A tax audit can be the worst nightmare for many business owners. But there are proactive ways to prevent an audit and get through it if it does happen.
A tax audit may sound daunting and expensive. Many business owners fear the IRS and potential penalties and fees incurred if they do something wrong.
The good news is that audits are rare, and the IRS audit rate has even fallen in recent years. In 2019, the IRS audited just one individual taxpayer out of every 220; 10 years ago, the rate was 1 in 90.
Still, it’s important to know how you can avoid an audit from happening in the first place. And if you do end up getting audited, learn how to get through it without too much headache.
Preventing a tax audit
First, let’s talk about how you can avoid an audit altogether. The tax returns that the IRS audits are generally very complex, and audits usually occur to ensure that all income was reported and that you only took legal credits and deductions.
Fortunately, there are a few specific steps you can take that will reduce your risk of experiencing. These include:
1. Be honest.
The number-one way you can prevent a tax audit is by telling the truth. Many taxpayers try to cheat the system, whether by leaving off income or stretching a deduction, but this only increases the chances of a lengthy audit that could end them in trouble or with significant fines. Be completely truthful about expenses and income, even if you don’t think you’re at risk for an audit.
According to the IRS, paper returns have a 21% error rate, while e-filed returns have a 0.5% error rate. Thus, consider filing electronically for greater accuracy.
3. Be careful with credits and deductions.
This is an important one, especially for the self-employed. Deductions like luxury entertainment items that are ostensibly used for business purposes can turn into a red flag for the IRS. Whatever you claim as a business expense has to be used for business purposes. Be reasonable with claimed deductions—make sure you’re actually eligible, and all numbers are accurate.
4. Maintaining records.
Sometimes a tax return is inaccurate because a taxpayer has failed to maintain tight records. Keep all of your receipts for business expenses and ensure you’ve accounted for every channel of income. Track your purchases as well as assets. Store everything in one place, so it’s easier to complete your return when the time comes.
5. Get tax help from a professional.
The last tip for avoiding an audit will essentially help you with all the above steps. Work with a professional who understands tax laws. Your best bet in getting your taxes done right is to hire a qualified CPA who will walk you through best practices and deductions for which you are eligible.
Surviving an audit
If you’ve done everything you can and are still facing an IRS audit, there are ways to get through it. Here are some audit best practices to help you along the way.
1. Look at your recordkeeping system.
Reevaluate your books. You need an efficient method for tracking business costs and expenses. Your accounting system should be tight and straightforward so that all transactions are accounted for. Everything should be organized so it can be presented well for the audit.
2. Respond quickly.
Most audits are conducted by mail but, in rare cases, they’re done at an IRS office or your home or business. When you receive a notice in the mail, it’s crucial that you respond immediately to avoid penalties. You will likely be asked to provide additional documentation to support the claims on your tax return. Deliver everything following the agency’s specific instructions.
3. Be prepared to advocate.
The IRS may then start to ask additional questions, and they may not agree with something you provided on your return. Be prepared to present all the facts and advocate for your return if you know you have done everything correctly.
Your best bet for getting through an audit is to follow all instructions closely, respond immediately, be as transparent as possible, and be willing to work with the IRS to get the matter resolved. The case will eventually be closed, either with the IRS proposing no changes to your return or specifying adjustments. If you disagree with the decision, you can appeal within 30 days of receiving their summary.
Work with experienced tax professionals
Whether you’re trying to avoid an audit or facing one, work with a tax professional who will help you understand tax law and everything you’re eligible to claim. They will be there to support you during the audit to ensure you’re responding promptly and are working out all details to avoid penalties and further issues. And with the right advice, you’ll likely avoid this scrutiny altogether.
The team at Provident CPA and Business Advisors is ready to assist you with your tax or business questions. Contact us today to get started.