Cash based businesses, like salons, are often targeted for random audits. The audit rate is roughly 1 in 100, but we’re in a unique position that puts us at special risk. In this article, you’ll learn how to avoid drawing any negative attention and how to ensure your books will be solid if you happen to be one of the unlucky few whose returns get flagged.
Don’t deduct questionable expenses.
A typical deduction is a recurring business expense, like your online booking service or your salon’s rent. Daily commuting to and from your work is not a legitimate deduction.
The general rule is that anything you have to spend money on to make money on is deductible.
For our industry, a trip to a trade show is understandable. An extravagant European cruise is not. Big deductions for meals, travel, and entertainment are inviting audit. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, the place, the people attending, the business purpose and the nature of the meeting. Without that documentation, you get no deduction.
If you can’t verify your deduction, don’t claim it.
Snap your receipts and save them on Dropbox (or whatever cloud-based storage system you prefer). Keep the originals in labeled monthly envelopes.
If you’re ever audited, you can correspond your deduction with the original receipt. Some places give really crappy receipts, so if you need to notate what the expenses were, do so on the back of the slip.
File your taxes online.
Sometimes, mistakes happen when IRS representatives manually enter your handwritten return information into the system. Numbers get omitted or added. This mistake (that is entirely out of your control) can result in an audit. Eliminate the middle man entirely and e-file.
According to the IRS, the error rate for a paper return is 21%. The error rate for electronically filed returns is 0.5%.
Eliminate cash from your business.
The IRS knows that those who receive primarily cash are less likely to accurately report all of their taxable income. So, eliminate cash from your business.
I don’t like cash. I don’t like that it’s impossible to track. I hated counting it every night. I hated filling out deposit slips every night. I hated depositing it every evening. When I’m done working and cleaning up, I just want to walk out of the building. (In addition, I often worked alone in the building and both my husband and the doctor I worked with worried about me getting robbed.)
I made the decision to quit accepting cash entirely. None of my clients routinely paid with cash anyways so this policy didn’t generate any complaints at all.
I implemented a new policy and only took traceable forms of payment. This included checks, gift certificates through SpaWeek, credit cards, and instant transfers from Paypal. Not only did this policy make me less likely to be audited (and robbed), it simplified my accounting, saved me daily trips to the bank, and gave me peace of mind.
I opened an account with Simple (an entirely online bank without branches that doesn’t take cash deposits unless they’re turned into money orders and submitted as checks) and never exchanged physical currency again. Checks were instantly photo deposited and destroyed once they cleared.
I think as a modern society, we’re all moving towards digital currency. For me, this was one of the best decisions I could have made for myself and my business, but it does have a downside.
Payment settlement entities have been required since 2012 to report all credit card transactions to the IRS on Form 1099-K.
This includes Visa, MasterCard, and American Express, as well as online merchant processors. The IRS compares your credit card and cash receipts with your industry average. The IRS may send you a letter asking you to re-examine your books to make sure you didn’t omit any cash transactions if they feel your non-cash transactions make up too large a percentage of your annual revenue.
To protect yourself from this, make sure your refusal to accept cash is clearly stated on your website, your brochures, and posted in your business. Keep your appointment records and your daily sales records. It shouldn’t be difficult at all to compare each appointment from the book with the corresponding payment record, especially now that many merchant service companies provide and store digital signatures and digital receipts.
Hire an expert.
Managing your own business finances puts you at risk. Turn that responsibility over to a professional. It’s a small annual investment that can pay off big. If you’re going to be itemizing (which you most likely will), a tax professional can help keep you organized and maximize your deductions and credits.
Focus on making the money. Let someone else handle the paperwork.
Cross your T’s and dot your I’s.
Make sure your social security number is correct. Don’t round your numbers. Triple-check every figure. Leave nothing blank. For the love of God, this is
2014 2020. If you aren’t using software, get out of the stone age and start doing so now.
Incorporate or register an LLC if you’re self-employed.
Small businesses are a favorite target of the IRS…and for good reason. Self-employed people are most likely to underreport income and overstate deductions. The IRS doesn’t care whether your business is high-grossing or not. If you are self-employed (booth renters, I’m looking at you), consider incorporating or forming a limited liability company (LLC). Corporations and LLCs are audited less frequently than other small businesses. Incorporating or forming an LLC also allows for more deductions. You can learn more about the different types of business structures and the pros and cons of each here.
Watch your charitable deductions.
The IRS knows what the average charitable donation is at every income level. If your salon holds a charity event where services are rendered in exchange for donations to a particular charity, be sure to document everything. When I worked in management, we held cut-a-thons for charity twice a year. Each client filled out a form with their contact information, the services rendered, and the donation made. They received a receipt from us so they could also claim that charitable donation themselves.
Always consult with a tax professional when claiming charitable deductions to ensure that you have all the documentation necessary to justify that deduction.
Classify your staff appropriately.
By now, anyone who has read this blog should understand that the independent contractor classification absolutely DOES NOT apply to our business except in very specific, limited instances. If you aren’t yet aware of what misclassification could mean for you, I recommend reading this post and this post ASAP.
Expect to be audited and be prepared for it before it happens. That way, if/when it does happen, you’ll be ready for it. Keep yourself organized. Keep yourself honest.
Remember that even the most minor illegal, fraudulent activities are indefensible in the eyes of the IRS.
An accidental crime is still a crime, so run everything by your accountant/bookkeeper. Excessive preparation and organization will always be your best defense.