You get the letter you’ve always dreaded. It’s from the Internal Revenue Service (IRS) or your local tax authority saying they’re going to audit your business. So, now what?
We’ll start with the basics. “IRS audit” are two words that can cause anxiety for small business owners. But the IRS audit process for small business owners doesn’t have to be stressful. An IRS audit means an auditor checks your business’ documents and paperwork to confirm if the information on your tax return is accurate. This includes the reported:
- Taxable income
- Losses
- Expenses
- Deductions
An audit can happen at an IRS office or at your business. To help make for a smooth process, it’s a good idea to be prepared and have as much documentation as possible.
Learn more about the IRS business audit process and what you can do if you’re getting audited.
Why Has My Small Business Been Selected for an IRS Audit?
The IRS uses different methods to choose which businesses get selected for an audit, such as:1
- Random selection: Returns get picked based on a statistical formula. The IRS’ system compares your business return with similar returns and uses the findings to determine if it should get audited.
- Related examinations: Your business’ tax returns were selected because they involve issues or transactions with other taxpayers whose returns the IRS selected for an audit.
Be aware that certain financial practices that your small business may take can also act as small business tax audit triggers, like:
- Excessive expenses
- Misclassification of employees
- Types of deductions
It’s important to remember that an IRS audit doesn’t mean your business did something wrong. It’s a way to verify the information you reported on your latest tax returns and to confirm you’re paying the right amount.
Types of IRS Audits for Small Businesses
There are different types of tax audits that your business may have to complete. These include:
Correspondence audits, which is a written letter usually questioning some of the items on your business return, not your entire return. Copies of a few receipts or bank statements might satisfy the audit.
Field audits, which begin with a face-to-face meeting with an IRS representative to talk about discrepancies in your return. Documentation isn’t immediately required for the initial meeting, but it can lead to an audit of your entire return. You have the right to choose where the meeting happens. This can include a neutral site, like the office of your accountant, tax attorney or tax professional. You also have the right to schedule the meeting when it works best for you. Some tax professionals recommend asking for a delay to give you time to gather the appropriate documents.
Criminal investigations if the IRS believes your business conducted fraud or owes a large amount in taxes. It’s important that you work with an attorney so that you understand local and federal tax laws.
IRS Audit Process: What Happens During an Audit?
The most common type of audit that small businesses face is a correspondence audit. If your small business gets selected for a correspondence audit, here’s typically what happens:2
- The IRS mails an “Initial Contact Letter” to you, requesting records and documents to conduct an examination.
- IRS agents examine the records and documents in an IRS office.
- A closing conference gets scheduled by telephone.
- The IRS will notify you of its findings and whether you have to pay any tax penalties and interest.
- If you agree to the findings, the IRS closes the case and issues a “Closing Letter.”
While there are different types of audits, preparing for an audit gives your small business the best chance at having a smooth process and passing.
Finalizing the IRS Audit Process
The IRS business audit process can end in three ways:3
- No change: The IRS reviewed all items and results in no changes to your business and its returns.
- Agreed: An audit where the IRS proposes changes and you agree with them. You’ll have to sign the examination report and pay any additional tax, fees, penalties or interest.
- Disagreed: The IRS proposes changes, but you disagree with the changes. You can request a conference with the IRS manager, file an appeal or go through mediation.
Your Rights During the IRS Business Audit Process
The IRS publishes a list of the rights that you have during business audits in “Publication 1, Your Rights as a Taxpayer.” Among these is the right to:
- Challenge the IRS’ position and be heard
- Appeal before an independent forum
- Retain representation
If you record your business’ expenses and income appropriately and file your tax returns on time and correctly, your tax audit experience shouldn’t be painful.
