IRS audits can be a business owners’ worst nightmare: the hassle, the heaps of paperwork, the potentially hefty bill. However, with the right preparation and resources, an IRS audit doesn’t have to be a stressful event.
Read on for our ultimate guide to IRS audits. We answer all the most common questions to help you navigate an audit as smoothly as possible. Let’s get started.
What is an IRS Tax Audit?
IRS defines an audit as “as a review and examination of an organization’s or individual’s accounts and financial information to ensure information is reported correctly according to the tax laws and to verify the reported amount of tax is correct.”
How Will You Be Notified of an Audit?
You will know if you are selected for an audit if you receive a verified letter in the mail from IRS. They do not call to notify you about your audit.
Why Was Your Business Selected For an Audit?
There are several different reasons your business may be flagged for IRS audits.
Some businesses are audited in random checks. However, the chances of a random audit are low. Most taxpayers have less than a 1% chance of receiving a random audit check.
Incorrect Tax Filing Information
IRS runs tax returns through their Discriminant Information Function (DIF) system to track industry benchmarks for each industry and tax bracket. The DIF system also checks for incorrect tax filing information. Any discrepancies in tax forms, or if the form isn’t complete, may trigger an IRS audit.
Other Reasons Businesses May be Audited by IRS
People are more susceptible to an audit if they:
- Have a home-based business
- Have a cash business
- Have foreign assets
- Have large numbers of cash transactions
- Claim a disproportionate number of deductions
- Are self-employed
- Issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit
Learn how to avoid IRS red flags from cash transactions, here.
How Long Do You Have to Respond to an IRS Audit?
You have 30 days to reply to the initial audit letter.
What if You Need More Time to Respond to an IRS Audit?
Your attorney can help by advocating for more time with the IRS agent. We don’t recommend hesitating on responding to an IRS letter on your own, IRS is likely to offer extensions without assistance from an experienced tax attorney who can help present your case.
What Do You Need to Provide in an Audit?
According to IRS, they may ask for copies of:
We recommend presenting receipts by date with notes of how they were used by or relate to your business.
Business owners can include dated bills with information such as the name of the organization that received the payment as well as the type of service it provides.
Business owners can organize canceled checks with copies of the bills they paid and any applicable employer reimbursement.
Include a description of what the case was about, when it happened and how it relates to your business, credit or deduction. Examples include:
- Divorce settlements including custody agreements
- Criminal or civil defense papers
- Property acquisition
- Tax preparation or advice
- Loan agreements – Include a copy of the original loan with the following:
- Names of the borrowers
- Location of the property
- Financial institution making the loan
- Amount borrowed
- Terms (the number of months to pay)
- Settlement sheet
- If the loan was from an institution, include an end of tax year statement indicating interest paid
- If the loan was not from an institution, provide a statement from the payee indicating the interest paid that year as well as the payee’s address and Social Security number
- Provide a break-down of how you used the money
- Logs or diaries
- Medical and Dental records
- Medical savings account statements
- A copy of a handbook or other statements showing benefit and reimbursement policies
- Physician statements
- Capital improvement records for medical purposes including appraisals of the property before and after the improvements
- Contract for attendant care
- Theft or loss documents
- Insurance reports detailing the nature of the loss or damage
- If not insured, copies of fire department or police reports on the loss, theft or accident
- Photos or video showing the extent of the damage (if available)
- Appraisal from a qualified adjustor showing fair market value of the property before and after as well as an estimate of the damage
- Brief explanation of the loss
- Employment documents
- Schedule K-1
You can view a list of records IRS may request here.
How Long Do Audits Take?
The time it takes to conduct an audit depends on the case. It fluctuates depending on:
- The tax reporting error
- Communication between the person being audited and IRS officer
- When and whether the right information is provided to IRS
How Far Back Can IRS Audit Your Return?
IRS audits tax returns from the past three years. However, audits are typically from the past two years.
IRS will not look for information older than three years unless they find discrepancies within the audit they are conducting. Most audits do not look for information past six years. In criminal cases, IRS can look back more than nine years.
Facing an IRS Audit?
If you or someone you know received an audit letter from IRS, reach out to our expert team at Milikowsky Tax Law. We have over a decade of experience working with IRS and tax audits and are experts in defending business owners in the face of IRS or other government agency audits.
Read on to learn how to respond to an IRS audit in 2022, here.