After just a few short years in business for herself, it was her first run-in with the IRS and she was panicking. Thankfully, she had used a certified public accountant (CPA) to help her set up the business and file her taxes each year.
Once she calmed down she placed a quick call to her accountant and faxed over a copy of the letter. She and her accountant supplied the additional documentation and answered a few clarification questions, the auditor’s concerns were answered and the matter was cleared. Susan was lucky and her situation was resolved quickly. Other business owners may be facing a more complicated process.
Who gets selected for an audit?
Generally, taxpayers are selected for an audit for a few reasons. Possible triggers could include a simple random draw of the taxpayer’s filing, several items on the return were questionable or exceeded acceptable thresholds, or the IRS has an interest in a particular business or industry and your business fit the profile. Whatever the reason, a taxpayer’s best defense is to seek immediate expert advice and quickly response to the audit notification.
Before Susan started her freelance graphic design business, she had a lucrative position as an advertising executive. After her second child she decided to leave her full-time position to start a home-based business. She had experienced a significant downward shift in her income from the previous year and had increased her deductions and itemizations to include equipment purchases, several business trips and client meals. All of these instances appearing separately wouldn’t raise a red flag, but together are more likely to trigger an audit.
The IRS is also increasing the number of random audits it performs in order to generate more revenue for the government’s operations. That being said, right now the IRS audits approximately 1.5 percent of all taxpayers each year. For taxpayers with income between $50,000 and $100,000 the odds are about one in one hundred to have a tax return examined. That number nearly doubles for business returns claiming over $100,000 in income. Rest assured that if you receive an audit notice that you are not alone.
There are four different types of audits typically requested by the IRS. These include the Correspondence Audit, Notice of an Office Audit, the Field Audit, and the Taxpayer Compliance Measurement Program audit (TCMP). Each audit type will require a different action on your part.
The correspondence audit is a letter from the IRS Service Center and will arrive by regular mail. The questions asked by the IRS can usually be answered by providing simple documentation in response. Most business audits do not occur in a correspondence audit and are reserved for small, simple tax returns.
The office audit notice will also arrive by mail. The letter will include details on specific items of your return that are in question. You can and should bring a tax representative with you to explain any documents you and answer questions posed by the IRS agent. A tax representative such as a certified public accountant, tax attorney or enrolled agent (EA) is the only legal representative you can bring into the process with you. The office audit is typically used for small, sole proprietors with annual sales under $500,000.
Taxpayers selected for a field audit will receive a personal phone call from the IRS agent who will want to select a date and time to visit the business. Representation at this meeting is highly recommended as the IRS often sees these site visits as an opportunity to review not only your tax year in question but also business operations. Your representative will be better able to advocate on your behalf and keep the auditor contained to your conference room rather than wandering about your business.
The last type of audit is the Taxpayer Compliance Measurement Program (TCMP) audit. The primary purpose for this type of audit is to help update the data used in the IRS scoring program. The audit will require a total review of the entire return including all forms of documentation. This is a highly time consuming and rigorous process,as the auditor will literally review the return line-by-line and all supporting documentation will be required. Your tax representative will be invaluable in the process.
Whatever the reason for the audit there are a few simple steps you can take to prepare your response.
1. Call your tax preparer or accountant and review the tax filing in question.
2. Call the IRS and request an extension of the time to respond to the audit. This
will allow you a little more time to gather your data and have a solid response
prepared. Generally extensions are granted for an additional 30 days for the first
3. Collect all of your supporting documentation including:
c. Meals, travel and entertainment receipts including mileage logs and calendar
d. Bank statements
e. Credit card summaries
f. Interest statements
g. Business expenses and any home improvement receipts
h. Bring only the documents and receipts that apply to the tax year in question.
An audit can be a terrifying process if you try to face it alone. With a skilled and trusted tax representative on your side, the whole event can go quicker and less painfully.
PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants, Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations. To find a trusted accountant in your area, visit www.SmallBizAccountants.com.
Copyright Information 2011 Professional Association of Small Business Accountants