Misclassify Your Workers

This past weekend Laura and I visited my oldest daughter at James Madison University. We went to watch a football game on Saturday afternoon and just catch up with Meg. Early on Saturday afternoon, Meg and her roommates held a pregame cookout. At the cookout, I met Meg's BFFRN. For those of you not fluent in text speak, that means boyfriend for right now. I liked him a lot. He is a Capitals fan, so liking him was easy. After a couple of beers and a little sports conversation, I unloaded my pistol and put it away.

The next morning I called Meg from our hotel to tell her we were leaving to pick her up for a late breakfast. We weren't out the door yet. So that gave her about half an hour to get ready. When we pulled up to her apartment, we saw her BFFRN walking out of the apartment. In my younger days, half an hour was plenty of warning to vacate my girlfriend's apartment when her parents were on the way. Fifteen minutes warning was even enough for me to get a shower first. He had a sheepish look on his face when we greeted him. We told him that we were young once. We weren't going to hassle him. I did reload the pistol, however. I hope his life insurance is paid.

I apologize in advance for this being a two part piece, but this is an urgent topic for business owners. Please indulge me this time. In this first part, I will tell you about a new audit program the IRS is using to catch employers, who are misclassifying employees as independent contractors. I will talk a little about rules for classifying workers as employees or independent contractors. Then I will show where a company has gone horribly wrong in their policy. In the second installment, I will show you how to avoid problems in an independent contractor audit and talk about a client who survived an audit by doing everything right.

Two months ago, I got a message from a client telling me that the state unemployment tax people had scheduled an audit of their payroll. This type of audit is usually to determine if you have paid all of the unemployment tax payments that you owe. I have helped clients through a lot of these over the years. The client wanted me to attend the audit and I agreed.

During the course of the audit, I struck up a conversation with the auditor. I usually try to develop a friendly relationship with auditors. If I can get an auditor to view my client and me as good people, we may be able to get the benefit of the doubt if an issue arises. During the course of the conversation, he told me that this audit was part of a IRS program to identify employees misclassified as independent contractors. To make this clear, this was a state unemployment tax audit that was part of a joint program sponsored by the IRS. At this point, I knew the auditor didn't really care about auditing payroll. He was interested in auditing my client's 1099 forms. He was looking to reclassify independent contractors as employees. Since that first audit, I have had a couple more clients audited under this program. The first audit was in Maryland, but the subsequent ones were in Virginia. This is a national program.

To determine if you have misclassified an worker as an independent contractor, the IRS considers three factors: degree of behavioral control, degree of financial control, and relationship. In short, if you exercise significant control over a worker, that worker will likely be considered an employee by the IRS. If you have classified that worker as an independent contractor, the IRS will assess the taxes that you should have paid if you had treated the worker as an employee – plus interest and penalties. Rather than go into a long discussion of the three factors, I will show an example of a misclassified worker.

Let's say you own a nursing home, and you need to hire someone to clean bedpans. You hire some miscreant, named Frank Stitely, just to throw out a name. You don't really want to pay the employer share of Social Security, Medicare, and unemployment taxes for him. So you give Frank a contract that explicitly states that he will be treated as an independent contractor, not an employee. In addition, you hand him a W-9 form to complete. Frank dutifully signs the contract and completes the W-9 form using his Social Security number as his taxpayer identification number. Some days cleaning bedpans seems preferable to preparing tax returns.

In the contract, you agree to pay Frank twenty dollars per hour. You tell him that the going rate for bedpan duty is $15 per hour, but you are paying him more since he is an independent contractor to cover his taxes. To perform his duties, Frank has to come to your facility from 8:30 A.M. To 5 P.M. just like your other employees. He will use your bedpans, and you agree to pay him every two weeks just like everybody else. He also has to submit the same timesheet everyone else uses.

