Audits on Small Business and Some Big Misconceptions

Paper with the word Audit on it

If you knew what we knew about IRS audits, you would rest a little easier — even with an audit letter in hand.

Out of the approximately 148 million tax returns that the IRS received in fiscal year 2016, just under 1 percent of individual earners was audited. About 1 percent was audited in 2015 and 2014, as well. For businesses that have less than $10 million in assets, the number is less than 1 percent.

On a side note, approximately 14% of businesses with assets of $500 million to $1 billion got audited and as the dollar value of assets grow, so does the audit percentage. It makes sense, right? The IRS prefers to go after big fish to recover billions of dollars.

Most small businesses supply unaudited accounts. However, from time to time, you may be required to undergo an audit to prove that your accounts are fair, honest and accurate, and that you are not evading tax or other legal obligations. And though a majority of audits on individual earners’ tax returns are conducted through the mail, tax audits on small businesses and businesses operated from home often require sitting down with a field agent from the IRS.

Why am I being audited?

If you’re selected for auditing, it doesn’t mean you’ve done anything wrong. The IRS and other agencies select a certain number of businesses at random, and your number may just have come up by chance.

However, an audit can also be triggered if something looks unusual:

  • Very high claims for exemptions
  • A major change in revenues or expenses from previous years
  • If they’ve had a tip from someone, such as a disgruntled employee

Most often, the audit is conducted to get information, request backup documentation (such as receipts) for tax claims made on a return, and to uncover unpaid taxes.

How do I need to prepare?

  1. First, speak to your CPA right away, and tell them you’ve been selected for auditing. They’ll be able to advise you on how best to prepare and can arrange to be present during the audit if you would like them there.
  2. Respond promptly to any requests for information, and find a convenient time to have the auditor visit. If it looks like you’re stalling or playing for time, this can give the impression that you have something to hide. The auditor will normally send you a checklist enumerating all the documents they will want to see. They may also send a questionnaire which you should complete and return before the audit.
  3. Make sure you have all your records easily available, including all paper receipts and electronic records. You may choose to print out electronic records, or else provide the auditor with access to a computer where they can easily see everything. You should hold all records for at least five years.

Set aside an area where the auditor will be able to work, out of view of customers and other staff.

What happens during the audit?

The auditor will review your records and cross-check everything to ensure they are truthful. They may require you to produce additional documentation, and may question you or your staff.

The important thing to remember is that they are not out to “get” you (as stated before, anything they may recover from you is nothing compared to the billions they find through audits of big, multinational corporations). It’s just as common to have an IRS problem mitigated or even go away after your CPA clears up the information that is provided to the IRS. Moving things along to get straightened right away will save you the most money and headache.

What happens afterwards?

If the audit reveals discrepancies, you will normally be required to submit adjusted accounts that reflect the auditor’s findings. The auditor may also require you to fulfill additional reporting obligations in future years.

You may be required to pay additional taxes and interest if the audit reveals that you have underpaid. If you are deemed to have deliberately evaded taxes, there may be an additional penalty fee, or you may face prosecution. Or, you may end up with a tax credit if the audit reveals that you have overpaid!

If you think the result of the audit is wrong, you can appeal. Speak to your CPA or lawyer who can advise you on the correct procedure and your likelihood of a successful appeal.

Contact us today for a free consultation!

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