There are few words more prone to cause panic than “audit.” Receiving an audit notification is more than stress-inducing: it suggests unanticipated expenses of time, accountants' fees, taxes potentially owed, plus any interest and penalties you might be assessed.
The good news is that despite sleepless nights spent worrying about whether an IRS letter is coming, a good understanding of audits reveals that they're both unlikely and generally not as bad as you might think. Here's are the five things every business owner needs to know about IRS audits.
Like so many other events that we fear, the truth is that audits of businesses are pretty infrequent. In fact, statistics found in the 2020 IRS Data Book showed that between September 30, 2019 and October 1, 2020 (the government's previous fiscal year), only 0.3% of C corporations with balance sheets of $5 million or less were audited. Though no statistics were provided for Schedule C filers, the percentage of S corporations audited was only 0.1% and partnership percentages were even lower.
For 2021 there may be increased audit activity, as last November the agency announced plans to increase the number of small business audits performed by 50%, but 50% of an exceedingly small number is still very small, and budget increases that the agency requested to fund increased audits may not come to fruition.
If you are part of a partnership or a limited liability company that files partnership returns, you may be subject to the BBA Centralized Partnership Audit Regime. This special audit regime makes the entity level of partnerships responsible for tax audit monies owed and for making all appropriate amendments to returns (though the company may eventually turn to individual partners to recoup expenses.) As for S corporations, C corporations, partnerships consisting of 10 or fewer members, foreign entities, and estates of deceased partners, these small partnerships have the ability to opt out of the audit regime, leaving the IRS no choice but to reach out to an individual partner for answers on irregularities.
An IRS audit may be intimidating but it is not the end of the world. In many cases there is a simple reason for an audit – an individual may have left out important information on a return or omitted income that was reported by another entity. When the explanation is straightforward and you are in agreement that you erred, the situation is quickly addressed and corrected. On the other hand, if you think the IRS made a mistake and you want to counter their assertion, you have the ability to do so, though you are required to do so in a timely manner. IRS Publication 556 outlines all of the protections and right available to you, which include being able to maintain confidentiality, to be represented by a tax professional, and to be treated with curtesy and respect.
If you do get audited and your initial results don't go the way you had hoped, there are several opportunities to pursue an appeal. The initial stage for those who the IRS says owe $25,000 or less is to file a small case request. Those who wish to appeal cases representing greater amounts need to go through a more elevated process as described in Publication 5.
The Tax Court has the final say on what is owed to the IRS, so if you think that an IRS audit decision was wrong, you still have options. There is a small Tax Court procedure
available to those whose outstanding amount is $50,000 or less, and this route is faster and cheaper. The details on the process can be seen under Title XVII. Just keep in mind that whichever process is appropriate for you, the clock starts from the moment the IRS mails you a notice of deficiency and stops at 90 days, so make sure you file on time if you're going to appeal an IRS decision.
There are several other methods of fighting back against the IRS, including just paying what the IRS says you owe, then applying later to the Federal Claims Court of a U.S. district court. If you win this process, it will result in you receiving a tax refund. You can also get more information on filing a petition in Tax Court by clicking here.
Being audited is frustrating, and the best way to avoid it is by being meticulous in your tax filing. Do not claim deductions or credits that you're not entitled to, make sure you provide the documentation to support your claim, and get your return and all applicable extensions in on time. If, despite having reported all income and deductions correctly, you still get audited, you can represent yourself or seek guidance and representation from a tax professional. Though you may feel confident in your own abilities, consulting with an expert will save you effort and expense in the long run.
About Martinez & Shanken, PLLC
Martinez & Shanken, PLLC is a Certified Public Accountant (CPA) firm based in Gilbert, Arizona. We provide a full range of accounting, bookkeeping, consulting, outsourcing and business services. Partners Deborah Martinez and Earl Shanken work to ensure your business accounting is done with integrity and to your satisfaction.
