For most middle-income taxpayers, the chances of getting audited by the Internal Revenue Service (IRS) are slim indeed. In fact, only about one percent of such taxpayers get audited, and most of those audits involve an exchange of correspondence with the IRS, usually to correct or clarify a few items on a federal tax return. If you operate a small business, the likelihood that you’ll be audited increases a few percentage points, but a full-blown audit is still unlikely.
That said, the IRS generally audits tax returns based on perceived risk. In other words, if your return contains certain “red flags” or risk indicators, your return is more likely to be audited. For example, the IRS may receive 1099 (miscellaneous income) forms showing that you were paid for freelance or temporary work. If that income isn’t reported on your individual tax return, the IRS’s numbers and yours won’t agree. Or maybe you’re self-employed and claim substantial expenses for business travel, meals, and entertainment. Based on long years of experience, the IRS knows that business owners often fudge these numbers.
So how should you respond if that dreaded letter from the IRS shows up in your mailbox?
- Don’t panic. For one thing, an IRS audit may actually result in corrections to your tax return that reduce your tax liability. Such a scenario is not uncommon. Remember, the auditor’s goal is to make sure your tax return is correct and supported by appropriate documentation. That’s all.
- Understand how audits work. If your business is being audited, you can expect the auditor to interview employees, examine records, and observe your operations and inventory. Be sure to encourage your staff to cooperate fully and answer questions truthfully. If they’re asked for a document that isn’t readily available, it’s acceptable to ask for more time.
- Get organized. In the audit world, nothing beats good documentation. So it’s important to keep accurate records throughout the year. If certain supporting documents can’t be located, check online. Your mortgage company, for example, will likely maintain records of interest paid, and your employer should have duplicate copies of your W-2 forms.
- Treat the auditor with respect. Most auditors, contrary to Hollywood’s depictions, aren’t vindictive or dishonest. Like your local policeman or business owner, auditors have a job to do. Treat them as professionals, and they’ll likely treat you in kind.