The last thing any business owner wants is to receive notice that they’re being audited by the IRS. As if you didn’t have enough on your plate, now you have the stress and extra work of compiling documentation and proving to an agent that your tax return was done correctly. First, don’t panic. Take a deep breath, accept that you’ll have to dig in and deal with the audit, and recruit an experienced tax professional to help you through the process.
In this article, we’ll look at how IRS audits work, why you might have been flagged for audit, and concrete steps to take to ensure you’re prepared and to avoid unnecessary interest and penalties.
How Does an IRS Audit Work?
There are three main types of IRS tax audits:
- The correspondence (mail) audit: The most common type, conducted through letters and phone calls, and generally limited in scope
- The office audit: Conducted at a local IRS office to verify specific aspects of your return
- The field audit: The most comprehensive and least common type, requiring face-to-face meetings with an auditor
In the event of a correspondence IRS audit, you may receive one of two notices by mail:
Notice CP 2057: This notice informs you that there appears to be an income discrepancy on your return. The notice instructs you to review the return and file an amended return to correct the information, if necessary.
Notice CP 2000: In this notice, the IRS proposes changes to your tax return based on information received from third-party sources (i.e. Forms W-2, 1099-INT, 1099-MISC, etc.). You typically have 30 days to either agree with all the proposals, partially agree with the changes, or dispute all the changes proposed by the IRS. You may sign an authorization that enables another party to represent you in connection with the Notice CP 2000. The authorization is part of Notice CP 2000, and a separate power of attorney is not required.
In the event of a field audit, the revenue agent will send you a letter requesting a phone call to set the date, time, location, and agenda for the first meeting. You have the right to request that the examination occurs at a reasonable time and place that is convenient for both you and the IRS.
The fourth type of IRS audit you may have heard about is the Taxpayer Compliance Measurement Program (TCMP).
Known as the “audit from hell,” the TCMP was discontinued in the 1990s and replaced with the National Research Program (NRP).
The NRP compiles data on reporting, payment, and filing compliance. However, the sample size for this program is tiny—less than one-tenth of one percent of filings. So it’s safe to say that, while it’s not impossible, you are very unlikely to experience this type of audit.
What Triggers an IRS Audit?
Your tax return may come under audit for several different reasons. For example,
- The income you’ve reported does not match the information on Forms 1099 and W-2
- You are classified as an independent contractor, but the IRS determines you are actually an employee
- There are issues with your sole proprietorship, such as unreported income, significant losses reported on Schedule C, losses continuing over two or more years, or products or services received through bartering that counts as business income
- You have claimed unusual deductions
- Your filing includes transactions with a taxpayer who has been audited
You can minimize the chances of being audited—and of the IRS finding discrepancies in the event you are—by working with an experienced tax professional to ensure ongoing tax compliance and implement strategies to mitigate audit risk.
Being under audit can feel like being under investigation. It’s important to remember that an audit does not imply suspicion of criminal activity. An audit is more of an examination. The purpose can be as simple as confirming accuracy or fixing unintentional errors.
What to Do When You Are Audited by the IRS
There’s no getting out of an audit by the IRS, but that doesn’t mean you’re helpless in the situation! Being proactive, prepared, and working with a professional will make things much more manageable. Where do you begin? Start with these 5 essential steps to getting the best results from your IRS tax audit.
Get Representation
If you take only one action, make it this one: hire a tax professional immediately. Failing to do so can be a dangerous mistake. Given the tax code’s complexity, going it alone puts you at undue risk.
You need more than a technician; you need a partner who will expertly guide you through every step of the audit process. Work with someone who has the experience and training to understand and articulate your position. The right tax professional can also help you address proposed penalties and, if possible, refute the examiner’s rationale. Long story short: In all but the most straightforward cases, hiring an experienced partner will be well worth the cost.
Build Your Case
Too much documentation? When it comes to an audit, there is no such thing. Find those old receipts, invoices, bank, credit card, brokerage, mortgage statements, pay stubs, account records, and emails. Digital point-of-sale and invoicing systems make it easier than ever to track down copies of old receipts, so try reaching out to vendors and suppliers if needed. Check your calendar, social media history, or cell phone logs if you need to reconstruct your travel history or mileage. Ask yourself the tough questions. After all, the examiner certainly will.
Fill in the Gaps
If you are missing documentation and can’t replace it, or if you lost your original records in a disaster, you still have options. The IRS provides options to reconstruct records destroyed in a disaster.
If you have no way to obtain a reliable receipt for an item you purchased for your business, try to establish the item’s market value and approximate how much you paid. Find the item or a similar item for sale in a print or online catalog, and document the price. If you bought the item used, research the price of similar items on the secondhand market. The best way to prepare for an audit is to not have gaps in the first place. Well kept records will help tremendously in an audit.
Know Your Rights
You have a right to fair, professional, courteous, and confidential treatment by IRS employees. Furthermore, you have a right to know why the IRS is asking for information, how they will use it, and what will happen if you do not provide it. Finally, you have a right to representation and a right to appeal disagreements within the IRS and, if needed, before the courts.
Take an IRS Audit Seriously
Even if you’re sure you’ve done nothing wrong, do not take an IRS audit lightly. Don’t ignore the audit. The IRS will not forget about you. Additionally, do not under any circumstances lie to the auditor; that is a federal crime. Be upfront, prompt, courteous, and professional.
Do not joke around with an IRS employee. During the examination, answer only the questions they ask and do not say anything they might interpret as a threat. Pay attention to deadlines, and organize your documentation by year and the type of income or deduction. Managing your part of the process is your responsibility. The examiner will not do it for you.
What Happens After an IRS Audit?
The audit is complete. So what happens next? An audit may end with no adjustments to your return, adjustments you have agreed to, or a disputed issue you wish to appeal. If the IRS accepts the return as filed, they will issue a “no change” letter. You will not need to take any further action.
If you have agreed that you owe additional money, be sure to pay the balance in full or arrange a payment plan as soon as possible. The longer you wait, the more you’ll owe in interest and penalties.
In the case of a disagreement, the IRS will issue a “30-day” letter. The letter will contain information about appealing the results of the audit. You must respond to this notice. If you do not, the IRS will issue a statutory Notice of Deficiency, which gives you 90 days to file a petition to the Tax Court.
If you are unable to pay, you can ask for a 120-day extension. If you cannot pay in full within this timeframe, you can file an offer in compromise. This allows you to settle your debt for less than the total amount you owe if you can demonstrate financial hardship.
Would You Like Some Help?
Stable Rock has an expert team of tax professionals who routinely help clients with audits and other tax controversy matters. We can represent your business in an IRS audit, work with you to develop an effective tax strategy, and ensure compliance going forward, giving you peace of mind so you can focus on growing your business. At Stable Rock we also have outsourced back-office professionals to handle any or all of your accounting, bookkeeping, tax, technology, HR, insurance, strategic advisory, and CFO needs.