Is the IRS Targeting Small Businesses? What the Audit Data Shows

Is the IRS out to get small businesses? No. But if you’re a sole proprietor or you report business income on Schedule C, the published data says you have drawn more scrutiny than comparable nonbusiness filers.

Does the IRS being about 27% smaller than it was at the start of 2025 mean you can worry less? Not as much as you’d think, because audit staff fell hard, but matching notices kept coming.

Why Do So Many Small Business Owners Feel Targeted by the IRS? A Quick History Recap

The worry didn’t come from nowhere. Four moments over the last decade and a half gave owners a reason to feel watched, and in each case the rumor that went around was bigger than the fact behind it.

2013: Letters to Roughly 20,000 Small Businesses Asking About Possibly Underreported Receipts

The letters started going out in late 2012, according to the AICPA’s The Tax Adviser(thetaxadviser.com). The program compared the card payments shown on Form 1099-K, the information return a card processor files to report the payments it handled for your business, with the gross receipts you reported on your return. Owners whose cash sales looked low against their card sales were asked to explain the gap.

How many owners got one? Press reports put the number at roughly 20,000. TIGTA, the IRS’s watchdog, later counted more than 13,000 notices to individuals and more than 8,000 to businesses, covering tax years 2011 to 2013 (oversight.gov).

Those letters were notices. They asked a question and didn’t open an examination. The same program did run two audit pilots alongside the letters, one conducted by mail and one conducted at an IRS office or in the field.

2016: Testimony That Most Audits Are Not Random but Algorithm-Driven

In September 2016, the House Small Business Committee held a hearing on small businesses and the IRS. One of the outside witnesses was Donald Williamson, a tax professor at American University. He testified that “most audits are not random” and that the IRS has a “secret algorithm” for spotting unreported income (smallbusiness.house.gov).

Was he right? Partly. Most audits aren’t random, and on that point the testimony holds up. But the IRS publishes the methods it uses to select returns. One is a computer score that compares your return with similar returns, and a reviewer decides whether the high scorers get audited.

2022: Inflation Reduction Act Funding and the Fear It Would Be Aimed at Small Businesses

The Inflation Reduction Act became law in August 2022. What it did is simple to state: it gave the IRS $79.4 billion on top of its regular yearly budget, to be spent through September 30, 2031, and it marked $45.6 billion of that for enforcement (oversight.gov)(govinfo.gov). The fear was about two things: how many new auditors the money would hire, and whether they’d be handed an audit quota. The act says nothing about either. It sets no hiring number and no audit quota.

So where did “87,000 agents” come from? From a Treasury proposal that came out more than a year before the law. In May 2021, Treasury projected that the IRS would have 86,852 more full-time equivalent employees, a count of full-time positions’ worth of staff, in the tenth year of the funding (home.treasury.gov). That figure covered every job at the agency, from the people answering phones to the people writing software, and it was never a count of auditors. It was also a ten-year projection, and Treasury expected a lot of retirements over the same stretch. In a memo to the IRS Commissioner dated August 17, 2022, Treasury Secretary Janet Yellen wrote that the money had to “replace the attrition that is on the horizon from the expected retirement of at least 50,000 IRS employees over the next five years”(millerchevalier.com). The May 2021 report had already said why that mattered: as experienced employees retired, the IRS “has been unable to replace departing workers with new revenue officers and with agents of comparable training and skills.”

Congress then took most of the money back. Four laws passed between 2023 and 2026 rescinded $53.5 billion of the $79.4 billion, and $41.8 billion of that came out of enforcement. The latest was the Consolidated Appropriations Act, 2026, signed February 3, 2026. Here is what was given, what was taken back, and what was left:

(oversight.gov)(tigta.gov)

The Consolidated Appropriations Act, 2026 also set the IRS’s regular budget for fiscal 2026 at $11.2 billion, with about $5 billion of it for enforcement. That’s down from $12.3 billion and $5.4 billion in fiscal 2025, an 8% cut to the enforcement allocation (tigta.gov).

