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The IRS recently posted an Audit Techniques Guide (ATG)
to provide its agents with guidance when auditing cash
intensive businesses. The following are some excerpts
from the guide that points up the importance of
maintaining detailed records for your business,
especially one that is cash intensive. The audit guide
essentially encourages the agent to turn over every
stone in search of unreported income, and points up the
importance of proper preparation for an audit should you
be chosen for examination.
Misappropriating cash from a business - The ATG
lists three main ways that cash can be misappropriated
from a business:
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It can be skimmed from receipts, for
example, pocketed before it is recorded. If this
happens, it will not be discovered by auditing the
books.
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It can be stolen after it has been
recorded, for example, cash removed from the cash
register or goods stolen from the shelf for future
resale.
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A fraudulent disbursement can be
created, for example, a payment to a vendor that is
actually cashed by the owner’s son.
Indicators of unreported income
- The most significant indicator that income has been
underreported is a consistent pattern of losses or low
profit percentages that seem insufficient to sustain the
business or its owners. Other indicators of unreported
income include:
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A lifestyle or cost of living that
can’t be supported by the income reported.
-
A business that continues to operate
despite losses year after year, with no apparent
solution to correct the situation.
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A Cash T analysis (measuring the
taxpayers' personal expenditures against their
reported income) shows a deficit of funds.
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Bank balances, debit card balances
and liquid investments increase annually despite
reporting of low net profits or losses.
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Accumulated assets increase even
though the reported net profits are low or at a
loss.
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Debt balances decrease, remain
relatively low or don’t increase, but low profits or
losses are reported.
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A significant difference between the
taxpayer’s gross profit margin and that of their
industry.
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Unusually low annual sales for the
type of business.
Auditing cash businesses
is both a science and an art
- Tax law, accounting and the process of reporting
income are sciences. These require specific knowledge
and are concrete and tangible. These can all be
verified. The art comes from the examiner’s own
creativity in developing a method to determine that all
income is properly included. For this, the examiner must
use their individual style and flexibility to modify the
examination process as needed for each particular case.
If an examiner wants to find income, they must actively
look for income. Unlike examining expenses, which can
either be verified or not, hidden income is harder to
find and requires a proactive approach. Examination
techniques must be tailored to provide for the best
analysis of a specific taxpayer's possible income
stream.
Whenever you are audited, it is wise to be represented
by a professional who is experienced in taxes and
dealing with the IRS. Don’t attempt to handle an audit
on your own; call this office for assistance. |
