I don’t think any business owner wakes up saying, “Gosh, I hope I get audited today!” Most small business owners do everything to keep their interactions with the IRS to a minimum—with special exceptions made for sizeable small business tax returns.
However, if you set off any IRS audit red flags, you might find yourself on the wrong end of the IRS—the auditing end. There are things you can do to make sure you’re prepared for an audit before the IRS dives into your small business finances.
Preparing for an audit ahead of time
The best audit is the one you never get. The second best is the one that resolves quickly because your finances are so well-organized that it makes the process a breeze.
Of course, having organized finances requires a proactive, deliberate approach before the audit comes. Whether you’ve just been notified of an impending IRS audit or you’re making sure you’re ready when it comes, the following tips will help you prepare.
Any documents, information, or payroll forms for small business that you use to calculate your estimated taxes and tax returns are fair game for the IRS to look through. Make sure all the items used in your tax filing processes are easy to locate, complete, and ready to be turned over for review.
The more disorganized you are, the longer the IRS will look at your information for mistakes. Showing organization establishes that you are credible and thorough with your work and tells the auditor you are less likely to have made mistakes.
Scrutinize your books
Brush up on your accounting lingo and wade back into your books. Make sure claims for general business expenses match your tax filings. Look for entry errors, and, in areas where difficult accounting was done, make sure you understand and can explain both the documentation and the reason it was done that way.
What you’ll need during an audit
During an audit, you’ll want to bring as many forms of financial identification as you can. What I mean by that is you should have redundant copies of the same financial information on hand.
Have your bank statements, receipts of purchases and transactions, start-up business credit card statements—all of it. It may be that some of it is not needed, but the more evidence you have to support your tax return information, the better.
Is your business prepared for an IRS audit? If you’re not sure, check that you have the following items available in case of an audit:
To the auditor, finding the full picture of your finances is like putting together a puzzle. They’ll piece together your financial history with the following clues:
- Invoices and sales slips
- Bank statements
- Voided checks
The auditor will match the documents with your tax return to look for errors. Often, the goal is to find mistakes, like over-reported expenses or unreported income.
You also need to bring your small business accounting records to the audit. The auditor will reconcile your books with the supporting financial documents listed above.
Journals, calendars, and logs
Journals, calendars, and logs serve to reinforce how your business behaves, which ultimately dictates how your finances behave.
Think of them as witnesses or character references. They prove what your financial documents are testifying about. Journals, calendars, and logs can show that your business is organized and consistent.
Equipment and leasing records
Many small business owners purchase assets and use them for both personal and business purposes. Sometimes, the line between personal and business use can get blurry.
For example, many small business owners have cell phones, which they write off as a business expense. However, it’s highly unlikely that you’ve never made a personal call on your cell phone, which would raise the eyebrow of many auditors if you claim the phone is for 100% business use.
If you’ve bought items that you use for both personal and professional reasons, make sure you have a receipt of the purchase. You can apply small business tax deductions to your tax return to reduce your tax liability. How much you deduct will depend on how often you use that item for your business.
For example, if you have a home office, you can only write off the portion of your utility expenses that were used in your home office.
When the IRS audits your small business
If your business receives an IRS audit, don’t panic. An audit does not necessarily mean you are in trouble. The IRS is simply checking for discrepancies between your tax return and your financial records. As long as you keep organized, thorough books, you shouldn’t run into any major problems when the auditor comes knocking at your door.
Preparing for an audit can be made easier by staying on top of your accounting. Get prepared by downloading this free guide to avoiding IRS audit triggers.Business & Finance Articles on Business 2 Community