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IRS Requesting Small Business Databases (i.e. QuickBooks & Peachtree)

Do you own a small business using QuickBooks or Peachtree as your accounting software?  Most likely you have stored critical unrelated financial information within the framework of the software.  By unrelated financial information we are referring to customer/client lists, personnel data, confidential client information, and other information used for business purposes.

Jump forward a few months from now and imagine receiving a letter from the IRS giving your business an examination notice (meaning you’re under audit).  How concerned would you be, or your clients for that matter, if the IRS requested your software database containing all this unrelated financial data?  Unfortunately this request is occurring more frequently and is being explained as the IRS’ attempt to modernize.  The IRS has purchased copies of various small-business accounting software to accomplish this task.  Requesting the electronic files is now standard operating procedure.

In recent years the IRS has ramped up efforts to more aggressively collect taxes from small businesses.  Statistics show that small businesses are one of the largest contributors to the “tax gap” (taxes owed but not paid or reported).  What better way to close the gap than to increase audits on small businesses where non-compliance is an issue?  Let’s face it…large corporations have their own accounting armada to keep everything straight with laws, regulations, and the taxes they pay.  Small businesses don’t have that luxury.

The main concern we have in providing IRS access to an accounting database is whether the auditor will stay within the scope of the requested information.  Do you want to IRS potentially contacting one of your clients?  Seeing what they purchase from you? Seeing what you purchase from vendors?  The fact that you are being audited is not something to brag about, but client relationships could be affected if some of their private information is handed over.  How would you feel if your personal information was handed over to IRS?  What would you do if you found out?  Another concern would be your reputation if  word got out that your business was under audit.  Questions could arise regarding the circumstances of the audit (randomly selected as opposed to improper filing). 

If a company turns over complete electronic records, there is no way of knowing what the IRS will do with that information.  The IRS has not addressed this issue except to say “privacy of return information” is of utmost importance to the agency.  Virtually all professional organizations in our industry are vehemently opposing this policy.

In subsequent posts we will discuss ways to approach this dilemma if you are audited and IRS requests your data base.

Schedule C “Hot Buttons” for Sole Proprietors. Part II: Automobile Expenses and Contract Labor

In Part I of the Schedule C “Hot Buttons” we touched on Gross Receipts and Cost of Goods Sold (COGS), as well as an explanation of why the IRS salivates over Schedule C audit opportunities.  Remember, once the IRS begins an examination of your tax return, expect them to dig deep.  All those personal expenses you’ve been running through as a Schedule C deduction will likely be found and subsequently removed, causing a chain reaction of increasing taxes and penalties you owe.

Part II of the “Hot Buttons” has 2 points of emphasis:  Automobile Expenses and Contract Labor.

1)      Automobile Expenses – You can deduct the actual expenses of running your automobile or take the standard deduction rate for business miles driven (whichever is higher).  Most important is to keep a log of the business miles driven, as well as an odometer reading on January 1st and December 31st of each year.  This will help determine the business use of the vehicle.  (WARNING to California Residents:  the Franchise Tax Board typically finds a noncompliance rate of 80% each year, so they scrutinize automobile expenses extensively).  Keep good records or risk losing the deduction all together.  No proof, no deduction.

a)      Actual expenses can include depreciation, registration fees, gas, insurance, repairs/maintenance, lease payments, personal property taxes, and parking fees.  If business use of the vehicle is less than 100 percent, expenses must be allocated between business and personal use.

b)      The standard mileage for 2010 is 50 cents per mile.  This can only be applied to business miles.

2)      Contract Labor – This area can cause headaches for those attempting to avoid payroll taxes, worker’s compensation insurance, etc.  If it is determined by an IRS auditor that the hired help is actually considered an employee, be expected to pay unpaid payroll taxes and penalties.

a)      If you are unclear on whether the worker(s) you hire are considered employees or non-employees, fill out Form SS-8 and send in for a final determination.  When in doubt, consider the worker as an employee until it is determined otherwise.  Contact your accountant if you have any questions about filing payroll taxes and any other employee or payroll related forms.  Also take a look at our previous blog on making the determination.

Most of you will not read this on December 31st and say ,”I better get a log book placed in the glove compartment of my business vehicle in the morning!”  But what about for 2010?  The answer is that it’s best to start now and estimate what the first part of the year was like, and do it sooner rather than later so that the likelihood to reasonably estimate what occurred will be as accurate as possible (especially for those of you who like to extend to October 15th to file your personal tax return).

Up next for the Schedule C “Hot Buttons”, Part III – Depreciation, Other Expenses and the Home Office Deduction.

Schedule C “Hot Buttons” for Sole Proprietors

Part 1:  Gross Receipts and Cost of Goods Sold

Ever wonder what makes the “tax man” tick?  Unfortunately for you sole proprietors out there, you’re a high profile target for an IRS inquiry or examination.  The IRS has concluded that the most frequent contributors to noncompliance and false reporting are the small business taxpayers.  Based on what IRS examiners have found, roughly 60% of sole proprietors underreport their net business income.

So how is it possible to avoid getting a lovely examination letter in the mail from the IRS?  In short, you can’t.  However, you can limit your exposure by accurately and consistently reporting your business activities.  The main purpose for accuracy is not only honesty, but in the event of an IRS examination you will have nothing to be concerned about.

The first 2 points of emphasis are Gross Receipts and Cost of Goods Sold.

1)      Gross Receipts – What are considered gross receipts?  If there is any connection between any income received and a business, it’s considered business income and must be reported.  A Form 1099-Misc will usually be sent to the sole proprietor if amounts received were for $600 or more for services performed.  A copy is also sent to the IRS, so if your gross receipts on the Schedule C are less than the total from reported 1099’s…you may have just red flagged yourself.

a)      A good rule of thumb for those who don’t keep accurate records would be to go through the business’ bank statements for the year and add up all deposits.  Those deposits should be close to what is reported as gross receipts on the schedule C.  (WARNING:  separate your personal and business bank accounts.  You don’t want deposits to your personal account to be considered business income.)

2)      Cost of Goods Sold (COGS) – The simple formula for COGS is (beginning inventory + purchases + related labor costs + related materials and supplies – ending inventory).  Unless the sole proprietor is a manufacturer or involved in mining operations, the only parts of this calculation that will be used are inventory and purchases.

a)      Are you a sole proprietor with average annual gross receipts of $1 million dollars or more?  You may need to report on the accrual basis of accounting.  Contact your tax preparer for more information regarding proper accounting methods.

At the end of it all, your Gross Receipts minus your COGS will give you Gross Profit.  If everything is being reported accurately and consistently, the percentage of Gross Profit over Gross Receipts (gross profit percentage) should be relatively consistent from year to year.

Up next for the Schedule C “Hot Buttons”, Part II – Automobile Expenses and Contract Labor.

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