The Dos and Don'ts of Business Tax Audits

CHICAGO (TheStreet) - It's the ultimate nightmare scenario for many business owners: a letter from the Internal Revenue Service informing them they're being audited.

Statistically speaking, it's highly unlikely you'll be subjected to a tax audit this year. But if you are, it doesn't have to be a traumatic experience if you have the right preparation and expectations.

Here's what you need to know:

1. DON'T flip out: Make sure your business is being audited. The IRS' document-matching computer system searches for discrepancies in tax returns and generates letters to taxpayers whose documentation is inconsistent. Receiving one of those written requests for clarification does not mean you're being audited. Provide what the IRS asks for, and you'll probably never even talk to an agent.

If you do receive a letter informing you of an audit, you'll be asked to call and make an appointment for an agent to visit your office. Remember that an audit means the IRS needs to reconcile what they think you owe with what you've paid. Being audited doesn't necessarily mean you've done anything wrong or that you're facing penalties. As long as both sides act reasonably and rationally, tax issues are usually resolved with a minimal fuss.

2. DO provide what the IRS asks for -- and no more: Before your scheduled appointment with the IRS agent, you'll get a written request for certain documents.

"The IRS tells you what they're looking for," says accountant Brad Jones, a partner with PBGH in Fredericksburg, Va. "You should provide exactly what they ask for, and be complete. Make sure all your receipts and invoices reconcile with your tax return. You don't want to create a situation where the agent is uncomfortable enough with your records to expand what they're looking at."

At the same time, resist the urge to show off your stellar recordkeeping. The goal is to get the agent to move through your case quickly, not get distracted with irrelevant paperwork.

3. DON'T assume you've done anything wrong: The IRS occasionally does compliance audits for particular industries, looking for patterns of misrepresentation. Such audits can be time-consuming and drag on for several months. But companies in those industries are mostly chosen at random. Being picked doesn't mean the IRS has concerns about your business in particular.

If, on the other hand, you've been fudging numbers or making shady deductions, you'll need all the help you can get. Which leads to the next point:

4. DO make sure you're properly represented: Why do the vast majority of criminal defendants choose not to represent themselves in court? Because they know their interests will be better served by a lawyer who understands the language and rituals of the justice system.

The same goes for an IRS audit. You have the right to request that you accountant be present during the audit, and your can authorize him or her to speak for you.

"An IRS agent can ask questions that seem innocuous, but have ramifications you're not aware of," Jones says. Often it's a matter of terminology: for example, an "investment" expense could mean one thing to a business owner, and another to the IRS. A casual chat about spouses and children could transition into a sticky discussion of tax implications for a family-run business.

Conversation is crucial to an audit because numbers on a tax form don't always reflect the true state of your business. But owners can end up unintentionally hurting themselves. "You don't want to confess your sins as soon as the agent walks in the door," Jones says.

5. DO get organized: Many problems with tax returns come down to simple disorganization. Maybe you forgot to submit the correct backup documents, or kept only haphazard records of your expenses.

Showing up prepared and organized for an audit gives you an advantage from the minute the agent walks in. The better your documentation and the easier it is to sort, the sooner the agent will be able to finish your audit and move on.

You may even emerge from with the ultimate prize: a letter stating that no change is necessary to your tax payment. That's a piece of IRS mail any business owner would be happy to get.

-- Reported by Elizabeth Blackwell in Chicago.

Elizabeth Blackwell is a freelance writer based in Chicago. She is the author of Frommer's Chicago guidebook, and writes for the Wall Street Journal, Chicago, and other national magazines.

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