What is an IRS audit?
An IRS audit is when, as a business or individual taxpayer, your financial statements, financial information, and accounts are reviewed. This is done to verify that the information you reported when filing your tax and information returns is correct. It is also done to ensure that you paid the right amount of tax, according to the law.
Recently, the IRS has shown an interest in increasing the number of audits performed on small businesses. Their argument is that small businesses are more likely to commit tax fraud. Small businesses, in their numbers, tend to not follow all the rules of income and expense reporting. Some of them are also cash-intensive, meaning they sell their products in cash as opposed to using credit cards, bank transfers, and other electronic means. This makes most of them be enticed to underreport some of their income because the IRS will not easily find records of their sales.
However, this should not be the reason for you to be tempted to underreport your income. The IRS has means, including assessing your financial information, to determine if you were honest with your reported income. Given that they are hiring more analysts to look into your returns, the only thing you can do for yourself is to stay prepared. You need to learn how to prepare for an IRS audit.
5 ways to prepare for an audit
1. Keep updated documents
By all means, make sure that your accounting and financial records are kept up-to-date, accurate, and organized. To do this effectively, make sure you have good internal controls. Internal controls are measures that you put in place to uphold the integrity of financial and accounting information, promote accountability, and prevent fraud in your business. Examples of internal controls are documentation policies and physical controls, among others. Once you have these in place, you are highly likely to go through successful audits. This is because the IRS will not struggle to follow your income and expense history. That is what they use to arrive at the final amount that they compare with what you reported in your tax return.
Regarding documents for audit preparation, you must have a checklist that looks like this;
- A general ledger
- Employee handbooks
- Fiscal year budgets
- Paid bills and checks
- List of transactions done during the period under audit
- Internal financial statements
- Accounting policies.
2. Adhere to various industry standards
Compliance is a very key area when running a business. You should ensure that all compliance requirements are met through your organization. Assess your team’s awareness about this. An organization with good compliance history has its data management and tracking organized. This will put IRS agents at ease, knowing that you are likely to have followed all the rules. Without it, you will look like the rest of the other entrepreneurs who cut corners at will.
3. Your accounts must be reconciled
Reconciling your accounts is a process of ensuring that two sets, or more, of financial records, are matching. During the auditing process, agents will also reconcile your financial records. If financial statements and records are not in agreement, that brews trouble for you. Therefore, you must set a certain date every month to reconcile your financial records. Ensure that you double-check if there are any bills outstanding and other employee expenses that may have been left outstanding. More so, you must collect all invoices and update your bookkeeping. If your accounts reconcile, they give you an accurate projection of income and expenses and removes the likelihood of other issues arising from contracts with other businesses – for example, the things that can affect your information returns.
4. Single out significant changes through the year
You must check for this each quarter. For example, set a date at the end of September or the first week of October to check for significant changes in your business between July and September 2021. This is a significant audit preparation process since some changes have a material impact on your income and expenses. When IRS agents see such changes, they want to know if they are included in your returns, especially if they happened during the period under audit. Such changes may include you selling some shares in your business to a partner, or you signing a major contract with a huge client. That will have an impact on your income. Keeping good records of such changes will help you report these changes accurately to the IRS, without mixing up dates because that has an impact on the amount of tax you end up paying.
5. Delegate tasks
Delegation within the small business fraternity seems to be an old problem. I hear many of you be like, “I can do this myself,” which is OK until you start being overwhelmed. This can easily lead to mistakes. When the IRS comes, they won’t ask who did what, all they will see are the mistakes in your financial records, which does have financial impacts on your business. Therefore, delegate some tasks to ensure maximum accuracy. Hire a bookkeeper, accountant, and tax professional. Your role must only be to check the final output and ensure that everything aligns. If you have not hired any of the above in your business, talk to us today. Send a message with your request for either bookkeeping services, accounting services, or tax services. You could be requiring all of the above, indicate that and we will still assist you. We have been doing this for several small businesses and they have nothing but the best experience as they focus on growing their businesses!
People have also asked the following
1. How to Prepare for an Annual Audit?
Your business must have its own annual internal audit to preserve the quality of your financial records. The first step to prepare for this is to reconcile all your financial statements and records.
2. How to Prepare for an Audit?
To prepare for an IRS audit, you may start by performing your own internal audit. But sometimes you may not have time for this. In that case, hire a tax professional for extra help.
3. Is your documentation ready?
To check if your tax documents are ready before an IRS audit, perform your own reconciliation exercise or quick internal audit. It helps to check if all documents are in place for every transaction.
4. What is the audit process step by step?
First is the audit notice from the IRS, by mail. However, the steps that follow depend on the type of audit that the IRS will carry on you. Mail audits are the easiest as opposed to in-person interviews or field audits.