Why IRS Audit Technique Guides Are Helpful Business Resources

As a business owner, you are in partnership with the IRS, like it or not.

You share your net profits with the IRS according to your partnership agreement (known to you as the Internal Revenue Code).

To make sure you are sharing fairly, the IRS can audit your tax return. You have to hate the idea of an IRS audit.

But your big audit worry is not about the potential bills for unpaid taxes, interest, and penalties. No, your big worry is the additional time the audit will take.

Tax audits can go on for months or even years. Time and resources spent preparing for and participating in an IRS audit are time and resources that are not available for you to run your business.

So, you should consider two things here:

1. How can you spend less time in an IRS audit?
2. How can you pay the IRS nothing extra, or at least as little as possible, in an audit?

Get ready for some insights that can help you.

When to Get Ready for the Audit

You need to get ready for the audit every day, because you are in business. The major chunk of records you need for the audit are the records that help you run your business.

The minor additional records you need to prove certain tax deductions for your vehicles, entertainment, and travel takes only minutes a day.

Planning point. Keep good records every day.

Okay, so you’ve got that. But now you’re looking at the letter from the IRS about the audit. What is the IRS going to be looking for?

Check Out the IRS Playbook

The IRS provides extensive documentation on what it wants its examiners to look for. And it makes a big chunk of that available to you in the Internal Revenue Manual and Audit Technique Guides (ATGs).

Currently, the IRS publishes ATGs for about 50 industries, ranging from the aerospace industry to the wine industry.

The ATGs on the IRS website1 are available as PDF documents, web pages, or both. The ATGs explain 

• industry-specific examination techniques;
• common and unique industry issues, business practices, and terminology; and
• how to examine income and deductions, interview the taxpayer, and evaluate evidence.

For example, say you are in the retail industry operating a liquor store or a gas station. The IRS recently updated the ATG for the retail industry, and your liquor store or gas station is addressed in this audit guide.

You as the business owner can not only learn what the IRS is going to do and why, but also find good information on practical procedures and techniques that are common to today’s liquor stores and gas stations, such as

• Business operations
• Inventory valuation
• Control procedures
• Cash on hand
• Personal expenditures

How Does the IRS Use the Retail ATG?

When the IRS conducts an in-person audit of a retailer’s business returns, it is looking to verify the accuracy of the business’s tax return and the sources of gross income.

In addition to giving the IRS examiner general interview questions common to all retail industries, the retail ATG has particular questions relating to specific segments of the retail industry, such as your liquor store or gas station.

Here’s a list of the retailers in this IRS guide:

• Grocery stores
• Electronic business and online retail
• Retail liquor sales
• Mobile food vendors
• Gasoline service stations
• Motor vehicle dealerships
• Auto body/repair
• Direct sellers

Common to all examinations, the IRS examines the retailer’s ledgers, bank statements, invoices, and receipts to see whether it reported all its income, and whether the expenses claimed are legitimate.

Thus, you can expect the IRS examiner to conduct minimum income probes during every examination. If the minimum income probes and examination of gross receipts show all taxable income from known sources is reported, the IRS may limit its examination.

For you, this means that you want clean income records—which, as a businessperson, you want anyway.

On the other hand, the IRS will undertake a more in-depth examination of income if

• the results indicate the potential for unreported income due to inaccurate reporting of taxable income from known sources;
• the books cannot be reconciled to the return; or
• a material imbalance in the financial status analysis cannot be reconciled.

If direct records are not available, the IRS will use one or more of the following indirect methods to analyze the sources of income:

• Source and application of funds method
• Bank deposits and cash expenditures method
• Markup method
• Unit and volume method
• Net worth method

Why Should I Care about IRS ATGs?

Preparing tax returns is complicated, but not because the math is difficult or the accounting procedures are complicated. There are complexities in knowing what legitimate deductions are and how they are claimed on the various tax forms.

Generally, the answers to the deductions are not found in tax statutes, or even in the case law. The ATGs help by giving you insights into various deductions and options that can apply.

For example, the inventory discussions in the retail ATG give you the variety of options that are available, and likely some you had not previously considered.

Takeaways

The IRS ATGs can help you develop financial best practices and become a better businessperson.

And of course, they also provide valuable insight as to how the IRS conducts audits.

The IRS uses ATGs to help its examiners understand the particular and peculiar aspects of an industry, a line of business, or even select tax deductions.

The retail ATG mentioned in this article contains a wealth of information on how the IRS conducts audits for

• Grocery stores
• Electronic business and online retail
• Retail liquor sales
• Mobile food vendors
• Gasoline service stations
• Motor vehicle dealerships
• Auto body/repair
• Direct sellers

If you operate a business in one of the retail sectors mentioned above, you should spend some time examining the retail ATG even if you are not yet under audit, because you will find useful information such as tax deductions and financial best practices.

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