Keep yourself out of IRS trouble
No business is more vulnerable than a cash only business. Record- keeping is often sparse. Every day, there are hundreds of transactions that can’t be traced. The lure of taking money out of the till is great. Unless the company maintains a series of checks and controls, there’s little oversight. In time, the motivation to be scrupulous fades. The IRS knows this and targets such concerns as their most frequent audit choice.
In part, that’s because the IRS recovery rate with cash-only business is extremely high. No one knows the exact statistics (the IRS keeps this information strictly confidential), but one IRS agent tells me that if you’re a cash-only business, you have three times the chance of being audited and five times the chance of owing some money to them.
The interesting thing is that the IRS has set forth very little requirements for cash-only business. There is no dictated procedure for record- keeping, no preferred system of taking in cash, no computer requirements and no designated forms to use. One reason for this slackness is that the cash-only business involves everything from mall booths to food carts. For these low-end concerns, it’s difficult to create uniform standards and to require universal compliance from these diverse concerns.
As a first step, if you are a cash- only business, realize that your audit risk is high. Check payments and charge receipts leave paper trails. Cash doesn’t. That’s why there’s a lot of suspicion. Auditors might select your company in their random audits. A few business auditors might decide to concentrate on cash- only operations and scour the pizza industry for potential candidates. A computer-checking program might be set up to select cash businesses to audit. Yet another method of triggering an audit is a disgruntled ex-employee calling the IRS and pointing the finger at your concern. So you are on their radar –– probably, one day, it will be your turn. The question is, how will you handle the investigation?
The general rule is maintain scrupulous records with backup proof. If you keep books through Quicken or another computerized system, keep backup tapes to substantiate monthly figures. You could keep monthly file folders with 30 tapes, each tape clearly dated. If you keep a ledger account book, devote a page to each day. Have the total cash sales. Scotch tape in the cash register tape. Include any backup information you need.
Another excellent form of backup is to deposit the take in your bank every day. Then the bank deposit slip is the backup, which, of course, you will save in a monthly folder along with the bank statement. If you just keep a cash box, then come up with a method of correlation. Have two employees sign a form that the revenue is accurate every day of the work year.
Back-up is the essential component. Without backup, the IRS has to take your word for the figures and they don’t like to do that. They want some tangible evidence that your figures are accurate. In an IRS audit, the burden is on you to prove your case. The IRS can simply disallow your figures and create their own figures. They will do that if they don’t have confidence in your numbers. They might investigate your business variables — sales to cost of product, sales to labor, etc –– and if the numbers don’t tally, this could be a sign that something is not correct. A lifestyle audit might be further evidence that your figures aren’t honest. If you live like a king but earn the profit of a prince, that might set off an alarm.
What you do not want to do is hand the auditor a shoebox of paperwork. Don’t make him work to assemble the data. Have everything laid out in a clear, easy-to-understand format. Total every column. Neatness counts. Make his job easy, or he or she will make it tough on you.
In one case, the IRS examined records that had no backup. The owner insisted that his figures were accurate. The IRS went back to the office and checked in their files to see that solo pizza operators typically had a 30- percent cost-of-goods sold figure. So why did this outfit have a 45 percent? That led them to investigate. An employee gave them information, which led to a full-scale audit. The pizza operator wound up owing several thousands of dollars.
In a cash business, there is always the temptation to take money out of the till. It’s easy, it’s tax-free and it’s tempting. But there are two good reasons not to do so. For one thing, it distorts the business. The numbers — cost of good sold, capital investment, labor percent — won’t gibe. In time you will make decisions based on the unwarranted withdrawals, not on the business basics. That is a time-proven formula for remaining a small business. If you took the time you spent thinking up cash pullout strategies and applied it to running a solid concern, your business would thrive. You would eventually be making more money running an above-the-board operation than in operating a personal cash cow.
The second reason you shouldn’t pull out money is the chance of being caught. Already mentioned is the high probability of audit. But, even worse, once suspected of finessing the books, you will not only face scrutiny of that year. The IRS agent, finding questionable records, can go back several years to assess underpayment. Business graveyards are filled with tombstones of people who got caught. To offer just one example, one profitable business owner decided to not file his taxes. He determined he could go under the radar. When the IRS finally caught up with him, it was eight years later. Because he could not furnish records, they constructed what his income and expense figures might have been (based on previous returns and their own liberal estimates). Result: a $135,000 assessment. Collapse, loss of house, divorce, bankruptcy and fleeing the country followed.
Don’t let that happen to you.
Howard Scott is a former business owner and longtime business writer. He has published 1,600 magazine articles and five books.