Is $11.2 billion a lot or a little? Measured with the Bureau of Labor Statistics consumer price index, it’s worth about $7.6 billion in 2010 dollars, 37.5% below the $12.15 billion Congress enacted for fiscal 2010 (irs.gov)(data.bls.gov). Put the other way, the $12.15 billion Congress enacted for fiscal 2010 would be about $17.9 billion in 2025 dollars, the latest full year of the index. That’s our own arithmetic: the index averaged 218.056 in 2010 and 321.943 in 2025. The table below uses a slightly different base, what the IRS spent each year rather than what Congress enacted, which is why its 2010 line reads $18.24 billion. The Congressional Budget Office did its own, with its own price indexes, for 2010 to 2018: IRS appropriations fell about 20% in real terms, the enforcement account fell 29%, enforcement staff fell 31%, a loss of 15,000 people, and the number of revenue agents fell 35% (cbo.gov). For the longest view, the Data Book publishes what the IRS spent against its appropriations each year, which is a different measure from what Congress appropriated. Here it is back to fiscal 2000, with each year’s total restated in 2025 dollars using the same consumer price index:

The 2000 and 2005 enforcement figures are the older Data Books’ “tax law enforcement” line, which the IRS didn’t draw on exactly the same boundaries as the enforcement account it has reported since 2010, so read that column for direction rather than to the dollar.

(irs.gov)(irs.gov)(irs.gov)(irs.gov)(irs.gov)(irs.gov)(data.bls.gov)

The 2025-dollar column is our arithmetic on the Bureau of Labor Statistics consumer price index for all urban consumers, applied to the Data Book’s current-dollar totals. Read that way, the IRS spent less in fiscal 2019 than it had in fiscal 2000, and the Inflation Reduction Act enforcement money that helped lift fiscal 2024 back to the 2010 level was gone by the end of 2025.

2022-2023: Treasury Directive and IRS Pledge

The $400,000 promise isn’t a law. In an August 2022 directive, Treasury Secretary Janet Yellen said the additional resources can’t be used to raise the share of small businesses or households under the $400,000 threshold that are audited “relative to historical levels”(tigta.gov).

The directive has three limits:

• The directive caps the share of those returns that are audited, and it doesn’t cap the number of audits.
• The directive covers only the additional resources that came from the Inflation Reduction Act.
• The directive’s baseline is tax year 2018, when the overall individual audit rate was nearly 40% below tax year 2017’s, so the pledge allowed little increase for small businesses and households under $400,000.

Treasury and the IRS never defined “small business” for the pledge. TIGTA reported in July 2025 that the directive remains in effect according to the IRS, but TIGTA couldn’t say whether the IRS had met it (tigta.gov).

What the IRS Audit Numbers Really Say

0.4% Of Individual Returns and Under 1% of Corporation Returns Are Actually Audited by the IRS

The headline figures you see quoted are nine-year totals. Each one is the share of returns filed for tax years 2015 through 2023 that the IRS had audited by September 30, 2025.

The IRS fiscal 2025 Data Book, Table 3-1, puts that share at 0.36% of individual returns and 0.57% of corporation returns. Last year’s edition said 0.40% of individual returns, for tax years 2014 through 2022 (irs.gov). The corporate figure leaves out S-Corp returns. And the figures for the most recent tax years will rise, because those returns can still be examined.

What does a single year look like? Tax year 2021 is the latest tax year whose normal three-year audit window has closed. For that one year, 0.32% of individual returns and 0.40% of corporation returns had been audited.

Was the rate always this low? No, and the comparison takes some care, because the IRS has measured audit coverage two ways over the years and the two can’t be put on one line:

• The older measure divides the audits closed in a fiscal year by the returns filed the calendar year before. On that measure, 1.1% of individual returns were audited in fiscal 2010, 0.8% in fiscal 2015, and 0.4% in fiscal 2019.
• The current measure pools several tax years and asks what share had been audited by the end of a fiscal year. On that measure, 0.60% of individual returns and 0.97% of corporation returns for tax years 2010 through 2018 had been audited by the end of fiscal 2019, against the 0.36% and 0.57% above for tax years 2015 through 2023.

