While only a small percentage of tax returns get audited, it’s a good idea for businesses and self-employed individuals to understand how the process works. During a business audit, the IRS will investigate the validity of your tax return to determine if the information provided is correct or if additional taxes are owed. Here are some of the most frequently asked questions regarding IRS business audits.
How does the IRS select who to audit?
Various “red flags” will make your tax return more likely to be selected for an audit. Computer algorithms assist the IRS in identifying tax returns that have the highest likelihood of containing errors. A tax return is assigned a Discriminant Function System (DIF) score which compares the return to others like it. A return that differs too much from the norm may get flagged for an audit. Additionally, an Unreported Income DIF score helps the IRS find returns that have likely underreported income. Other reasons the IRS may audit a business includes inaccurately claiming deductions, filing tax returns late, or filing an amended return that results in considerable changes to the information initially provided.
How are business audits conducted?
The IRS conducts business audits in one of three ways. The most basic form of audit is a correspondence or mail audit. These audits are done through the mail or over the phone. If certain information is needed that cannot be easily acquired through correspondence, the IRS may request an in-person meeting at a local IRS office. The most rigorous form of audit takes place at an individual’s place of business or home.
What do I need to do to prepare for a business audit?
It’s essential to organize all pertinent documents and financial records ahead of the audit. Collect receipts, income statements, balance sheets, payroll records, and any other information the IRS may request. Having comprehensive records ready for review will make the process go much more quickly. It may also be helpful to employ a tax audit specialist to assist in preparing all the necessary information.
The auditor has determined I owe money to the IRS. What happens now?
If the audit indicates that you owe money to the IRS, you can either pay the total amount at once or request to set up an installment plan. Making late payments will often result in penalties. It’s also possible to request an extension if more time is needed to pay back taxes.
What can I do to avoid an audit in the future?
There are several ways to reduce the risk of the IRS auditing your business. First, make sure your tax return is accurate and filed on time. Even if you cannot afford to fulfill your tax obligation, it’s essential to file anyway, or file an extension to avoid fees and penalties later. Respond right away if the IRS reaches out to discuss aspects of your tax return. Failure to cooperate with the IRS can make matters worse and almost certainly result in a more detailed office or field audit. For optimal peace of mind, find a professional CPA who specializes in the audit process to represent you and ensure the completion of all details.