What happens if your business gets audited?

As a small business owner, keeping your finances in order should be high on the priority list. While there could be a number of worries on your mind, getting a notification that you’re going to be audited by the Internal Revenue Service (IRS) is sure to cause some level of stress. 

You may not have the resources to have a full-time bookkeeper or accountant on staff to manage your business accounting. That means you may be handling everything yourself or only use an accountant once a year.

If you think the IRS is singling you out, think again. As you start making more money, the IRS tends to look at your business a little more closely. And as your business income and assets increase, the IRS starts paying more attention to your business dealings.

Why would the IRS want to audit your business?

There are a few reasons why the IRS may want to take a look. These reasons are called audit triggers and can start the tax audit process for even the most legitimate business. Here are some practices that might trigger a small business tax audit:

Deductions for entertainment and meals

If your business is taking a tax deduction on everything, the IRS could flag some of these events or items as unnecessary, prompting them to pay you a visit. The IRS considers it a huge red flag when meals and entertainment expenses are super high.

Home office deductions

With so many people working from home now, it’s not uncommon to have home office deductions. The problems start when the business deductions for working from home are very high. You should have a designated space within your home that is solely for business. You should also be able to accurately report the square footage of the space used as a home office.

Rounding off numbers

If your tax return keeps coming up with round numbers instead of exact figures, the return may get flagged because it may seem as if you’re guessing instead of reporting real figures.

Failing to report corporate employee salaries

If you are being taxed as a C- or S-corporation, you should be receiving a reasonable salary before any non-wage distributions are made. If you’re filing Form 1120-S and don’t have an entry for officer wages, or wages that are questionably high or too low, you may be getting a call.

Year-over-year losses

The whole point of having a business is to make money. If your business continues to only lose money and does not show any gains, the IRS will start thinking you’re co-mingling funds.

Not reporting taxable income

This is a huge red flag. You must pay taxes on everything, even your accounts in other countries. If you’re neglecting to report income, the IRS will have no problems going after you.


When you’re a sole proprietor, it’s easy to co-mingle funds. The IRS wants to see the division of assets to make sure you’re not hiding money or double-dipping.

Cash-based businesses

Do you operate your business solely with cash? These types of businesses are heavily scrutinized because it is very easy to hide income when you only deal with cash.

What happens when a business gets audited?

The IRS will send correspondence in the form of an audit notice advising you of the upcoming audit. From the moment you receive the letter, it’s important to start gathering everything you need. IRS auditors dig into everything, taking note of any discrepancies or questionable items that may result in you having to pay penalties, additional taxes, and interest.

Here’s what you will need:

Bank statements

Bank statements are very telling – they indicate what money has come in and gone out and paints a true picture of the transactions that have taken place. You will need to provide business bank statements and your personal bank statements as well.


This is where a lot of business owners go wrong. Receipts are essential to keeping track of your business activities. If you haven’t started scanning them, or you can’t get an electronic copy emailed to you, now is the time to start putting this into practice (before you get audited).

Electronic records

Business credit card statements, online financial records like those from PayPal, Stripe, Zelle, and Venmo all play their own part. If these apps have been used for business purposes, the IRS wants to know.

Vehicle records

If you have made claims or deductions on your vehicle use for mileage, wear and tear, or anything else, you will need to provide a full maintenance history of your vehicle. You will be reporting when it was used, for which business purpose and the dates must coincide with what you have reported.

What happens after the audit?

There are three outcomes that can result from your small business audit:

The information is reported as being correct

This is by far the best outcome. The auditor finds that everything is accurate and in order on your tax return and you won’t face any penalties, additional taxes, or interest.

A mistake was found, and you agree with the auditor

If the auditor finds errors and you agree with them, you may be on the hook for paying additional taxes, penalties, and interest on the amount due. The error found may also be in your favor, which means the IRS will be refunding your business money.

A mistake is found, and you don’t agree

If this occurs, you can disagree with their findings and file an appeal. You have 30 days to file. If you are still not satisfied, you have every right to file suit against the IRS.

Knowing that your business is facing an IRS audit can be scary and intimidating, but it doesn’t have to be. When the IRS is conducting the audit, you should have your accountant or tax attorney present to address any issues.

Having your finances in order is smart business sense. That’s why using an all-in-one system like Homebase can keep your records in one place, making sure everything is carefully documented, taxes are paid, and you won’t have any worries.

The Homebase payroll features make things painless, with organization at the forefront for your payroll, taxes, compliance, timesheets, and more. The burden of trying to figure it out by yourself doesn’t have to be your reality anymore. From payroll to HR and more, you can have it all – in one place, with Homebase.

Need help figuring it out? Homebase Payroll puts everything at your fingertips through the desktop or an employee-accessible app. We’re ready to help. Sign up today!

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