You may think that in a midterm election year, a bill like the Inflation Reduction Act would solely help small businesses. The bill was passed into law, but one component has many small and medium-sized companies (SMBs) worried, and not about inflation. SMBs may be subject to additional tax Audits as a result of the bill's new money for the IRS, according to some.
Is it plausible that tax auditors will begin to focus more on small and medium-sized businesses? And if it turns out to be true, what steps should small businesses take to ensure they continue to follow the rules and pay their taxes on time? If they are audited, how should they respond? The following is a detailed examination of these issues, incorporating the opinions of tax specialists.
How Did the Inflation Reduction Act Affect IRS Funding?
After 10 years, the Internal Revenue Service would receive $79.6 billion thanks to the Inflation Reduction Act, which took effect on August 16, 2022. Due to frequent budget cuts over the previous decade, the IRS will benefit greatly from this windfall. There has been a lot of employee turnover at the IRS as well; 23,000 people have left the agency since 2010.
Sarah York, an enrolled agent with the IRS and accountant at Keeper Tax, says the influx of cash is very appreciated. This infusion of funds is expected to stop the agency's downward spiral of budget cuts and restore its financial footing.
The new money might be used to "revamp their phone lines, improve their computer systems, and hire new and younger employees to kind of manage the situation," as York described it. Most CPAs have been affected by the IRS's personnel crisis during the past three years, as stated by one CPA.
Why Would New IRS Funding Lead to More Smb Tax Audits?
The previous post of the IRS lends credence to the idea that increasing its budget could lead to an increase in tax audits of small and medium-sized businesses. Having lost so many skilled auditors, the agency is now understaffed and unable to do sophisticated audits. The more money an organization makes, the more difficult its audit is likely to be. Thus, a reduced IRS workforce may focus on low- and medium-sized businesses.
Eric Green, a tax attorney and partner at Green & Sklarz, stated, "You'll hear folks say [the IRS is] just auditing poor people." There is some truth to that, as such individuals are simpler to audit via mail and desk checks. However, I seriously doubt that any [IRS] commissioner has ever gathered and thought, "Let's go after poor folks."
Syracuse University's data supports the idea that people with lesser incomes are audited at a higher rate. Based on these numbers, 13% of low-income taxpayers were selected for an IRS audit in 2021. Five times as many audits were conducted on low-income taxpayers than on other taxpayers (2.6 per 1,000).
Do SMBs Really Have to Worry About More Tax Audits?
The tax professionals we questioned predicted that the average number of audits of small and medium-sized businesses will rise in the years ahead. Though these experts were asked about the probable size of this rise, they provided widely contrasting estimates. Here is a breakdown of how they feel about it that we came up with.
Opinion 1: Yes, Smbs May Need to Worry About More Audits
Tax attorney and partner at Capell Barnett Matalon & Schoenfeld LLP Yvonne Cort claims an uptick in audits of small and medium-sized businesses is already underway.
A rise in audits is something that Cort has noticed already. It's in place, correspondence has begun, and audits of individuals have begun. In order to address the "tax gap," which Cort defined as "those who have not been paying, either through not submitting [a return] or] they didn't put down the proper amount of tax owing," the IRS is conducting audits of SMB owners, he added.
CPA Keith Jones, who goes by the handle TheCPATaxProblemSolver, concurs. Jones predicted that there would be "more audits and less relief to taxpayers." He also said that "revenue-generating spots and not customer service spots" would be prioritized with the additional funds. Auditors would be responsible for bringing in the money.
Since much of the new budget is going toward the IRS's "civil enforcement" section, CPA and owner of tax relief company Choice Tax Relief Logan Allec is confident that more SMB audits will occur.
According to Allec, $45.6 billion will be used for civil enforcement. As he continued, he clarified that "auditing and collecting taxes from particular groups that the IRS feels contributes to the tax gap," which includes business owners, is part of civil enforcement.
Opinion 2: More Audits Will Occur, but Not to a Meaningful Extent
Concerns about an increase in tax audits of small and medium-sized businesses may be overblown, Green said Business News Daily, albeit a little bump could be expected.
Should I anticipate an increase in audits as a result of the [additional funding]? "It's true," Green affirmed. Do you really think they're going to have 87,000 auditors storming homes and seizing property? No. That's just not true. Current auditing rates stand at 1.3%... There will be a marginal increase in the percentage.
York concurred with Green's assessment, and he also mentioned that U.S. Secretary of the Treasury Janet Yellen had instructed the IRS to stop unfairly targeting people with incomes of $400,000 or less. York believes that the IRS's enhanced operations will lead to a modest increase in audits compared to prior years.
Small business owners "shouldn't notice that significant of a difference in the present audit rates," York added. She predicted an increase in audits as a result of the agency's increased capacity and the improved accuracy of its new computer systems: "With the influx of resources, and as [the IRS] modernizes its computer systems."
The opinions of Andrew Griffith, CPA, proprietor, are identical. What Griffith meant by saying "I think most of this speculation is unfounded and sad" was that he believed the rumors were false. In spite of this, Griffith added that he "would not be surprised" if additional audits occurred "since that is part... ensuring compliance with the tax code, and also [fixing] the IRS' own system issues."
How to Keep Your Taxes Compliant
The following is some guidance from the tax specialists we consulted on how small and medium-sized businesses can remain audit-proof in their tax practices.
