Recently my single-member LLC was audited by the IRS. I met all the known triggers in the filling year in question, the most obvious being that I filed an amendment after noticing a major mistake in my initial filing (double-counted some income). Luckily I showed up to my audit prepared and was able to completely prove all of the items in question. According to my tax book the IRS normally wins 80% of their audits. And according to my auditor I was only the 3rd audit she had done in 2 years that passed. I couldn’t have done it without the tips below.
Tip #1 – Become Confident
This is absolutely the most important step. You must take the steps, prior to the audit, to become confident that a) you submitted your taxes properly and b) that you’re prepared to prove this. I can say that this was the single-most important factor to the audit going smoothly. I knew that I had filed my (amended) taxes properly and I knew that I had the proof. I had absolutely no doubt going in. Take the steps to be confident. This will mean following the steps below. Don’t overlook the importance of being confident in the validity of your filing. For me this step included reading the “Audits” section of the “Tax Savvy for Small Business” book I had laying around. This book was a lifesaver.
Tip #2 – Print Receipts
For my audit specific areas were being audited. These were the business expenses of “Advertising” and “Other expenses”. Lucky for me I use Quickbooks and also do my taxes 100% off of my QB data (tax report). This made it very easy to print off all of the transactions in question and start digging up receipts/invoices. Luckily most of the website services I pay on a monthly basis allowed me to sign in and print old (2010) invoices. Print every single invoice you can find for the tax year in question.
Tip #3 – Print Bank Statements
Sign in to your bank’s website and print every month’s statement for the tax year in question. Do not remove any pages, bring the summary pages, ledger pages, etc. Just bring it all.
Tip #4 – Print Your Books
Assuming you use a program like Quickbooks, print off a report covering your expenses or income in question. Although the auditor dismissed the report a few times as not being a validated report, I feel that it helped to add to the overall image of “I’m prepared” and “I’m not hiding anything.”
Tip #5 – Highlight Everything
It absolutely shocked and amazed my auditor that I had highlighted both the receipts and the bank statements. I highlighted the “total” and “date” on every invoice as well as each bank statement line item that made up the “Advertising” and “Other expenses” sections of my deductions. My auditor made statements like, “This is my favorite audit, ever!” before we had even started. Not only did I make her job easier, I made it obvious that I was hiding absolutely nothing.
Tip #6 – Handling Missing Data
I was surprised to learn, when researching how to handle the audit, that I didn’t have to have every single receipt/invoice I had claimed a deduction for. You will be expected to prove a majority of the deductions but the law allows for some instances of losing invoices, etc. You’re going to want to come as close to proving each deduction as possible, though. Some deductions can be validated without the actual receipts. Here are a few examples from my audit. Although I did not have receipts for an email newsletter ad I purchased with Entrepreneur magazine I still had the emails where they quoted me the price of the ad. Match this to the bank statement where I paid that exact amount and you have your proof. In the tax year in question I spent a considerable amount on Google Ads. I also spend a much smaller amount on Yahoo ads. Unfortunately, since Yahoo ads have shut down, I couldn’t sign in and print those invoices. But, explaining that I spent X on Google ads and Yahoo was the next biggest competitor I argued that it was reasonable that I would have spent 1/10th X on Yahoo ads. This was enough of an explanation to get the Yahoo deductions approved.
Don’t go into an audit with a chip on your shoulder. A computer chose you based on some valid triggers and now the auditor has to do their job. Each audit goes through a review and approval process, so each auditor is under pressure to not make mistakes. They aren’t out to “get” you, they just don’t want to fail in their own job performance. When my auditor began filing the paperwork to “fully allow” all of my expenses she physically felt ill and was extremely nervous. It was so rare that she was just afraid that she was missing something. It was only after consulting with peer auditors that she was able to confidently submit her report. Print everything, highlight everything, and take the steps to know that you’re right. If you’re not right, well, expect to pay the missing taxes as well as a penalty.