A tax audit is an accounting procedure where the IRS examines your business financial records to make sure you filed your tax return accurately. If you receive an IRS audit notice, here are the basic steps you can take to assist in resolving the situation.
1. Determine Why Your Return Was Selected For An Audit. It is the IRS’s obligation to inform you as to why your return was selected. However, you must be diligent in making the inquiry. Taxes may be audited for several reasons, including:
- Specific activity on your return, such as cash wages, 1099 and W-2 forms that don’t match your reporting, high deductions relative to your income, reports inconsistent with previous years, etc…
- Automatic flags, where computer programs find outlying “scores” on returns, such as above average withholding.
- Random selection.
Once you know what you are being audited for, you can narrow your focus and start gathering the relevant documentation.
2. Determine the Type of Audit. There are different types of tax audits, each with their own requirements. Knowing the type of audit will help you determine what documents you need, where to send them, and whether you need a tax lawyer.
- Correspondence Audit. In a Correspondence Audit, the IRS asks you to send copies of cancelled checks and receipts to its office so it can verify the deductions on your return. This type of audit is reserved for small, simple tax returns. Small businesses typically are not subject to a Correspondence Audit.
- Office Audit. In an Office Audit, the IRS asks you to bring certain documents in to your local IRS office and the audit is conducted there. The notice of an Office Audit arrives by mail. The letter identifies specific items on the return that are in question and requests that you or your representative bring certain documents to the local IRS office for the auditor’s examination. If your own a small business or run a sole proprietorship with sales under $500,000, you may be subjected to this type of audit.
- Field Audit. In a Field Audit, an IRS agent comes to your place of business to conduct the audit in person. The IRS agent will call the owner/president of the business and notify him/her that the return has been selected for audit. Most corporate businesses and partnerships are audited in this manner. During the initial telephone contact, the agent will be asking for the following: (i) to interview the principals; (ii) to arrange a date(s) to be at your place of business; (iii) to determine where the records are located; and (iv) to provide a list of records that are to be made available. The IRS agent is instructed to interview you and go to your business so that he/she can ask detailed questions about business operations and see the business facility first hand.
- Taxpayer Compliance Measurement Program Audit. This is the most extensive type of audit, where every part of your tax return must be substantiated by documents. The primary purpose of this type audit is to update the data used to write the audit scoring program. This will cost your business significant time.
3. Preparing for the Audit.
- Gather Your Documents. Once you know what is expected of you, you can start going through your records to find the relevant receipts and documents. It is imperative that you do not send in your original documents or your only copy. In addition, never send in more than is requested. If are unable to find relevant documentation, it is highly recommended that you immediately seek out and request duplicates because IRS auditors will not accept an explanation that records are missing or lost. Once you have all your copies and originals, get them organized. Organized records and documentation may help to limit the scope of an auditor’s investigation.
- Respond Timely. Timeliness demonstrates that you and your business “have nothing to hide” and it limits the amount of time the agent spends looking at your information.
- Request copies of materials in the IRS’s file and copies of anything you sign.
- Consider Hiring a Tax Lawyer. You can choose to handle the audit by yourself, have a representative go with you, and/or have a representative go in your place. If choose to handle the audit yourself or to have a representative accompany you, you increase the risk that the agent/auditor will ask questions that you would prefer not to have to answer. There is no such thing as idle conversation with a person from the IRS. Each question has a purpose and that purpose is to get information which will indicate that you have underreported your income or over stated your expenses. A tax lawyer may be of significant assistance in a Field Audit or a Taxpayer Compliance Measurement Program Audit.
4. Conclusion of the Audit. When the IRS agent/auditor presents you with its findings and a bill, you have the option to agree and sign the document or disagree and request a hearing with an appeals officer. The IRS is required to inform you of your appeal rights.
Less than 2 to 4 percent of filed tax returns are audited. If your number comes up, be prepared to get your documents and records organized and present your business in the most favorable light possible.