to correctly navigate the situation. Keep in mind, if your auditor finds a mistake, it’s vital that you attempt to negotiate your options without being defensive or argumentative. In most cases, having a tax attorney present will help avoid these situations and ensure the IRS doesn’t take advantage of you.
A Tax Audit Shouldn’t Alarm You
Owning a small business means you already have a lot of responsibilities, from creating employee schedules and developing an effective marketing strategy to scheduling building repairs and closing sales. Being selected for a tax audit should always be in the back of your mind, so you can adequately prepare. However, an audit shouldn’t be a reoccurring fear. Verifying that your yearly documents are organized either on your own or with your tax professional or bookkeeper will save you the headache should you be notified of an audit request.