By Coleman Jackson, Attorney & Counselor and CPA
July 17, 2021
Operating a business enterprise with cash can be an IRS audit flag because businesses operating in cash are susceptible to fraudulent financial transactions. However certain business operations handle a lot of cash in their normal operations. These businesses are classified in tax parlance as cash intensive businesses. Convenience stores, donut shops, massage parlors, hair stylist, mini-marts, bodegas, coin operated amusements venues; such as video games, pinball machines, jukeboxes, pool tables, slot machines and other gaming machines to only name a few classic cash intensive businesses. All of these types of businesses can legitimately operate with a high incident of cash transactions. So, there is absolutely no badge or indicia of fraud exist in most of these cash intensive businesses. Marijuana operators are another example of perhaps legitimate businesses operating in cash. Where the marijuana operators being legal, they must operate in cash because the use, sell and distribution of marijuana is illegal under federal drug enforcement laws even though several states have legalized this drug for medicinal as well as entertaining purposes in some cases. Since it is illegal under federal law to sell or distribute marijuana, those enterprises that sell and distribute marijuana cannot use the normal banking system. And certain laundry facilities also are coin operated businesses. They too are legitimately cash intensive businesses. All of these cash intensive businesses have one thing in common, cash is fungible and hard to trace. Therefore, when the IRS examiner comes to audit their books and records, it can be a challenging experience for the auditor and extremely frightening to the cash intensive business owner.
It is not lost on the State of Texas and IRS examiner that cash operated businesses can have multiple sets of books and records or no records at all. And often when they have records, they are poor, incomplete and inaccurate. The basic issue is proper accounting for transactions during the audit period: are sales, purchases, and inventory properly and timely accounted for where the operator and the auditor can timely and accurate compute taxes owed and the operator can submit the right amount of taxes to the tax authorities? These questions are proper concerns of any auditor who examines the books and records of any cash intensive business. Personal expenses paid out of the cash of the business. Business expenses paid with cash from receipts without any records. Personal use of items purchased. Physical inventories none existent or sporadic which leads to missing, stolen or unaccountable purchased items. Cash sales recorded on paper or separate ledgers completely separate and distinct from credit card sales registers or any register tape at all. Multiple employees using the same cash drawers without any accountability or cash reports or registry procedures or system of control. Now these things could be done intentionally, but, quite often they are done unintentionally. Many immigrants work in cash intensive businesses and many come to the United States where different cultural and business norms apply with regards to operation of a business enterprise. They are not familiar with the requirements to keep timely and accurate business records for Texas limited sales, use and excise tax purposes and federal income tax purposes. Many immigrants are surprised and afraid when the Texas or Federal tax examiner knocks on their door. Good internal controls can serve the auditor well and lessen the fear of the business owner.
Internal Controls is an accounting process. It is a very important process in any business to account for the receipts of money, disbursement of money and account for the inventory and property of the business. Cash intensive businesses should implement strong internal controls because cash is fungible. Internal controls are the process or systems in place to ensure the efficient and effective capturing of critical data to ensure that the business can run with accountably to its owners and consistent with the owners’ objectives; produce reliable and accurate financial summaries for management purposes and pursuant to outside obligations; and reports and comply with applicable laws, regulations and ordinances. In order for a business to have effective internal control requires that the job duties of employees who collect the money, record the money and review the money reports are adequately separated. Internal controls require documentation, documentation and more documentation. And this is critical for cash intensive businesses because under the Texas Tax Code all businesses must keep accurate contemporaneous books and records. The Internal Revenue Code requires the same for federal tax purposes; and it also requires taxpayers to substantiate its receipts and deductions upon IRS examination. Cash intensive business owners will do well to review their internal controls prior to a visit by auditors from either the Texas Comptroller of Public Accounts or the Internal Revenue Service to ensure that they are in compliance with all applicable tax laws.
This law blog is written by the Taxation | Litigation | Immigration Law Firm of Coleman Jackson, P.C. for educational purposes; it does not create an attorney-client relationship between this law firm and its reader. You should consult with legal counsel in your geographical area with respect to any legal issues impacting you, your family or business.
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