If you recently received a notice from the IRS that they plan to audit your small business, you may be panicking. Take a deep breath. With good planning and a little help, you can get through this.
The IRS conducts three types of audits: correspondence audits, office audits and field audits. They conduct many audits by correspondence, which is only through the mail and used for correcting errors or verifying information. The IRS does regularly conduct field audits for businesses, however, where they come to your place of business to review your records. Here are five tips for preparing your small business for an audit:
Read the letter. Understanding why they IRS is auditing your business is the first step. They may audit your business for several reasons. Some audits are random, some may be a simple math error or typo and some are due to a discrepancy the IRS found in your information. Either way, contact your tax professional who helped you with the return. They can assist you in drafting a response, as well as handling the next steps. If they are unavailable, contact another tax professional. Audits can become confusing, and you will appreciate the help.
- Organize your records. Sort them by year and category. If you cannot locate certain records, replace them by contacting banks and vendors. The IRS can penalize you for not keeping good records, so don't give them that chance. If you lost records due to a fire, flood or computer malfunction, document the incident and still try to recreate as many of the records as you can.
- Separate all personal expenses. Your business records should not include any personal expenses. They should have different bank accounts and credit cards. The IRS will look closely at items marked as business travel and business entertainment and meals. You should be prepared to show that those items were legitimate business expenses and not for your personal benefit. Similarly, if you run your business out of your home and claim part of the property as a home business on your taxes, the auditor may want to ensure that you are using it "regularly and exclusively" for your business.
- Show that the error was unintentional. Tax evasion is an intentional effort to manipulate your taxes to pay less, and it is illegal. You want to be able to show that your error or omission was not intentional.
- Prepare to explain losses and expenses. The IRS wants to make sure that people claiming business expenses are actually engaged in a business. If you have only reported losses for several years, the IRS may be wondering if you are working hard, or if your endeavor is just a hobby. Document your marketing attempts and keep good records to show you run a serious business.
You know your business better than anyone. With some preparation and organization, you will survive the audit and be back to business as usual.