How do I prepare my business for an IRS audit?

_{Welcome to Ask an Accountant, a column where Ramp’s resident accountant, Penny Nichols, answers questions submitted by our SMB customers. Many thanks to Edwine Alphonse and our accounting firms for contributing to this week’s answer.}

Dear Stressed by the IRS,

First things first: deep breaths. Getting your business ready for an audit doesn’t have to be daunting. With some organization and a solid plan, you’ll get through the process without too much headache.

You’ll need to get your financial house in order. And yes, that will take some work. It means digging into your filing cabinets and clouds, making some color-coded binders, and creating well-organized digital drives. Here we go.

Understand what’s being audited

The letter you received from the IRS will tell you what the audit covers, including the time period and the documents you need to prepare.

Get ready to take a deep dive into your financial statements for the period under audit. If financial auditors have already reviewed these statements, chances are that you don’t have any material errors. Otherwise, prepare to review them with a fine comb.

Evaluate your procedures and processes

Take a look at the policies you have in place for reporting and preparing financial statements. If you’re thinking, “What policies?” then now’s the time to tighten everything up. Generally, the IRS might be on a cash basis, while your financial statements might follow U.S. GAAP and be on an accrual basis. Talk to your tax preparers or advisers to ensure you understand on what basis your tax returns were prepared.

Reconcile everything

This is essential. Everything needs to match up.

Did you tack a little December revenue onto January’s books? Have you paid for expenses personally and forgotten to reimburse yourself? Clean all of that up.

Here’s your checklist:

1. Ensure there are supporting reconciliations for all significant accounts in your balance sheets. Principally, all your bank accounts should be reconciled. You need to compile all supporting documents, such as receipts, contracts, invoices, and documents that can justify the transactions that went through the banks.
2. Reconcile all other accounts, such as prepaid fixed assets. If your company purchased equipment during the audited period or made significant leasehold improvements, ensure that you have all invoices for these purchases on file. Ensure that your useful lives and depreciation for the assets are appropriately documented. Again, make sure you have the right evidence for any accruals and liabilities. If there were accruals for bonuses and commissions, ensure that these payments were made appropriately.
3. Review the tax returns prepared for the audit period and ensure that the reported balances are supported with the reconciliations you made above. Remember, the IRS is just looking for validation that the numbers you recorded have justification. You control the information and by being prepared, you can satisfy their requests and send them away.

Finally: keep everything on track

Create a plan for your audit prep and stick to it. Key employees should be briefed on their roles—everyone needs to know their part to keep the process running smoothly.

If you have a team, set up a twice-weekly meeting with stakeholders to discuss outstanding needs, apply firm timelines, and impose accountability. You’ll be shocked at what people can do when they have a deadline.

If the IRS wants to visit your office, make sure that your team is aware (“best behavior, everyone”) and create a formal VIP area for your visitors. Pro tip: schedule recurring calls with the IRS examiners to keep them engaged. The sooner the audits can get completed, the easier it will be for you and your team.

With a little preparation and teamwork, you’ll be ready for your audit in no time.

Sincerely,

Penny Nichols

_{The advice and strategies provided in this post are offered for general informational purposes only and do not constitute professional financial, legal, or business advice.}