Though the odds of your business getting audited are low, with the IRS increasing its focus on finding small businesses that are underreporting income, it pays to think about how you would handle it if your business were to receive an audit notice.
Hopefully you’ve avoided the two things that many startups are guilty of: not properly tracking expenses and mixing business and personal accounts. But what should you do if the IRS comes calling?
1) First, Don’t panic — Getting an IRS notice doesn’t necessarily mean that you’ve done anything wrong. In many cases, clarification and documentation of a few items are all that’s needed. Sometimes, once you’ve gone through the exercise, whether an examination by mail or a full-scale traditional audit, your tax liability is unchanged. But you do need to review what triggered the audit. The IRS will include a general description of the information it wants to verify. Make sure your records are in order and that you can support all the expenses and deductions you claimed.
2) Respond promptly to all notices — You might think if you ignore it, it will go away. But believe me, the IRS is not going away. IRS notices will be by mail and phone and will always include deadlines by which you need to respond. Don’t start off on the wrong foot by missing deadlines: for one thing, the IRS will automatically disallow your deductions — and you’ll be setting yourself up for penalties and fines.
3) Hire a professional — There are two different types of audits: the IRS might initiate an “Examination by Mail” or it may request an “In-Person Audit.” Even if you originally prepared your return yourself, unless it’s a straightforward issue concerning a discrepancy in one area only, get professional help. Like all of us, the IRS makes mistakes, and you don’t want to let your anxiety lead you to jumping the gun and paying a liability that might not exist. For an in-person audit (at a local IRS office or at your place of business), you definitely need a seasoned professional experienced in managing audits, not your cousin Jimmy who happens to have an accounting degree, to guide you through the process. It will take a lot of the strain off you, can expedite things, and help avoid potential minefields.
4) Get creative … to a point — Let’s say you weren’t too thorough when you first set up and are missing receipts. The IRS accepts alternative forms of documentation to support your figures. These could be affidavits or reconstructed records. The IRS also accepts and increasingly asks for electronic accounting records: but be very careful with how much information you disclose here! Also, don’t go overboard. You don’t want to rely on alternative documentation to support your claims. A pattern of not having formal receipts could make it seem you don’t have a good financial management system in place, triggering greater IRS scrutiny and potentially a wider audit.
By following these four steps you’ll get through the small business audit process sooner and with a lot less pain!
Do you have questions on small business audits? Let us know in the comments section below or contact Early Growth Financial Services for a free 30 minute financial consultation.
Glenn McCrae is Early Growth Financial Services’ Chief Strategy Officer. He is a CPA, with extensive experience working with early-stage companies. His expertise spans capital raising (from seed stage to IPO), strategic analysis of business opportunities, business development, financial analysis, and corporate governance. He previously held the roles of VP of Finance and CFO in several dynamic organizations including: a non-profit, a real estate firm, and a broker-dealer.