Navigate an IRS Business Audit With Confidence - Hands gesturing over papers with graphs and data.
Article

Navigate an IRS Business Audit With Confidence (and Lower Your Odds of One)

by Kim Peterson
October 23, 2023

Are you concerned about the threat of an IRS audit? It’s a reasonable fear because the dreaded process may require countless hours, disrupt your business and cost you additional taxes, penalties and interest. However, you can lower your chances of IRS scrutiny, gain peace of mind and reduce potential costs and time demands if your business faces an IRS audit. Here’s how.

Tips to Reduce Your Odds of an IRS Audit

There’s no way to completely eliminate your chance of an audit because the IRS randomly selects a small percentage of tax returns for audit each year. But the agency determines other audit targets after identifying variances or red flags in returns that could indicate noncompliance.

Avoiding careless mistakes on your tax return is a simple yet effective strategy that helps alleviate unwanted IRS scrutiny. Always double-check for omissions, mathematical errors and transposed or incorrectly entered numbers in the information you provide to your tax advisor, as they rely on these figures to prepare your return.

Timely, accurate compliance with tax obligations reduces the likelihood of an IRS audit and lessens potential negative consequences if you are audited. Good record-keeping practices help, too. When you have current information and proper documentation available for tax reporting, it makes the process easier.

Other types of triggers may be unavoidable due to the nature or performance of your business. Your best move in this situation is to be aware of the increased IRS audit risk and work with a qualified tax professional to ensure that your position is defensible and well-documented. Some of the most common red flags that raise the risk of an IRS audit include :

  • Large or repeated business losses
  • Unreported revenue
  • Large charitable contributions
  • Conservation easements
  • Cryptocurrency accounts and transactions
  • Micro-captive insurance companies
  • Research and development tax credits
  • Farming businesses
  • Rental businesses such as yacht charters
  • Airplane expenses
  • Financial transactions that could be considered self-dealing

When to Seek Professional Guidance for an IRS Audit

The first indication of an IRS audit is typically a letter notifying you that your business has been selected for one. However, not all unexpected IRS notices mean an audit is in your future. If you get an agency request for more information about something on your tax return, for example, providing the requested information is often enough to resolve the issue.

Similarly, if the IRS thinks you made a mistake on your tax return and sends a letter stating that you owe additional taxes, it doesn’t mean you are being audited. You can challenge their position or simply remit the additional payment.

Consult your tax advisor for guidance any time you get an unexpected communication from the IRS. They will help you respond appropriately and can sometimes avert problems before they arise. However, if you are unable to resolve the issue quickly and to your satisfaction or you receive an audit notice, you should seek the services of an IRS audit specialist immediately.

While there is no legal requirement to employ professional support during an IRS audit, working with a professional who has extensive tax dispute resolution experience can greatly improve the process. IRS audit specialists can help you get through the audit as quickly and effectively as possible, reducing potential costs and stress. The sooner you seek assistance, the more they can help you.

In any IRS audit, your goal is to tell “your side of the story” in a way that explains your position clearly and helps the IRS see why your tax return is accurate. An IRS audit specialist is better equipped to help you achieve that goal.

They will quickly identify the agency’s concerns and define what the IRS needs to clarify your tax return. They can also determine the best response to information requests, clarify questions on both sides and handle IRS communications so you can focus on managing your business.

3 Keys to a Successful IRS Audit

1. Clear , consistent communication can help your IRS audit move faster and help you reach a more favorable outcome. From the outset, it’s essential that you and your IRS audit specialist maintain open lines of communication with the IRS agent assigned to your case. Your audit specialist can communicate with the IRS for you, if you prefer.

Establish a mutually agreeable cadence with your IRS audit specialist to review agency requests, official notifications, documents responsive to IRS requests and other progress on your IRS audit. Weekly, semi-monthly or monthly check-ins will help ensure that you and the IRS agent are on the same page and that nothing slips through the cracks. These regular touchpoints are an opportunity to identify missing information and confirm IRS acknowledgment of your response to any requests.

