In 2017, the IRS conducted 18,962 audits of corporation tax returns. While this number is only about 1 percent of all corporation returns. Any business can be subject to an IRS audit.
Many business owners don’t have a game plan for when they get the notice from the IRS. Are you one of them? Want to learn how to prepare for a small business audit?
We’ve you covered. We’ll tell you all about the tax return audit process and how to get your business ready. Read on for your essential IRS tax auditing prep guide.
Small Business Audit Preparation: How to Get It Right
So your business received a dreaded IRS audit letter, now what? Panicking might be your first instinct. Instead, you should get all your accounting affairs in order.
Before getting ready for your audit, you must read the IRS request. Their letter may seem confusing but, it’s important to read it carefully and understand what they expect from you. The letter will explain the type of audit they will conduct.
The IRS performs correspondence, field or office audits. The first type is the most common among small businesses. This audit will take place through the mail.
You have the option to request an in-person examination if you prefer. If the letter you receive orders a field audit, you should expect the IRS agents to drop by your place of business. In contrast, if they request an office audit, the IRS will ask you to take your records to the closest IRS office.
If you are unsure about the IRS request, it’s recommended to consult a tax professional. They can provide insight into the IRS audit request.
Tax Return Audit Process: What to Expect
The simple version of a tax return audit process is you receive the audit notification, gather your records and submit them by the deadline. The IRS will examine your submission and issue their determination.
But, there’s a lot more to it. It will come down to the type of audit and what the auditors look for. They won’t only look at your returns.
The IRS auditors also examine your lifestyle, the way you conduct business, payroll tax returns, among other details. Did you report all your business receipts?
Does your business handle a lot of cash? Are you claiming personal costs as business expenses?
The initial audit request may stem from forgetting to report a large business sale receipt. If the auditor determines your lack of reporting was intentional, the IRS may conduct a criminal investigation for tax evasion. In these cases, it’s advisable to hire a professional and not deal with the process yourself.
If your business handles a lot of cash, the auditor will suspect you divert some of your income into your personal accounts without declaring it. Many business owners claim personal costs as business deductions. Some small expenses might be overlooked by the IRS auditor.
But, don’t get too comfortable. It’s recommended to keep all your personal affairs separate from your business to stay safe during an IRS audit.
If you have employees, get ready for a payroll taxes audit. IRS auditors always examine all payroll taxes filings and payments for businesses with employees.
Also, it’s common for them to audit businesses that hire independent contractors. If your business hires contractors, make sure to keep detailed and complete records.
How to Fight Audits by the IRS
Before submitting any paperwork to the IRS, you must make sure your letter came from the agency. Every day, scammers try to get private information and money making calls and sending emails posing as the IRS. Once you confirm your audit request came from the IRS, it’s time to get all your records in order and fight the request.
You might believe that the best strategy is submitting the requested documents. But, there are tactics you may use to fight a tax audit and minimize your tax liability.
Here are some of the best strategies you should consider to fight your dreaded tax audit.
1. Claim Additional Deductions
You might think the best strategy for an IRS audit is defense. But, a business audit is a great time to submit evidence of deductions you forgot to include on your tax returns. Keep in mind that you can only deduct the expenses essential to conduct business.
Your available deductions may vary depending on your business structure and new regulations. Some of the most overlooked deductions are business mileage, gifts, and office expenses. If you are unsure about claiming these more expenses, it’s recommended to consult a tax professional.
2. Submit Evidence for Flagged Deductions
If you lost receipts or evidence of your flagged deductions consider using other forms of verification. Believe it or not, the IRS accepts third-party documents and oral testimonies as evidence. An example is using customer receipts as evidence of business mileage.
Other documents you may submit to the IRS are proof of payment from vendors, bank and credit card statements. In the future, you may consider using apps or keeping mileage logs to keep track of these expenses.
3. Dispute Disallowed Deductions
The IRS might disallow deductions under the hobby loss rule. Under this regulation, the agency determined that your activity is a hobby, not a business.
They may only classify your business as a hobby during an IRS audit. If the agency classifies your business as a hobby, you may dispute these disallowed deductions.
An example is to offer evidence of economic turndown, situations out of your control, prior profitable years or success in the industry. If you don’t engage in the businesslike activity for profit, tax law requires you to claim these expenses on your individual return.
Can You Beat a Small Business IRS Audit?
Yes, you can beat a small business audit. It will all come down to your preparation and records. You must understand what the IRS expects from you, organize your records and submit the evidence within the deadline.
Don’t forget to use the right strategies to fight your audit. If you aren’t sure about the reason for the IRS request or don’t know how to handle the audit, you should consider hiring an expert. A tax professional can provide the insight and guidance you need to survive the process and obtain the best outcome.
Surviving an IRS audit will depend on your tax preparation. The year-end is near and it’s vital to take care of your tax-related housekeeping matters. Read our article to learn essential tips on how to do your year-end tax prep the right way.