(irs.gov)(irs.gov)(irs.gov)

On the older measure, the individual rate fell by more than half between fiscal 2010 and fiscal 2019. On the current one, it fell about 40% between the fiscal 2019 and fiscal 2025 editions of the Data Book.

The “under 1%” figure holds only for smaller C-Corps. For tax year 2021, corporations with $10 million or more of assets were examined at 2.3%, and corporations with $20 billion or more were examined at 35.9% (irs.gov).

Sole Proprietors, S-Corps, Partnerships and C-Corps: Who Is Audited Most

An S-Corp or partnership audit rate counts the business return only. The owner’s Form 1040 is a separate return with its own chance of being picked, and the IRS publishes no combined rate for the business and its owner together.

Sole proprietors have the opposite gap. The IRS stopped publishing Schedule C audit rates after fiscal 2019, so the most recent figure is already several years old. A single-member LLC owned by an individual and running a trade or business files on Schedule C too, unless it makes an election to be taxed as a corporation or S-Corp. Our sole proprietorship, LLC, S-Corp or C-Corp guide covers the choice.

Here is how the four structures compare:

(irs.gov)(gao.gov)

Audit Rates Are Highest at Both Ends of the Income Range: You Are Somewhat Safer in the Middle

Plot individual audit rates against income and you get a U shape. The curve sorts individual returns by total positive income, which adds up only your positive income and leaves losses out. So an owner whose business lost money is sorted by his or her other income alone.

The tax year 2021 rates for selected bands:

(irs.gov)

The lowest audit rate sits between $50,000 and $200,000, at fewer than two returns in a thousand. Earned Income Tax Credit audits are concentrated in the $1 to $25,000 band, which is part of why its rate sits above the middle. From $500,000 up, the rate climbs with every band, and above $5 million it’s more than twenty times the rate in the middle.

The highest rate at the low end belongs to returns with no total positive income at all, meaning only losses or zero. Those returns can’t claim the Earned Income Tax Credit, so that credit isn’t what drives their 1.85%. The group can include a business that lost money, and the IRS doesn’t say what drives the rate.

The IRS Is About 27% Smaller Since 2025: Good News for Small Businesses?

The IRS Workforce Fell From About 102,000 to Roughly 74,000 During 2025

The National Taxpayer Advocate reports that the IRS started 2025 with about 102,000 employees and ended it with about 74,000, a 27% drop (taxpayeradvocate.irs.gov). That cut is real. But the starting count of 102,101 came right after a fiscal 2024 hiring surge funded by the Inflation Reduction Act, so part of the drop unwound staff the IRS had only just added (tigta.gov).

Where did the cuts hit small businesses? Three places:

• The Small Business/Self-Employed division lost 38% of its staff, counting employees who don’t examine returns.
• About a third of revenue agents, the IRS’s business auditors, left between January 2025 and January 2026, before any rehires.
• The Small Business/Self-Employed division paused new audit starts from March 2025 through September 2025, its officials told TIGTA.

(taxpayeradvocate.irs.gov)(tigta.gov)(tigta.gov)

How does 74,000 compare with the IRS of earlier decades? The Data Book counts staff as average positions over the year, a full-time-equivalent measure rather than heads on a given day, so its series and the 102,101 to 74,465 head count above are two different measures, and the Data Book itself notes that its years aren’t completely comparable. On the Data Book’s measure the agency’s 1990s high came in fiscal 1992, and it shrank, with interruptions, through 2019 before it grew again:

• 116,673 average positions in fiscal 1992, the high point of the 1990s.
• 97,074 in fiscal 2000.
• 94,711 in fiscal 2010.
• 73,554 in fiscal 2019, a 37% drop from fiscal 1992.
• 90,516 in fiscal 2024, a preliminary figure, after the Inflation Reduction Act hiring, and still 22% below fiscal 1992.

Revenue agents went from 12,527 in fiscal 2000 to 13,879 in fiscal 2010 and 8,526 in fiscal 2019, while the returns the IRS received rose from 230.4 million in fiscal 2010 to 253.0 million in fiscal 2019.

