08/ 05/ 2005
by Steve Strauss
Q: I was notified that my small business is going to be audited by the IRS. I don’t think I did anything wrong, but I’m not sure. What should I do, and what should I expect?
A: First, let me say that any small-business owner reading this should be concerned about the “big A” — small businesses are audited three times more often than individuals. And, if you are audited, the taxman will most likely focus on your auto, travel and entertainment deductions. Thus, to avoid audit problems with Uncle Sam, keep good records. IRS studies show that poor record keeping rather than over deducting cause most small businesses to lose an audit.
An audit is a formal examination of your income tax returns by the IRS. The purpose is to look for fraud or inaccurate tax returns. Three types of audits include:
The mail audit: This asks you to explain something or requests additional information. It’s very simple.
The interview audit: Here, you will be asked to take your records and returns to an IRS office for review.
The field audit: For a small business, this is the most common type. The auditor comes to your office or the office of your lawyer or accountant and reviews your records.
If you have been selected for an audit, tell your lawyer or accountant immediately and ask them to attend the audit. IRS agents like working with professionals because they speak the same language.
Whether you bring a professional or not, IRS auditors will review your tax returns, receipts, logs and anything you used to compute your returns. Specifically, they will look at four areas:
1. Income: Income to the IRS is all money received, no matter how derived––an encompassing definition. The auditor will want to make sure you reported all your income and will ask to look at bank statements, sales records, alimony receipts, pension income, tax refunds and everything else.
2. Deductions: Over deducting is the big red flag that causes your return to be audited. You better have all receipts ready, as well as all cancelled checks, credit card statements and anything else you need to back up your deductions.
3. Previous returns: The IRS agent will also look at previous and subsequent returns to determine any pattern of abuse––whether other adjustments or similar deductions have been made.
4. Previous audits: If you have been audited before, the agent will look at the results.
After the audit, the agent will send you a copy of his or her report, called the “Revenue Agent’s Report.” It explains the agent’s analysis and lists the additional money you owe, if any.
After that, you still have options. You can sign the waiver enclosed in the report, pay any tax you owe and be happy it’s over. Or, if you disagree with the amount, you can pay the tax, then apply for a refund.
Another option is to request a hearing with the IRS Appellate Division. This takes the audit to the next level for review.
Yes, audits are scary, but you can reduce the anxiety by being prepared. Have a good team on your side, organized records and reasons why you did what you did. If you can do that, all should be well.
This article should not be used in place of personalized, professional information directly from your accountant or lawyer. Contact him or her for more information about the IRS and audits.
