If you accept credit cards at your place of business, the Internal Revenue Service may have its eye on you.
According to CNNMoney, the IRS has sent letters to 20,000 small-business owners over the past year to verify that they’ve reported all of their cash earnings on their income taxes. Why? Some $140 billion in taxes go unpaid by small businesses every year, and Uncle Sam wants to collect. These letters are an attempt to do so.
Here’s the deal: Since January 2012, payment settlement entities have been required to report all credit card transactions to the IRS on Form 1099-K. These entities include credit card companies like Visa, MasterCard, and American Express, as well as online merchant processors. For example, PayPal files 1099-Ks for account holders who process more than $20,000 in goods and services sales and complete at least 200 transactions.
The IRS then compares your small business’s credit card and cash receipts with your industry’s average, based on 1099-K reporting. If it thinks your non-cash transactions make up too large a percentage of your annual revenue, the feds may send you a letter asking you to re-examine your books to make sure you didn’t omit any cash transactions. You’re given 30 days to provide an explanation in writing; failure to do so adequately could result in an audit.
Whether or not this IRS tactic is fair to businesses is up for debate. Some accountants argue that cash has become an outdated form of payment and thus the percentage of credit card transactions is rising. Others assert that the IRS is just doing its job, and if you haven’t made an error, you can simply respond to the letter saying that your tax return is correct.
So, what happens if you receive a letter from the IRS — and your written response triggers an audit? Here’s how to make sure your tax return stands up to scrutiny.
1. Keep meticulous records. The IRS doesn’t like businesses that lack a digital audit trail. For that reason, it’s not enough to keep cash-register receipts (which often show only the dollar amounts associated with a purchase) for your cash transactions. You must be able to provide specific details of each sale, so keep itemized receipts for all cash payments and customer refunds.
2. Log all of your appointments. If your workday essentially consists of service appointments — say you’re a plumber, an attorney, or a consultant — keep detailed records of each one. (It’s easy to do with a free service like Google Calendar or app like Findmyshift.) This enables you to demonstrate to the IRS that all cash payments were accounted for by comparing your sales to your appointment log.
3. Use accounting software for cash payments. Popular accounting apps like QuickBooks Online allow you to record each payment type and run customized reports that give you all the data you need to back up your numbers with the IRS. Resist the urge to record cash sales as a bulk transaction at the end of the day. Everything you enter into your accounting program should include details (see #1).
4. Enlist professional help. If you receive a letter from the IRS questioning your revenue, you may find it easy to reply with supporting evidence. Or not, in which case you may want to hire an accountant or a tax professional to help you respond. Your business is important, so don’t make this a do-it-yourself task if you’re feeling uneasy. When in doubt, hire out!