Cash businesses generally do not leave the detailed paper trail that would enable a straightforward audit of gross income, expenses, and profits. Nonetheless, businesses that operate on a cash basis develop their own methodologies to track their revenues. The IRS, however, has its own auditing standards and methodologies for cash businesses. Discrepancies between those two methodologies can lead to civil and criminal penalties if the cash business is not properly tracking and recording its income.
The tax attorneys at Rosenberg Martin & Greenberg LLP represent cash businesses in Maryland, Delaware, and throughout the mid-Atlantic states, both to establish structures that can stand up to an IRS audit and to respond to requests for information when IRS auditors come calling. The keys to surviving an IRS audit are to implement those structures properly and to retain records of all cash receipts and expenditures.
How the IRS Conducts a Tax Audit on a Cash Business
The IRS process for a tax audit on a cash business will be the same regardless of whether the business was randomly selected for an audit or it came under IRS scrutiny for potential under-reporting of income.
- The IRS first analyzes tax returns and both internal and external sources of income and expense information. It then compares that information to data from similar businesses with respect to gross margins, inventory balances, net sales, and costs of goods sold.
- If warranted, the IRS will exercise its authority to review records and information from multiple sources, including current and former employees, banks and currency depositories, loan applications, immigration records, and third-party witnesses.
- Following this preliminary analysis, the IRS will interview the business’s owners and officers. That interview gives the business an opportunity to explain its cash accounting methodology and other aspects of its financial structure.
- The IRS will also conduct Minimum Income Probes, which is where an auditor often uncovers cash flow imbalances, unexplained spending patterns, inconsistent financial histories, and mismatches between an owner’s lifestyle and spending habits and the income claimed by the business.
- As the audit continues, the IRS will apply different examination techniques to evaluate the evidence it has collected. The auditor will pay special attention to claimed net operating losses, employment taxes, and receipts and other records that do not match income and expenses.
After it has reached its own conclusions, the IRS will then determine whether the business has an outstanding tax liability and, if so, whether it will seek civil or criminal penalties.
Preparing a Cash Business for a Tax Audit
The best time for a cash business to prepare for an IRS tax audit is well before the audit even takes place. A good tax accountant can handle the basic elements of that preparation, but a tax attorney who has in-depth knowledge of the IRS’s financial status audit techniques will be better able to structure and document those elements in ways that minimize the risks that an IRS audit might present. This includes setting up receipt and document filing and retention policies that allow the business to quickly respond to IRS requests for information. A good tax attorney will also help a cash business to analyze its own income and expenditures, including the income of the business’s owners, for unusual spending patterns and imbalances between claimed income and an owner’s lifestyle.
In any case, a business owner whose business is being audited should not agree to any interview with IRS agents unless an attorney is present in that interview. IRS audits always carry some risk of criminal charges, and a business owner’s unguarded statements in an IRS interview can exacerbate that risk.
Contact the Baltimore Tax Lawyers at Rosenberg Martin Greenberg for Legal Assistance with Your Cash Business
Small businesses that operate on a cash basis are easy targets for IRS audits. The good news is that an IRS audit will not be a problem for a cash business that has set up its operations in ways that allow strong audit defenses. The tax attorneys at Baltimore’s Rosenberg Martin & Greenberg LLP represent businesses of every size in tax matters, and particularly in responding to IRS audits. Our attorneys understand the IRS audit procedures and we will use that knowledge to place your business in the best possible position to minimize or eliminate any liabilities it may face in the course of an IRS audit.
For information on our cash business tax and IRS representation services, please see our website or call us to speak with one of our cash business tax attorneys today.
- irs.gov: Cash Intensive Businesses Audit Techniques Guide. https://www.irs.gov/businesses/small-businesses-self-employed/cash-intensive-businesses-audit-techniques-guide-table-of-contents
- forbes.com: ‘Cash Only’ Small Business Targeted by IRS: The Case of Nick’s Roast Beef. https://www.forbes.com/sites/walterpavlo/2015/12/15/cash-only-small-business-targeted-by-irs-the-case-of-nicks-roast-beef/#2671075d42dc
- thebalancesmb.com: What Cash Businesses Can Do to Avoid IRS Audits. https://www.thebalancesmb.com/how-can-i-avoid-having-my-cash-business-audited-398973