These must-do preparations improve your chances of surviving an IRS business audit without serious damage.
Hearing about an impending tax audit might be a nerve-racking experience. You might feel like the Internal Revenue Service (IRS) is out to get you. You might inadvertently lose your case before it’s even begun just because you can’t calm yourself down. Here, it’s important to recalibrate your initial response.
Think of it this way: The IRS is mandated to collect taxes. As a citizen, you’re responsible for helping the IRS make its mandate more manageable. There’s nothing personal about the whole enterprise. It’s purely business. More accurately, it’s the government’s business. So approach it with the same methodical proficiency as you conduct yours.
IRS Business Audit Facts You Need to Know
It’s imperative to know how the IRS conducts its business. Doing so will help you assess how to best approach your dealings with the agency. In that regard, here are business audit and tax facts to mull over.
IRS business audits are not very common
The 2021 IRS Data Book shows that only 0.1% of S corporations were audited between September 2019 and October 2020. That’s an arguably insignificant portion.
Even if the IRS followed through with its declaration to increase small business audits, the number would still be pretty negligible. That is unless your business has serious tax compliance issues to contend with.
You have rights
If you were selected for an audit, you’re not entirely at the IRS’s beck and call. You retain rights as declared on the IRS Publication 556. Those rights include representation by a tax professional,
confidentiality protection, and courteous service, among others. So, if, by any chance, you feel like you’re being harassed, you may call out the IRS representative doing the deed through proper channels.
You are entitled to appeal
Should the audit result place you at a disadvantage, you may refuse to acknowledge its veracity via your right to appeal. That may be in the form of a small case request or a formal request for tax discrepancies beyond $25,000. Should your appeal yield the same result, which you still want to contest, you can bring the case to the tax court.
What to Do if Selected for an IRS Business Audit
While we’ve touched upon how infrequent IRS business audits are, you can’t always count on your luck. Sometimes, fate gives you the short end of the stick, and it’s up to you how you’ll handle the situation. If you receive an IRS audit letter, here’s what you must do.
1. Know the common audit triggers
That is so you can tailor-fit your preparation based on what you surmise has triggered your business audit selection. The most common reasons why small businesses get chosen for an IRS audit are as follows:
High income reported on a Schedule C
The IRS is always on the lookout for individuals blurring the lines between business and personal expenses. As such, if you’re a Schedule C filer reporting a high income, your odds of getting audited increase.
Shareholder employees with low or absent salaries
Some small businesses open to shareholders register as an S-corp instead of an LLC. That is to avoid the self-employment tax of 15.3%. The IRS may flag individual tax returns of shareholder-employees earning low or zero salaries.
Excessive deductions and expenses
Make sure to declare deductions aligned with your business model or proportionate with your income bracket. Otherwise, the IRS might consider your business tax returns a red flag.
A large number of independent contractors
Hiring employees requires businesses to pay payroll taxes. To circumvent that, some work with so-called independent contractors. However, the IRS has strict rules on what constitutes independent contractors. If your arrangement with workers doesn’t fit those rules, you might get flagged for an audit.
If you keep reporting losses year after year and yet your business stays operational despite those losses and their repercussions to your financial health, the IRS might schedule you for an audit to see if you’re legitimately not making any taxable income.
2. Determine the types of business audits
You will be scheduled either for a correspondence audit or a field audit. Knowing the difference between the two will help you prepare better for either scenario.
For instance, preparing relevant documents to be mailed to your auditor might be enough for the former. Meanwhile, for the latter, which puts an IRS auditor in your place of business, you might have to make more extensive preparations. Ensure that you organize all your documents neatly.
3. Review the audit notification
Audit letters are typically specific regarding what the agency asks you. Make sure you carefully read and comprehend the IRS audit letter to know the purpose of the audit. That will enable you to anticipate the line of questioning you’ll likely experience, thus allowing you to prepare the correct answers.
While it’s essential to grasp what the letter says entirely, you can’t wait too long to respond. Promptly reach out to the IRS to acknowledge receiving the correspondence.
4. Gather and organize documents
Whether you’re scheduled for a correspondence or field audit, you must furnish the audit officer with documents. Those may include receipts, electronic payment records, bank statements, travel logs, etc. The manner of presenting such papers matters as much as the documents’ content, so organize them properly.
5. Get represented
It’s understandable to get intimidated by an IRS officer. After all, chances are you’re not an expert on tax laws and labor laws. A subject outside your knowledge might easily cause you to handle the matter haphazardly. That is where tax professionals such as a CPA or tax lawyer come in. Do not hesitate to partner with one. In this case, it’s an investment worth spending.
Wrapping It Up
Ideally, you declare your income correctly. That way, the IRS won’t have to do a double take and subject your business to an audit. However, what’s ideal might not always be what happens in your reality.
If your reality puts you face to face with an IRS officer, do not panic. Instead, prepare accordingly. Follow the pointers mentioned above. Most especially, do not skip that part where you ask for help. Keep in mind that any trouble you might have with the IRS could be ironed out with the guidance of a competent tax attorney.