Few things cause as much anxiety as receiving an IRS audit letter. The initial reaction is often panic—even before opening the envelope. Once you've read the letter and realize that you (as a Schedule C filer) or your business has been selected for audit, that feeling of dread may intensify.
First, take a moment to breathe deeply. This simple step can help lower your heart rate and ease the overwhelming emotions. Remember, while an IRS audit may seem intimidating, it’s not worth compromising your health over.
Here are practical and empowering steps to take if your business is chosen for an audit:
Understand the Process
The IRS provides resources to guide you through the audit process, such as IRS Publication 3498: The Examination Process. It’s an easy-to-read, 8-page document designed to help you navigate this situation.
Review the Audit Notice Carefully
Read every page of your IRS audit notice to fully understand why the IRS is auditing your business. Pay close attention to any deadlines for responding to the notice, as timeliness is critical. If the audit concerns payroll taxes or officer compensation, the IRS may be assessing whether you are paying yourself a reasonable compensation as an S-Corp owner.
Contact Your Tax Professional
If a tax professional (e.g., registered tax preparer, Enrolled Agent, CPA, or tax attorney) prepared the return for the year under audit, notify them immediately. Share a complete copy of the notice—not just the first page—so they can provide accurate assistance. If the audit involves reasonable compensation, they can help determine if your salary aligns with IRS expectations.
Gather the Required Documentation
Whether you’re handling the audit yourself or working with a professional, you’ll need to collect the documents requested in the notice. Common requests include mileage logs, expense receipts, bank statements, payroll records, and other financial records. If the audit involves officer salary, using a reasonable compensation calculator can help justify your earnings to the IRS.
Submit Documentation to the IRS
Once you’ve gathered the necessary documents, submit them to the IRS as instructed. If you’re mailing or faxing the materials, include a detailed cover letter with the following information:
- Taxpayer name
- EIN or SSN
- Tax year under audit
- Notice or letter ID number (if applicable)
Await the Results
After reviewing your documentation, the IRS will notify you of the audit results. If the audit questions what is reasonable compensation for your industry, be prepared to provide supporting evidence, such as salary surveys, job duties, and business revenue comparisons.
Respond to the Results Promptly
If you agree with the findings, sign and return the paperwork promptly. If you owe additional tax, penalties, or interest, explore payment options such as an installment agreement or an Offer-In-Compromise to settle your liability.
Bonus Tip: Adhere to Deadlines
The IRS enforces strict deadlines for responding to notices. Staying organized and responding on time can significantly ease the process.
By proactively addressing the IRS’s concerns and maintaining accurate records, you can reduce the stress of an audit and ensure compliance, especially when it comes to determining reasonable compensation for business owners.
