As a business owner, just the words “tax audit” are enough to make you sick to your stomach. Having to face Uncle Sam and wondering whether your records will show you as honest and law abiding is a daunting thought.
However, there are ways to prepare now for a potential audit in the future. In addition, there are ways to navigate through an audit should you be selected for one.
Your Small Business Audit Guide
So, what exactly is a business audit? Does the IRS even care about small businesses, or are they too busy finding bigger fish to fry?
Are audits really that common? Do certain businesses get targeted more than others? We’ll share important facts you need to know regarding small business audits.
What Exactly Is A Business Audit?
When the IRS performs a business audit, they do so with the goal of verifying that your tax reporting information is accurate. They’re also looking to ensure you’re running your business in compliance with local, state and federal laws.
The IRS might perform an audit because they see something on your tax return that raises a red flag (more on that later). Or, they might select your business for a random, luck-of-the-draw audit.
You can expect an auditor to ask for information on all aspects of your business:
- Receipts for expenses
- Payroll records
- Income records
- Bank statements
And more. Audits are time-consuming and can be very stressful. However, the better prepared you are for an audit, the less stressful the whole experience will likely be. Later on, we’ll share tips on preparing for an audit that can help you navigate the experience more easily.
Do Small Businesses Get Audited?
Just as large businesses get audited, it’s possible for small businesses to get audited as well. The most common type of small business audit is what’s called a “correspondence audit.”
This type of audit happens most often when the IRS finds an issue with your tax return. They’ll notify you in writing and ask you to send in documentation to support what you’ve claimed on your return.
A field audit–one where an IRS representative comes to your home or place of business–is much less common. However, they do happen.
How Common Is It For A Business To Get Audited?
The IRS 2018 Data Book shares statistics on tax filings and audit information in the U.S. According to this publication, audits are quite rare. In fact, small non-corporation and small corporation businesses alike had less than a 2.5% frequency of being audited in 2018 (as a whole).
Interestingly, small businesses with middle-of-the-road gross receipts had a larger frequency of being audited than other small businesses. Look at these statistics from the IRS 2018 Data Book:
- Under $25k in gross receipts: 0.9%
- $25k to $100k in gross receipts: 0.9%
- $100k to $200k in gross receipts: 2.4%
- $200k or more in gross receipts: 1.9%
So, from a percentage standpoint, the likelihood of your business getting audited is small (pun intended). However, the chance of getting audited does still exist, and it’s important to be prepared just in case.
Can A Closed Business Be Audited?
It’s important to know that the IRS can audit your business even if it’s been closed. Note that while there are statutes of limitation (SOL) in place for audits–even on closed businesses–you must file your taxes in order to qualify for the statute of limitation rules.
Typically, the statute of limitations for audits is three years. However, that doubles to six years if irregularities are found during the audit.
And if you failed to file a tax return on your closed business, there is no SOL regarding a potential audit. The same goes for intentionally fraudulent returns filed.
If you purposely file a fraudulent return, you’re on the hook forever.
The moral of the story?
File your returns and do it ethically, for the tax man cometh. But if and when he (or she) does come, there are things you can do to ensure you’re prepared.
How To Prepare Now For A Possible Audit Later
Although the chances of your small business being audited are minute, it’s smart to prepare now for a possible audit later. There are steps you can take to ensure you’ve got your ducks in a row should the IRS come calling.
Larger companies perform internal audits to ensure records and procedures are being handled accurately. However, the expense of an internal audit isn’t always cost-effective for small businesses.
That being said, there are things you can do to help minimize mistakes and confusion regarding your business operations.
Keep Good Records
Possibly the number one thing you can do to prepare for a potential audit is to keep good records. Records that are easy to find and easy to understand will make the audit process much easier.
In addition, good records will help you to look honest. Bad records or constant answers of “I don’t know” to auditor questions could make you appear dishonest.
Here are other tips for ensuring your records are in order.
Have an organized system that helps you keep track of income, expenses, payroll, and other business transactions. Files and boxes are fine, however, in today’s technology-driven world you may want to consider storing information electronically.
In order to be best prepared for a possible audit, you need to be able to quickly find and show and auditor all of your business records. You’ll also need to be able to verify those records.
For instance, let’s say you show deductions of $1,536 for meals and entertainment. Plan on having receipts to back those purchases up. You’ll also want records on who you dined with and why.
You can handwrite all of this information down and store receipts in a box. However, there are tools that can help make keeping track of business records easier.
Use Business Accounting Programs and Tools
Hire an Accounting Service
If you don’t want the headache of keeping your own records, you can always hire an accounting service such as Cloud Friday. Full-service accounting companies can manage your records for you–and do so completely virtually.