2. Organization and documentation will help you achieve a better IRS audit experience. Keep clear records of what the IRS has requested, the documents you provide in response to each request and the date you provided them. Create a tracking system (e.g., spreadsheet or software system) where you can track each interaction.

  • Respond to IRS requests in writing with identified exhibits, and in general only respond to written requests for information.
  • If your IRS agent makes an oral request, ask them to document it. Include a cover sheet that lists what you are submitting in response to all agency requests.
  • Use documentable forms of communication for your submissions, whether fax, registered or certified mail, or secure email process with the IRS.
  • Be sure to retain proof of each submission and record your response's date and contents in your IRS audit tracking system.
  • Ask the IRS to acknowledge receipt of the information and that it satisfies the agency’s request.

3. Sound records management makes an IRS audit go better. Keeping detailed and well-organized records lets you provide complete documentation supporting all positions you’ve taken on your tax return, which can make a huge difference in the audit outcome. Having the right records — easily accessible and in a usable form — greatly reduces your logistical burden and can facilitate a smoother resolution.

  • The IRS typically has three years from the date your tax return is filed to begin an examination or audit.
  • IRS audits can reach back 10 years or more for tax positions that the business carries over for multiple years (e.g., passive activity losses), so it’s imperative to retain these records long term.

Strategies to Help Smooth the IRS Audit Process

Set realistic duration expectations – The typical timeframe for an IRS audit of a privately held business is nine to 18 months, but some can take far longer. Although the IRS is actively hiring new agents, there is a significant backlog. Remember that the agency wants the same thing you do: a complete and fair resolution to your audit.

The IRS will make multiple requests for information and documentation throughout the engagement. Providing the requested information quickly and completely will allow the process to move forward as efficiently as possible. Generally, these requests start broadly and become narrower as the IRS audit progresses.

Watch for agency overreach – The IRS has broad authority to request information, but that authority is not unlimited. There may be times when the agency asks for something to which it is not entitled. The IRS should target its requests to information that is relevant or that may lead to relevant information. They should only request information that exists, is in your business’s possession or control and is not privileged.

Similarly, the IRS should not request that you create a business record that does not already exist. You may be required to provide the data the agency seeks, assuming you have it in another form, but you don’t have to create new data or a new document. Recognizing the nature of IRS requests and helping you respond appropriately is a significant advantage of working with an experienced IRS audit specialist.

Anticipate potential scope creep – Once begun, it’s possible for the IRS audit scope to expand to cover additional issues, tax returns for additional years, or both. The IRS may also shift from looking only at the business return to include other related returns, including the owner’s (or any relevant individual’s) personal tax return. An IRS audit specialist can help you understand what’s happening and why and determine an appropriate response.

Take advantage of final review opportunities – The IRS should keep you informed of its progress throughout the audit and clearly alert you to any potential proposed changes to your tax return. Near the end of your audit, the IRS should provide you with a draft document summarizing the results of the audit. The document will identify the information you’ve submitted in response to IRS requests and explain the agency’s position on any proposed changes to your tax return.

Review the draft document carefully with your IRS audit specialist to be sure it accurately reflects the information and documentation you have submitted. This step provides you with a final opportunity to offer additional information or explanation to further support your position if the draft document shows there’s still a gap between your position and the agency’s.

Recognize the IRS audit’s close – When the IRS audit is over you’ll get a formal written document that states the final outcome, including any proposed changes to your tax return for the year(s) being audited. You may or may not agree with the IRS’s conclusion, and you should consult with your tax advisor on what to do next.


Don’t Let an IRS Audit Derail Your Business — or Your Equilibrium

Having an IRS audit specialist in your corner makes an audit less stressful, less time-consuming and potentially less costly. Reach out to Armanino’s highly experienced tax experts for ongoing tax guidance and specialized help that lets you navigate the IRS audit process with confidence.

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Author
Kim Peterson - Tax | Armanino
Director
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