Published on: June 22, 2020 Last modified: November 23, 2020

How to Prepare for an IRS Audit If You Own a Small Business and Work From Home

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    Nothing strikes fear in the hearts of small business owners and people who work from home like the words “tax audit”.

    The Internal Revenue Service (IRS) has more power than almost any other federal department. They can freeze your bank accounts and place a lien on your home. It took the IRS to bring down notorious mobster Al Capone and America’s sweetheart, Martha Stewart. The “good” news is that the IRS only audits around 1 in every 220 taxpayers.

    If you’ve received a notice of a tax audit, your first step should be to take a deep breath. The IRS isn’t out to get you. They simply want to make sure that you’re paying all the taxes you owe and that the deductions you’ve taken are legitimate. After you’re feeling a little better, here are some things you need to know to prepare for an audit. 

    Red Flags for Small Businesses

    You may be wondering “why me”? In reality, the IRS only audits a small percentage of small business owners. They look for specific red flags — items that catch their attention — on small business tax returns. If your company has too many of these red flags, you may be faced with an audit. Here are some of the most common red flags for small business owners that the IRS looks for on tax returns:

    Steps to Take When Faced With an IRS Audit

    The IRS isn’t going to just arrive at your doorstep one morning and want to discuss your taxes. When you’re being audited, you’re given ample time to get your records in order ahead of the meeting. There are steps you can take from the time you receive the notice until the actual audit to make the process go more smoothly. Here are a few of those steps.

    what to do during an IRS audit
    Total Estimated Time Needed: 220 minutes
    Total Estimated Tax Attorney Cost: 1000 USD

    Required Tools:

    - A Phone.
    - A Computer.
    - An Internet Connection.

    Things You May Need:

    - A Tax Attorney.
    - Past 3 Years of Tax Returns.
    - Past 3 Years of Vehicle Records.
    - Past 3 Years of Bank Statements.
    - All Requested IRS Documentation.
    - Past 3 Years of Equipment Records.
    - Past 3 Years of Ledgers, Books, and Journals.
    - Past 3 Years of Electronic Transaction Records.
    - Past 3 Years of Appointment Logs and Calendars.
    - Past 3 Years of Travel and Entertainment Receipts.

    4 Audit Preparation Steps to Follow:

    Step 1 – Learn What to Expect During the Audit Process
    By learning more about the auditing process, it’ll take some of the scariness out of it. Typically, you’ll receive a notice of an IRS audit through the mail. The IRS never calls or emails to notify taxpayers of an audit. The IRS conducts the audit in one of two ways; by mail or in person. In-person audits can be conducted either at the local IRS offices or at your office. If the IRS conducts the audit by mail, you’ll need to mail them all the request documentation. An in-person audit means you need to take the documentation with you to the IRS office or have it on hand when the audit is held at your office.
    understand the process behind tax audits
    Step 2 – Meet With the Company That Prepares Your Taxes
    The IRS provides you with 30 days to respond to their request for an audit. During this time, you need to contact the company that prepared your taxes. In many cases, the company will want to represent you during the audit. Even if that isn’t the case, they can help you get together all the necessary paperwork. You might have prepared your taxes yourself. If that’s the case, you might want to contact a tax firm to help you through the audit process.
    meet with a tax attorney to prepare
    Step 3 – Locate and Organize all of Your Relevant Paperwork
    During your typical audit, the IRS will request records that include the past three years; however, if the IRS suspects that you owe back taxes, they might request records for up to the past 10 years. Use your 30 days notice to gather all of your essential paperwork, such as:

    Bank statements; This can also include the monthly statements and canceled checks. They might request the bank records from your personal as well as your professional accounts.

    Travel and entertainment receipts; If you took it as a deduction, you should have a matching receipt.

    Electronic transaction records: These records must show the name and address of the payee, the date, and the amount for the IRS to accept them.

    Vehicle records: If you deduct any portion of your personal vehicle, you need a travel log to show the portion of the mileage that was business-related. You also need gas and repair receipts.

    Ledgers, Books, and Journals: While you aren’t required to keep a ledger, if you do, you must produce them for the audit. Equipment records: If you’ve deducted equipment from your taxes, you’ll need the receipts for it along with any repair records.

    Appointment logs and calendars: A service-based business uses a calendar or appointment book to organize its schedule. You’ll need these records during your audit.
    audit paperwork concept
    Step 4 – Prepare Your Home Office
    If the decision is made to meet at your home office, you need to have it ready for the auditor’s arrival. For instance, if you have a bed in your home office, the auditor isn’t going to allow you to deduct the total square footage of the room from your tax liability. You also want to have a seating area and space for the auditor to work.
    how to prepare your home office for the IRS

    3 Possible Outcomes From an IRS Audit

    After the auditor goes through all of your paperwork and gets answers to their questions, they’ll come to a decision. From there, there are three possible outcomes of your audit:

    correctly filed taxes

    1. The Auditor Determines That Your Tax Returns Are Accurate

    After sorting through your records, the auditor determines that your tax returns are accurate. This is the best possible result. 

    agreement with the irs concept

    2. The Auditor Finds a Mistake, and You Agree

    In some cases, the auditor might find an error or multiple mistakes. If you recognize the errors, then you’ll be responsible for paying the additional taxes along with interest and possible penalties. You might even find errors in your favor, and the IRS will refund the taxes.

    Audits Small Business

    3. The Auditor Finds an Error but You Disagree

    You have 30 days after the decision to file an appeal if you disagree with an error identified by the auditor. You can even sue the IRS

    In Conclusion

    At Silver Tax Group, we know how daunting an audit can seem, and we’re always ready to stand beside our clients. Contact us as soon as you receive an audit notice and we’ll help you with the entire process from A-Z. 

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