No one likes the IRS, especially when they’re asking questions. Audits aren’t as rare as they seem, but there’s a lot you can do to make them less probable. Despite popular opinion, the IRS are relatively easy to work with if you’ve kept clear and consistent records. If you’re looking to future-proof your business operations, or at least make the idea of dealing with the IRS a bit less terrifying, there are a few things you can do.
How The IRS Actually Audits People
If you’re worried about an auditor showing up at your door with an official looking letter, relax; the IRS doesn’t work like that. 99% of all IRS interactions take place via good old certified mail. Most audits, in fact, are “correspondence audits” that involve nothing more than sending a few forms and scanned documents back and forth through the post office, and even in-depth audits start with a letter.
Statistically speaking, the chances that you’ll be audited are low. Only ~1% of businesses are selected for random audits, and the majority of those are the aforementioned correspondence audits. The odds go up in relation to your annual earnings, but even among businesses with holdings in excess of $10 million, only ~16% are audited.
On the other hand, there are 27.9 million small businesses in the United states. 1% of almost 30 million isn’t a small number. Your chances of being audited increase depending on whether you’ve made any tax-filing errors, too, however the exact impact of any one specific issue is hard to measure.
With that in mind, here are some things you can do to make your life a little bit easier in the auditing department.
Keep Intelligent Records
Holding onto financial records is easy. Storing financial records in such a way that you can use them is another story. You’ll need more than binder clips full of receipts or hap-hazard filing cabinets if you want to make it through an audit.
Legally speaking, you need to keep most financial records for up to six years, up to a maximum of seven years depending on the circumstance. Digital record keeping goes a long way towards streamlining the process, but you’ll still need to digitize and archive the receipts and invoices that come in from other sources.
The secret to an effective filing system is building an efficient index. Going through three months of records to find a particular invoice is relatively easy. Trying to do the same with three years of records, without an effective way to navigate those records, is incredibly tedious. Extrapolating that to six or ten years of records is close to impossible.
An ideal records keeping system allows you to search and navigate based on multiple variables. You should be able to divide data based on date, customer, and service category at the absolute least, and all financial records should be consistently labeled and filed. There are tons of software solutions available that can help you do this.
The worst thing you can do when dealing with the IRS is delay. The sooner you start the auditing process the sooner you can resolve it, and responding promptly will protect you from potentially painful fees. Even if you can’t provide the information they request, establishing contact and working with them to identify what you need to do is far better than leaving a bad impression by staying quiet.
While the IRS communicates primarily by mail (if you get a phonecall by someone claiming to be the IRS, it’s a scam), you can always call in to verify the information you’ve received. The paperwork you receive in the mail will include relevant contact information and a case number, and the IRS maintains multiple points of contact that you can find online.
Depending on where you operate, you may be able to visit a regional tax center to verify the details of your case. This isn’t a feasible option for everyone, but an in-person conversation shouldn’t be passed up if it’s an option.
It’s important to note that there’s a difference between responding promptly to an IRS notice and actually complying with it. In most circumstances you can apply for an extension in order to gain extra time, which can help you marshal your resources for a response. The key part here is to make sure you stay within the deadlines, and stay proactive enough to keep the IRS from escalating your case.
Control The Situation
If, in a worst-case situation, the IRS has found filings or deductions that they believe to be incorrect, control the situation. Familiarize yourself with the taxpayer bill of rights, specifically in relation to your right to representation and appeal.
If you’re being audited, handle it the same way you would a lawsuit. Comply with the law, but remember to protect your business interests. There’s no need to over-supply information or to bend over backwards to meet demands made outside of the IRS’s legal authority. You’re well within your rights to rely on professional representation or retain the services of a CPA for the purpose of responding to the IRS.
For small businesses especially, IRS auditors are looking for situations where the line between personal and professional expenses blur. If your tax paperwork implies that and your audit is escalated to an in-person process, the IRS will push for conducting the audit on your property. It’s in your best interest, even when you’ve done nothing wrong, to base the process in a neutral facility. At the end of the day, the IRS auditor you deal with is not your friend.
Getting audited is stressful, but it isn’t the end of the world. Few audits are entirely random, but the majority of the audits that take place are easily and amicably resolved. As long as your records are clear and you communicate properly, the process should be relatively smooth.
If you’re forced to deal with a pushy or biased auditor, stick to your guns. Your legal rights are clearly defined, and seeking legal assistance isn’t a sign of guilt; it’s common sense. If worst comes to worse, the rules are biased in your direction.