When your business receives an audit engagement letter, don't panic. While an audit may be time-consuming, costly, and invasive, having an experienced advocate on your side to navigate you through the process and represent your interests can turn a tax audit into a tax-savings opportunity. It's important to remember that the initiation of a tax audit does not necessarily mean that the taxpayer did anything wrong. A tax-collecting body may initiate an audit where the company has made innocent errors on its tax filings, where there has been a higher than normal increase in revenues, or simply being randomly selected for audit, among many other reasons.
Nonetheless, when a taxing authority initiates an audit, it's generally anticipated to increase the taxpayer's tax liability and collect additional revenue. Therefore, businesses who are under audit should always proceed with caution when cooperating with an auditor. With experienced tax counsel, adequate preparation, and a responsive mindset to provide requested accounting documents, contracts, and other relevant information, Buckingham, Doolittle & Burroughs explains how businesses may be able to minimize its costs, time, and stress expended during the audit.
What to Do If Your Business Receives a Tax Audit
Receiving a notice of a tax audit can be a daunting experience for any business owner. However, it's crucial to approach the situation with a clear understanding of your rights, responsibilities, and the steps you can take to navigate the process effectively. In this guide, we will walk you through what to do if your business receives an audit commencement letter, offering practical advice to help you handle the situation with confidence and ease.
What is a Tax Audit?
An IRS tax audit is an examination of an individual or organization's financial information intended to confirm that person or organization is reporting taxes in accordance with federal and state tax laws. Most business tax audits are conducted in person by IRS or state tax agents and are comprehensive. In each case, the taxing authorities examine the business's finances and tax returns to verify correct reporting of income and expenses, proper deductions, and other exclusions from tax.
Different Types of Audits
There are three common audit types: Correspondence Audits, Office Audits, and Field Audits. Both the IRS and the Ohio Tax Commissioner have broad powers to investigate the books and records of taxpayers and audit the taxpayer's income and purchases in search for additional tax revenue. The IRS also has an additional Audit type, stemming from the National Research Program. For every type of tax audit, we recommend retaining a tax attorney, familiar with the subject area. The Audit types are:
Correspondence Audits
The most common form where the IRS or a state authority sends a letter to a taxpayer, informing them of a perceived error on a filed (or unfiled) return and requesting additional information. It is important not to ignore these letters. If the IRS or tax authority does not receive a response from the taxpayer after a prescribed period (usually 30 or 60 days), the taxpayer may be issued estimated assessments that become final based upon a lack of response, making it more difficult for the taxpayer to challenge the tax authorities' findings. Therefore, it is critical the taxpayer respond promptly (and thoughtfully) to any tax notices.
Office Audits
The second most common audit, where the questions for the taxpayer are too complex or extensive to conduct a correspondence audit, but too small to justify a field audit. In these cases, the IRS or state authority requests the taxpayer's come into their offices to conduct an interview. These audits are common in cases of itemized deductions, business profit and loss or rental income or expenses. The interview generally last a day, but additional information may be requested after the audit.
Field Audit
The most comprehensive of the audits, involving specialized representatives of the taxing authority to visit the taxpayer's business. These reviews can be far deeper, longer, and more intrusive, and the agents may ask for financial records, interviews, and many other items. The scope of the audit may expand upon information discovered by the taxing authorities.
Markup / Statistical Sample Audit
Used to estimate revenue or costs, they are typically applicable in Ohio and state tax audits, markup or statistical sample audits are performed when there are limited records and support for the taxpayer's purchases and sales or sales and purchase records that are too voluminous to analyze efficiently. Mark-up audits apply to restaurants, bars, and other businesses selling liquor and alcohol whose primary sales records are missing or incomplete. Given the absence of available records, Ohio analyzes the businesses alcohol purchases and estimates sales using a "mark-up analysis." Similarly, statistical sample agreements are used to limit an audit to a specific period. These mark-up and statistical sample agreements are binding upon taxpayers and are more difficult to challenge after the taxpayer has agreed to the methodology. Thus, it is critical to consult with experienced tax counsel to ensure agreements are crafted in a manner favorable to the taxpayer.
Each audit is its own trial, with the more comprehensive ones being more expensive, time-consuming and stressful. Nevertheless, should your business be the subject of an audit, preparation is key to minimizing the intrusiveness and harm.
What Triggers a Business Tax Audit?
A business is most likely to have a tax audit if the IRS or state detects a possible error on your tax return, such as a mathematical mistake or unreported income. A tax return or entity may be selected for audit for many different reasons, but the most common causes include the following:
- Substantial expenses;
- Large amounts of cash transactions (potentially underreported income);
- Incorrect reporting of income and mistakes on tax returns;
- Disproportionate deductions for income that appear to exceed what is ordinary and necessary (travel costs, vehicle use, home-office deductions, and internet bills);
- Repeated claims of business losses year after year; and
- Misclassification of Employees.
Steps to Address Your Business Tax Audit
A business audit can takes years to resolve, so it is important to address the following these steps to minimize the time and cost of the audit:
- Consult a tax lawyer upon receipt of the notice of an audit. A tax lawyer's experience will save time and energy that might be otherwise expended by a businesses' staff, owners, or other professionals and promotes efficiency in responding to an audit. Our tax team has extensive experience representing taxpayers' interests in IRS and state tax audits. Most importantly, experienced tax counsel is critical especially because an unaware business may unintentionally waive certain rights, or make harmful admissions if it tries to address the audit alone.
- Be aware of your rights. Both the IRS and Ohio have a taxpayer's bill of rights, which includes a right to assistance and representation, and a right to pursue additional legal remedies, among other rights. Knowing and leveraging its rights will allow a taxpayer to maximize their opportunity to minimize their costs.
- Understand the scope of the audit. Businesses should consider what documents and information is being requested, and be prepared to answer in-depth questions about the businesses' finances, activities, accounting and record-keeping.
- Prepare to respond to agent questions. The auditor will request certain information and documentation, but a business may anticipate follow-up requests that the auditor may seek. This will enable the business to determine the items important to address, collect, or preserve. Be prepared to answer the auditor's questions directly and succinctly. However, do not provide the auditor with more information than they request, as it can lead to additional time spent focusing on innocent business activities, especially if it causes the auditor to expand the audit.
- Provide documentation timely to address requests. This may include receipts, bills, canceled checks, loan agreements, exemption certificates, theft or loss reports, employment documents, schedules and questionnaires. It is also possible that a business lacks a requested document, such as if you are audited and don't have receipts, it may be able to reconstruct the document from third parties or other records. This may require attestation to prove to the auditor that these documents are fair and accurate. Just like in responding to IRS questions, do not provide the auditor with more information than they request.
Post-Audit Procedures
What happens if you are audited and found guilty, or disagree with said audit? Should an auditor disagree with the business's positions during the audit, finding that a business has committed errors in its tax reporting or payment, the auditor may impose additional liability. However, taxpayers have an opportunity to appeal the audit's determination in order to receive a more favorable outcome. If the taxpayer disagrees with the audit's determination, it is important to obtain an attorney specialized in procedures and presentation of an appeal before the taxing authority and thereafter
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.