1. Use the Right Software
Payroll software can be useful for businesses of any size, whether they hire other people or pay themselves from the profits. Inherent in the greatest payroll software solutions is the ability to stay in compliance with ever-evolving regulations. Additionally, many of the top accounting software platforms, which are also a vital part of maintaining compliance, are also cloud-based.
2. Keep Your Paperwork Organized and Substantiate Your Expenses
According to Green, maintaining records in order is crucial to remaining tax compliant.
"When filing your taxes, have all your records in one location," Green advised. Having all of your return's supporting documents in one convenient location lays the framework for a smooth audit.
Green added that audits of small business taxpayers typically occur years after the taxes were originally filed. He warned that audits could happen up to 18 months later, so it was wise to prepare in advance.
Cort said, "Keep solid records," adding that receipts used to claim a tax deduction must be supported by documentation. When it comes to purchases like office supplies or items that may be utilized in either a professional or personal setting, "I notice a lot of people who don't have appropriate justification," says one observer.
She also stressed the importance of a detailed spending recordkeeping system for small business owners. If you have a lunch meeting and want to deduct it as a business cost, make sure to keep track of who you met with and what was said.
The guidance was echoed by Griffith. Taxpayers need not be concerned about an audit "[if] transactions are correctly disclosed on the appropriate tax forms."
3. Separate Your Business and Personal Finances
Most small business owners have heard this before, but it bears repeating: Create a company bank account in addition to a personal one.
Never mix work money with your own, Jones warned. You should have two different bank accounts. I can't tell you how often I come across examples of small company owners (SMBs) that use their own personal bank accounts for all financial transactions, mixing business and personal costs. Doing so is a surefire way to fail.
As well, Allec offered similar guidance. According to the IRS, showing disarray is "if you send the IRS... all [your] bank statements and it's a mix of personal bank statements that you ran your business through."
He warned that doing so could complicate your audit process. This issue can be resolved by maintaining a wall between corporate and private funds.
How to Handle an Audit
Here are a few ways to lessen the blow of a corporate tax audit.
1. Go Over Your Audit Letter with a Fine-Toothed Comb
The IRS will notify you by mail if an audit of your tax returns is in the works. As soon as you can, please open this letter and read it carefully. Keep in mind that the IRS will only contact you via USPS if an audit is warranted; all other contacts could be from fraudsters. Take careful notes as you read your audit letter to be sure you have everything the IRS requests.
“Usually, you’ll get something called an information document request,” Allec added. So, "it will tell you what the IRS is investigating." Once you've read this letter carefully, Allec says to send everything to the IRS at once.
He hoped that by making the auditor's job simpler, the auditor would move on to the next file. But it doesn’t often go so nicely.
2. Hire a Professional
We found that most professionals we talked to recommended consulting a certified public accountant (CPA) for assistance during an audit. This makes perfect sense, given that tax audits naturally cause tension and worry, making it more likely that one may act rashly under pressure. On the other hand, tax experts face audits routinely and have developed a methodical approach to the process. They are welcome to attend and represent you at any audit meeting.
Green emphasized the need of hiring qualified attorneys to represent their clients. Don't think you can take care of things by yourself.
"When you get audit letters, contact somebody and obtain representation," Jones concurred.
"When you get [a notification from the IRS], that's an excellent opportunity to involve a tax professional," said York.
York, though, did concede that this would not be doable for some small business proprietors. Then she advised, "Be prepared with bank statements and remember that IRS auditors are people who genuinely want to assist you." They want to check that you're just claiming what's legal. They intend to search the premises. They'll help you out if you help them out.
3. Cooperate with Auditors While Being Careful with Their Questions
Always maintain a level of professionalism when communicating with the IRS. Any sign of negativity, such as anger, could lead the IRS to suspect that you are trying to hide something and so prolong the investigation. Even if you're feeling angry on the inside, it's best to maintain as calm and pleasant a front as possible. While maintaining composure during an audit may not feel great in the time, doing so may result in a quicker resolution.
When the IRS comes in to audit your books, you might be shocked at how sympathetic the auditors are, as York remarked. They are aware that small business owners do not use the same accounting methods as large enterprises. When approached with the mindset of "We want to work with you," they are more lenient and forgiving.
Therefore, when an auditor asks you a question, you should respond exclusively with the specific information they requested. If you say anything else, the IRS will have additional ammunition to pursue you, The insightful example, given by Green.
"I have a taxpayer who discontinued their consultancy business," Green disclosed. That they haven't made any money in two years was something the auditor picked up on. My client claimed, "I wasn't working at it." If you're not putting in any effort, the auditor will assume it's just a hobby. You will not be eligible for the reductions.
Therefore, the auditor did not accept any of the write-offs.
According to Green, a competent expert would have stated that "the taxpayer had halted operations and was in their wind-down period, conforming to regulations."
Green stated he appealed the auditor's decision to eliminate the client's deductions and was successful. This is just one scenario in which a tax expert would prove invaluable to a small business owner facing an audit.
More SMB Audits Might Be Coming, but You Can Be Prepared
An increase in audits of small and medium-sized businesses may not be disastrous for your organization. Sending the IRS the necessary paperwork with the assistance of a tax professional can often resolve an audit swiftly. It is hoped that the information presented here will prove useful in the event that the audit proceeds.
