Unfortunately, many clients we work with share a similar story.
First, someone receives an IRS letter asking for documentation. Their filing was accurate, but the expense records were long gone, and they couldn’t prove it.
And what should’ve been a brief correspondence turns into months of document hunting, mounting stress, and wasted time.
In this article, we’ll share how, and why, March is the best time to prep for an audit.
What Actually Happens During an Audit (And Why Prep Makes It Easier)
Most business owners have never been through an audit. And it’s no wonder; audit rates hover just below 1% annually for nearly all Americans, across all tax returns.
But while the likelihood of an audit is low, it’s still a scary possibility. We grew up with idioms like “the only two certainties in life are death and taxes” and jokes about how nobody but the IRS could catch Al Capone.
Surely the IRS deserves its reputation. Right?
In reality, audits are mostly mundane affairs.
- The IRS sends you a letter asking you to verify or document a specific item on your return.
- You gather the requested materials.
- Then, you respond yourself, or through your accountant, with supporting information.
- In many cases, that’s the end of it.
However, audits are headaches, manpower drains, and in many cases, cash flow strains as well; audits routinely delay tax refunds. Even if they’re not the devastating events we fear, they’re still growth hurdles.
There’s good news, though. They’re not entirely random.
What It Looks Like When You’re Prepared
Preparing early prevents the likelihood of an audit happening in the first place.
Here’s how.
The IRS uses automated systems to flag returns. Common triggers include:
- Reported income that doesn’t align with the 1099s and W-2s.
- Deductions that are unusually large relative to income.
- Outsize home office and vehicle expense claims.
- Cash-heavy businesses, where reported revenue seems low for the industry.
And if your tax filings are accurate, and on time? Your business avoids the trigger, and the attention of the IRS.
But let’s say you do get a letter from the IRS (and you’re prepared).
What happens next?
Many businesses panic after they get their letter. They want to see what? From how long ago? I don’t even know where to find that information; they may think…
But you?
You’ll pull the requested info, wait to hear back from the IRS, they’ll review, and in most scenarios, close the case. You may have a penalty or a back payment to take care of, but at least the affair didn’t tax your valuable time (too much).
Why March, Specifically?
If they aren’t already, your accountant is about to be very busy.
Indinero works hard to keep turnaround times low. We beat industry averages and continually strive to provide the best customer service possible.
But the truth is?
The balance of college graduates vs retirements has been tilting the wrong way in our profession, and for quite some time.
There aren’t enough of us to keep up with demand, and we’re entering the busiest season of the entire year.
Filing on time, and avoiding IRS triggers, is still possible. But you have to get going, and quickly.
Your Audit-Readiness Checklist
Here’s where to focus your attention before filing in April.
- Confirm payroll tax filings match W-2s: The IRS doesn’t have the manpower to double-check most filings. However, since both you and your employees should be reporting the same figure to the IRS, mismatches are one of the easiest things for the IRS to notice.
- Reconcile last year’s bank and credit card accounts: If your filing isn’t built on solid footing, there’s good chance you’ll miss something, risking as little as a some tax deductions, and as much as triggering scrutiny from the IRS.
- Review contractor payments and 1099 accuracy: If you paid anyone over $600 this year, you’ll need to send them a 1099. Mismatches between your, and a contractor’s, reported income can potentially trigger an IRS follow-up.
- Choose a revenue recognition approach: Most business owners benefit from filing under accrual, rather than cash, accounting methods. But though this approach can strategically minimize tax burden, unusually large deduction claims can draw attention. Be sure to maintain appropriate records to back up any claims.
Red Flags to Be Aware of
Here are a handful of scenarios that may draw the IRS’s attention.
Profit Changed Significantly Year-Over-Year
The IRS compares returns against historical patterns, and a significant swing in either direction can trigger questions.
Large or Unusual One-Time Deductions
Maybe you made a major equipment purchase, wrote off a bad debt, or took a loss on an investment. But the larger or more unusual the deduction, the more important it is that your supporting documentation is airtight.
Business Structure Changed During The Year
If you formed a new entity, brought on a partner, or converted from an LLC to an S-corp, your tax obligations may have shifted in ways that need extra attention.
New State Tax Obligations
Hiring a remote employee in a new state, opening a second location, or crossing a sales tax nexus threshold can all create filing requirements you didn’t have last year. State tax rules vary widely, and missing an obligation you didn’t know existed is one of the easier mistakes to avoid.
Get Ahead of It
If your books need some work before you file, we’re here to help.
Book a free consultation, and we’d be delighted to see how we may be able to help.
We’ll take care of the finances. You focus on growth.
