How to Survive an Audit

When Brad Heath’s small business was audited by his sales tax authority, he learned a lot, including how to prepare in case he’s ever audited again. But mostly he learned that it’s no fun.

“I’m not sure there’s a way to keep it from being one of the most expensive and tedious things you’ll ever experience,” says Heath, owner of VirTex Assembly Services, an electronics manufacturer.

VirTex’s audit spanned more than two weeks, required Heath to hire part-time help to assist his overwhelmed one-person accounting department, and ended up costing him thousands of dollars in state use taxes he found he was required to pay on purchases made online and through other means from out-of-state vendors.

He’s made a few changes as a result, such as tightening recordkeeping on tax-free sales to exempt organizations and resellers. And he fervently hopes it won’t happen again. “It was such a disruption to the business. They go back three years; so you’re having to go back two and three years to find a receipt,” he says.

Get Organized

If your business gets audited, you can expect a pretty similar experience, says Karen Burns, a partner with accounting firm Sensiba San Filippo. She recommends hiring a tax professional as soon as you learn of an upcoming audit, even if you prepare your own taxes and consider yourself well-versed. “Often you’re personally attached to that return,” she explains. Having a dispassionate pro on your side may help minimize unrealistic expectations and irrational arguments.

Whether you go it alone or with help, organizing your information is critical. Burns recommends using the advance list of documents sent by the auditor as a detailed guide. That includes putting all your papers in the order the auditor requests them. As long as everything is there -- and matches what you put on your return -- such a well-orchestrated start can be the end of the affair. “Even if something’s a little questionable, that can be overlooked by the agent because you appear to be so well-organized,” she says.

While you should be sure to have everything the agent requests, don’t offer anything else. “Respond only to what is asked,” stresses Burns. Even if you genuinely have nothing to hide, volunteering information may prompt the agent to ask more questions, request more documents, and take up more of your time.

Some experts recommend going even further and requesting that audits be performed at a location other than your business. The idea is that if you’re at the auditor’s office or your accountant’s place of business, the auditor is less likely to hear or see something that would prompt additional requests.

While avoiding being extra cooperative, you should accommodate requests with the same courtesy you’d extend to a customer. Burns notes that an audit is nothing personal, and most are prompted by a specific issue that appears on a tax return, usually because a computer has found that some numbers aren’t matching up.

“It’s not like they reach into a box and pull out a name and say, ‘Let’s audit these people,’” Burns says. “Everything’s automated. Oftentimes it’s nothing more than that you have transposed a number on your tax return.”

As important as what you do is what you should not do when confronted by an audit. In addition to volunteering information, one of the worst mistakes business owners make is to put off preparing for an audit until the day it’s been scheduled. “Suddenly your time is up, and now you don’t have time to prepare,” says Burns.

Take Time to Follow Up

The audit itself is only one stage in a process that doesn’t end when the auditors walk out the door. If your audit comes back with a judgment you disagree with, most of the time you can file an appeal. And even before then, Burns recommends monitoring the progress of your audit once auditors have returned to their own office and are preparing their report.

Feel free to call the auditor about the audit’s progress and even ask how the final recommendation is likely to turn out. Having a pleasant attitude during the earlier phase of the audit is likely to pay off. At the same time, if you get the impression that the situation is going against you, ask to contact the auditor’s supervisor. Many auditors are younger, less experienced employees, Burns notes. “It’s possible they might not know what they’re doing or what they’re looking for,” she says.

Unlike many larger businesses that are constantly being audited by one taxing entity or another, small businesses experience audits fairly infrequently. That doesn’t mean you can assume your number won’t come up, however. “It’s bound to happen sooner or later,” Burns says. Still, she adds, there’s no reason to worry about it. “If you consistently follow your core principals and do the right thing, you’ll be fine,” she says.

That’s generally the approach taken by audit veteran Heath. Having been there, he knows he can survive another one -- but he also knows he doesn’t want to have the next one turn out worse. So he’s built in rigorous processes to ensure that he’s collecting and paying sales tax when required and documenting any tax-exempt transactions. “Now we chase that down pretty religiously,” he says, “to make sure we aren’t going to get surprised down the road.”

Mark Henricks writes about business, technology, personal finance, and other topics from Austin, Texas. His work has appeared in The Wall Street Journal, Entrepreneur magazine, The Washington Post, and other leading publications.