Prepping for a Small Business IRS Audit: Document Everything
The best time to prepare for an audit is before you ever have one. Always keep an accurate record of all your income and expenses, including dates and amounts. Document the “why” behind questionable expenses, such as travel and entertainment.
Keeping records of your tax-related documents for two to six years is usually long enough to satisfy small business tax requirements. Be aware that your business has to keep
business audit records indefinitely for audits alleging fraudulent returns.
Why Do Small Business IRS Audits Happen?
Sometimes, the Internal Revenue Service (IRS) chooses small businesses at random for tax audits. However, certain financial practices or factors can raise red flags and be
tax audit triggers, such as:
- Big drop-offs in business
- Bankruptcy
- Branch closings
- Excessive business expenses
- Taking too many business deductions, like the home office deduction
- Misclassifying employees as independent contractors
- Sole proprietorships reporting a loss
If your small business’ income or expenses will be significantly different than the previous tax year, that can trigger an audit. But if you’re prepared and use accounting software to keep good records, you should have nothing to fear.
How Likely Is a Small Business IRS Audit?
There’s not an easy answer to how likely it is that the IRS would audit a small business. In 2018, the IRS audited 140 partnership returns out of over 4 million returns filed.1 In November 2020, the IRS announced that it would increase audits of small businesses by 50%.2 So, it’s a good idea to keep accurate business documents, just in case.
Types of Small Business Audits
There are various
types of tax audits that your business may face. Different types of taxes and plans can all trigger IRS tax audits, such as:
- State and local income tax
- Business taxes, like sales tax
- Employer-provided health insurance
- Company 401(k) plans
Regardless of the type of tax audit your business faces, it’s essential to have comprehensive documentation. Be sure to document everything related to these areas.
The IRS Is Auditing Your Company - Now What?
The
IRS audit process can happen in many ways. You may receive a simple letter requesting to clear up a few tax discrepancies. Or, you may be notified of an all-out review to look over everything on your company’s past tax returns.
If you don’t feel comfortable representing yourself during an audit, you can hire a tax professional. Provide only the information requested and make sure you understand your rights. For example, you can request a delay if it’s needed or even choose to meet the IRS in a neutral site instead of your home or business.
