The IRS sent an audit letter: what happens next and how to respond

What an audit really involves

An IRS audit of a small business starts with a letter, never a phone call, and asks you to support specific items on a return, such as income, expenses or deductions. Many audits are handled entirely by mail; others are interviews at an IRS office, your business or your representative's office. You have the right to be represented, and a CPA you authorize can deal with the IRS for you. If you respond by the deadline with organized records that tie to the return, most audits end with no change or a limited adjustment.

At Malnory, McNeal & Company, IRS audit representation is part of our tax relief work. The first thing I tell an owner holding one of these letters is to read it carefully, note the deadline and resist the urge to call the IRS right away. What follows is general information about how the process works, so you know what to expect. For advice on your situation, talk to a licensed CPA or tax attorney before you respond.

First, confirm the letter is real

Scammers imitate the IRS constantly, so verify before you act. The IRS states that it notifies taxpayers of an audit by mail and does not initiate an audit by telephone. A genuine letter includes the contact information and instructions you need, references a specific tax year and form, and comes with a notice or letter number printed on it.

Be suspicious of calls, texts or emails claiming to be the IRS and demanding immediate payment, gift cards or wire transfers. If you are unsure whether a letter is genuine, do not use the phone number on a suspicious letter. Look up the IRS contact information independently on irs.gov, or hand the letter to your CPA, who can check it against your account. You can also check the status of an audit in your IRS online account.

Mail audit or interview: reading the letter

The letter tells you what kind of audit you are facing. In a mail audit, the IRS asks for documents supporting particular items, such as income, expenses or itemized deductions, and you send copies. In an interview audit, an examiner meets with you or your representative, at an IRS office or at your home, business or your representative's office. According to the IRS, if you have too many records to mail, you can request a face-to-face audit instead.

Read the scope carefully. The letter lists the tax year and the items under examination, along with a written list of the documents the IRS wants. That list defines the job. Your response should answer what was asked, completely and clearly, without wandering into years or issues the letter did not raise.

The type of business you run shapes what the examiner looks at. A cash-heavy business can expect questions about how deposits match reported income. A business with large vehicle, travel or meal deductions can expect requests for the logs and receipts behind them. A business with employees or contractors may see questions about payroll filings and worker classification, which I cover in the payroll tax mistakes that draw attention.

Your rights, including someone in your corner

Among the taxpayer rights the IRS lists is the right to representation, by yourself or by an authorized representative. In practice, that means you can sign Form 2848, which the IRS describes as the form used to authorize an individual to represent you before the IRS and to receive and inspect your confidential tax information. Once it is filed, your representative can communicate with the examiner, attend meetings and handle document requests.

As our firm's own representation page puts it, IRS auditors represent the IRS, not you, however friendly they are. Representation keeps the conversation focused on the items under examination and on the documents that support them. It also means you are not answering questions on the spot about records you have not reviewed. If you are still choosing a CPA, how to check a Texas CPA firm's license covers what to verify.

The first week after the letter arrives

What you do in the first few days sets the tone for everything that follows. The goal is to meet the deadline with a complete response, or to ask for more time before the deadline passes if you truly need it.

The most common early mistake I see is an owner calling the examiner the day the letter arrives, before reviewing the return or the records, and trying to explain everything from memory. Good intentions can create statements that later have to be corrected. A day or two spent organizing the facts with your CPA almost always leads to a shorter, calmer audit.

• Write down the response deadline and the tax year and items under examination.
• Pull a copy of the return in question and the workpapers or file used to prepare it.
• Call the CPA who prepared the return, or another CPA, before contacting the IRS.
• If you want representation, sign Form 2848 so your CPA can speak for you.
• Start gathering the documents on the IRS list, organized by item.
• Do not discard, alter or recreate records; if something is missing, tell your representative.

Building a response that ends the matter

A strong response is organized around the IRS's list. For each item, provide the supporting documents, a short schedule that ties those documents to the number on the return, and a brief explanation where the connection is not obvious. Send copies, never originals, and keep a complete copy of everything you send. The IRS recommends using a delivery method that confirms receipt.

Ask before you send everything on paper. The IRS says it accepts some electronic records, so check with the examiner about which formats are acceptable. Reports exported from accounting software, scanned receipts and bank statements downloaded as PDFs are usually easier to organize than boxes of paper, and they make it simpler to keep an exact copy of what was submitted.

This is where good books pay off. If your accounting file is reconciled and receipts are attached to transactions, pulling support for a deduction takes minutes. If not, the audit becomes a reconstruction project, and reconstructed records are harder to defend. That is one of the reasons I encourage owners who keep their own books to follow a monthly routine, described in doing your own books in QuickBooks.

• Answer exactly what was asked, item by item.
• Tie every document to the figure on the return with a simple schedule.
• Explain unusual items briefly and factually.
• Do not volunteer unrelated years or issues.
• Keep copies and proof of delivery for everything you send.

How far back the IRS looks, and how long to keep records

The IRS tells taxpayers to keep the records used to prepare a return for at least three years from the date it was filed. Its record-retention guidance lists longer periods for specific situations: 6 years if you did not report income you should have and it was more than 25% of the gross income shown on the return, 7 years for a claim for a loss from worthless securities or a bad debt deduction, and at least 4 years for employment tax records after the tax is due or paid, whichever is later. Records should be kept indefinitely if no return was filed or a fraudulent return was filed.

For a small business, the practical rule is simple: keep tax returns, the books behind them and supporting documents in an organized, retrievable form, and do not purge anything until you have confirmed the applicable period has passed. Digital copies stored securely are fine as long as they are legible and complete.

If you disagree with the result

An audit ends in one of a few ways: no change, a proposed adjustment you agree with, or a proposed adjustment you do not. If you disagree, you have options. The IRS describes the ability to request a conference with the examiner's manager, to use mediation, and to file an appeal within the IRS if the statute of limitations allows enough time, as well as the right to take disagreements to court.

Disagreement works best when it is specific. Identify exactly which adjustment you dispute, why, and what documents or law support your position. An experienced representative knows when an argument is worth pursuing and when accepting a small adjustment is the cheaper path. Either way, keep responding on time; ignoring notices narrows your options and adds penalties and interest. If an adjustment leaves a balance you cannot pay at once, raise that early too, because payment arrangements are easier to discuss before a bill turns into a collection matter.

How we handle it for clients

When a business owner brings us an IRS letter, we start by reading it with them, confirming the deadline and the scope, and comparing it with the return and the books. If the client wants us to represent them, we file the authorization, communicate with the examiner, organize and submit the documents, and keep the client informed at each step. Our firm handles correspondence and communication with auditors and pursues appeals when the facts support one. We serve owners from our Dallas office across the Dallas–Fort Worth area.

We also look ahead. An audit often reveals a recordkeeping gap or a payroll process that needs attention, and fixing it now makes the next return stronger. The goal is to close the audit with the best supportable result, and to leave the business with records that would make the next letter, if one ever comes, a routine matter.

Questions people ask me