The best way to prepare for an audit is to understand ahead of time that you ARE going to get audited, and therefore have your company financials in decent order to be able to do the following:
The thing to remember is that the agent is like any salesman or bill collector. He is judged by the amount of money that he’s going to collect from you during the audit. There are certainly businessmen that approach an audit by being tough as nails, delaying or being unable to provide information, providing illegible copies or backup that doesn’t match the information the Agent is looking for. That kind of activity will just get the agent upset. If he’s on your side (and he never is – the actual question is “How much of an adversary is he?”) he may be willing to forgive some things that are in that grey area. If you make his life difficult, he will likely dig in his heels, and make your life more difficult and the audit result more expensive.
Remember, he has a boss that is looking for him to have a successful result after spending time with you. And that doesn’t mean that he can readily come back to the office and say with a bright smile, “wow, what an honest business, I couldn’t find anything that they did wrong!” The more time he spends with you, the bigger the pot of gold that his boss is going to expect to have when all is said and done.
Any expenses that you can’t justify as a company expense will be disallowed by the Agent. That means that your company will have more income, and have to pay more in taxes. But, worse than that in my mind, is when the Agent discovers that you’ve used the business checkbook to provide for personal gain. You’ve bought yourself “things” or took “trips” that have been identified as business expenses, which were really thinly veiled ways of reaping a benefit without considering it income. The agent is going to start preparing a listing of those things, and the small dollar amounts will really add up.
If you have multiple companies that work together, make sure that the intercompany accounts match. One client we worked for had several companies that did business across the desk from each other. One company primarily funded the losses of the other company. The intercompany balance sheet accounts didn’t match between the companies. As the years went on, the owner continued to “forgive” the debt of the losing company, without noting them on the books of either company. The end result was that the IRS Agent identified that mismatch, which became a tax obligation of the owner. It amounted to a large bill.
In another case, the owner of the business had been doing accurate recordkeeping for years. At the end of a month of working at the company, the Agent declared that the owner owed $20,000 in back taxes for a variety of things that we could easily document as legitimate business expenses. The Agent declared that, “I’m sure that I could spend more time here working on this, but I would probably find enough questions that I would want to audit the two years before and two years after this particular year. Who knows what I might find in those 4 years of tax returns and financials!” Under threat of a continuing audit covering 4 more years, we agreed to make a payment to the IRS for a lesser amount, saving us considerable time and sweat while he pored over years of reports, trying to justify his time.
The upshot is that you need to have a number of things that you are willing to give up. What expenses are you willing to give the Agent (after he finds them) as being a bit aggressive in the company’s recordkeeping, and you might owe taxes on that issue. Your willingness to give in on some things early in the audit might save you significant time while he combs through your records to justify his time in being there.
Because I promise you. No matter how well you have done with your recordkeeping and documentation, he needs to justify his time – and he will.
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