There are two types of audits, corresponding audits, and field audits. To point out mathematical errors and other doubtful expense categories are the main reasons for a tax audit. In this article, we will discuss every bit of detail about IRS audit, how to prevent bad points, and what to do if you receive an audit notice. Audits should be handled carefully. No need to worry if you get the notice. People take it as stressful and overwhelming for a small business, audits will deal to report errors and IRS may suspect. If you are a taxpayer then no need to worry.
Business Tax Audits:
Now we will discuss the business tax audits of an organization. IRS will gather the organization’s financial information to make sure whether the organization is reporting all accounts according to the tax law. Mostly tax audits occur when IRS detects an error on a tax return file within the last 3 years. It includes the following scenarios;
- Business loss
- Losses for multiple years
- Reporting wrong information about income
- Unexpected income levels
- Substantial deductions
Small and mid-sized business audits:
Many small business owners get third party auditors for their financial statements. Mostly small businesses file their tax return file on especially on sole proprietorship. For this reason, IRS carefully checks the tax returns of small businesses. Its main focus is on hiding sales and exaggeration of expenses.
Why red flags:
The statistical formula is used to audit a small business. The IRS uses the program to outline the returns. If the result deviates from the ratio of a small business then you will be audited. The most common mistake which causes a business to be audited is when a sale is reported less than the actual record of payments. If you made a mathematical error then it is also going to show unusual results.
Types of Audits:
There are several ways of auditing tax returns but where are we going to explain 2 types of IRS. We will elaborate on both primary types and the difference between them.
Correspondence audits: Correspondence audits are considered easy to deal with because it is for limited information. IRS needs clarification on a specific area of the return file. It is the most common type and easy to manage than a field audit. IRS identifies a problem and sends you an email describing each error in detail. These audits can be explained by sending documentation of the related subject.
Field Audit: It is the most thorough type of audit where the IRS auditor will visit the place in person. He will examine all financial records and compare them with the tax return file to see if the records line up. These audits should be done carefully as it is going to play an important role. The auditor might inadvertently provide wrong information to the IRS that may hurt the outcome of the audit. The small business owner must provide a clean and clear picture of his company.
How to handle an audit:
If your company receives a notice regarding an audit, make sure to handle the situation carefully, and try to minimize the negative impact on your business.
Review the audit letter: If you receive such a letter, try to read it carefully. For this purpose, you need a financial advisor or hire an accountant to understand the letter. Go through the letter and identify the problems that IRS has flagged. Do not ignore it or delay action because it will create suspicion. There are a lot of scammers who often send you email in an attempt to get your personal data. Real IRS does not ask for this type of information in these ways.
Organize records: When you receive an email from IRS, make sure to collect and organize all of your records from the past year before responding to them. IRS will mention which kind of data they would like to check. Make sure to provide receipts, invoices for income and expenses, accounting books, hard copies, or anything related to the company.
Answer the auditor’s question: When the auditor arrives and asks for numerous information about your tax return, just answer the questions. No need to beat around the bush and answer the question accordingly. Don’t make lame excuses and respond in a straightforward way.
Hire an accountant: To deal with IRS you must involve a professional person. If you do not have any idea how to deal with an auditor then let the tax professional do the talking. Hopefully, that person is going to take you out of the loop and put the auditor in. It is the best way to deal with IRS by hiring a professional person for assistance.
How to avoid business audits in the future for small businesses:
Few companies are selected for audits because of certain red flag expenses. However, IRS does not give a red flag to all small business owners. If you skipped any information regarding bank transfers or other financial records then you must explain it on paper. Whenever you are filing a tax return file make sure to double-check the mathematical procedure. Keep proper documentation according to the rules of IRS. You can only deduct ordinary expenses that are allowed by IRS, nothing else should be deducted. If you have completed the file by fair means then you need not worry about IRS anymore.
The best way to avoid the red flag is to keep a record of all documents and track all business income and expenses. Try to save data in one place. So whenever an auditor asks for a specific problem you must know how to handle it.
Let’s talk about expenses you can deduct on your taxes:
- Medical and dental expenses
- State taxes
- Home loan interest
- Property taxes
- Charitable contributions
To claim a deduction you must fall in a specific employment category. For miscellaneous deductions, one must fall in a specific category to claim a deduction that relates to unreimbursed expenses.