(irs.gov)(irs.gov)(irs.gov)(irs.gov)

So the 2025 cuts landed on an agency that was already much smaller than it had been in the 1990s, after a decade of decline and a one-year rebuild.

Where Audits Fell and Where They Rose

For the return types small businesses file, closed audits fell between fiscal 2024 and fiscal 2025, and for large corporations they rose. Closed S-Corp audits dropped by 1,973, from 6,438 to 4,465, a 30.6% fall. Closed partnership audits dropped by 2,084, or 39.9%, and closed audits of C-Corps with under $10 million of assets by 2,356, or 36.1%. Audits of C-Corps with $10 million or more of assets went the other way, up 1,581 and nearly doubling, from 1,659 to 3,240. The table counts audits closed, by IRS fiscal year, which ends September 30:

(irs.gov)(irs.gov)

Large Corporate Audits Are Up

The rise is real for large corporations only. TIGTA counts audits started, and by that measure audits of large corporations rose 7% from fiscal 2023 to fiscal 2025. Over the same stretch, the extra tax examiners proposed when corporate audits closed fell 41%.

The table above counts closures, which is a different measure from starts. Neither measure touches small C-Corps, whose closed audits fell from 6,527 to 4,171 (tigta.gov).

Partnership Audits and High-Income Audits Are Down

Audits started, unlike the closures in the table, fell 76% for partnerships from fiscal 2023 to fiscal 2025. Most of that drop came in fiscal 2024, during a reorganization at the IRS and before the 2025 staff cuts began.

High earners saw a drop too. For individuals with incomes over $400,000, audits started fell 27% from fiscal 2024 to fiscal 2025 (tigta.gov).

Why a Smaller IRS Does Not Mean Fewer Notices

Matching notices keep going out when audit staff leave. The Automated Underreporter program is the IRS’s computer match of the W-2s and 1099s it receives against the income on individual returns. When the numbers don’t line up, the program sends a CP2000 letter. A CP2000 isn’t an audit.

How many letters does the IRS send in a year, all told? The last total we found comes from the National Taxpayer Advocate, who counted 146,970,625 notices and letters of every kind in fiscal 2019, down from 153,850,992 in fiscal 2018 and 157,681,651 in fiscal 2017. That count takes in the IRS’s CP notices and C-letters of every kind, from math-error notices and balance-due reminders to audit letters, and we found no comparable total for fiscal 2024 or 2025 (taxpayeradvocate.irs.gov). What is published comes program by program.

Did underreporter cases fall in 2025? They did, but by less than the 30% drop in individual audit starts. Closed underreporter cases dropped about 14%, from 1,151,873 in fiscal 2024 to 987,460 in fiscal 2025, and they still outnumber closed audits about two to one (irs.gov)(irs.gov).

What rose were notices to people who hadn’t filed a return at all. Those nearly doubled, from 1,679,141 in fiscal 2024 to 3,157,055 in fiscal 2025 (tigta.gov).

The IRS Is More Technologically Advanced Than It Used to Be With Automated Matching Driven by Systems Instead of Headcounts

Matching runs on systems, so a smaller workforce doesn’t switch it off. In fiscal 2025, about 1,400 staff closed those 987,460 matching cases (irs.gov).

The IRS Is Betting Audits Can Be Performed Faster, Deeper and With Fewer Auditors Than in the Past

The IRS says AI and analytics find high-risk noncompliance “with greater accuracy and efficiency than in the past,” and it now uses machine learning to pick returns for examination. TIGTA found that the IRS “cannot readily demonstrate” those models improve its exams (tigta.gov). So the claim that a smaller staff can pick better targets is the IRS’s own, and TIGTA hasn’t seen it demonstrated.

What Former IRS Officials Expect: Data Analytics, Fewer Audits and Heavier Scrutiny When You Are Selected

At a Federal Bar Association tax conference in March 2026, former IRS officials gave their read on where a downsized agency is headed. Carolyn Schenck, the IRS’s former national fraud counsel, said she expected “fewer audits, but maybe deeper audits,” as reported by Thomson Reuters’ Checkpoint (tax.thomsonreuters.com).

