United States - Tax Authorities (2024)

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When your business receives an audit engagement letter,don't panic. While an audit may be time-consuming, costly, andinvasive, having an experienced advocate on your side to navigateyou through the process and represent your interests can turn a taxaudit into a tax-savings opportunity. It's important toremember that the initiation of a tax audit does not necessarilymean that the taxpayer did anything wrong. A tax-collecting bodymay initiate an audit where the company has made innocent errors onits tax filings, where there has been a higher than normal increasein revenues, or simply being randomly selected for audit, amongmany other reasons.

Nonetheless, when a taxing authority initiates an audit,it's generally anticipated to increase the taxpayer's taxliability and collect additional revenue. Therefore, businesses whoare under audit should always proceed with caution when cooperatingwith an auditor. With experienced tax counsel, adequate preparation,and a responsive mindset to provide requested accounting documents,contracts, and other relevant information, explainshow businesses may be able to minimize its costs, time, and stressexpended during the audit.

What to Do If Your Business Receives a TaxAudit

Receiving a notice of a tax audit can be a daunting experiencefor any business owner. However, it's crucial to approach thesituation with a clear understanding of your rights,responsibilities, and the steps you can take to navigate theprocess effectively. In this guide, we will walk you through whatto do if your business receives an audit commencement letter,offering practical advice to help you handle the situation withconfidence and ease.

What is a Tax Audit?

An IRS tax audit is an examination of anindividual or organization's financial information intended toconfirm that person or organization is reporting taxes inaccordance with federal and state tax laws. Most business taxaudits are conducted in person by IRS or state tax agents and arecomprehensive. In each case, the taxing authorities examine thebusiness's finances and tax returns to verify correct reportingof income and expenses, proper deductions, and other exclusionsfrom tax.

Different Types of Audits

There are three common audit types: Correspondence Audits,Office Audits, and Field Audits. Both the IRS and the Ohio TaxCommissioner have broad powers to investigate the books andrecords of taxpayers and audit the taxpayer's income andpurchases in search for additional tax revenue. The IRS also has anadditional Audit type, stemming from the National Research Program.For every type of tax audit, we recommend retaining a tax attorney,familiar with the subject area. The Audit types are:

Correspondence Audits

The most common form where the IRS or a state authority sends aletter to a taxpayer, informing them of a perceived error on afiled (or unfiled) return and requesting additional information. Itis important not to ignore these letters. If the IRS or taxauthority does not receive a response from the taxpayer after aprescribed period (usually 30 or 60 days), the taxpayer may beissued estimated assessments that become final based upon a lack ofresponse, making it more difficult for the taxpayer to challengethe tax authorities' findings. Therefore, it is critical thetaxpayer respond promptly (and thoughtfully) to any taxnotices.

Office Audits

The second most common audit, where the questions for thetaxpayer are too complex or extensive to conduct a correspondenceaudit, but too small to justify a field audit. In these cases, theIRS or state authority requests the taxpayer's come into theiroffices to conduct an interview. These audits are common in casesof itemized deductions, business profit and loss or rental incomeor expenses. The interview generally last a day, but additionalinformation may be requested after the audit.

Field Audit

The most comprehensive of the audits, involving specializedrepresentatives of the taxing authority to visit the taxpayer'sbusiness. These reviews can be far deeper, longer, and moreintrusive, and the agents may ask for financial records,interviews, and many other items. The scope of the audit may expandupon information discovered by the taxing authorities.

Markup / Statistical Sample Audit

Used to estimate revenue or costs, they are typically applicablein Ohio and state tax audits, markup or statistical sample auditsare performed when there are limited records and support for thetaxpayer's purchases and sales or sales and purchase recordsthat are too voluminous to analyze efficiently. Mark-up auditsapply to restaurants, bars, and other businesses selling liquor andalcohol whose primary sales records are missing or incomplete.Given the absence of available records, Ohio analyzes thebusinesses alcohol purchases and estimates sales using a"mark-up analysis." Similarly, statistical sampleagreements are used to limit an audit to a specific period. Thesemark-up and statistical sample agreements are binding upontaxpayers and are more difficult to challenge after the taxpayerhas agreed to the methodology. Thus, it is critical to consult withexperienced tax counsel to ensure agreements are crafted in amanner favorable to the taxpayer.

Each audit is its own trial, with the more comprehensive onesbeing more expensive, time-consuming and stressful. Nevertheless,should your business be the subject of an audit, preparation is keyto minimizing the intrusiveness and harm.

What Triggers a Business Tax Audit?

A business is most likely to have a tax audit if the IRS orstate detects a possible error on your tax return, such as amathematical mistake or unreported income. A tax return or entitymay be selected for audit for many different reasons, but the mostcommon causes include the following:

1. Substantial expenses;
2. Large amounts of cash transactions (potentially underreportedincome);
3. Incorrect reporting of income and mistakes on tax returns;
4. Disproportionate deductions for income that appear to exceedwhat is ordinary and necessary (travel costs, vehicle use,home-office deductions, and internet bills);
5. Repeated claims of business losses year after year; and
6. Misclassification of Employees.

Steps to Address Your Business Tax Audit

A business audit can takes years to resolve, so it is importantto address the following these steps to minimize the time and costof the audit:

1. Consult a tax lawyer upon receipt of the notice of anaudit. A tax lawyer's experience will save time andenergy that might be otherwise expended by a businesses' staff,owners, or other professionals and promotes efficiency inresponding to an audit. Our tax team has extensive experiencerepresenting taxpayers' interests in IRS and state tax audits.Most importantly, experienced tax counsel is critical especiallybecause an unaware business may unintentionally waive certainrights, or make harmful admissions if it tries to address the auditalone.
2. Be aware of your rights. Both the IRS and Ohiohave a taxpayer's bill of rights, which includes a right toassistance and representation, and a right to pursue additionallegal remedies, among other rights. Knowing and leveraging itsrights will allow a taxpayer to maximize their opportunity tominimize their costs.
3. Understand the scope of the audit. Businessesshould consider what documents and information is being requested,and be prepared to answer in-depth questions about thebusinesses' finances, activities, accounting andrecord-keeping.
4. Prepare to respond to agent questions. Theauditor will request certain information and documentation, but abusiness may anticipate follow-up requests that the auditor mayseek. This will enable the business to determine the itemsimportant to address, collect, or preserve. Be prepared to answerthe auditor's questions directly and succinctly. However, donot provide the auditor with more information than they request, asit can lead to additional time spent focusing on innocent businessactivities, especially if it causes the auditor to expand theaudit.
5. Provide documentation timely to addressrequests. This may include receipts, bills, canceledchecks, loan agreements, exemption certificates, theft or lossreports, employment documents, schedules and questionnaires. It isalso possible that a business lacks a requested document, such asif you are audited and don't have receipts, it may be able toreconstruct the document from third parties or other records. Thismay require attestation to prove to the auditor that thesedocuments are fair and accurate. Just like in responding to IRSquestions, do not provide the auditor with more information thanthey request.

Post-Audit Procedures

What happens if you are audited and found guilty, ordisagree with said audit? Should an auditor disagree with thebusiness's positions during the audit, finding that a businesshas committed errors in its tax reporting or payment, the auditormay impose additional liability. However, taxpayers have anopportunity to appeal the audit's determination in order toreceive a more favorable outcome. If the taxpayer disagrees withthe audit's determination, it is important to obtain anattorney specialized in procedures and presentation of an appealbefore the taxing authority and thereafter

The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.