The IRS is ramping up its audit efforts, especially for large businesses and high-income individuals. By 2026, audit rates for corporations with assets exceeding $250 million are expected to nearly triple, and audits for partnerships with assets over $10 million will increase tenfold. This push is part of a broader strategy, funded by the Inflation Reduction Act, to target higher-wealth entities and complex returns.
However, audit rates for individuals making less than $400,000 annually and small businesses are not expected to increase. The IRS is prioritizing returns from wealthier entities, such as those involving personal use of business assets like corporate aircraft. Although business-related aircraft expenses can be deducted, personal use, including vacations, isn’t deductible.
Key Audit Preparation Strategies
Preparing for an IRS audit requires thoroughness and organization. Here are key steps a business can take to prepare:
1. Maintain Accurate and Organized Records
Keep Detailed Records: Ensure that financial statements, tax filings, receipts, and other documentation (e.g., contracts, payroll records, expense reports) are accurate and well-organized. Proper record-keeping can demonstrate compliance and make it easier to respond to IRS inquiries.
Match Financial Statements to Tax Filings: Your income and deductions on tax returns should align with the information on your financial statements and bank records.
2. Understand IRS Red Flags
Identify Risk Areas: The IRS may focus on areas such as excessive deductions, large charitable donations, or inconsistent income. Be prepared to explain any unusual figures or fluctuations.
Stay Compliant with Industry Standards: Ensure that deductions, credits, and tax positions are reasonable compared to industry norms.
3. Hire a Tax Professional
Work with an Accountant or Tax Attorney: A CPA or tax attorney familiar with your business can provide advice and representation during an audit. They can help you understand complex tax regulations and ensure you're complying with IRS standards.
Audit Readiness Review: Some accountants offer audit preparation services where they review records and practices to ensure readiness in case of an audit.
4. Respond Promptly to IRS Requests
Meet Deadlines: If you receive any notices or requests for documentation from the IRS, respond in a timely manner. Failing to meet deadlines can lead to penalties or a deeper investigation.
Prepare Explanations: If there are discrepancies or items that might raise questions, be prepared to explain them clearly and concisely.
5. Use IRS Audit Techniques Guides
Review IRS Industry Audit Guides: The IRS publishes audit technique guides (ATGs) for various industries. These can help you understand what the IRS will focus on in your specific sector and how to prepare for those areas.
6. Ensure Internal Controls
Strengthen Internal Controls: Having effective internal controls over finances, including regular reconciliations and segregation of duties, can minimize the chance of errors or fraud, which could trigger an audit.
Document Policies: Keep records of your business's financial policies and procedures to show that proper checks and balances are in place.
7. Conduct a Pre-Audit
Internal or External Audit: Regularly conducting an internal or external audit can help identify any potential issues before they escalate into a tax audit. This helps you fix problems proactively.
Responding to an Audit
If selected for an audit, the IRS will notify you by letter (not by phone, email, or text). Many audits are straightforward, requesting that you mail receipts or documents supporting certain deductions. Field audits, where you meet with an IRS auditor, are less common.
The IRS will inform you of any discrepancies and give you time to respond. Collect and organize all relevant records and reconstruct missing information based on available documentation. Audits are usually conducted within three years of filing, and many are routine, so don’t panic if contacted.
By staying organized, understanding potential audit triggers, and seeking professional guidance, businesses can effectively prepare for an IRS audit and mitigate potential risks.
Our firm can assist you by clarifying what the IRS is questioning, gathering necessary documents, and responding effectively to audit inquiries. If your business finds itself in a position to be audited by the IRS, get in contact with us immediately. We are here to help!