That’s an expectation, and the closed-audit data points somewhere less dramatic for most owners. In fiscal 2025, 81% of the audits the IRS closed were handled by mail (irs.gov). We tell clients the same thing: most audits now are audits by mail. The IRS’s own guide to them says the letter “may ask you to send in documentation to support items claimed on your tax return,” and that you send everything it asks for by the due date (irs.gov). A deeper audit is possible, and for business returns it’s already the pattern: in fiscal 2025, 95.5% of S-Corp exams and 87.6% of partnership exams closed as field exams, while 89.2% of individual exams closed by correspondence. So if the IRS picks your S-Corp or partnership return, plan on an examiner in your books, and if it picks your Form 1040, plan on a letter and a deadline (irs.gov).

Are Small Businesses Over-Represented in IRS Audits?

A group is over-represented when it draws a bigger share of audits than its share of returns. By that test, sole proprietors were over-represented in the last data published. For S-Corp and partnership owners the test is harder to run, because the business audit rate leaves out the owner’s own return and the IRS publishes no combined figure. But most of what an examiner would question, the income the business reported, the expenses it deducted, and what it paid its owner, sits on the business return. So a low business-return rate matters, even though your own Form 1040 can be picked separately.

There Are More Small Businesses Than Bigger Ones in the Country

The SBA counts 36.2 million small businesses and 21,041 large ones, using 2022 data (advocacy.sba.gov). So of course small businesses draw more audits by count: there are about 1,700 of them for every large one. But a bigger count isn’t a higher rate, and the rate is what matters to any one owner.

Does the number of small businesses drive the number of audits? No. From tax year 2011 to tax year 2017, the number of sole proprietors grew about 13%, while IRS audits of sole proprietors fell about 56% (gao.gov).

The IRS Scores Returns Against Norms for Similar Returns So Outliers Get Flagged

The IRS rates returns with a score called the Discriminant Function, or DIF, which measures a return’s potential for a tax change. The scoring happens within classes of returns grouped by income or asset size, so your return is measured against similar returns (irs.gov).

Where do the norms come from? They come from the National Research Program, which audits a random sample of returns for research. A high score sends your return to a person for review, and that person decides whether to audit it (irs.gov). The score alone doesn’t open an audit.

Cash and Self-Reported Income Are Harder to Verify Than Wages, Which Is Why Owners See More Scrutiny Than Employees

The IRS estimates how much of each kind of income goes unreported, on net. For tax years 2014 to 2016, the estimates were:

• Wages, which have information reporting and withholding: 1%.
• Income with information reporting but no withholding: 6%.
• Income with little or no information reporting, such as nonfarm sole proprietor income: 55%.

(irs.gov)

That 55% is a share of dollars, not of people, and it’s a net figure for the whole category. The IRS estimates how much income was left off returns in that category, subtracts the smaller amount that other filers overstated, and compares the result with what should have been reported. It comes to about $55 of every $100 of income in the category, which includes sole proprietor income. It doesn’t mean 55% of owners cheat.

Does that gap explain who gets audited? The IRS doesn’t say in so many words that it audits Schedule C filers because their income is harder to check. But the last Schedule C rates it published line up with the gap. Among returns with total positive income under $200,000 and no Earned Income Tax Credit claim in fiscal 2019:

• Schedule C returns were audited at 0.6% to 1.6%, depending on gross receipts.
• Returns with a Schedule E, which reports rental and pass-through income, or a Form 2106, which reports employee expenses, but no Schedule C were audited at 0.6%.
• Nonbusiness returns with none of Schedules C, E, or F or Form 2106 were audited at 0.1%.
• All individual returns that fiscal year were audited at 0.4%.

(irs.gov)

The Tax Gap Argument: Why Small-Business Underreporting Draws Attention

The tax gap is the IRS’s estimate of the tax legally owed for a year that wasn’t reported or paid voluntarily and on time. Most of it is underreporting, meaning income left off returns or deductions overstated, rather than returns never filed or bills never paid. The gross gap is the whole shortfall, and the net gap subtracts what IRS enforcement and late payments bring in afterward.