Frank is happy processing poo until he goes to S&K to get his income tax returns prepared. There, a very knowledgeable tax preparer tells him that he is paying way more in taxes than he would if you had treated him as an employee. The tax preparer goes further and has Frank complete an SS-8 form. An SS-8 form is a form that can be submitted to the IRS to ask them to determine if a worker should be classified as an employee or an independent contractor. Frank is no longer a happy little bedpan jockey. He mails the form to the IRS, and a few months later you get a cryptic letter from the IRS telling you that a nice man in a boring blue suit will be visiting your facility to determine if you are misclassifying employees as independent contractors.

How do you think you will fare in this audit? Let's evaluate Frank's situation against the three factors the IRS uses to determine the correct status. First, what is the degree of behavioral control you exercise over Frank? He works in your facility, using your tools (bedpans), and is required to follow all of the procedures your employees follow. Strike one.

What is the degree of financial control you exercise over Frank? He gets paid by the hour just like your other employees. He has no risk of financial loss. In other words, he incurs no business expenses. You pay for all of those. Strike two.

What is your relationship with Frank? You had him sign a contract that stated that he understood that he would be treated as an independent contractor. You also had him complete a W-9 form and issued a 1099-MISC form to him after end of the year. All of that is in your favor. However, Frank does not have a business license and does not carry a liability insurance policy. He only works for you and isn't really in business for himself. Strike three and you are out. Taxes,penalties, and interest are in your future.

Unfortunately, I see a lot of situations like Frank's. The more a worker looks like an employee, the more likely he is to be reclassified as one by the IRS. In the next installment, I will show you some ways to make certain you can survive an independent contractor audit.

For more informative tax and accounting information, please visit the main S&K web site, www.skcpas.com. Thanks for reading and go Redskins! Beat those dog hating Eagles.

I Almost had a Positive Experience with the IRS

I am a victim of domestic abuse. No, Laura isn’t beating the crap out of me. Maybe she should, but she is a gentle and affectionate person. No, Jennifer Aniston’s bodyguards didn’t beat the crap out of me. I’m a stealthy stalker. The twelve year old bitch from my last blog is terrorizing me. Apparently, she wants something in return for a good licking. Last Thursday, she pinned me down against the couch with her front paws and demanded some heavy petting. No means no – even to Jack Russell terriers. When she was done abusing me, she left a ten inch deep gash across my chest. Actually it was a two inch scratch, but this is a blog. So I get to exaggerate.

Most people feel a similar sense of abuse after dealing with the IRS. There is even a sense of shame that maybe they aren’t being good citizens and deserve some abuse from the IRS for owing back taxes. Since I get paid to deal with the IRS, I don’t feel shame, except as a US citizen that they represent our country. I normally feel exasperation. While on hold with the IRS, you will frequently find me on Facebook lamenting my life as a tax preparer. I used to work on other tasks while on hold, but I found that I wasn’t being productive. When I call the IRS, I normally have a stack of paperwork related to why I am calling on my desk. As soon as an IRS representative picks up the line, I want to be ready to launch into the facts of my client’s situation. If I am working on something else, I have to put that quickly away and retrieve the paperwork for the call. That takes time, and I found I wasn’t immediately effective and organized in presenting my case. Like rabid dogs (and Jack Russell terriers), IRS agents smell fear and uncertainty.

Last Wednesday, I almost had a positive experience with the IRS. In a ritual I have performed a dozen times this summer, I called the IRS to arrange for a payment agreement for a client. He owed a mid five figure amount for a couple years and needed some time to pay off the balances. I had his paperwork spread out on my desk and was listening to the on-hold IRS music. The music doesn’t have lyrics, but I imagine if they did, they would go something like, “You suck, deadbeat. Wait ‘til we get a hold of you.” The refrain would be, “Now we’re gonna levy your bank account, ha ha ha.” Imagine this sung by Yoko Ono. That’s how much pleasure I get from their on-hold music.

