When your income goes up…

By Jim Edwards

When your income goes up…your taxes don’t necessarily need to follow suite

I was involved in a pretty toxic IRS audit of the tax return of one of my clients (a plumber who was operating his business as a Sole Proprietorship) a while back.The auditor seemed pretty intent on not allowing his business deductions as business expenses because, although his income had been steadily going up, his expenses had been also.This had been happening largely because of extensive further education AND more extensive and aggressive marketing.And, he had been operating in the red for more than three years.

After several hours in this audit, where each of the “validations” of expense were produced and then systematically challenged for necessity, I politely asked the auditor if she had ever been in the plumbing business.When she replied in the negative, I said, “Well, you know, neither have I.But this man has been in it for nearly seven years, and he worked alongside his father in it for over 10 years before that.Can’t we give him the benefit of the doubt of these things that don’t make all that much sense to us?”

After a short consideration of the question by the auditor, and a couple of finger-taps on her desk, she said, “Good point!”Within a few minutes the audit was over.The result was “no change”.

About two years later this same client was audited again.His gross revenue is now up above the two-million mark.And he is still operating as a Sole Proprietor.This time it’s one of their dreaded “office audits”.

This is where they basically come in and nest with you, right where you live.They’ll stay anywhere from a few hours, to a few days.It can be quite un-nerving and business disrupting, to say the least.For my client, however, it was business as usual while this thing played itself out

This field auditor was VERY thorough!The plumber had over 150 items of depreciable assets.The auditor studied the purchase records and the depreciation worksheets on each of these assets with the diligence of an NSA Cold War Code Breaker!

He changed nothing.

Amazingly though, he managed to find a flaw.This was VERY important to my client as well as the auditor, however.Seems that one of the office personnel who worked in the Accounts Payable arena was NOT thoroughly checked out on how to correctly record Credit Card charges, and THEN correctly record their payments, in my client’s computerized accounting system!

Generally, when the Credit Card charge is recorded, the EXPENSE related to the charge is recorded at the same time.But, when subsequent payment is correctly made on the charge you just reduce the Credit Card balance and don’t touch the expense again.Well, the Accounts Payable lady had this a little inside-out!

When she made the payments, she ALSO “added” to the expense, again!And…as a result of this error…not only was the expense being overstated, BUT the balance on the Credit Cards was increasing instead of decreasing!Of course, these overstatements had an impact on the Income Statement and the Balance Sheet!Overstatements on expenses lower Net Income, which lowers New Worth.And overstatements on Credit Card balances additionally lower Net Worth! Two pretty important issues to business owners and their families, their bankers, as well as the IRS!

BOTTOM LINE: This “cost” my client just over eleven-hundred dollars in taxes. (Which by the way was ALL he paid in taxes that year, on over $2 Million of Gross Revenue!) But it SAVED HIM multiple times that in all-else he stood to lose by NOT having this little discrepancy isolated and corrected quite quickly.

Three lessons to be learned; four key secrets to successfully finding Peace of Mind in your business THIS SUMMER

Lesson One: Of course!My client SHOULD HAVE been watching his books more closely!He had correctly chosen to “trust” his staff.However, his “trust” caused him to take his eye off the business barometer. NEVER do that!Of ALL the potential places to let your guard down in your business, this AIN’T NEVER the place to do it!

Lesson Two: His system was performing EXACTLY as it should perform!The only way it could have been “better” would have been if it were intuitive enough and smart enough to actually YELL at the operator and say, “Hey…Sunshine…you don’t enter this stuff like this. If you keep this up…Here’s how you’re suppose to do it…”The error was made in the system, but the system REVEALED the error when it (the system!) was audited.

