What to Expect in an IRS Audit
When you’re self-employed or run a small business, meticulous recordkeeping is a must as you bear the burden of proving the deductions you claim. If the IRS chooses to audit your business, you may be asked to provide details about your daily transactions for the past three years.
If you’ve received a letter from the IRS notifying you of your upcoming audit or just want to prepare for that possibility, here’s what you need to know:
Types of Audits
The IRS conducts audits in three ways:
- Field exam – In an accountant’s office, your home, or your place of business
- Office exam – In an IRS office
- Correspondence – The most common type of audit, conducted via mail.
Businesses may also be subject to random review, which is exactly what it sounds like – a review of your tax return. This process doesn’t require taxpayers to provide any additional information, unless the reviewer finds something questionable on the return.
Records and Documentation
Your auditor may ask you to provide bank statements, purchase orders, receipts, and personal and business bank account information. Electronic records are generally acceptable for most requests, as many businesses conduct financial transactions online. However, you may need to provide a corresponding ledger that provides supporting details for each transaction, such as:
- The purpose of any business travel for which you have claimed deductions (such as, “Travel to/from meeting with client Bob Smith”)
- Receipts for travel-related expenses, such as fuel, meals, airfare, cab fare, and hotel accommodations
- Itemized purchase orders.
Audit Process and Results
There is no standard timeframe for completion of an audit, and it could take as little as a few hours. Concluded audits are classified as:
- No change – Auditors found no changes are required
- Agreed – Changes are required, and the taxpayer agrees to those changes
- Disagreed – Changes are required, but the taxpayer disagrees with those changes.
If you disagree with the result of your audit, you have two (non-mutually exclusive) options:
- File an administrative appeal with the IRS Office of Appeals. Investigators working in the appeals office are independent senior-level employees with legal and/or accounting experience, and their primary function is to resolve disputes with taxpayers through negotiation. On administrative appeal, taxpayers may find that an investigator’s ruling significantly decreases the tax burden assessed by the auditor. However, in their investigation, appeals officers may uncover new facts that increase your tax liability.
- File a judicial appeal in U.S. Tax Court. If you choose this option, the court cannot consider any evidence other than that included in the original audit.
The taxpayer also has the option of contesting the tax assessment in either the U.S. District Court or the Court of Federal Claims, but this option requires that the taxpayer first fully pay the assessed tax, and then petition the court for a refund.
Overall, IRS audits have decreased in recent years, as budget cuts have forced a reduction in staff in many IRS offices. Most small businesses will never have to face an audit, if they’re paying taxes on time and being consistent in the deductions they claim.
An inconsistent pattern of deductions from year to year or especially large deductions could trigger an audit. People who operate as sole proprietorships, especially those engaged in professions that could be considered hobbies, may be at a somewhat higher risk of an IRS audit than their peers.
With good legal and accounting advice, small businesses can ensure they’re complying with all tax laws, and hopefully avoid being audited.
Lusk Law, LLC, concentrates on assisting small businesses, helping them at every stage of their business lifecycle. Our experienced attorneys have provided legal counsel and representation to entrepreneurs in DC, Maryland, and Virginia. If you need legal advice about your rights and responsibilities as a taxpayer, please call us at 443-535-9715 or fill out our contact form.
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