What to do if your small business is audited by the IRS

Image by Mary Pahlke from Pixabay

By Sheryl Wright

As a small business owner, the prospects of an audit can feel terrifying. You may have questions like, how far back will the IRS look? How long does an audit take? What is your liability?

Many of these questions are best answered by a direct conversation with tax professionals. However, some essential tips can help a small business know what to do when they are audited.

Reasons small businesses get audited

Approximately 2.5 percent of business owners get audited. If your small business is audited, it could seem like the IRS is picking on you. However, there could be things that you are doing or have done that increase your chances of being part of that 2.5 percent who get audited.

For example, if your business reports year-over-year losses consistently, the IRS will start to get curious. They may see this as a sign that you are intermingling your personal funds and your business funds.

If you are constantly filling your taxes late, the IRS may think that you are not taking your tax obligations seriously. This could indicate that there are other problems with how you are filing your taxes, so the red flag is waved.

Another thing that catches the IRS’s eye is a steady stream of deductions. You should only deduct things that are ordinary and necessary for your line of work. However, if it seems like each lunch expense is being deducted, you may be in for a surprise from the IRS.

As a small business owner, the number one way to increase your chances of getting audited is to be a sole proprietor. This is because, as a sole proprietor, the line between personal money and business money can quickly become blurred. The IRS wants to make sure that your accounting is spotless. If you don’t do this, you could pay serious consequences during an audit.

What happens to your business during an audit?

Although an audit sounds terrifying, it is simply tax professionals taking a second look at your business taxes. In some ways, an audit is like the quality control measures people use in their own business.

Most audits are correspondence audits. This means that the IRS will send you something in the mail telling you that there is an issue with your tax return. You respond by mail with the tax information supporting your case. It is sporadic for the IRS to perform a field audit and go to your workplace. Either way, if you face an audit, you want to talk to an income tax expert.

Preparing for and surviving a small business audit

Most small business audits are random. You have little control over whether an audit will take place. However, you can control how you respond when you receive notification of an audit.

Survival depends on having good records. This includes documentation for your income, expenses, deductions, and losses. In the vast majority of cases, the IRS will accept electronic documents.

It is your responsibility to store and protect all records, be they physical or electronic, for at least three years. Most tax professionals recommend keeping records for up to seven years to cover your back.

Any records you provide to the IRS should be copies. Never give the IRS originals because they are not responsible for damaged or lost documents in transit.

The IRS will tell you in advance about the date of your audit and the tax year that is being examined. This means that you have time to get your records together. If you have everything laid out clearly, the audit process goes smoothly. You may want to download all of your financial documents for the audited year and store them in one place.

While auditors are viewed as impartial, impersonal cogs in the machine, they are humans. IRS auditors have a difficult job. Part of preparing for your audit is to prepare your heart and mind to treat the auditor kindly. The nicer you are to them, the smoother the process goes.

They are accustomed to dealing with people who are defensive, aggressive, and rude. During your conversations with the auditor, keep things professional. You do not want to say something in passing that could incriminate you further accidentally.


A small business audit can seem terrifying. However, if you go into it with the proper perspective, you prepare your documentation, and you treat the auditor in a courteous manner, you may be surprised at how positive the experience can be.


Sheryl Wright is a freelance writer who specializes in digital marketing, inclusive business, and interior design. If she is not at home reading, she is at a farmer’s market or climbing in the Rockies. She currently lives in Nashville, TN, with her cat, Saturn.

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