Lesson Three:(And this one kind of makes my own skin crawl!) IRS audits are NOT all necessarily “bad”!This auditor spent three days in my client’s office, rifling his files.He discovered an error that would have, ultimately, eventuated in great embarrassment, loss of credibility with Vendors, Customers, Creditors, his Banker, AND his Staff.He COULD HAVE suffered great financial loss too if this audit had happened FIVE YEARs later and this “mistake” had continued to go undetected!Moreover, the auditor did NOT “charge a fee” for this audit.If one of the (formerly!) “Big Six” accounting firms would have spent three days doing what this auditor did it would have cost my client a Lot More than “eleven hundred dollars”!

The REAL SECRETS to WHY all this worked out:

Secret One: The System; you gotta have good one…that does what it needs to do according to YOUR standards.What is a “good records system”?I define it as one that holds the information you need AND provides easy and immediate access TO that information when/if you need it.

Secret Two: When you have such a system you don’t sweat things like “IRS audits”. Maybe I am just a wimp, but I’ve discovered that, for me, it’s real difficult to think and sweat at the same time!When you are confident that your records system contains ALL the information you need to validate ALL you might NEED to validate as regards your business’ activities, your mind is at ease on the subject.A mind at ease can write, plan, and oversee execution related to the tasks required to make revenue happen IN that business.

Secret Three: The ONE PERSON who is really…actually…finally…where the buck starts AND stops in your business is YOU!Own this fact.Don’t molly-coddle it; don’t think for a micro second that ANYONE ELSE can or will or even has the ABILITY TO do this in the way it MUST be ‘done’!The REAL FUN in being in business is doing what YOU DO to cause massive revenue to happen because of the way you execute your business.Fun and worry go together like milk and gasoline.They make for a very toxic toddy!

Secret Four: Having good records (easily, immediately accessible financial and logistical business information!) is MORE important than having WRONG STUFF in your system!This is because INTENT is the key ingredient in defending yourself against purposeful wrongdoing, in case you are ever accused of such a thing.Where most audits of business records by governmental or banking officials can cause a firestorm of mental anguish, (Just the THOUGHT of them, generally does!!) the real reason for such a thing is that you are NOT confident of your system!For my plumber-client, this “firestorm” was an imperceptible dimly-lit candle! He knew that, even if errors were ‘found’ that they were NOT intentional in nature.Moreover, he ALSO knew, because of what I had taught him about my experience working with government auditors, that penalties and even interest are OFTEN waived when errors ARE isolated when the error was simply an oversight or a “typo”!

Never in the short history of Free Enterprise has it had to exist in an environment such as the one is NOW HAS to exist in!We have to tolerate MORE of our government’s intrusion into our businesses than EVER before.We can EXPECT it to get a whole lot MORE “intrusive” before it’s all over.We can rebel against this and go sour…OR…we can simply acquiesce to the fact that that’s “just how it is”.And then flex to it.We STILL HAVE Free Enterprise; we STILL HAVE the opportunity to actualize our dreams; we STILL HAVE more freedom to “make money” than ANY OTHER SOCIETY on the planet!AND…we STILL HAVE the freedom to choose our own destiny, and then execute on the choice.

Are you?

Will you?

About the author

Jim Edwards has been a Tax Practitioner since 1974.He has personally prepared over 10,000 income tax returns during this time.He does not operate on “theory” and “postulation”. Simply put, the IRS is NOT a “mother may I” operation.The misunderstood reality is that the tax code is FULL of opportunities to preserve business cash.Make CERTAIN that you align yourself with someone who understands these things and who is not ‘timid’ about putting them to use!Any other choice puts your legacy in jeopardy!His focus has always been within the small business arena.His experience is not academic in nature, but comes from operating in the trenches in support of Free Enterprise.Having spent 20 years in the US Navy, and (now) over 30 years helping other people understand what he has learned of our income tax system, he has lived his life in defense of, and in the perpetuation of our Free Enterprise way of life.Jim and his wife and two teenage sons now live on a small farm in rural Iowa.

For his free report entitled, What my 30 Years in the Trenches as a Tax Guy has Taught me About the Mechanics of Keeping Good Records please go to….

Contact Jim at the1040co@netins.net.Or, visit his (under construction!) website at www.the1040company.net.