For tax year 2022, the IRS projects a gross gap of $696 billion and a net gap of $606 billion. Underreporting makes up $539 billion of the gross figure, and underreported nonfarm sole proprietor income alone accounts for $117 billion (irs.gov).

Those are projections. The tax year 2022 figures rest on behavior the IRS measured for tax years 2014 to 2016, so they show what the gap would be if owners behaved the way they did then.

Red Flags That Can Get Small-Business Returns Flagged

Seven things make a small-business return stand out. Each one has a reason it draws attention and a habit that answers it:

A CP2000 proposes a change to your tax. The IRS says a CP2000 is not a bill (irs.gov).

For payment apps, the One Big Beautiful Bill Act (OBBBA) put the old Form 1099-K test back, retroactive to 2022. A payment app or marketplace files a Form 1099-K for you only when both of these are true:

• The app or marketplace paid you more than $20,000 for goods or services in the calendar year.
• You had more than 200 transactions with it that year.

A payment app can still send you a Form 1099-K below those amounts, and your state may set a lower threshold. Card payments are reported at any amount.

The forms you send have their own rule. On 2026 payments, a business files a Form 1099-NEC for a contractor it paid $2,000 or more for services in its trade or business. Two kinds of payments are excluded:

• Payments by card or through a third-party app such as PayPal, Venmo, or Cash App, which take no 1099-NEC because the 1099-K rules cover them, even below that form’s threshold. A Zelle transfer is a bank payment, not a third-party network, so it still counts toward your 1099-NEC threshold.
• Payments to a contractor taxed as a C-Corp or S-Corp, except payments for legal services.

(irs.gov)(law.cornell.edu)(irs.gov)(irs.gov)

Repeated losses bring in the hobby loss rules. In plain words: if you keep reporting losses from something that looks more like a pastime than a business, the IRS can decide you’re not in it to make a profit, call it a hobby, and disallow the losses. The rules sit in Section 183 of the tax code, and they work this way:

• A profit in 3 of 5 years, ending with the year at issue, creates a rebuttable presumption of a profit motive, meaning the IRS has to show otherwise. For horse activities the test is 2 of 7 years.
• Form 5213 lets a new activity postpone that test, and in exchange it gives the IRS longer to assess tax.
• Failing the test sends the question to nine factors, including how you run the activity, your time and effort, and your history of income or losses, and no one factor decides it.
• Start-up losses, and losses beyond your control such as drought or theft, don’t by themselves show a hobby.

(law.cornell.edu)(law.cornell.edu)

In an audit, examiners watch for several years of minimal income and large expenses, with the losses offsetting other income (irs.gov). Why does the label matter so much? Hobby expenses have been nondeductible since 2018, and OBBBA made that permanent (law.cornell.edu).

An S-Corp owes reasonable compensation, meaning pay in line with the value of the work, to a shareholder-employee, an owner who also works for the company, when that owner performs more than minor services. There’s no formula, and the wages required never exceed what you take out of the company (irs.gov).

Watson (8th Cir. 2012) shows what happens when the number is too low. Watson was an accountant who paid himself $24,000 a year. The court valued his work at $91,044 a year and treated the difference as wages (ecf.ca8.uscourts.gov). But too high a salary also wastes the S-Corp’s benefit, and our reasonable compensation guide explains where the line sits.

Vehicle deductions live or die on records. Your vehicle records have to show:

• Business miles, the date, and the business purpose for each use, plus your total miles for the year.
• Each expense, with receipts, if you deduct actual costs instead of the standard mileage rate.

A log you keep weekly counts as timely. Estimates don’t count (irs.gov).

Reminder: Audits Aren’t the Only Way for the IRS to Contact Small Businesses

Automated Underreporter Notices and Correspondence Exams Are Far More Common Than Field Audits

In fiscal 2025, the IRS closed about twice as many underreporter cases as individual audits, and 89.2% of the individual audits it closed were done by mail (irs.gov). Across all return types, the mail share was 81%.

