Proper tax planning and tax preparation may alleviate the anxiety when a small business owner opens the envelope from the IRS and sees a letter that starts out “Notification of Possible Income Underreporting”. It is no secret that the IRS believes that small business owners do not report all of their income and that $140 billion of tax dollars go uncollectible because of this underground economy. To identify taxpayers who underreport their income, Congress requires that Form 1099-K, Payment Card and Third Party Network Transactions, be filed by merchant services providers, the companies that process those credit card sales. Thus the merchant service provider is reporting to the IRS the amount of credit card sales of the business. The IRS, using industry averages of credit card sales versus cash (and check) sales, will compute the expected total sales based on the business’ credit card sales. If the total credit card sales reported by the business owner comprise an unusually high percentage of total sales, the business owner will receive the letter from the IRS as it is thinking that cash sales are not being properly reported.
In our Exton PA CPA office, we see red flags whenever industry averages are used because they do not always reflect how a particular business operates. The problem with this type of IRS inquiry is that the burden is placed on the business owner to show that all sales have been reported. How can the business owner prepare for this type of IRS inquiry? The business owner should work with its CPA to ensure that procedures are in place that reconciles sales reported on the income tax return to bank deposits to Z reports or other cash register sales reports. Once the reconciling items are identified by the CPA, the monthly reconciliation should not be difficult or time-consuming. Examples of reconciling items may include the treatment of sales tax (included by the merchant service but not a component of reportable sales), sales returns and allowances, gift cards, deposits in transit, and how many days it takes for the credit card merchant service provider to credit the sale to the business owner. While many reconciling items will reverse themselves during the tax year, the last month of the tax year is truly the most important month for identifying these timing differences.
Note: Because each business has unique factors that need to be examined when determining its tax situation, we invite you to call 610-594-2601 today to make an appointment to discuss your situation. You can also schedule a consultation at Click Here. To learn more about various tax and business services, visit Tax Preparation Services and Small Business Accounting Services
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