No business owner likes to receive an IRS notice that they’re being audited. What resources are available to you to handle an IRS audit? Do you need to keep receipts in order to complete an audit? How long should you keep records in case you are audited?
Normally, when a business owner receives an IRS notice, panic can set in. The packet from the IRS can be very thick, with many pages and confusing information. If you choose to handle it yourself, you’ll want to read the information carefully and then determine your strategy to respond to the notice. The IRS does publish the rules their agents should follow during an audit. It’s called the Internal Revenue Manual. If you’re facing an audit and you want to handle it yourself, you’ll want to reference this material. The IRS also uses Audit Technique Guides (ATGs) found here. The information contained here is specific to the industry of the business. It’s a guide for revenue agents assigned to an audit, and it’s useful for the business owner when trying to prepare for an audit.
Should you keep receipts to help you defend an IRS audit? The answer is yes, however those receipts can be electronic. Forget the shoebox. In the digital age, most receipts are stored on your bank or credit card statements, and banks and credit card companies are doing a better job organizing those expenses into categories for the business owner. Some credit card companies will organize all of your yearly expenses into a year-end summary that you can use to prepare your tax return. If you’re unsure about the receipts you would need, the IRS has an entire website dedicated to the types of receipts and records you should have in case you are audited.
If your business is primarily cash based and you don’t have receipts, the IRS agent will need to do a little more work to determine if all of your income is reported correctly. According to the ATG on Cash Intensive Businesses, specifically chapter 5, page 14 of 15, the IRS will rely heavily on the pre-audit interview with the taxpayer: what the agent can observe from you, a tour of your business, the prices you charge for your services, the inventory and assets on the business premises, and commonalities in your industry will all be considered. The agent is allowed to use reasonableness tests to determine what should have been reported on your tax return and make their determination of under reported sales or over reported expenses.
In short, not having records and receipts can be costly. The less information you have, the more assumptions the IRS agent will need to make. The IRS agent’s job is to expand the audit and capture as much revenue as possible for the government. An initial audit of one particular year can expand into an audit of the last three years, because that’s the time frame that your business is open to IRS inspection. Generally, you should keep receipts for three years. Most banks and credit card companies allow you to access information back at least that far. If the IRS thinks that you have committed fraud, they can request information back as far as six years.
Finally, consider what you want your story to be if you are audited. Would you like to tell a nice, concise story to the IRS that allows them to leave you alone as quickly as possible, or do you want to run the risk of having an agent that wants to keep the audit open or even expand it? This could take time away from your business and end up costing you more money in the long run. Keeping receipts will afford you the opportunity to tell that story to the IRS.