Six Essential Tips for Handling an IRS Audit
Audits are an essential part of the federal taxation process — and with good reason. In-person field audits and audits managed by mail are responsible for recovering billions in unpaid taxes. In fiscal year 2023 alone, Internal Revenue Service (IRS) auditors assessed $31.9 billion in unpaid taxes. But even if you don't make the kind of red-flag tax mistakes that typically trigger an audit, the IRS may select your tax return at random for a second look.
How you respond can impact your results. Here are some useful guidelines for keeping Uncle Sam happy and your business running without any hiccups.
1. Don't ignore that letter.
The IRS sends audit notifications by U.S. mail on its official letterhead and allows 30 days for your response. Ignoring an audit notification is, quite frankly, a bad idea that can only escalate what might be a small and easily resolved issue.
In most cases, the letter addresses a specific issue and proposes a financial remedy. If you agree, then you can pay the amount due. If you disagree, you'll likely need to provide additional documentation and meet with an IRS agent.
2. Call your accountant.
Though you can certainly represent yourself in an audit, you can have your accountant (or one you hire) to join your or to attend in your place. If you have an accountant and their firm prepared the tax return, it should handle the audit at little or no cost to you. But even if you prepared the return yourself, hiring a tax expert to represent you during the audit is worth the investment, as they will know best how to respond to an auditor's questions. At the very least, consult with a tax professional upon receiving the examination letter. They can prepare you for the process ahead.
3. Gather your records — all of them.
Organized, archived records are critical to your success. In preparation for the audit, gather and make copies of the records you used to prepare the tax return in question. Critical documents include tax documents, account statements, invoices, and itemized receipts for any claimed expense. An auditor will check the filed return against these records for discrepancies or errors. A great way to keep things moving and to earn credibility with your auditor is to organize and maintain your financial records diligently. If you lack supporting documentation, you can attempt to reconstruct it. However if your auditor doesn't accept these new records, you may be subject to penalties.
If you're a packrat, that's quite alright when it comes to financial records. In most cases, the IRS reviews tax returns within three years. But... the IRS recommends maintaining financial records for up to seven years.
4. Know your rights as a taxpayer.
Familiarize yourself with the IRS's Taxpayer Bill of Rights before meeting with an auditor. If the IRS proposes additional taxes that you don't believe you owe, you can challenge the decision. If at any time during the audit you don't think you're being treated fairly, request a recess and ask to speak to your auditor's manager. Finally, have your accountant and/or another tax expert review the IRS's findings before you sign anything.
5. Keep it short: Provide the information requested... and that's it.
During an audit, you must share financial records supporting the tax return under review. But giving the IRS more records than requested, or providing more information, is seldom a good idea. Answer all questions with honesty and brevity. If you're not sure how to answer, do your research and promise to get back to the auditor with an accurate response as soon as possible.
6. Don't panic.
Audits are usually an exercise in double-checking your bookkeeping. If you've been honest and your records don't include any blatant anomalies (e.g. reporting a net loss in more than two out of the last five years), you shouldn't be overly concerned.
The bottom line: Consider the small but ever-present threat of an IRS audit as motivation to maintain excellent bookkeeping and pay your estimated taxes on time. After all, when all your numbers are lining up nicely, your business benefits.
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