How to Prepare for a Tax Audit

1145A tax audit is an experience every businessperson hopes to avoid. If the IRS does pay your business a visit, however, understanding what an auditor might look for can make the difference between a minor inconvenience and a major hardship.

During a full-fledged audit, an IRS agent may look at several specific items in your tax return and business records, including:

Income. The IRS will compare your bank statements and deposits to the income you reported. They will also review your invoices, sales records and receipts, along with your general ledger and other formal bookkeeping records. If you received gifts of money or an inheritance, keep records to document how much you received. Without proof, the IRS may classify these as income and tax them as such. They will also classify any exchange of goods or services in lieu of cash (such as barter transactions) as taxable income.

Expenses and deductions. An auditor may compare canceled checks, bills marked “paid,” bank statements, credit card statements, receipts for payment or charitable gifts, and other business records to the expenses and deductions you reported on your return. They may pay special attention to reported debts or business losses; charitable gifts; and travel, meal and entertainment expenses. Keep a log to substantiate travel, meal and entertainment expenses, and be sure to deduct only legitimate business expenses. Read Tax Deductions and Your Small Business for additional information.