Business returns go the other way. An S-Corp, partnership, or C-Corp audit closed in fiscal 2025 was far more likely to be done in the field:

(irs.gov)

Payroll Tax Deposits and Filings Are a Frequent Source of Penalties for Employers

Every payroll, you withhold income tax and payroll tax from your employees’ pay. That money was never yours. You hold it for the government until you deposit it on the IRS’s schedule, and a deposit that’s late, short, or missing draws a federal tax deposit penalty. The IRS assessed 1,216,346 of those penalties in fiscal 2025 (irs.gov).

The deposit penalty is common, but the worse risk is personal. The IRS calls withheld taxes trust fund taxes, because you hold them in trust for the government, and when they go unpaid it can assess the trust fund recovery penalty. That penalty makes anyone responsible for paying the taxes over who willfully didn’t do so personally liable for the unpaid amount. The company’s payroll debt becomes your debt.

Credit and Refund Reviews: Claims That Look Aggressive Get a Second Look

The Employee Retention Credit (ERC), a pandemic-era payroll tax credit for employers who kept workers on payroll, shows what that second look is like. On September 14, 2023, the IRS stopped processing new ERC claims through at least the end of that year. On December 6, 2023, it began mailing more than 20,000 letters disallowing claims from businesses that either didn’t exist or paid no wages during the period they claimed, and it said thousands of claims had been referred for audit (irs.gov). By spring 2025, the National Taxpayer Advocate counted disallowance letters on about 84,000 ERC returns, with more than 597,000 claims still sitting in the IRS’s inventory (taxpayeradvocate.irs.gov). As of October 3, 2026, about 13,000 claims remained (irs.gov).

Research credit claims also have a new form requirement: for tax years beginning after 2025, Section G of Form 6765 is required, with some exceptions (irs.gov). Section G is the part of the form that itemizes the business components behind the credit, meaning each product, process, or piece of software the research was meant to develop or improve.

How to Lower Your Audit Risk and Be Ready If a Letter Arrives?

Five Habits That Reduce Risk

Each of these habits lowers your risk, and each one has a limit worth knowing:

• Separate accounts. The IRS recommends a separate business account. A sole proprietor isn’t required to have one, but it’s worth doing anyway, for two reasons. The books are far easier to keep when business and personal money never mix. And in an audit you’ll have to explain every deposit into the account, personal or not, which is a lot harder when the two are mixed.
• Monthly bookkeeping. The law sets no frequency, and IRS Publication 583 recommends daily records. Monthly is the least you should do.
• Reconciled 1099s. Match every 1099 you receive to your books, and send the 1099-NECs the contractor rule above requires.
• Reasonable pay. S-Corp shareholder-employees who work in the business get reasonable compensation through payroll.
• Documented deductions. If you’re ever audited, the IRS isn’t going to take your word for it. Our guide to business vs. personal deductions covers what to keep.

(irs.gov)

What to Do the Day an IRS Letter Arrives

First check that the letter is real. The IRS starts audits by mail and never by phone. You can verify a notice at 800-829-1040, the number listed on irs.gov (irs.gov).

Once you know the letter is real, take these steps:

• Read the notice type, which is the CP or letter number in the right-hand corner.
• Note the deadline, which runs from the date printed on the notice.
• Get professional help before responding, from a tax professional who represents clients before the IRS.

How long do you have? It depends on the letter:

(irs.gov)(irs.gov)

What a Correspondence, Office and Field Audit Each Involve, and How Long They Usually Take

Every audit starts with a letter. There are three types:

• Correspondence audit, conducted by mail.
• Office audit, conducted at an IRS office.
• Field audit, conducted at your home, your business, or your representative’s office.

How long does one take? The IRS doesn’t publish a typical length. The closest figure is the National Taxpayer Advocate’s average time to close an individual audit in fiscal 2025: about 228 days for returns with total positive income under $50,000, 271 days from $50,000 to $10 million, and 544 days above $10 million (taxpayeradvocate.irs.gov). Those are averages across correspondence, office, and field audits of individual returns, so they say little about how long yours will run.

