What Is A Business Audit, And How Can You Prepare?

Even external audits can help you stay on good terms with shareholders, investors, and lenders. As far as IRS audits go, they are nothing to fear either, as long as you are accurate about your income and deductions. At the end of the day, the best way to prepare for any business audit is to keep well organized financial records.

why do companies get audited

If you take several deductions, claim losses for multiple years in a row, or report high income levels, these are all risk factors for an IRS audit. If you’re chosen for an IRS audit, you’ll be notified in writing. There are two types of IRS audits—correspondence and field audits. If a company doesn’t receive a clean opinion, they might need to correct errors in their financial records and re-do the audit. The taxpayers whose returns they review are often defensive, and they deal with this work environment every day.

Large companies have an internal audit department, but smaller companies do not. An external auditor may have to perform more work for a client that does not have an internal audit function. Not every bank will mandate an audit of your business financials. However, there are many of a certain size that do require them. Most small business owners are intimidated at the thought of an audit, but an audit can actually help your business to be more productive and plan better for the future. From attracting clients, closing sales, and managing difficult employees, small business owners face many uncertainties and challenges.

This discussion defines an audit, explains the differences between types of audits, and reviews why this process is critically important for your business. The IRS will notify you in advance—and in writing—of your audit date and the year under examination. Having everything at hand for the audit helps the process go more smoothly. Isolating the tax year in question in your accounting records—for example, by downloading the records for that specific year in your cloud accounting platform—is a very good idea.

Whatever you choose, make sure this system is easy to use and tracks all of your transactions reliably. Being audited is never fun, but it’s most painful and expensive when you don’t have the records you need. Best Business Loans for 2021 Here are the best business loans and financing options… Clear expectations and proper planning are necessary for reducing your frustration and anxiety before and during the audit. Have an open line of communication with all department heads, including ensuring they are prepared to submit all information they need in a timely manner.

“This enabled me to reconcile my expenses and income against the data in my database and my receipts and documentation. Having a high ratio of independent contractors to full-time employees can trigger an audit because businesses can use contractors to avoid paying payroll taxes. Some external auditors might want to look at the complete picture of your business’s financial records while others may examine specific aspects of business operations. Another good rule of thumb is to distribute financial duties and responsibilities so it’s not one person handling all financial tasks. For example, you could require counter signatures on all checks. This type of audit is done by employees of the organization who will report their findings to the board of directors. An internal auditor, on the other hand, is a company employee, and these auditors are not independent.

We detail the difference between a review, compilation, and an audit here. A company may be better prepared to seek financing with audited financial statements. Hiring a CPA firm to conduct an annual audit is a critically important step to take, in order to manage growth and make informed business decisions. Sure, an audit will require an investment of time and money, but the benefits of an audit far outweigh the costs. Premier Homes owns $150,000 in fixed assets, including machinery, equipment, and vehicles used for home construction. To prove the existence assertion, the auditor will physically inspect each of these fixed assets. Once an auditor gathers evidence to support each type of assertion, Julie will have third-party validation that her financial statements are materially correct.

There’s a good chance this will set off some alerts at the IRS. But rather than sending over the numbers and hiding under your desk with your fingers in your ears waiting for the auditor to come knocking, be proactive.

What Is An Irs Audit?

Careful recording of mileage, clients or potential clients information and reason the visit was conducted will help you in the event your business is audited. The IRS takes a dim view on you trying to write off the epic New Year’s Eve party you threw last year, unless you can prove that every single penny and every single party guest was solely a business contact and expense. In addition, when deducting entertainment such as taking a client to a show, or golfing, even legitimate expenses are only deductible at 50 percent of the cost. Claiming a larger percentage can trigger an audit of your business. If you really, honestly, screwed up and forgot to take a legitimate deduction that is going to cost you thousands of dollars, file an amended return.

If you have board members or shareholders, you might conduct an internal audit to update them on your finances. They can find errors in your numbers, which can help you with decision making. In the long term, a company audit can help you get your small business on track and boost your business bottom line. Learn what an audit is, what types of audits there are, how they can benefit your business, and more. You might think an audit is the last thing your business needs, but they aren’t always bad. Regular audits can be more like a routine maintenance check than an invitation for IRS penalties.

Ken is the author of four Dummies books, including “Cost Accounting for Dummies.” Julie works with an auditor on the December bank reconciliation and finds a check payable to “cash”—and signed by Julie—for $12,000. After further investigation, the auditors determine that the administrative assistant had Julie sign the check and that the assistant cashed the check and kept the funds. The existence assertion, for example, addresses whether or not the assets listed on the balance sheet actually exist. A company may be tempted to inflate the dollar amount of assets in the balance sheet, to make the business appear more valuable. It’s important to understand the difference between external and internal auditors because they each serve a different purpose.

