Audit Techniques Guide Provided By the IRS

The IRS recently posted an Audit Techniques Guide (ATG) to provide its agents with guidance when auditing cash intensive businesses.  The following are some excerpts from the guide that points up the importance of maintaining detailed records for your business, especially one that is cash intensive. The audit guide essentially encourages the agent to turn over every stone in search of unreported income, and points up the importance of proper preparation for an audit should you be chosen for examination.

Misappropriating cash from a business - The ATG lists three main ways that cash can be misappropriated from a business:

• It can be skimmed from receipts, for example, pocketed before it is recorded. If this happens, it will not be discovered by auditing the books.
  
  
• It can be stolen after it has been recorded, for example, cash removed from the cash register or goods stolen from the shelf for future resale.
  
  
• A fraudulent disbursement can be created, for example, a payment to a vendor that is actually cashed by the owner’s son.

Indicators of unreported income - The most significant indicator that income has been underreported is a consistent pattern of losses or low profit percentages that seem insufficient to sustain the business or its owners. Other indicators of unreported income include:

• A lifestyle or cost of living that can’t be supported by the income reported.
  
  
• A business that continues to operate despite losses year after year, with no apparent solution to correct the situation.
  
  
• A Cash T analysis (measuring the taxpayers' personal expenditures against their reported income) shows a deficit of funds.
  
  
• Bank balances, debit card balances and liquid investments increase annually despite reporting of low net profits or losses.
  
  
• Accumulated assets increase even though the reported net profits are low or at a loss.
  
  
• Debt balances decrease, remain relatively low or don’t increase, but low profits or losses are reported.
  
  
• A significant difference between the taxpayer’s gross profit margin and that of their industry.
  
  
• Unusually low annual sales for the type of business.

Auditing cash businesses is both a science and an art - Tax law, accounting and the process of reporting income are sciences. These require specific knowledge and are concrete and tangible. These can all be verified. The art comes from the examiner’s own creativity in developing a method to determine that all income is properly included. For this, the examiner must use their individual style and flexibility to modify the examination process as needed for each particular case.

If an examiner wants to find income, they must actively look for income. Unlike examining expenses, which can either be verified or not, hidden income is harder to find and requires a proactive approach. Examination techniques must be tailored to provide for the best analysis of a specific taxpayer's possible income stream.

Whenever you are audited, it is wise to be represented by a professional who is experienced in taxes and dealing with the IRS.  Don’t attempt to handle an audit on your own; call this office for assistance. 

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