An Internal Revenue Service (IRS) audit is a necessary evil that can strike any small business at any time. IRS investigations look at how your business operations and revenues match up with what you reported on your income tax return. Discrepancies can lead to tax penalties and owing money to the IRS. If you’re one of the unlucky companies the IRS examines, there are several things you for which you need to prepare to make the process run as smoothly as possible. You may need professional help to ensure the financial safety of your business. Here’s how to handle IRS audits as a small business owner.
Prepare for an Audit
The point of IRS audits is to check for accuracy between what a business reports in tax return statements and what it actually makes and spends. During an audit, the IRS will ask specific questions and request to see information to prove that you reported your finances honestly and accurately on tax return documents. Understanding what the IRS will want to know can help you prepare and prevent a question from catching you off guard.
The first step is preparing your small business for an IRS audit. As a small business owner, you should be prepared for an audit at any time. Audits occur at random, with no warning. Being as prepared as possible can help you come out on top if the IRS selects your business.
Before you meet with the auditor, thoroughly review the tax returns involved in the audit. Prepare to explain how you or your tax preparer came up with the figures you submitted on your returns. Find all records you used for your tax reporting and return. The IRS will want to look at any documents you used to prepare taxes to check for reporting accuracy. These documents may include business receipts, checks, bank statements, and appointment books. Good recordkeeping can simplify the audit process.
Find Out What the IRS Wants to Know
IRS auditors are examining you and your small business, not just your tax return. The auditor will look at your lifestyle and spending habits, sizing up your assets such as jewelry, property, and vehicles to see if it reflects the income you reported on your tax return. If the two don’t seem to add up, the auditor will dig deeper into your finances. If your business deals mainly in cash, the auditor will likely inspect your operations more closely due to the potential for business owners pocketing the cash without reporting the sale.
Some business owners claim personal expenses such as meals, entertainment, phone calls, and vacations as business ventures. For this reason, auditors will look closely at what a business owner records as business expenses. Look closely at what you claimed on your taxes as business expenses and be prepared to show strong documentation for those expenses, such as receipts and daily activity logs.
Auditors are also on the lookout for unreported income. Hiding income is a form of tax fraud that can result in significant legal issues. If you failed to report income in excess of $10,000, hire a tax professional to handle your audit. Unreported income can mean unpaid taxes, so your business will be indebted to the IRS – a position no small business wants to be in. Finally, an auditor will look at how you classify your workers. If they are technically employees but you reported them as independent contractors, this could create tax issues with payroll.
During an IRS audit, expect in-depth questioning about your business operations, expenses, and purchasing history. If your tax return statements are complex, with many different exemptions and high dollar amounts, trust a tax professional with your audit. You may even want to retain a tax attorney to deal with IRS auditors on your behalf. It is possible to get through IRS audits unscathed and even on top with the right preparation and professional help on your side. Learn more about IRS audits on the official IRS website.