If record-keeping and organization aren’t your strong suits–or if you simply want an easier life–you may find it well worth it to let a good accounting firm manage your records for you.
Detail Any Potentially Misunderstood Information
It’s important to save detailed records of anything that may be construed as deceptive. If there are any business dealings or expenses that are out of the norm, keep notes explaining details about what happened.
Know A Good Tax Lawyer
Finally, it doesn’t hurt to know a good tax lawyer. Hopefully, you’ll never need his or her services. But form a relationship with a tax lawyer now, so that if you do need one they’re not new to you and your business. Your accountant may be able to recommend someone.
If you know you’ve got your records in order, an audit will be far less stressful.
How To Avoid Being Audited
So, the best way to deal with tax audits is to try and avoid being audited in the first place. Granted, that may not always be possible. But there are some things you can do to minimize your chances of being audited.
Work With A Qualified Accountant On A Regular Basis
As a small business owner, you probably look for ways to minimize expenses. That’s just smart business. However, there are some areas in which you shouldn’t compromise, and accounting is one of them.
Yes, lots of do-it-yourself tax filing programs have the capability to help you file your tax return yourself–even if you do have a small business.
But the one thing those programs don’t have is personal experience. A qualified small business accountant can give you business management and tax filing tips that automated tax filing programs can’t.
For instance, when I filed my taxes after my first year as a realtor, my tax accountant told me off the top of his head what the IRS flags are for deductions such as mileage. You won’t get that from an automated tax filing program.
Use an accountant who specializes in small business and knows the ins and outs of tax filing and deductions.
Avoid Audit Triggers
There are certain red flags the IRS looks for that can increase your chances of getting audited. By knowing what those triggers are, you can ensure you don’t accidentally make a filing or business management mistake that will shine the spotlight on your business.
Some of the more common IRS audit triggers are:
- Running your business with lots of cash transactions
- Claiming over-inflated home office deductions
- Claiming your vehicle is used 100% for business
- Having over-inflated meal and entertainment deductions
- Consistently filing past the due date for your returns
- Reporting round numbers instead of exact numbers
- Having a negative business income year after year
- Claiming deductions that are disproportionate to your income
Work to avoid these and other audit triggers in order to minimize your chances of being chosen for an audit.
Follow Your Accountant’s Advice
Another step you can take to avoid an audit is to follow the advice your accountant gives you. If your accountant suggests an action step, take it as important and get it done.
The advice she’s giving you may just save you a whole lot of headache someday. For instance, follow her advice on deduction thresholds. And on record keeping.
If your accountant warns against claiming 60,000 miles for your web design business, take her seriously. Her goal is to make your record-keeping and tax filing life as seamless as possible.
What To Do If You Get A Notice You’re Being Audited
So, your biggest fear has come to life. You ran out to get the mail and see a dreaded letter from the IRS. You’re being audited. What do you do next?
Call Your Accountant Right Away
The first thing you should do if you get a notice you’re being audited is to call your accountant. He or she can calm your fears and walk you through getting ready for the process.
Experienced accountants have been in the business long enough that they know the ins and outs of the audit process. They can help you prepare for your IRS visit and answer any questions you may have about the process.
Be Cordial And Helpful To The Auditor
Yes, IRS audits are stressful. However, you don’t want to add to the stress by being rude or avoiding questions or requests for information.
Instead, be as cordial as possible. Do your best to answer questions to the best of your knowledge. Give the auditor what he or she asks for in terms of paperwork too.
Give Auditors What They Ask For
Being cordial and helpful is important. So is giving the auditor what they ask for.
It might feel a bit invasive when he or she asks for items, as if though you are being accused. But remember that the auditor is simply doing their job. Therefore, when answering questions and providing documentation, give what you are asked to give. This means don’t give any additional information out either.
For example, let’s say your auditor asks if you engage in any bartering activities. Give details about any bartering activities that relate directly to your business. Don’t go into detail about what you might think are “gray areas.”
For instance, don’t tell them about the time your brother fixed your car for you and you made a steak dinner for him in return. Why? The auditor is likely swamped with projects–and so are you. You’ll make it easier on both you and the auditor if you avoid wasting his or her time with information they don’t need.
Stick to your business information and only share information as it pertains directly to your business. If you go off on rabbit trails and start asking about and sharing other information, you could make the audit experience more time consuming than it needs to be.
Getting audited by the IRS can be incredibly expensive, time-consuming and stressful. By using a qualified tax accountant for your business and following the other tips above, you can help make your business life a lot more relaxing.
And you’ll have peace in knowing that if you do get audited, you’re prepared.