While your chances of being audited may be at historic lows, if you’re unlucky enough to be selected for an audit, you are likely in a panic. Calm down and review the steps you can take now.
1. Determine the type of audit you’re facing.
There are audits, and there are audits. Not every type of audit is lengthy and painful.
- Correspondence audits are letters that typically request proof of positions taken on a return that the IRS is questioning. For example, the letter may ask for proof that you bought office furniture. The matter can be easily handled by sending photocopies of the receipt or credit card statement showing the date and amount of the purchase. Or an independent contractor may have inadvertently failed to include as income an amount reported on Form 1099-MISC. Upon receiving the IRS letter, the contractor may agree to pay the tax shortfall from this omission. The vast majority of IRS audits are simply inquiries by mail. For instance, in the government’s 2014 fiscal year, 71 percent of all audits were conducted by mail.
- Office audits are audits conducted in an IRS office. This audit is more strenuous than a correspondence audit, but usually focuses only on particular matters that are laid out in a letter. For example, the IRS may be suspicious of a retail store owner who has deducted substantial travel costs. The agent here will want to see receipts for travel expenses as well as required documentation (e.g., the purpose of each trip and what occurred on it).
- Field audits are the most dreaded, because they’re conducted at your home or place of business. Again, the IRS is looking into particular deductions but is also getting a feel for you personally to put your tax situation in context. Clearly, conducting an audit at your office may be disruptive (space needs to be provided to the agent) and can raise questions from your staff about what’s going on in the company. However, even a field audit can be managed and is a cost of doing business.
2. Get representation.
You probably can handle a correspondence audit without any professional help if you merely have to produce documentation that you have on hand. However, if you’re facing an office or field audit, it’s highly advisable not to DIY. You may say something or produce something that could lead to even greater inquiries from the IRS agent. What’s more, having representation can relieve you of the need to be there in person for every meeting, allowing you to run your business.
Work with your CPA or attorney during the audit process so you’re prepared to answer questions concisely without opening up other avenues of inquiry. Only answer questions put to you; don’t volunteer information. Discuss with your representative how things are going and whether you want or need to take things to the next level (see step 5).
3. Gather your records.
An audit is the time to back up the positions taken on your tax return with documentation. This can be receipts, bank statements, mileage logs for your vehicle or other paperwork requested by the agent.
Give the agent what is asked for in IRS Form 4564, Information Document Request (there are several versions of the form). Read the form carefully and don’t produce more documentation than is needed to meet the document request and address the questions raised on the audit. For example, if an audit is looking at a cash-intensive business for its 2013 tax year because it suspects that there is unreported income, provide a printout from your accounting solution (e.g., QuickBooks) of the Wage and Income transcripts and bank records; you can provide the information on a DVD or flash drive. Don’t voluntarily share information about any other year or any other business-related information.
In some but not many cases, the agent may want to see your accounting information electronically, and you probably have to give the IRS access to your full accounting information online. Find more information on this from the IRS.
4. Know your rights.
Like the original Bill of Rights in the U.S. Constitution, the IRS has laid out 10 rights that you have as a taxpayer. The IRS spelled out these rights in 2014. As part of the so-called extender legislation this past December, Congress codified these rights.
If, at the end of the audit, the IRS says you owe something and you agree that it’s fair, pay up and put the audit behind you. But if you think the agent has been unfair, didn’t listen to your arguments or suggests a tax bill that’s outrageous, don’t agree with the amount. Instead, take your case to the IRS Appeals Office. Here you have another shot of defending your tax position with another person in the IRS who may be more sympathetic.
If you are still unhappy with the results from the IRS Appeals Office, you can continue the fight in Tax Court. If the amount outstanding (what the IRS says you owe in taxes, interest and penalties) is less than $50,000, you can use the small Tax Court procedure to expedite the matter and save money on the cost of presentation. However, no appeals can be taken from a summary opinion in a small Tax Court case. If the tax dollars are big enough, or the principal of what the IRS is claiming is important enough to you, consider using the regular Tax Court procedures for having your day in court.
The likelihood of being audited is small. But if you find yourself in the IRS’ sites, take appropriate action. Don’t ignore any notice you receive, and consult with a tax pro before responding if you have any questions.
For more tips on how to help ease your way through tax season, access our exclusive guide, It’s Tax Time: A Business Owner’s Survival Guide.
The information contained in this article is for generalized informational and educational purposes only and is not designed to substitute for, or replace, a professional opinion about any particular business or situation or judgment about the risks or appropriateness of any financial or business strategy or approach for any specific business or situation. THIS ARTICLE IS NOT A SUBSTITUTE FOR PROFESSIONAL ADVICE. The views and opinions expressed in authored articles on OPEN Forum represent the opinion of their author and do not necessarily represent the views, opinions and/or judgments of American Express Company or any of its affiliates, subsidiaries or divisions (including, without limitation, American Express OPEN). American Express makes no representation as to, and is not responsible for, the accuracy, timeliness, completeness or reliability of any opinion, advice or statement made in this article.
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