A woman sits at a desk and looks down at a open binder and a calculator. She uses her left hand to type something into the calculator; in her right hand, she holds a piece of paper. In the foreground, a cup full of pens is out of focus. In the background, a window shows a couple of trees and a light sky.
You may not know when or if an IRS audit is coming, but you can always be prepared. — Getty Images/AndreyPopov

In late 2020, the IRS announced that it planned to increase tax audits of small businesses by 50% in 2021. At a time when many small business owners are trying to keep track of pandemic-related loans, manage remote contract workers, and simply stay afloat, the proposition of an audit can be intimidating.

If you’ve received notice that your business has been selected for an IRS audit, don’t panic. Here’s what to expect, as well as some simple steps you can take to prepare for the process.

Understand the steps of the audit process

If you are selected for an audit, the IRS will notify you by mail. This is important: There are lots of scammers and fraudsters out there posing as the IRS who may contact you via phone or text message. The real IRS will never initiate an audit via telephone.

Once you receive the notification, there are two ways that the IRS conducts an audit: by mail or through an in-person interview. A mail-based audit will start with a letter that requests additional information about items on your tax return: income, expenses, deductions, etc. You will need to send in hard-copy records detailing all the transactions or payments in question.

[Read more: What to Know About Taxes When You’re Running a Family Business]

If you are asked to attend an in-person interview, this takes place either at your home, your place of business, or your accountant’s office. The IRS will provide all the details, contact information, and instructions in the initial letter.

The IRS offers Audit Techniques Guides to give you a further idea of what to expect. Once you’ve submitted the documents or gone for your interview, the IRS will make a decision to either propose changes to your tax return or make no change.

The real IRS will never initiate an audit via telephone.

Gather the right documents

The letter you receive from the IRS will detail the documents and records you will need to submit to support the income, credits, or deductions on your tax return. The IRS may request, among other things, receipts (for both your payments to others and amounts received by your business); bills; loan agreements; canceled checks; legal documents, such as property purchases; and diaries that show important expenses, such as business travel. Employee contracts are also frequently requested by the IRS, especially with the growth of the gig economy and remote work.

[Read more: Contract Worker Forms, Explained: From IRS Forms to Invoices]

If you haven’t been tapped for an audit, keep records of all your expenses and deductions anyway. “You must keep tax records for as long as what the IRS calls the ‘period of limitations,’ including the time they can audit your return and assess additional taxes,” wrote The Balance. “Most audits are of returns filed within the last two years, but the review of a tax return can go back further (usually no more than six years) if there are substantial issues.”

Know your options

You have the right to appeal the IRS audit if you don’t agree with the result. If you do decide to appeal the decision, don’t sign and return your copy of the audit report. This will trigger the IRS to send you a letter explaining how to appeal the audit and detailing that you must file your official protest within 30 days of the date listed on the letter.

Your formal protest will lead to a hearing and mediation with the IRS Office of Appeals. Many business owners choose to work with a CPA or legal representation during this process, but it is possible to navigate the appeals with your own documentation and well-presented argument. The Office of Appeals has tons of resources to help you understand the process and prepare accordingly.

Is it worth appealing the results of your audit? While there are a small number of taxpayers that go through this process, it can be worth the effort. “The odds of winning your case are surprisingly high. The average taxpayer who appeals an audit can expect to see the total dollar amount originally assessed by the auditor reduced by a total of 40%,” wrote Investopedia.

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Published July 18, 2022