IRS Audit: How Does it Work and How Can You Prevent One?

• Reading Time: 4 Minutes
• Published: April 22, 2022
• Last Updated: January 14, 2025

Auditing is a scary word for business owners. It means they have done something wrong with their accounting and need to suffer the consequences. The word ‘Audit’ comes from the Latin word ‘Audire’, pointing to hear. Business owners usually freak out over IRS audits because they are afraid. So what is an IRS audit, and what makes it scary? An IRS audit refers to examining your financial accounts and transactions to ensure an accurate and fair presentation of financial health. It provides you do not go against the accounting and bookkeeping standards and avoid window dressing. They match your financial statements with the bookkeeping records, receipts, and invoices to assure you have not claimed anything unnecessarily. Their main goal is to ensure you are not bearing less tax liability by overstating expenses or income. If you want to avoid this hassle, hire a virtual accountant.

IRS audit occurs when officials doubt your accounts and tax and financial files do not satisfy them. It can go three ways:

• One, they do not find any discrepancy and let you work.
• Two, they find out the money you owe to them. You will have to sign an official document confirming the owed amount and pay it.
• Three, they say you owe them additional tax, but you dispute. Based on your arguments, the case will either get discarded or a reduced or total tax amount payable. In such cases, you will have to hire a virtual accountant, CPA, or tax lawyer to lend his expertise.

Triggers of Audit:

So, why would the IRS, out of several businesses, audit you? The reason may be one of the following triggers:

• You may come as a randomly selected business from the IRS system.
• If you do not comply with IRS norms, you can get flagged through computer screening.
• Auditing by association, meaning, if any, of the taxpayers has associations with your tax returns and is getting audited, they may audit you through a connection established.

Signals that trigger an audit:

Although you cannot predict your time of getting audited, you should still know the signals and triggers to audit:

• You do not report an already filed income with the IRS through ‘W2’ or ‘1099’. They may call you out for tax evasion.
• Claiming abnormally high deductions that get IRS suspicious can include a 100% car deduction for personal use. You may get accused of committing tax fraud.
• You do not classify your employees correctly.
• You do not issue information returns like W2 and 1099.

Ways of getting audited:

Field audits are possible, but rare. IRS doesn’t need to knock down your door and mess up the place to find errors. The following ways are standard audits that happen in reality:

• Correspondence audit: Under this type of audit, you get asked about missing, omitted, or error-prone information via physical or e-mail. You can either offer the necessary documents, pay the eligible amount, or dispute by hiring top accounting firms in the US.
• Office audit: You may get asked for a one-on-one interview with the IRS office. You can hire a virtual accountant and go with him to pay taxes and penalties or dispute it.
• Line-by-line Audit: It entails random business selection by IRS to identify triggers and discrepancies.

You won’t have to bear harsh consequences if you establish your stance with adequate proof, timely penalty payments, and no criminal intent.

Preventing an audit

Although there is no foolproof method to avoid getting audited altogether, you can reduce its likelihood by practicing the following points:

Do not miss reporting any income:

IRS uses a central database and numerous forms like W2 or 1099 to establish the points where you receive your income. It checks your reports with your suppliers and customers to ensure correct payment and expense reporting. Discrepancies in reported revenues cause red flags for the company as the tax gets understated and provokes investigation. Therefore, hire a virtual accountant to ensure no hiding anything from IRS.

Double-check your return:

Before filing your tax return with the officials, check and review it again to avoid errors. Even silly mistakes can lead you to get audited by the IRS. Instead, hire a virtual accountant or professional expert to maintain up-to-date books and accurately prepare statements and tax files.

Consistency is the key:

Always stay consistent with the accounting methods you choose. Whether cash or accrual, single entry or double, written down or straight-line depreciation, LIFO or FIFO, closing balance, or market price for inventory, you should calculate the values by applying one fixed method. If you keep changing or alternating between the two, you invite IRS to audit. Therefore, hire a virtual accountant and plan a suitable method the first time without hassle. Also, give valid reasons, if you ever need to change from one to another.

Classify employees correctly:

Ensure your employee classification is correct as it determines the type of taxes to pay, their due dates, and their responsibility to pay. Firms must withhold tax and pay unemployment, social security, and Medicare taxes for internal employees. However, with independent contractors, there is no such need.

Conclusion:

Auditing may seem like a complicated process, but you have no reasons to worry if you are honest in your work and have adequate evidence for your transactions. Keeping accurate books will help you avoid auditing as long as possible. However, stay calm and answer IRS queries confidently if you get audited. If you get penalized, make timely payments or raise a dispute if you disagree with the verdict.

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