Chapter 9. Audits in a Nutshell

Audits can happen to anyone. It doesn’t mean that you did something wrong. Let’s talk about audits and how to prepare for them.

What an IRS audit is

An IRS audit is a review/examination of an organization's or individual's accounts and financial information to ensure information is reported correctly according to the tax laws, and to verify the reported amount of tax is correct. The IRS will investigate or examine your business and tax returns and determine whether there are any adjustments or amendments that need to be made.

Why would IRS choose your company

Selection for an audit does not always suggest there’s a problem. The IRS uses several different methods including random selection and computer screening and related examinations (other taxpayer issues).

When an auditor reviews your company's tax return, they may accept it or if the auditor notes something questionable, they will identify the items noted and forward the return for assignment to an examining group. 

What do you need to provide

The IRS will provide you with a written request for the specific documents they want to see. The IRS accepts some electronic records that are produced by tax software. The IRS may request those or other types of records. The law requires you to keep all records used to prepare tax returns for at least three years from the date the tax return was filed. 

How long will an audit take and how much will it cost

The length and cost are connected and depend on the type of audit, the complexity of issues, availability of requested info, the availability of both parties for scheduling meetings, and your agreement or disagreement with the findings. 

How does the IRS conclude an audit 

An audit can be concluded in three ways:

  1. No change - an audit in which you have substantiated all of the items being reviewed and results in no changes.

  2. Agreed - an audit where the IRS proposed changes and you understand and agree with the changes.

  3. Disagreed - an audit where the IRS has proposed changes and you understand but disagree with the changes. 

What you can do if you disagree with the conclusion

You can request a conference with an IRS manager. The IRS also offers mediation or you can file an appeal if there is enough time remaining on the statute of limitations.

What an external accounting audit is (vs. internal audit )

An external audit is the complete review of an organization’s accounting records and the physical review of its assets—all done by an external group. If a certified public accountant (CPA) performs the audit, the CPA can give an opinion on the fairness of the entity's financial statements. An IRS audit is an external accounting audit. Before raising funds, startups often do an internal audit to ensure accuracy of the accounting bookkeeping.

The key difference between external and internal audits is that external audits are done by a third-party group who does not directly work for the organization. They are independent of the organization they are auditing so it ensures an unbiased, objective opinion of the accounting records.

A CPA’s 2 Cents

Although it’s not required initially for a startup, audited statements may be required at some point for a potential investor. Audits are more costly, take longer and are move evasive. However, some external parties (like banks) will only deal with companies that have audited statements to prove their viability.

Next Section:
10. Exit Strategies