You received the dreaded letter in the mail – your business is being audited by the IRS. Aside from panicking, what should you do? Let's start with the basics and see how the IRS audit process works.
The Audit Process
In an audit, the IRS is simply questioning an item or items that you reported on your tax return. For example, the agency may question whether you actually reported all of your income, or claimed legitimate tax deductions. In most cases, you will need to provide additional documentation to support the item in question. The auditor will review your support and you may be required to pay additional tax if there is a change to your return or an accounting error is discovered.
The IRS always initiates audits by sending a letter in the mail. The initial letter you receive will contain contact information and instructions for sending the IRS information about certain items on your tax return.
You may be asked to send in receipts, canceled checks, payroll documents, loan agreements, and legal documents, among other documentation. The auditor may also ask you to fill out certain questionnaires to obtain more information. Common questionnaires include a general questionnaire, a car and truck questionnaire, and a travel, meals, and entertainment expense questionnaire.
Send in copies (never originals) of the requested documentation. Try to organize the documents by category and include explanations wherever they may be beneficial. Whichever delivery service you choose to use, always obtain a delivery confirmation.
The IRS will conclude the audit after the auditor reviews your documentation. If you've substantiated all the items on your return, the audit will conclude with no changes being proposed. If the auditor proposes changes to your return, you will either agree or disagree. If you agree with the proposal, you will sign a form or report and make arrangements to pay any additional amounts owed. If you disagree with the changes, you can request a conference with an IRS manager, file an appeal, or request mediation.
Do I Need a Professional? CPA Versus Tax Attorney
Although finding out they're being audited tends to induce a sense of panic, anxiety and overwhelm in most people, the process is typically straightforward and manageable. This is especially true if you consistently maintain accurate records of all business income and expenses. In most cases, you can simply respond to the IRS letter and provide whatever information the auditor requests from you. Many audit cases are closed after this preliminary stage.
If the IRS sends a second letter that discounts or contradicts information you've submitted, or requests an in-person meeting, it may be worth hiring a tax professional such as a CPA or a tax attorney to represent you.
A CPA (whether your in-house accountant or an external one) is knowledgeable about tax law and the audit process. They understand what the IRS is looking for and how to present information to the IRS. In most cases, when the audit is simply a review of your return and there is no dispute or conflict, a CPA can expertly handle the whole process on your behalf.
However, if you face criminal charges, large amounts of back taxes, penalties, or interest, a tax attorney is the ideal choice to represent your interests in communicating with the IRS. A tax attorney is a legal professional who is trained in handling tax disputes and controversies. In addition to being knowledgeable about tax law, a tax attorney is trained in settlement and resolution and can help devise a plan that will keep you out of trouble while still satisfying the IRS.
Bear in mind that while attorney-client privilege preserves the confidentiality of communication between a client and an attorney, accountant-client communication is not generally privileged in the same way. This may mean that your accountant can be compelled to testify against you in court.
Although a very small percentage of businesses get audited by the IRS, you may indeed be one of them. As always, careful bookkeeping, meticulous records, and timely response are the key to success. Should the need arise, there are professionals who can help you, but here's to hoping you don't get that far.