What to Do If the IRS Audits Your Small Business: A Practical Guide
Running a small business comes with many responsibilities—managing finances, paying employees, tracking expenses, and staying compliant with tax laws. One of the most stressful situations an owner may face is an IRS audit. But an audit does not automatically mean you did something wrong. In many cases, the IRS simply needs clarification or additional documentation.
This guide explains what an IRS audit is, why your business may be selected, and the steps you should take to protect your company, your records, and your peace of mind.
What Is an IRS Audit?
An IRS audit is an examination of your business’s financial information to verify that income, expenses, and deductions are reported accurately according to federal tax law. The IRS conducts audits to ensure compliance with the Internal Revenue Code (IRC), specifically IRC § 7602, which authorizes the agency to examine records and take testimony.
Audits can be conducted:
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By mail (correspondence audit)
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In person at an IRS office (office audit)
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At your place of business or your representative’s office (field audit)
Why the IRS Might Audit Your Small Business
Several factors can trigger an audit, including:
1. High Deductions or Unusual Expenses
Large deductions relative to income—especially for travel, meals, or home office use—can raise questions.
2. Reporting Inconsistencies
If income reported on Form 1099s or W-2s doesn’t match your tax return, the IRS may flag your file.
3. Cash-Heavy Operations
Restaurants, salons, retail shops, and other cash-based businesses are often selected for audit due to higher fraud risk.
4. Random Selection
Some audits are purely random under the IRS’s National Research Program.
What to Do If the IRS Audits Your Business
Follow these steps immediately to minimize stress and ensure compliance.
1. Stay Calm and Read the Notice Carefully
The IRS will send a written notice describing:
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The type of audit
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Documents requested
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Deadlines
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The tax year(s) being reviewed
Do not ignore the notice. Failure to respond can result in penalties or the IRS making assessments without your input.
2. Gather All Required Documentation
Typical records the IRS may request include:
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Bank statements
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Receipts and invoices
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Payroll records
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Bookkeeping reports
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Mileage logs
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Prior-year tax returns
Under IRC § 6001, every business must maintain adequate records to substantiate income and expenses.
If documents are missing, work with your accountant to reconstruct them using credible secondary sources.
3. Consider Hiring a Tax Professional
A CPA, enrolled agent (EA), or tax attorney can:
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Communicate directly with the IRS
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Organize documentation
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Protect your legal rights
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Help reduce or eliminate penalties
Professional representation is authorized under IRC § 7521, and you have the right to stop an interview until you obtain representation.
4. Respond Before the Deadline
Timely responses are critical. Missing deadlines may result in disallowed deductions or additional taxes. Be clear, organized, and factual in your submissions.
5. Understand Your Rights
The Taxpayer Bill of Rights gives you:
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The right to professional and courteous treatment
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The right to pay no more than the correct amount of tax
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The right to appeal an IRS decision
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The right to finality, meaning clear timelines and closure
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The right to retain representation
Always maintain professional communication and keep copies of every document you send.
6. Attend the Audit (If Required)
If the audit is in person:
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Bring only the documents requested
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Avoid volunteering additional information
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Keep responses short and factual
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Let your representative lead the conversation
7. Review the Audit Results
After the audit, the IRS will issue one of three results:
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No change — You owe nothing.
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Agreed change — You accept the IRS findings and any tax owed.
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Unagreed change — You disagree and want to appeal.
If you disagree, you can request an appeal through the IRS Office of Appeals, or later petition the U.S. Tax Court.
8. Prevent Future Audits
Strengthen your tax compliance by:
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Using reliable accounting software
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Keeping documentation for at least three to seven years
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Filing accurate and timely returns
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Working regularly with a tax professional
Good bookkeeping is the best defense against audits.
Final Thoughts
An IRS audit can be intimidating, but it doesn’t have to be disastrous. With the right preparation, documentation, and professional guidance, your business can navigate the process smoothly and avoid future issues.
If your business has received an IRS notice—or you want to prevent problems before they start—we’re here to help.
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