Let’s face it—just hearing the words “IRS audit” is enough to make any small business owner a bit uneasy. But take a deep breath: according to the IRS, the chances of your business being audited are actually pretty slim, somewhere between 0.1 and 3.9 percent, depending on your business type.
The key to managing this rare event is knowledge and preparation. When you know why businesses might get selected, understand the various types of audits, and prepare effectively, it becomes much less intimidating.
So, let’s break it down and make sure you’re ready for anything.
Why the IRS Audits Small Businesses
The IRS conducts audits to confirm compliance with tax laws and verify the accuracy of tax returns. It doesn’t necessarily mean you’ve done anything wrong. However, small business owners should be aware that their businesses can be flagged for audits for several factors.
Common red flags include:
- Discrepancies in reported income
- Inconsistencies in financial or employee documentation
- Certain tax deductions
- And more
Pro Tip! While tax deductions are a valuable tool for reducing taxable income, errors or improper claims can increase the risk of audits. The IRS particularly scrutinizes vehicle-related tax deductions since many overstate mileage and cost, as well as meal, travel, and home office claims, because of a lack of record keeping.
3 Types of IRS Audits
- Correspondence Audits
The most common form of audit is the correspondence audit, which is conducted via mail. The IRS may reach out to ask for some extra details, clarification, or adjustments on certain items from your tax return. While these audits aren’t as intrusive as others, they do require your immediate attention and accurate responses backed by any necessary financial documents. - Office Audits
Held at an IRS office, these audits are more detailed and cover specific areas such as business profit and loss or tax deductions. Small business owners are required to answer questions and bring supporting documentation to verify the items being examined. If any issues are identified, the audit could broaden, so getting advice from a tax expert and even a tax attorney is advisable to help small business owners prepare. Typically, these audits conclude in a single day, although you might need to supply additional information afterward. - Field Audits
Out of the three, field audits are the most comprehensive IRS audits. They’re conducted by skilled IRS revenue agents and involve thoroughly checking financial records, talking to employees, and touring the business. They can last from one day to a week, depending on how complex the situation is. Given the audit’s depth, it’s important to have a tax expert or attorney present to handle communication and make sure the audit stays on track.
How to Prepare for an Audit:
Organizing and maintaining accurate financial records is essential for both business operations and audit readiness.
Here are the key steps to ensure a smooth audit process, if it comes to it:
- Review the audit notice to understand its scope.
- Gather and organize financial documents like tax returns and bank statements.
- Check past tax returns for accuracy.
- Reconcile accounts to ensure they align with your records.
- Verify that all income is reported correctly.
- Validate tax deductions, paying special attention to any unusual claims.
- Audit payroll to confirm correct wages and tax withholdings.
- Prepare explanations for any discrepancies you find.
- Consult with your Ceterus Tax expert for help.
Ceterus As Your Tax Resource
Ceterus is your trusted partner for clear financial insights, tech-enabled bookkeeping, and tax prep. We help franchise and small business owners build a stronger future. Our experts manage tax forms for corporations and partnerships and can handle personal taxes.
Ready to learn how Ceterus can help you better understand your tax requirements? Schedule a call today.
