Your taxes are filed. You’ve paid what’s due, and breathe a huge sigh of relief. But then, you get the dreaded letter from the IRS requesting an audit and your heart is racing. Before you panic…. take a few deep breaths. Just because you got the letter doesn’t mean you did something wrong.
Sometimes, businesses are picked at random so the government can gain economic information. And even if there is a problem with your taxes, it doesn’t necessarily mean you’re in legal danger. If something doesn’t add up, the IRS may just want to make sure your mistake wasn’t intentional.
If you’re one of the “lucky” who is chosen for an audit, don’t fret. The first thing you should know is that, as a taxpayer, you have rights. And you also have time to prepare. Below, you’ll find everything you need to know if you’re faced with an audit, including:
- The Top 9 Reasons For a Small Business Audit
- 9 Rules for an Audit
- 10 Essential Items for a Tax Audit
- 9 Ways to Minimize Your Chances of an Audit
Top 9 Reasons For a Small Business Audit
If you get that pesky piece of paper in the mail, the first thing you’ll notice is that you were either chosen for a paper or field audit. Unfortunately for small businesses, the most common type is a field audit where you’ll be required to meet with an IRS agent in person. The letter will let you know the date by which you need to contact the IRS to schedule an appointment, as well as the documents you should have with you.
There are an array of reasons you may have been selected for an audit. The IRS compares your return to W-2s, 1099s and other bank information. If they find a discrepancy, they have three years from the date the return was due to conduct an audit.
Here are a few of the things that raise a “red flag” in the eyes of the IRS – and may put you and your business at risk:
- You’re a high-income tax payer
- Inaccurate W-2 or 1099 reporting
- Excessive itemized deductions
- A large number of business transactions
- Failure to report cash income (this happens most often with wait staff)
- A history of prior audits
- Large charitable deductions
- Tax-shelter losses
- Complex investment transactions
9 Rules For an Audit
The silver lining of all of this is…you do have rights. Many people are quickly intimidated by the idea of facing an IRS agent, but the truth is, the process is generally fair. The IRS isn’t out to get you – they just want to make sure the government is getting what they’re owed. Here are some general rules to keep in mind:
- Research – There are several publications available that you can use to learn about audits. Read commercial tax guides and IRS publications before going to your audit.
- File an extension – If you’re under audit, you have the right to file an extension on your current return until the audit is complete.
- Time & place – You have the right to choose a location and time that’s comfortable for you. If you don’t want to meet at the IRS office, choose somewhere neutral.
- Audio recording – You have the right to record the conversation that happens during an audit, as long as you let the agent know at least 10 days in advance.
- Stick to what’s asked – Don’t volunteer information; simply give the auditor the information they’re requesting.
- Never lie – If there’s a question you think is hard to answer, say something like, “I will need to look at my records and get back to you.”
- Get reorganized – If you are missing a document or receipt, you have the opportunity (and right) to get reorganized.
- Ask questions – If you have questions after you get the examination report, don’t be afraid to call the IRS agent and ask them for clarification.
- Penalties – If you underpaid on your taxes, you may be subject to one of these penalties:
- 20% penalty – This is a basic penalty that usually happens when you understate liability, mess up on your return, or there are problems with your stated property value.
- 75% penalty – This penalty is enforced if the IRS feels you were fraudulent in your return.
- Prison – This is the most extreme penalty, usually for tax evasion or related tax crimes.
10 Essential Items for a Tax Audit
So, you’ve scheduled your audit. Now all that’s left is to get all your ducks in a row. The worst thing you can do is shove a shoebox full of receipts at the auditor and expect them to take care of it. Instead, have the following ready so the auditor can quickly find the information he or she is looking for:
- Bank statements
- Copies of canceled checks
- All expense receipts (properly categorized)
- Electronic records
- W-2 and 1099 forms
- Articles of incorporation
- Travel and entertainment records
- Automobile records (including mileage, gas expenses, and repair bills)
- Loan records
- Mortgage statements
9 Ways to Minimize Your Chance of an Audit
Whether or not you were audited this year, there are several things you can do to help reduce the risk for next year. If you aren’t already doing so:
- Use a reliable bookkeeping system – Look into a service like QuickBooks, Outright, Freshbooks, or something similar. This can be a big step in ensuring your income and expenses are well documented and categorized.
- Record time spent – Keep a record of how much time you spend with the business and your daily activities, whether through a notebook, day planner, or calendar. This can help prove you’ve been working full-time and give you access to all tax benefits you’re owed.
- Get a business account – Separate personal and business income so you can better track what are truly business-related.
- Always have a paper trail – Keep your receipts, record of income, and everything related so you can cross-reference as needed.
- Keep at least 3 years’ worth of records and tax returns
- Keep all check stubs
- Keep your online bank records (if not done automatically)
- File all bills by category
- Record deductible items when they happen, not as tax season approaches
The time around tax season can be stressful, whether or not you’re getting audited. Keep in mind the above tips – and get organized – so if the unlikely event of an audit occurs, you’ll be ready.
These tips are provided by Pamela King, who promotes tax literacy and tax payer empowerment through research, education and technology. She preaches the “KISS-AF” gospel – Keep it Super Simple and Free. She encourages e-filers do their homework with an income tax calculator and seek free tax preparation resources.