Just came back from my interview IRS audit. Here's my experience:
My appointment was at 10am. When you arrive you have to call the agent to come out to get you.
I went with my business partner just so I don't go alone as I'm not sure if I might say the wrong thing and also to backup our claims on certain expenses.
I spent a good 1-2 days to prepare for this "expense" audit. What I did was look at my tax return and under your schedule C for expenses, I found all the expenses that backed up those numbers. What they really are looking for is how did you come up with the expense numbers you have on your tax return. So for example, you have advertising for $5000 for the year. Show all the expenses in the year that adds up to $5000. We use expensify.com to track our expenses, so it was easy to filter each category to output the expense numbers which is what we used in our tax return anyway. You can also do this in a spreadsheet by compiling all the transactions from your statements and just picking out those transactions that pertain to that category. Just keep in mind what you pull out from your statements should add up to $5000 advertising. They will look at this spreadhsheet and pick out a random one and cross reference it to one of your statements. Below is an example of how it might look:
You should have a page full of transactions just for each category with the total added up that matches what you have on the tax return under expenses.
My agent went through each category and asked for my spreadsheet breakdown. He would look through the page and randomly pick out ones that looked "questionable" and ask us what did you buy here at "urban outfitters" as it doesn't seem like a business expense. Keep in mind every transaction can be "questionable" depending on the agent as it's all really subjective from this encounter. After questioning us about it, we gave our argument, or some times we just said yeah we need to get the actual receipt and see what we bought. As we did not bring any receipts, but only bank and credit card statements. It wouldn't make sense to bring all the receipts because it would be thousands of papers especially if you run a business that deals with inventory.
As the agent goes through each category of transactions, he doesn't go through all of it. In our case he at most looked at less than 5 transactions per category. We had 50-100 transactions per category. Bottom line, its partially luck and really up to the agent if he wants to be extremely detailed or just let things go if he sees something off.
What really helped I believe is being able to come off as genuine about the situation and your business. Also being able to make small talk and have a talkative personality is a BIG plus. End of the day, the agents are just regular people and they can easily screw you over if they wanted to as many of their decisions are really subjective if you cannot defend your reason for an expense. Basically, get on their good side. We really lucked out as they only checked 2016 and they only penalized us for 2% of that year and then used that same percentage for 2017 and didn't even bother looking at 2017 as they assumed it would have the same issues as 2016.
After stressing over this for a good 2 weeks, it really wasn't that bad assuming you have most of your paper work in order. If you don't, its just all based on what you say and if they will believe you or not.
- If you don't have all your paperwork, and they want you to prove an expense, they give you a few days to find it. If you cannot find it, it would just be considered as income and have to pay taxes on it. Not that big of a deal...
- Some agents might not be as detailed. So they might not look at everything fully and just accept your expenses. This is just based on luck.
- We looked into someone to represent us, but it cost $5000. Most people might not need to hire anyone unless you have some very shady stuff going on and cannot explain certain expenses at all.
- After you get your bill if you owe anything, you just wait 2 months to get the actual bill in the mail and pay online. And also you might get a State tax bill on that income aswell in about 6 months.
- Hope they do not outsource IRS audits to AI bots in the future, as they would have no mercy on your audit. The fact that you are able to talk to another human, brings in the element of "human errors", "subjectivity", and empathy.
- I had a hard time finding others in the same boat that actually gave me sane advice on what I'm dealing with. Yes, sure you can read stuff online, but they all say the same thing as in bring in your expenses and make sure its all documented. But lets face it as a small business owner, you do not have everything perfectly documented, what do you do in that scenario? No one mentions that you can literally "talk" your way out of things in these audits. Others looking for advice can msg me if you want.