Thursday, September 10, 2009

Tax Games That Are Well Known by the IRS

This article was written by Dick Ginnaty, CPA

clip_image002Many new owners operating in “cash” businesses such as bars, restaurants, video rental, etc think that they can play tax games such as not reporting all the cash taken in.

These are not new games to the IRS. They are familiar with them and they have developed approaches to determine “sales” irrespective of the reported numbers.

In fact, over time the IRS has developed audit manuals for specific types of businesses which are actually public knowledge and can be researched on line. Their techniques for estimating sales are primarily based on analyzing supplier invoices, such as beer and wine suppliers, and then marking up the purchases with the “industry average” markups to equal estimate sales. They then compare their estimate to the reported number to determine if there is sufficient difference to continue to investigate. Many times the fact that the business is reporting little or no income and yet has been in business for five or more years will indicate a potential problem. They then may proceed to determine how the taxpayer is existing (paying mortgages, utilities, etc.) while making little or no money. Valid answers to such questions are loans, gifts, or inheritances.

In some cases, they will actually put the business under surveillance and count the customers. They have been even known to pretend to be a customer, pay in cash, and watch how the cash is handled. Was it put in the cash register? Was the sale rung up?

The point here is it is a dangerous game to play to not report significant amounts of sales. There of course will be penalties, and Congress is ratcheting up the amount of those penalties on an almost yearly basis. A penalty of 20% for underreporting is the usual starting assessment, and then interest, and late payment penalties are added, but criminal indictments can happen.

The old adage that “hogs get slaughtered” comes in to mind when warning people that their innovative technique for not reporting income is usually old hat for the IRS.

Good luck and here’s hoping it “all adds up” for you.

P.S. If there is any area in accounting or tax that you think needs to be addressed in this column please e-mail me at and if it is of general interest, I will address it in future columns.