How to Prepare for a Tax Audit: Small Business Checklist

The timely, practical guide that no professional services firm can afford to be without Managing the Risk of Fraud focuses on the laywers and accountants who have the professional responsibility for detecting and preventing fraud.

Introduction

Tax audit is always scary for any small business owner. Preparedness reduces anxiety, shortens the process and improves outcomes. This guide offers a straightforward, pragmatic toolkit to prepare yourself for a tax audit, from assembling of records through effective interaction with the auditor.

Step 1: Read the Notice Thoroughly

As soon as you get an audit notice, read it carefully. Record the name and agency of the auditor, the tax years they are looking at, what specific issues or items the auditor has expressed an interest in reviewing, and any response times. Date when notice received and Dating System: Keep a timeline to monitor activities and responses.

Step 2: Generate an Audit File For The Job.snapshot() Method Here we add a dedicated audit file.

Open one hardcopy folder then and a corresponding electronic folder where all audit work papers, memos, etc., will be kept. Keep labels consistent, and include a simple directory for each document's entry. With everything in one place you’re less likely to lose track of items, and it makes it simpler to hand over requested documents.

Step 3: Assemble Key Financial Documents

Begin with primary records: tax returns, general ledgers, bank statements, deposit slips, checks used and accounts receivable and payable ledgers; payroll records; payroll tax filings; and receipts for expenses. Attach all applicable supporting schedules and reconciliations that show how the numbers on your return were computed. Sort them in a chronological order and identify those records to which the audit notice refers.

Step 4: Assemble Supporting Documentation

Keep a record of invoices and contracts and vendor agreements, proof of payments, mileage records and receipts for work expenses. For inventory-related examinations, be prepared to produce purchase orders, inventory counts and calculations showing the cost of goods sold. If the audit includes deductions for home office, car or travel, make sure to have contemporaneous logs and substantiation supporting your claimed amounts.

Step 5: Put Together a Summary Package

Summarize with a list that ties the actual line items of your tax return to supportive documents. Attach a one-page cover letter that highlights what you are presenting, any assumptions, and the contact person for follow-up. This kit makes life easier on the auditor and shows that you are organized and cooperative.

Step 6: Read and so balance books

If preparing documents, reconcile bank and credit card with the general ledger. Confirm that income on your tax return agrees with your accounting totals. Make corrections on open-and-shut mistakes or explanations for discrepancies. Where applicable, also prepare reconciliations for inventories and fixed assets.

Step 7: Expect Common Examination Challenges.

Common auditor areas of concentration include reported income, expense deductions, payroll classification and independent contractor vs. employee status issues and inventory valuation. Look for these areas to see if there are any gaps in your documentation. If you find poor documentation, write up a clear description of the issue and any other corroborating evidence you can.

Post 8: Respond Professionally and Quickly

Appoint one staff member to act as the liaison with the auditor. Adhere to deadlines for responding to requests and keep a record of all communication with dates, names and discussion topics. A professional response at the appropriate time helps build trust and can lower the risk of escalation.

Step 9: Consider Professional Advice

If it’s a complicated audit situation, major adjustments or legal considerations, you should consult a certified tax advisor or accountant. A trustworthy counsel can assist you in submitting documents, organizing the positions and making reasonable settlement. If you go with a representative make sure the proper authorization is set up for the auditor.

Step10: Prepare for On-Site Visits

If the audit is in person, plan for a peaceful office and have needed files at your fingertips. Restrict the access of the auditor to such materials as are specifically mentioned in the audit notice. Keep a record of any documents left on your premises and make copies for your audit file if they are provided.

Step 11: Be honest and specific

Answer questions truthfully and only provide the information that is put down on paper. If you don’t know an answer, say so and offer to get back instead of guessing. If necessary, give explanations in writing and do not give out any unasked-for information that might prompt further examination.

Step 12: Audit Negotiation and Closing

If the auditor recommends adjustments, scrutinize them. Ask about the reasons and calculations behind any proposed changes. You might be able to submit extra documentation to resolve issues without having any adjustments. If changes are unavoidable, know the deadlines and how to appeal before you agree to anything.

Step 13: Implement Corrective Actions

Upon completion of the audit, correct any internal control deficiencies or record keeping deficiencies noted as part of the examination. Revise your documentation system to work for you, train all employees on record retention and upgrade your bookkeeping so that everyone can audit it.

Record Retention Tips

You should keep tax returns and accompanying records for several years, and some documents longer, for contracts, asset purchases and employment records. Keep your records organized so that you can easily access them. Backup electronic files on a regular basis and confirm that the backups are both secure and accessible.

Final Thoughts

Taking a methodical, even-keel approach to preparing for an audit can make all the difference. Through organization of records, clearly summarizing, professional communication and addressing issues early on, small business owners can minimize both cost and time involved in their audit to achieve a fair result. Follow this checklist to orient the grounds for your preparation, and forge better document management habits that can serve you (and your business) long after the audit is over.