If you own a small business, there is a good chance that at some point you will hear from the Internal Revenue Service (IRS). The IRS regularly audits small businesses, and in March 2020 it established a new Fraud Enforcement Office within its Small Business/Self Employed Division that is tasked specifically with enforcing small businesses’ reporting and payment obligations. Read on for an explanation of what small business owners can expect during the audit process.
There are Several Common Issues in IRS Small Business Audits
When facing an IRS audit, the first question that small business owners need to answer is, “Why is my business being audited?” The IRS vigorously enforces taxpayers’ reporting and payment obligations, and it pursues taxes, interest and penalties for all types of violations. This includes, but is by no means limited to, violations such as:
Failing to file quarterly or annual returns
Failing to report taxable income from all sources
Claiming fraudulent deductions or losses
Maintaining fraudulent books and records
Failing to pay all amounts owed to the IRS
Depending on the circumstances involved an IRS inquiry can either be civil or criminal in nature. While audits are civil proceedings, if an audit reveals evidence of intentional tax fraud or tax evasion, IRS Criminal Investigations (CI) may get involved to pursue criminal charges.
The IRS Conducts Three Types of Small Business Audits
The procedures involved in an IRS audit depend on the type of audit the IRS chooses to pursue. The three types of IRS audits are: (i) correspondence audits, which are conducted by mail; (ii) office audits, which require the business owner to meet with an IRS agent in person at an FBI field office; and, (iii) field audits, during which IRS agents will come to the business’s offices to examine its books and records.
Each type of audit is very different, and each generally serves a different purpose. Correspondence audits are typically used to obtain additional information in order to substantiate businesses’ tax returns, while office and field audits tend to involve the types of issues listed above. Additionally, while correspondence audits can lead to additional tax liability, office and field audits are more likely to result in substantial interest and penalties.
IRS Small Business Audits Can Have a Variety of Different Outcomes
An IRS small business audit can have several different outcomes. In a best-case scenario, the audit will simply confirm that the business’s returns are accurate and no additional action or payment will be required.
However, audits can also result in determinations of additional liability; and, as noted above, in some cases they can trigger criminal tax fraud investigations. In these situations, small businesses and their owners can face significant risk, and they will need to engage experienced legal counsel in order to dispute the IRS’s allegations. If an audit results in an unfavorable determination, it may be necessary to file an appeal with the IRS or in federal district court—although it will be necessary to first assess the potential grounds for filing an appeal with the assistance of the company’s Virginia tax attorney.