Navigating IRS Audits: A Comprehensive Guide for Businesses

Receiving a notice from the Internal Revenue Service (IRS) that your business taxes are being audited can be disarming. However, having a clearer understanding of why these audits occur, how they unfold, and what your rights are throughout the process can hopefully help alleviate some of the anxiety you may be feeling about it. 

Statistics Regarding Internal Revenue Service Audits

According to statistics published in the IRS’ 2017 Data Book, only 0.5% of business taxpayers faced audits that previous year. Now, estimates are around 1-2%, so around one or two businesses per 100,000. That same data reveals that sole proprietors that pull in $1 million or more a year and C-corps with $10 billion or more in assets are audited the most. 

Another statistic regarding audits to be aware of is that most occur within two years of a tax filing. However, auditors may review taxes for as many as six years if they find something awry.

Understanding Which Different Types of IRS Audits Exist

A common misconception is that there’s only one type of tax audit the IRS performs. However, that’s not the case. There are actually a few different kinds of them, with the most common type being what’s commonly referred to as a “correspondence audit.” As the name suggests, this type of audit involves the IRS mailing a taxpayer a letter in the mail requesting some other documentation or clarifying information, oftentimes regarding income you claimed or deductions you took.

The other two less common types of audits the IRS performs include office or field audits. The former involves the IRS requesting your presence at one of its offices so that they can interview you about your tax return and perhaps request additional documentation of you. The latter is the most serious. During that field audit, an IRS agent visits your place of business to comb through your financial documentation, including tax records. 

Factors That Commonly Trigger IRS Audits of Businesses

Generally, an audit occurs because a company’s tax return gets flagged for one reason or another. Some of the common reasons include:

  • Missing information
  • Typographical errors (typos)
  • A company is mostly cash-based (like a barbershop, laundromat, or restaurant)
  • Math computation errors
  • Business owners claim excessive expenses 
  • A company always seems to be “in the red” year after year (always claiming losses)
  • The business has misclassified employees or skirted paying payroll taxes before
  • A company takes too many deductions (if applicable, depending on the incorporation structure)
  • Businesses file amended returns
  • Not using actual numbers but instead using rounded-up ones or estimations
  • Paying excessively high wages (compared to standard pay) for certain roles (i.e., executives or shareholders)
  • Claiming a personally registered vehicle as 100% used for business
  • Taking high deductions for home offices

Although the reasons described above are certainly some of the more typical reasons businesses face audits, the IRS uses software that randomly selects companies, so it is quite possible that it was identified in that way.

How Businesses Can Minimize Their Chances of Being Audited by the IRS

Audit-proofing your business is a bit of a lofty goal given how, as we mentioned, sometimes they’re done at random. While certainly taking  the “red flags” listed above into account and adapting your decisions accordingly can minimize your chances of an audit, other steps you can take to reduce your risk of the IRS auditing your business include:

  • Keeping thorough financial records: This is especially the case with your deductions or expenses. Being able to quickly produce documentation for these is your best bet for shutting down an audit quickly.
  • Double-check your numbers: Carefully review your return before dropping it in an envelope or electronically submitting it to ensure your numbers match invoices and receipts, they’re not estimated or rounded off, and that you’ve calculated all the amounts correctly. It can even be helpful to have a second set of eyes review the numbers to make sure everything looks accurate.
  • Ensure you’re up-to-date on the latest tax codes: While you can certainly do this yourself, it may be challenging to stay on top of all you need to do while running your business. Whether you work with a certified public accountant or tax attorney who makes their career out of remaining abreast of the latest nuances in this space, that expertise can make a difference as to whether your business tax return raises red flags or not.

What the IRS Audit Process Is Like

Since a correspondence audit is most common, when you receive a letter from an auditor, you can expect it to outline a few key details, such as:

  • Your auditor’s name and contact information
  • Additional documentation or information they would like you to provide
  • Instructions for responding, including the deadline for doing so

Whether you’re asked to send in the documentation somehow or to bring it with you during an in-person meeting with the auditor, you can expect them to closely compare any newly requested records you bring with your tax return to see if any discrepancies exist. 

Common Types of Additional Documentation Requested by IRS Auditors

Documents an auditor may ask you to produce may vary, but some of the most common ones they request of businesses include:

  • Profit and loss statements
  • Invoices
  • Balance sheets
  • Receipts
  • Bank statements

In a request for documentation situations like these, tax lawyers like ours at Murray Moyer PLLC often advise our business clients that their ability to secure an outcome in their company’s favor when they’re facing an audit is contingent upon their degree of preparedness in being able to produce requested paperwork and respond satisfactorily to questions posed by the IRS. Thus, it’s imperative that you ensure your documentation is well-organized when presenting it to IRS agents.

Potential Outcomes of a Business Tax Audit by the Internal Revenue Service

Some of the possible end results when IRS audits occur include:

  • Verification of information as accurate: In this situation, the auditor decides that no changes to your company’s tax return are warranted, nor do you need to be assessed additional taxes.
  • A conclusion that inaccuracies exist (which you agree with): An auditor may decide that the IRS made an error and thus owes you a reimbursement of an overpayment or, alternatively, they may conclude the error is on your business’ end, and you owe unpaid taxes plus interest and penalties.
  • A decision that incorrect information is on your return (which you’re in disagreement with): Should an auditor reach a decision you disagree with, your business can file an appeal with the IRS Office of Appeals within 30 days or take independent legal action with the assistance of an attorney.

Understanding Your Rights When Facing an Audit

If you’ve received notice from the IRS of an impending audit, it’s important that you remember that it’s nothing more than a “second look,” and you do, in fact, have rights. One of perhaps the most important ones is the right to representation when dealing with tax issues.  

An IRS Enrolled Agent or tax attorney can represent you during an audit, including interacting on your behalf with agents. This communication may occur after the request for documentation, during the examination process, and after they reach a decision. 

That authorized tax professional or lawyer can guide you through the appeals process described above and, if necessary, also assist you in requesting a reduction or removal of penalties. Penalty abatement is available to businesses in cases where they can show it’s warranted, whether due to tax preparer mistakes, financial hardship, etc.

And, of course, should you exhaust all of the options above and still be seeking a resolution to your tax issues, an experienced attorney can advise you of legal remedies available to you to address lingering concerns. Please reach out to our law firm if you have more questions about how to best navigate an IRS audit as a business owner. We’re eager to help.

Written by Justin Moyer on February 8, 2024.