What Happens If Your Business Gets Audited by the IRS?

Getting audited by the IRS naturally sounds very scary. Many business owners fear an audit by the IRS more than any other obstacle they face. This fear—or at least this level of fear—is largely unfounded. If you’re wondering what happens if your business gets audited by the IRS—keep reading.

While concerning, an IRS audit typically results in nothing more serious than an additional tax bill and occasionally a penalty. Sometimes, no adjustments are made to the tax return at all, and the audit is simply an inconvenience that costs the taxpayer and his accountant a day or so of their time.

But what is an IRS audit? What happens if your business gets audited, and what can you expect during the process? What should you do if you are notified one of your tax returns is under audit? And as a small business owner, should you be afraid of getting audited?

What Is an IRS Audit?

At its core, an audit is simply a “second look” at a business’ tax return for a certain year. While there are certain things that increase your chances of being audited, most audits are completely random. The IRS selects a certain number of tax returns each year as a compliance check. In this regard, audits are similar to the quality control measures you use in your own business.

What Happens If Your Business Gets Audited by the IRS?

Here’s exactly what happens if your business gets audited.

During an audit, the auditor compares the tax return for the year under examination to the business’ books for that same year. They might also ask to review source documentation, such as invoices, receipts, bank statements, etc. The auditor’s job is to ensure there are no discrepancies or other errors on the tax return for the audited year.

If the auditor does find discrepancies or errors, the business might be liable for additional taxes, as well as penalties and interest on that additional tax amount due. You have the right to disagree with the auditor’s findings should they not be in your favor, including filing an appeal or requesting mediation.

Audits can be conducted via mail or in person. In-person audits can be conducted at an IRS office (an office audit) or at your office or your accountant’s office (a field audit). You may engage a tax attorney if you wish, but this is typically not necessary.

There are a few other important notes about what happens if your business gets audited and the audit process:

• Most audits are initiated within two years of the date of filing, but the IRS may go back six years if they identify a substantial error.
• In most cases, electronic records are acceptable for the purposes of an audit.
• As a taxpayer, you have certain rights that your auditor must respect.

The Audit Process

If one of your tax returns is selected for an audit, the IRS will notify you by mail. The IRS will never initiate contact with you via phone with a demand for money or personal information, nor will they contact you via email.

Should you receive a suspicious IRS-related communication, follow the steps outlined on the IRS website to report the phishing attempt.

Assuming you receive a notice of audit via the mail, you will have a certain amount of time to reply. Typically, the IRS requests a reply within 30 days. Failure to reply within this time period can result in an automatic adjustment to your tax return, meaning your next piece of mail from the IRS will likely contain a bill for additional tax due, an underpayment penalty, and interest.

In other words, don’t ignore correspondence from the IRS. If you receive a letter from the IRS, open it right away.

The audit notice will include what happens if your business gets audited, your auditor’s contact information, instructions on your next steps, and a list of documentation or information the auditor wishes to examine. You will want to follow these instructions closely and carefully compile and organize the information they’ve requested. Showing up to the audit with the legendary shoebox full of receipts will not be to your advantage.

Be courteous to your auditor. Remember, the auditor is a trained professional performing a service, just like you. While they have a certain set of guidelines to follow, auditors are allowed to use their discretion regarding what to examine and how closely to examine it. Being nice certainly doesn’t hurt your chances of getting through the audit as smoothly as possible.

On the day of the audit—assuming it is conducted in person—arrive to your appointment on time, or even a little early. Dress professionally, but don’t overdo it. Though the auditor’s primary focus will be on your financial records, auditors are also trained to look for other signs of underreported income, and showing up in an expensive suit could lead the auditor to take a closer look than he would have otherwise taken.

Along those same lines, make sure to keep your conversation with the auditor focused on the audit itself. You could say something in “casual” conversation that could incriminate you or cause the auditor to take a closer look at your records. Try to answer questions with a simple yes or no, or better yet, let your accountant do most of the talking for you.

What Should You Do If You Are Notified of an Audit?

Receiving a letter from the IRS is always a bit nerve-wracking, and learning one of your tax returns is under audit will probably put a damper on your day. Now you know what happens if your business gets audited, but what should you do when you receive a notice that one of your tax returns is under audit?

• Breathe. Remember, you typically have 30 days to respond to the audit notice. Take the notice seriously, but don’t let an audit notification ruin your day.

• Call your accountant. As soon as possible, let your accountant know you have received an audit notice. Your accountant will likely want you to send them a copy of the notice. Make sure to scan all pages of the letter so your accountant has all the information requested.

• Begin gathering the requested information. Organize your information and compile any records requested for the year under examination, making copies of the requested information. Never give the auditor original documents, as the IRS is not responsible for lost or ruined documents left in their possession.
  
  You are required by law to retain and safeguard all records you use to file your returns for at least three years. Most tax professionals recommend you keep records for seven years, just to be safe. If you find you’re missing requested documentation, take steps to replace it prior to the start of the audit.

• Isolate the audit year’s data. Remember, an audit encompasses a certain time period, so focus only on the records for the tax year or years under examination.
  
  Most businesses have multiple years’ worth of accounting data in their bookkeeping program. This is helpful for business analysis and management, but it can work against you in an audit scenario.
  
  In an audit, you should only provide the requested information, and this includes bookkeeping data. Create a period copy of your accounting file or otherwise isolate the audit year’s data. This will mitigate the risk of the auditor seeing something else that piques his interest and minimize the risk of adjustments to multiple years’ tax returns.

Should You Be Afraid If Your Business Gets Audited?

Many concerns keep small business owners up at night. From attracting clients, closing sales, and managing difficult employees, small business owners face many uncertainties and challenges.

While many business owners add getting audited to that list of concerns, it certainly shouldn’t be one of your primary fears. Though unpleasant, as long as you are keeping accurate records and not deliberately underreporting income or exaggerating expenses, an audit is nothing to fear.

In short, do not be afraid of what happens if your business gets audited. You have about a 1% chance of getting audited each year you file a tax return, which means you have a decent chance of undergoing an audit at some point in your life.

Rather than focusing on the fear of an audit, take the necessary steps to ensure you are accurately recording and reporting your business income and expenses each year. Engaging the services of an accounting professional to guide you through the complex tax landscape can help further ease your fears, as well as provide you with a valuable ally in the event of an audit.

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