How IRS Audits Work
The IRS can audit you by mail, in the IRS offices, or in your office. The location of your audit is a good indication of the severity of the audit. Typically correspondence audits are for missing documents in your tax return that IRS computers have attempted to find. This type of audit can be handled through the mail with correct documentation.
IRS Audit of Business Income and Expenses
This IRS audit will usually be done by an IRS Auditor who is a Revenue Agent. These audits should be taken seriously as this auditor typically receives more training techniques than IRS Tax Examiners. The auditor will request numerous documents, including bank statements, financial statements, invoices, receipts, QuckBook data, and the owner’s capital accounting. This audit is to determine if the gross business income and expenses reported on the business return and to determine if the owners have sufficient basis to claim any losses. According to the IRS Fiscal Year 2012 Enforcement and Services Results, the IRS audits 70,265 business returns in 2012, this is an 8% increase in the number of business returns that were audited in the 2011 fiscal year.
IRS Worker Reclassification Audit
Many businesses and industries have long standing practices to treat certain individuals as contractors rather than employees. If the IRS believes that your treatment of certain individuals as contractors was incorrect, they will audit the business to determine who was paid, what these contractors were paid and where these contractors should be reclassified as employees. If the IRS reclassifies contractors as employees, your business could be held liable for the unpaid FICA taxes that should have been paid on these individuals and could potentially hold the owners of the business personally responsible for the trust fund portion of the FICA taxes that should have been paid on the newly reclassified employees. The IRS has stepped up its employee reclassification audits and these audits should be taken seriously.
In addition to auditing the income and expenses of S-Corporations, the IRS has increased its audits on S-Corporations and whether a reasonable wage was paid to the owners and officers of the corporation. According to the IRS Fiscal Year 2012 Enforcement and Services Results, the IRS audited 21,658 S-Corporation returns in the 2012 fiscal year; this is an 11% increase in the number of returns that were audited in the 2010 fiscal year. If the IRS initiates an S-Corporation audit and determines that the business did not pay a reasonable wage to its officers/owners, then it will reclassify any distributions made to these officers/owners as wages and subject them to the FICA tax. This could potentially result in the business owing FICA taxes and the officers/owners being held personally responsible for the trust fund portion of the unpaid FICA taxes.