Types Of Small Business Audits

With independent contractors, the business controls the outcome of the work, but not how the work gets done. In contrast, businesses typically have greater input into how employees perform their work, pay for expenses, and interact with the company–including whether the relationship is long-term. Audits can also motivate you to implement new accounting processes.

While many business owners add IRS audits to that list of concerns, it certainly shouldn’t be one of your primary fears. Though unpleasant, as long as you are keeping accurate records and not deliberately underreporting income or exaggerating expenses, an IRS audit is nothing to fear. On the day of the audit—assuming it is conducted in person—arrive to your appointment on time, or even a little early. The most common type of small business audit is a correspondence audit, where the IRS notifies you in writing of a possible mistake or issue with your tax return. Then, you respond in writing with documentation to support your case.

  • Root out productivity killers – Doing an audit can help you spot fraud, employee theft, and operating inefficiencies.
  • The existence assertion, for example, addresses whether or not the assets listed on the balance sheet actually exist.
  • Home office deductions, business travel, and vehicle mileage are among the most misused business deductions, according to CPA and QuickBooks consultant Hector Garcia.
  • Likewise, a number of good apps exist for tracking mileage, to ensure you aren’t tempted to guess at your business mileage expense come tax time.

The IRS announced in late 2020 that it will increase tax audits of small businesses by 50 percent in 2021. At a time when many small-business owners are still scrambling to find relief from the coronavirus pandemic, this is likely the last news entrepreneurs wanted to hear.

Field audits—in-person audits that happen at your place of business, your tax professional’s office, or a local IRS office—are much less common. In either situation, you have the right to engage a business attorneywho specializes in tax matters. Even if you’re among those businesses that get audited, there’s nothing to fear from an IRS audit as long as you’re adequately prepared for it. While concerning, an IRS audit typically results in nothing more serious than an additional tax bill, and occasionally a penalty. Sometimes, no adjustments are made to the tax return at all, and the audit is simply an inconvenience that costs the taxpayer and their accountant a day or so of time. “I maintain a database on my expenses and income, and my filing system is categorized like my expenses and income on my tax return,” she says.

What Should You Do If You Get Audited Anyway?

You should have documentation for the income, losses, expenses, and deductions that you claim on your tax return. In most cases, electronic records are acceptable for the purposes of an IRS audit. You are required by law to retain and safeguard all records—in physical or electronic form—that you use to file your returns for at least three years. Most tax professionals recommend you keep records for seven years, just to be safe. If you find you’re missing requested documentation, take steps to replace it prior to the start of the audit. Also, never give the auditor original documents, as the IRS is not responsible for lost or ruined documents left in their possession.

If your bookkeeper works remotely, AccountingDepartment.com suggests that you include proper security protocols in the procedure manual. Rapid growth may cause an owner to lose control of operations, and business efficiency can decline.

S-corporations, partnerships, and LLCs tend to have low audit rates across the board. During an IRS audit, the auditor will check whether an individual or business has reported taxable income, losses, expenses, and deductions in compliance with federal tax laws.

Claiming Your Vehicle As 100% Business Use

You don’t have to report your income and expenses to the penny—in fact, most business accounting software automatically rounds to the nearest dollar. But if you submit a tax return where all the income and expenses are in multiples of $100, your return might get flagged for an audit. A quality bookkeeping system also saves you time and headaches when taxes are due.

What Are The Reasons For An Audit?

Usually, the IRS schedules audits for tax returns that were filed in the last three years. Receive certifications – Certain business certifications, like ISO 9001 certification, require regular business audits. These certifications can increase business revenue and lower operating costs. If at all possible, ask the tax professional who prepared your return and your bookkeeper to be present during the audit.

Depending on your business, this system might include accounting software, employees, or a third-party tax professional. In addition to serving as auditors, some accounting firms offer non-audit consulting services to their audit clients.

How Can I Find Out Who Audits A Particular Company?

Being courteous to the auditor smooths the audit process for everyone involved. Just be careful not to be venture into an area of niceness that can be construed as bribery. Since most small business audits are random, nothing you do guarantees that you will never undergo one.

A company’s management has the responsibility for preparing the company’s financial statements and related disclosures. The company’s outside, independent auditor then subjects the financial statements and disclosures to an audit. If the auditor cannot reach that conclusion, then the auditor must either require the company to change the financial statements or decline to issue a standard audit report.