The next question owners ask is how far back the IRS can go. The answer turns on the situation:

(law.cornell.edu)

The window runs the other way too. Your own window to claim a refund is also three years from filing, or two years from paying the tax if that’s later.

Should You Really Worry About an IRS Audit as a Small Business Owner? A Realistic View

Put your own numbers on it. For tax year 2021, the latest year with a closed audit window, an individual return with total positive income between $50,000 and $200,000 had a 0.15% to 0.16% chance of being audited, fewer than two returns in a thousand. Between $500,000 and $1 million the rate was 0.60%, six in a thousand, and between $1 million and $5 million it was 0.94%, about nine in a thousand. An S-Corp’s own return had a 0.13% chance in the same year, counted separately. If you file a Schedule C, the last rates the IRS published put you at 0.6% to 1.6% in fiscal 2019, for total positive income under $200,000 and no Earned Income Tax Credit, against 0.1% for a nonbusiness return.

The likelier contact is a matching letter. The IRS closed 987,460 Automated Underreporter cases in fiscal 2025, about twice its count of closed audits, and that program kept running through the staff cuts. Each contact asks something different of you:

• A CP2000 matching letter proposes a change based on a W-2 or 1099 the IRS has that you didn’t report, or reported differently. You have 30 days from the date on the notice, or 60 outside the U.S., to agree or to explain the difference with your records.
• An audit by mail, which is how 89.2% of individual audits closed in fiscal 2025, comes as a letter that, in the IRS’s words, “may ask you to send in documentation to support items claimed on your tax return,” due by the date in the letter (irs.gov).
• A field audit puts an examiner in your books in person. For business returns it’s the norm: in fiscal 2025, 95.5% of S-Corp exams and 87.6% of partnership exams closed as field exams (irs.gov).

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In each case, what the IRS wants from you is the records behind the numbers on the return.

Conclusion: The IRS Audit Risk for Small Businesses

The published rates don’t show S-Corp and partnership returns being singled out, though those rates leave out the owner’s own return. Sole proprietors drew higher rates in the last data the IRS published.

The 2025 cuts hit new audits more than they hit matching, so a matching letter is the contact you’re most likely to see, and the records you keep during the year are what answer it.

FAQ: IRS Audits and Small Businesses

Does the IRS Audit Small Businesses More Than Large Companies?

No, not by rate. In fiscal 2019, sole proprietors with total positive income under $200,000 and no Earned Income Tax Credit were audited at 0.6% to 1.6%, while corporations with $10 million or more of assets were audited at 6.2%. Small businesses get more audits by count because there are so many more of them.

What Are the Odds My Small Business Gets Audited?

For tax year 2021, 0.13% of S-Corp returns and 0.12% of partnership returns had been audited, counting only the business return. Sole proprietors with total positive income under $200,000 and no Earned Income Tax Credit were audited at 0.6% to 1.6% in fiscal 2019, the last year published.

Is the IRS Auditing Fewer Small Businesses in 2026?

Fiscal 2026 counts aren’t published yet. In fiscal 2025, closed S-Corp audits fell to 4,465 from 6,438, and exam staff kept falling into 2026, so fewer audits are likely, but that’s an inference the 2026 data hasn’t confirmed.

What Triggers an IRS Audit for a Small Business?

A return stands out when its income doesn’t match its 1099s or W-2s, when its deductions look high for similar returns, or when Schedule C losses offset other income. A mismatch produces a CP2000 letter, which is not an audit.

Are Sole Proprietors Audited More Than LLCs or S-Corps?

In the last data published, yes. Schedule C returns with total positive income under $200,000 and no Earned Income Tax Credit claim were audited at 0.6% to 1.6% in fiscal 2019, against 0.2% for S-Corp business returns. A single-member LLC owned by an individual is taxed as a sole proprietorship unless it elects S-Corp status.

What Should I Do If I Get an IRS Letter About My Business?

Check that the letter is real by calling 800-829-1040, then read the notice number and note the deadline, which runs from the date on the notice. Talk to a tax professional who represents clients before the IRS before you respond.

Want to plan the year ahead so your books and your tax return tell the same story? Reach out.