Especially since the passing of the Inflation Reduction Act that provided $80 billion in funding to the IRS, many small business owners have been concerned about the possibility of having their finances audited. While most of the funds are dedicated to improving taxpayer services, it is true that some of the funding will be used for enforcement and audits.
So, what does that mean for your business, and how can you avoid being audited in the future?
What is an IRS audit?
An IRS audit is an examination of your tax returns, financial records, and other documents to ensure that you have reported your income and deductions accurately and in compliance with the tax laws. Receiving an IRS notice doesn’t mean you’re being audited, and an IRS audit is not the same as other types of business reviews. An IRS audit is conducted by the government, and it can result in penalties, interest and even criminal charges if it uncovers fraud or other serious issues.
But don’t panic—audits are not a common occurrence. Last year, only 0.38% of returns were audited by the IRS, according to USA Today. It’s also unlikely that taxpayers making less than $400,000 in annual income will be targeted for audits.
What are the different types of audits?
While the prospect of an IRS audit may seem daunting, it’s important to remember that not all audits are created equal. There are several types of IRS audits that you may encounter as a small business owner. Here are the most common ones:
- Correspondence Audit: This is the most common type of audit, and it can be conducted entirely by mail. The IRS will request specific documents or information from you, and you will have a deadline to provide the requested materials. This type of audit is usually focused on a single issue, such as a missing tax form or a discrepancy in reported income, and most commonly occurs with charities and nonprofit organizations.
- Office Audit: An office audit is conducted in person at an IRS office. During an office audit, an IRS agent will review your financial records and ask you questions about your tax returns. This type of audit is typically focused on one or two specific issues, such as a deduction that the IRS believes may not be valid.
- Field Audit: A field audit is the most comprehensive type of audit, and it involves an in-person visit from an IRS agent to your place of business. During a field audit, the agent will review all of your financial records and ask you questions about your business operations. This type of audit is usually reserved for larger businesses or more complex tax issues.
- Taxpayer Compliance Measurement Program (TCMP) Audit: This type of audit is relatively rare, and it is typically used to measure compliance rates across a larger population of taxpayers. The IRS will select a random sample of your returns and conduct a comprehensive audit of those returns to measure your compliance with the tax laws.
- Specialized Audit: A specialized audit is conducted by an IRS agent with expertise in a particular area, such as international tax issues or employee benefit plans. These audits are typically reserved for businesses with complex tax issues that require specialized knowledge.
Note: Beware of scam calls impersonating the IRS! If you are selected for an audit, the IRS will only notify you by mail, not by telephone.
What should you do if you’re audited?
No matter the type of audit, you have the right to be represented by a tax professional, so make sure you choose one who is qualified to represent you. If you are notified of an IRS audit, it’s important to respond promptly and professionally. Ignoring or delaying an audit can only make the situation worse. Instead, gather the requested documents and information and work with your tax professional to respond to the IRS’s requests.
It’s also important to remember that an audit does not necessarily mean that you have done something wrong. The IRS uses algorithms to screen returns for potential red flags and sometimes selects random returns for closer review. However, the IRS has stated it will be auditing more employment tax returns in the future because of the possibility of false or incorrect Employee Retention Credit (ERC) claims. If your business has received this credit, make sure to have all the necessary documentation, like employee, wage, and eligibility information, to support the claim under audit.
If you have been selected for an audit, it’s not necessarily a reflection of you or your business. That being said, there are steps you can take to reduce your chances of being audited. First and foremost, make sure that you are reporting your income and deductions accurately and in compliance with the tax laws. By maintaining accurate records, reporting your income and deductions correctly, and working with a tax professional throughout the year, you can reduce your chances of being audited in the future.
If you need a tax professional, Padgett can help! Contact your local office today.