National income in the USA is on the rise, and so are the rates at which the Internal Revenue Service (IRS) is auditing businesses. In fact, they plan to increase their IRS small business audits by about 50% in the coming year!
So, what does that mean for small business owners like yourself? Well, it means that you need to be prepared in the event that your business is selected for an IRS business audit.
What is an IRS Business Audit?
An IRS business audit is a thorough system of checks and balances conducted by a tax professional known as an IRS auditor. They have complete authority to examine the totality of your business’ accounts to determine if you’re compliant with federal tax laws. If the auditor finds a mistake, either you or your business may have to pay a tax deficiency, as well as a penalty and interest on the deficiency.
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How Does the Selection Process Work for IRS Business Audits?
Even if you’ve been as careful as possible when filing your taxes, it’s still possible for an IRS auditor to find a mistake during their business tax audits. To avoid having to pay a tax deficiency with additional penalties and interest, you should know what kinds of mistakes that you can make during your tax preparation that can trigger an IRS field audit.
Rounding Numbers in Your Account Books
As a general rule, most small business owners don’t do their bookkeeping themselves. They defer their bookkeeping to someone else.
However, if you decide to do your own bookkeeping, keep in mind that if the IRS sees that your income tax return lists several items that are all rounded to the nearest $100, that may set off a red flag and prompt an IRS audit on your small business.
Frequently High Deductions
Business meals and home office expenses are all reasonable deductions and perfectly allowable in the eyes of the IRS. However, expenses that are eligible for tax deductibility must meet a number of strict criteria.
Take meals, for instance. If you’re grabbing a cup of coffee or lunch down the street from your home office, that’s not a deductible expense. A dinner with clients and food you eat while travelling for business purposes, however, is. Just make sure to record the names of people in attendance for client meals and the business relevance as well.
For home office deductions on returns filed, you must prove that your office is used “exclusively and regularly” for your business.
If any of these expense deductions are out of order, it could trigger audits from the IRS.
Reporting Higher Income
Keep in mind that as your overall gross income increases, so does your potential of getting audited. As your small business grows, you want to make sure that the systems you are using to account for your receivables, payables and all of your business expenditures are scalable and can maintain the necessary records.
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What Happens When a Business is Selected for an IRS Business Audit?
As discussed above, certain conditions pertaining to your tax return can influence whether or not your business is the target of an IRS business audit, but more often not, the selections are random.
At its core, an IRS business audit is a second glance at your return for a specific year, and there are two main types of audits you should be aware of:
- Correspondence Audit
This type of audit consists of the IRS notifying you by mail that you made a possible mistake on your return. In this case, you gather documentation to support your case and mail it in. - Field Audit
This is where an auditor shows up in person to conduct the IRS business audit and is much less common of an occurrence.
In both of these cases, having a professional business tax specialist or attorney to represent you is always a great idea.
As for the audit itself, the IRS will give you a specific list of documentation and information they wish to examine. It’s important to follow these instructions to the letter. The auditor’s job is to make sure there are no errors on your return, and they have the ability to exercise considerable powers in pursuit of that goal.
What are the Possible IRS Business Audits Outcomes?
Primarily, there are three main outcomes of an IRS business audit:
- The IRS Verifies that all of Your Information is Correct
Obviously, this is the best-case scenario. In this scenario, the auditor has found there to be no errors or mistakes and thus no change to your tax return or any potential tax refund. - The IRS Finds a Mistake, and You Agree
Here, the auditor has found errors or mistakes on your tax return, and you accept them as they’ve been described and laid out. It’s possible you may be liable for additional tax payments and penalties plus interest. Or, it could be that there was a mistake in your favor, and you could get an even larger tax refund. - The IRS Finds a Mistake, and You Disagree
You have the right to disagree with the IRS’ findings post-audit. For this scenario, you have 30 days to file an appeal or contact the IRS Taxpayer Advocate Service, which is an independent organization within the IRS that helps taxpayers and protects their rights.
If you do decide to officially argue with the IRS’ findings, it’s important to have a reputable tax accountant to represent you.
How to Get Through IRS Business Audits: Best Practices
Whether you’re worried about IRS estate tax audits or hold a tax-exempt status, it’s always good practice to prepare ahead of time and do everything you can to ensure the audit is complied with and results in a favorable outcome for you.
Keep Airtight Records
Everything from income and losses to expenses and deductions, the more accurate and collected your records are, the better chance you’ll stand at making it through an IRS business audit unscathed.
Prepare Ahead of Time
You’ll be notified in advance, in writing, by the IRS of your audit date and the tax year they plan to examine. Take that time to make sure you’ve got all of your records compiled and ordered neatly.
Have Your Tax Professional On-Hand
The best tool to have at your disposal during an audit is a certified tax professional who knows all your tax information.
Talk to HKMP today about any accounting concerns you may have, and let’s work together to figure out the best strategies for your small business.