From CBIA News, June 2003

What if you’re audited?

Be prepared: Thousands of small businesses will face an IRS or state tax audit 

By Chris Amorosino

Free-lance writer in Unionville

The IRS estimates that the total “tax gap” — the difference between what all taxpayer groups pay and what they owe — is at least $278 billion. In response, it has instituted the National Research Program (NRP), a comprehensive effort to measure payment, filing and reporting compliance. As part of NRP, some 34,000 small-business owners will receive face-to-face audits over the next two years. That’s just a small portion of the total audit contacts the IRS is planning, according to Dianne Besunder, an IRS field media relations employee.

Your business could also face an audit from the state Department of Revenue Services. DRS conducts two major types of audits — state income tax audits and sales and use tax audits — both of which occur more frequently than IRS audits. 

But don’t panic. “Just because your business is selected for an audit doesn’t mean they suspect something awful’s going on,” says Laura Wyeth, director of state and local tax for PricewaterhouseCoopers LLP in Hartford. 

“You’re much better off cooperating with an IRS or state auditor rather than approaching the audit with an adversarial attitude,” she says. “You can spot any misunderstandings earlier and work out any issues more easily if you establish a good working relationship up front. Cooperating also may make it less likely that you will receive a penalty if the audit reveals a tax underpayment.”

Be prepared

Besunder says the best preparation for a tax audit is keeping good records. Business record-keeping needs vary depending on the business you’re in, but your accounting system should clearly show business income and expenses for the tax year. Keep and organize by year and type of income all supporting documents — sales slips, paid bills, invoices, receipts, deposit slips, canceled checks, and so on. This includes documents that show gross receipts, such as cash register tapes, receipt books, credit card charge slips, and Forms 1099-MISC. You’ll need the same type of complete records on the expense side. Remember, too, that most tax audits cover a three-year period.

Conduct a pre-audit review

Wyeth recommends doing a pre-audit review. Go through your records yourself before the auditor arrives. Make sure they’re complete. Look for any trouble areas. Talk to your tax adviser about any potential issues or areas where your records may be incomplete or unclear. Sometimes it’s best to have your tax adviser work hands-on with the auditor.

During your pre-audit review, look for any tax overpayments you may have made in the past. You can generally use an overpayment as an offset against any assessment the audit may levy. 

Be realistic about when you can start the auditing process. If you need a few weeks to get your records together, ask for that time up front. Most auditors will grant you a month or so to prepare.

At the audit

At the first in-person meeting, listen carefully to the auditor so you understand exactly what he or she is looking for. Provide the requested records, but don’t volunteer additional information. Set up a start date and planned timetable for the audit process. Give the auditor an office or workspace, and introduce the auditor to a main contact person. “It’s generally best to have just one person deal with the auditor. That way you know what [information] is being provided,” Wyeth says. 

Perhaps the biggest mistake you can make is to put the auditor in a room and forget about him or her. Wyeth recommends staying in touch with the auditor on a daily basis so you can handle any issues immediately. This helps resolve questions before they grow into problems.

When the auditor presents preliminary findings to you, make sure you understand what areas were assessed and how the assessment was computed. Generally, taxpayers are given an opportunity to discuss any findings they disagree with and to explain their position before those findings become part of the official written report. 

If you can’t reach agreement with the auditor, you can usually take your concerns to the auditor’s supervisor or the division chief. Most small businesses resolve whatever issues they have at one of these two levels, according to Wyeth. It’s most cost efficient to handle any discrepancies at the lowest level possible. Using the appeal process typically raises your expenses because the interest on your tax assessment keeps growing and you incur more professional fees. 

You have virtually no control over whether the IRS or the state will choose to audit your business. But keeping good records and being well prepared will go a long way in preventing any unpleasant surprises. 

For more information on tax audits, visit the Web sites of the IRS or the DRS. 

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