I love telling stories about the good, and not-so-good, things clients have done over the years. Actually, to be honest, I like the not-so-good stories as they are educational and hopefully stop others from going down a path they might regret.
Part of my role is technical compliance and final reviewer of tax work. My responsibility is to make sure that any significant tax position taken was backed up by adequate documentation and research. I couldn’t stop clients from taking risky positions, but I could stop the firm from agreeing to dumb things that we couldn’t defend.
One tax return comes to mind. It was a new client and I was having trouble getting my head around his small business. It was on Schedule C and reported a loss of about $100,000. He had a W2 for about $150,000 so was getting about 30K back in refunds.
What stood out most were two items. Negative gross profit of $60,000 and an RV on the books which generated about $25,000 of depreciation.
Negative gross profit, by the way, comes from when you sell your product for less than the total cost of those products. In this case, he had revenues of $12,000 and Cost of Goods sold of $72,000.
I wouldn’t sign off and the partner wanted to know what my concerns were. I asked him if he talked to the client about his “business” and the answer was, “Not really.”
So, I was indulged and the client came in for a meeting. I asked him to explain how his business worked. He bought product, he told us and traveled up and down I-5 stopping at county fairs to sell his product.
Interesting. We didn’t notice any fees for space rental at any events, though.
That’s because he parked his RV in the lot and sold on the outside. Ok.
How many customers did the $12,000 represent? We inquired.
One, he replied. One client. So what was the $4,000 of meals and entertainment?
He took this client out to dinner and to various ball games and other events because of their loyalty.
Who is this client? we asked dreading the answer.
Yeah. He and his wife took the summer off to travel and he bought stuff and he “sold” it to her. Because she was such a loyal customer, he gave her a substantial discount on buying the stuff she “wanted”. And he rewarded her loyalty with dinners and events.
Now, I know you are thinking BS, I am making this up. I swear I am not. Public accountants get some of the most entertaining and too-good-to-be-true stories out there.
Our main problem was that his prior accountant let him get away with it. We suggested that he face the fact that on audit, the IRS would probably say this was a hobby (we didn’t bother to let him know it was probably outright tax fraud) and to protect the prior losses, he should shut down his business and maybe consider starting it up in 2 or more years after a cooling-down period.
He said no thank you but appreciated our advice. He paid us for the work we did, took his “records” and went to find another tax preparer who wouldn’t be so nosey.
The moral of the story? You may have heard the old saying that “Pigs get fat and hogs get slaughtered”. Sometimes, it doesn’t pay to push the boundaries of acceptability. He may never have been audited – hell he might have even been turned down by the next dozen tax preparers and decided he wasn’t going to win and dropped it – but it was still an extremely risky position to take and there was no real defense.
There are ways to make a business work while you travel. But the odds are, the bigger the loss, the greater the risk, so documentation is vital to winning. So, as you prepare for the end of the year and are looking to work with someone who wants to help you be successful, consider an accountant with integrity and who is willing to help you get everything right to protect you from major risks. If you need the name of one, feel free to write me and I will send back the contact information for one or two to help you.
Have a great Tuesday.