How to Handle an IRS Business Tax Audit
IRS business tax audits, at a glance:
- IRS agents conduct most business tax audits in person.
- Business audits are usually comprehensive, covering income tax issues and other issues, such as employment tax. It’s important to thoroughly prepare for the audit interview.
- The IRS agent’s determination in an audit is not final. You have the right to appeal.
You can get expert help and even have your tax pro represent you in an IRS audit.
What you need to know about IRS business tax audits
If the IRS audits your business tax return, the IRS is taking a closer look to see whether the business included all income and took only the deductions and credits allowed by law.
IRS audits usually aren’t random. The IRS selects returns that are the most likely to have errors, based on complex criteria. After you file a return, the IRS usually has three years from that point to start and finish an audit. The IRS starts most tax audits within a year after you file the return, and finishes most audits in less than a year.
The IRS audits returns in three ways:
- By mail (correspondence audit)
- At an IRS office (office or desk audit)
- In person, at your home or business (field audit)
The IRS does most business audits in person (the field audit). These audits can be extensive, often considering all aspects of the business and its owner(s). The field audit will look extensively into the business records and accounting system, and conduct tests to determine the accuracy of income. The average business audit can take a year to complete. Businesses can reduce this time by preparing well for the audit and responding promptly to audit questions and requests.
During an audit, the IRS will ask you for information and documents that explain your position on your business tax return. It’s important to provide the information exactly as the IRS requests it. If you have a licensed tax pro handling the audit, help your tax pro with the facts, and your tax pro will work with the IRS.
Here’s how it works.
How to address an IRS business tax audit
1. Understand the scope of the tax audit.
- Mail audits are limited to a few items on the audit letter you received from the IRS.
- Office and field audits require more work. You’ll need to gather the information/documents that the IRS is requesting, and prepare to answer in-depth questions about your business’s finances and activities. You’ll also need to prepare to explain, in detail, the business’s accounting and recordkeeping system.
- When it comes to office and field audits, unless you are adept at IRS procedures, it’s highly recommended that you get a licensed tax professional (enrolled agent, CPA, or attorney) to represent you and advocate your tax return positions before the IRS.
2. Prepare your responses to IRS questions.
- For a mail audit, prepare a complete response to the items the IRS is questioning in the letter/document you received.
- For office and field audits, prepare for the meeting with the IRS officer/agent. Gather all information the IRS has requested and prepare to present it to the IRS. Prepare for possible questions from the IRS, such as those concerning unexplained bank deposits or additional income. The IRS agent will also ask about your job, family, and any outside businesses. Basically, you’ll need to be prepared to give an account of your entire year’s activities.
- If you don’t have documents to prove any items on your return, you may have to reconstruct the documents from third parties or other records. If a third party can attest to an undocumented item, you can use techniques such as an affidavit.
3. Respond to IRS requests for information/documents on time, and advocate your business tax return positions.
- If the IRS thinks your business return needs to be changed, the IRS will start asking more questions. You’ll get an Information Document Request (IDR) asking for more information. It’s important to fully respond to it by the deadline.
- The IRS may disagree with you, stating, for instance, that you took a deduction that wasn’t allowed or that you should have reported more income on your return. If you disagree, present your interpretation of the facts and tax law to the IRS.
- Ultimately, the IRS will close the tax audit, either proposing no changes or proposing adjustments to your business return. You’ll get a report of the IRS findings and a letter that allows you 30 days to appeal if you disagree (called the 30-day letter).
4. If you disagree with the results, appeal to the appropriate venue.
- Within 30 days, you can request an appeal with the IRS Office of Appeals. After 30 days, the IRS will send you a letter, called a Statutory Notice of Deficiency. This letter closes the tax audit and allows you to petition the U.S. Tax Court.
- In mail audits, remember that the letter proposing adjustments also serves as a 30-day letter. Taxpayers commonly overlook this letter and lose their ability to appeal the audit findings within the IRS.
How to get expert help
Your H&R Block tax professional can help you navigate an IRS business tax audit and communicate with the IRS on your behalf.
Bring these eight items to your appointment
- A copy of your IRS audit letter, including any Information Document Requests
- Any information and documents that the IRS is requesting
- A copy of the tax return in question
- Copies of your business returns from the two years before the return in question
- A copy of the most recent year’s return (if it’s not the return being audited)
- A copy of any documentation you provided to your tax preparer
- A copy of any other IRS letters or notices that you have received for the tax year in question
- Any documents that show the results of any prior audits
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