A field audit by the Internal Revenue Service (IRS) can be unnerving. Even if you're the most confident, scrupulous controller, you cannot help feeling defensive when a branch of the federal government sets up a meeting at your place of business to scrutinize your financial records for tax compliance. And preparing for an audit can — pardon the pun — tax your already busy schedule.

Don't let a field audit alarm you. Read on to learn what to expect during a field audit and discover best practices that can help make your company's tax audit (relatively) pain free.

IRS audit letter

If you've been selected for an IRS field audit, you'll be notified through a letter from an IRS agent requesting a meeting to review your company's tax records for a particular year. This letter is an important document containing valuable information that should not be ignored. It will provide a date for the field audit, as well as explanations about your legal rights during a tax audit. The letter will include audit preparation instructions as well as a telephone number to reschedule the audit, if necessary.

The audit letter will also include a list of documents that you'll need to provide during the field audit. Some of the documents you may be asked to provide are:

• Tax returns for the prior and subsequent years of the year under audit
• Financial statements for the year under audit
• Depreciation schedules
• Payroll tax data

Creating an audit team

If you receive a field audit notification, you should immediately establish a team to prepare for the audit. In addition to collecting the requested documents for the audit, your team should review company tax records to assess tax compliance issues.

If you plan to handle the audit in-house, decide who on your audit team will serve as the primary contact person for the IRS agent. If you use an outside accountant to prepare your company's tax records, you may want to ask that person to act as the contact person for the and to also represent you during the field audit, answering questions about your business, its financial practices, and the preparation of the tax returns.

You may want to include your corporate attorney on your audit team. Your attorney will protect your interests and ensure that you provide only the information required — providing too much information might lead to a broader investigation. Your attorney would also know when it is appropriate to ask for more time to research an issue or an area of concern.

The audit notification letter might not detail the areas of your business that will be under review. You may find it helpful if your audit team researches the questions that IRS agents typically ask during a field audit. Helpful resources for this information include the IRS Audit Technique Guides, found in the business section of the IRS web site (www.irs.gov). These guides, sorted by business type, help IRS auditors with examination techniques, common and unique industry issues, business practices, and industry terminology.

Field audit

The field audit may last from one day to a week, depending on the size of your business, the industry type, and the condition and complexity of your financial records. During a typical field audit, you can expect the IRS auditor to perform the following tasks:

• Question employees   Be prepared for the auditor to question key employees about the operations of your company, including products, processes, accounting procedures, management structure, and internal controls. For example, the chief financial officer or accounting manager may be asked to explain the setup of your company's general ledger, while a production manager may be asked to describe the company's product line or production process.

  If your employees are asked questions to which they don't have answers, encourage them to ask the auditor for some time to find information. It's better to request more time than to appear as if you don't have the requested information or are concealing information.

• Review financial records   Field auditors are required to survey the preceding and subsequent years' tax returns for the year under audit, confirming whether you treated similar items consistently over the years. If they discover inconsistencies, they may choose to audit (not just survey) those other years' tax returns.

  Expect to verify any expenses that seem significant in relation to the size of your business, such as payments to independent contractors, commissions, or travel and entertainment expenses.

• Tour business facilities   A tour of your business facilities will help the auditor corroborate the information obtained during financial reviews and employee interviews. For example, the auditor may want to observe the size of your operation, labor force, and physical facilities to understand your overhead allocations. He or she may also want to inspect your finished goods or raw materials.

Closing conference

An IRS auditor might present conclusions from a field audit at a closing conference. If the auditor identifies proposed changes to your tax return, you'll be presented with a report explaining the changes and any penalties and interests that are due. The report will also include research from the Internal Revenue Code and other legal resources that support the proposed changes.

You may feel pressured to accept the auditor's findings, but you shouldn't sign anything that you either don't understand or don't think is fair or correct. It's a smart idea to request from the auditor more time to review the proposed changes with your accountant and attorney. If necessary, set up another meeting with the auditor so that your audit team can have time to research or prepare calculations about any discrepancies or questionable issues.

Don't be discouraged if you are unable to reach an agreement with the IRS auditor during a closing conference. Remember that tax law is complicated and subject to interpretation. Explain that your company may want to enforce its right to appeal the IRS decision and end the meeting amicably.

Appealing an audit decision

If you feel an appeal is necessary, work with your tax accountant or attorney to determine the best approach. If you choose to appeal, your case will likely go to the appeals division of the IRS. Unlike the IRS auditor who performed your field audit, the appeals officer will consider the time and expense it will require for the IRS to try your case in court. Because of this, about 90% of all cases referred to the appeals division are settled.

If you disagree with the decision of the appeals officer after your appeal has been decided, don't give up — you may appeal to the U.S. Tax Court. Or, as an alternative, you can pay the amount of tax due and file a suit for refund with either the U.S. District Court or the U.S. Claims Court.

Winning your audit

Follow these commonsense tips to ensure that your field audit is settled in a satisfactory manner:

• Be prepared   Make sure that your tax records are organized and complete for the field audit. More importantly, make sure that the person you designate as the primary contact person for the IRS auditor fully understands the tax compliance issues of your company.
• Keep track of all correspondence   Set up tracking systems for all audit-related communications and document requests, particularly the transfer of all original documents.
• Forge a working partnership   Establish a working relationship with the auditor from the first meeting. Define the agenda of the field audit, which part of your company's facilities will be used during the audit, and how many employees will need to participate in the audit. Develop a schedule so that the agent and your audit team understand the time frame for additional document requests.
• Treat the auditor with respect and cordiality   Even if you are angered by or frustrated with the field audit, treat the auditor as you would a respected client or business partner. Bite your tongue rather than complain or whine. If you disagree with the auditor, state your objection once — no need to raise the ire of an auditor by triggering a debate or, worse, an argument.
• Don't babble   Discuss only the sections of your tax return in question and nothing more. Providing more details than requested could lead to a broader investigation.

An IRS field audit can be time-consuming and worrisome. However, your audit will run smoothly if you create a competent audit team, approach the field audit with the same confidence and professionalism that you would devote to a meeting with an important client, and remember that you'll have the opportunity to appeal any decisions made by the auditor.