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Preparing Your Business for a Payroll Tax Audit

When you file your business taxes, you may feel a certain sense of relief just to have them done. But this relief can be short lived if the Internal Revenue Service decides to conduct a payroll tax audit later on.

By far the most common reason for a payroll tax audit is when a business classifies workers as independent contractors, but the IRS believes they may need to be hired as formal employees.

In most cases, these audits look at a three-year period. If you “lose” the audit, your business may need to pay penalties and interest, in addition to the employment taxes you did not pay when misclassifying workers. It’s worth noting that these penalties can be has high as 25 percent of the total amount of the missed tax payments.

The prospect of being audited is daunting, but there are some steps you can take to prepare your business and expedite the process as much as possible.

Basics of a payroll audit

When the IRS decides to audit a business, it may decide to go about it in three ways: through mail, in person or at an IRS office. An in-person audit, or field audit, is the most common method used for payroll tax audits and involves an extensive investigation into the business and its employment practices.

In some cases, audits are conducted on a random basis. However, if you are being audited, it’s most likely that the IRS has determined your business may have been misclassifying workers. Regardless of the reason behind the audit, an IRS agent will examine your business records and take a look at the duties of the workers in question, among other things, to establish the accuracy of your reporting. Payroll audits can about one year to complete in full.

Getting ready for a payroll audit

When you’re facing a payroll audit on your business, be sure to take the following steps:

  • Understand the audit: Audits can range in scope, so it’s important to understand the extent of an audit. IRS procedures can also be difficult to understand. Get the help of a tax professional or attorney who can help walk you through the audit process.
  • Prepare your records: As a business owner, it’s essential that you invest in an intuitive and comprehensive payroll system and accounting service to keep documents, receipts, invoices and revenue organized. The IRS may impose a penalty on your business if you do not have sufficient records, so keep your records in order and organize them by year so that they are always easily accessible. Have your records ready before the audit begins.
  • Cooperate with the audit: It may be frustrating to undergo an audit, but it’s important that you be as cooperative as possible. If the IRS requests certain pieces of information, send them promptly. Work with the agency to streamline the auditing process so that you can move forward as quickly as possible.
  • Understand your avenue for recourse: Just because the IRS issues a decision on your payroll audit does not mean that you have no recourse. You have 30 days after the decision to request an appeal if you disagree with the results.

Keep these tips in mind if you are about to face a payroll tax audit. While it’s certainly not the news any business owner wants to hear, you can move through the process quickly if you are prepared and willing to cooperate.