After an interminable forty minutes on hold, an IRS agent picked up. “My name is Ms. Satan, badge number 666. How may I assist you?” This translates as, “I am looking to bleed you dry as soon as you give me a little information, you filthy deadbeat.” However, I am used to the attitude and jumped into my spiel about getting a payment arrangement for my client. I know that if you propose a monthly payment amount that gets the tax liability paid in three years or less, you have a good chance at success. Nonetheless, I then had to listen to her rehearsed spiel. We were dancing together with her in the lead. She made me prove I had a power of attorney for the client. I had faxed it two months earlier, but it still wasn’t in the IRS records. So I had to run to our fax machine and fax it to her directly. This is why I need everything quickly accessible on my desk. Then she let me lead as I proposed a monthly payment amount that my client had agreed to present as affordable.

She took the lead again and asked me if I had a completed form 433-F. That form is a collection information statement that lists a taxpayer’s financial information so that the IRS can determine the maximum payment that a delinquent taxpayer can afford before emptying the bank accounts. I knew that form didn’t apply, since my client was self-employed. The more complicated forms 433-A and 433-B applied, and I had them prepared and ready to fax to her. However, she insisted that form 433-F was the correct form and proceeded to start asking me the questions from that form. This was fine with me, since I had all of the information required by that form and much more – information that I was happy not sharing. I called up a copy of a blank 433-F form on my computer screen so that I could anticipate the questions she would ask and have answers available immediately. Very rarely, will an IRS agent take the time to delve this deeply into a situation in the hopes of reaching an immediate deal.

She then asked me what we were proposing as a monthly payment. She knew as well as I did that my proposed payment amount would get the liability paid in three years or less. She told me she thought the amount would work and that she needed to put me on hold to reference some information on my client that wasn’t directly available on her computer terminal. Five minutes later, she returned.

“We have a problem,” Ms. Satan said. “I see that we have received your client’s 2009 tax return, but it isn’t processed yet. So I can’t determine the actual balance due.”

We had mailed the 2009 tax return at the very beginning of the summer. There were maybe a hundred numbers to keypunch from the return. That should take maybe an hour – if you type with one finger. I’m thinking middle finger here. After three months, the IRS hadn’t been able to process this. The really funny, or actually sad thing, about having to wait more than three months to process a tax return is that IRS employees, including their top executives, don’t see anything wrong. If you talk to them, they give you a funny look like, “What the hell planet are you on where they process work in less than three months?” That planet would be earth, i.e. the real world, someplace they never visit.

I had a similar problem this past winter with the tax returns for an elderly lady, who had not filed returns for three years. When you don’t file your returns, eventually the IRS makes up a return for you based on information they have in their computer records. It is never a good idea to accept their return. So we filed all of the back returns. Meanwhile, over a period of six months, they began to send ever more urgent threats to empty her bank accounts. Finally, in July, they processed the returns and stopped the collection actions. They harassed an old woman for most of a year. That makes for happy public relations.

My call with Ms. Satan wasn’t destined to have a totally happy ending, but it wasn’t a total disaster either. She agreed to place a six week hold on collections activity to allow some time to get the 2009 tax return processed. Of course, she expects me to monitor the six weeks and check back in with them again. That’s my responsibility?? When we are behind in our company’s work, I walk down the hall and tell somebody to start hauling ass. But again, I live in the real world.

I was informed a few minutes ago that my future wife, Jen Aniston, was in Washington DC this week. Surprisingly she never looked me up. She knows I’m a busy guy, but I would move some things around and make time for a lunch date with her. She shows no appreciation for all I have done for her career.

As always, if you are looking for useful (it hurts when I write that) tax and accounting information, go to our S&K web site http://www.skcpas.com.

Thanks for reading!! Frank

Reincarnated as an IRS Agent

Every Saturday morning, I am awakened by a little bitch licking me. She offers to lick Laura as well, but Laura isn't into that. To get licked by a twelve year old bitch, most men have to travel to Thailand and spend thousands of dollars. I get licked for free right here in Ashburn, Virginia. Please put down the phone. You don't have to dial 9-1-1 and have the Loudoun County PoPo pick me up. I am not a pedophile (and Richard Nixon wasn't a crook). The twelve year old bitch is our Jack Russell Terrier, Sidney. Jack Russell terriers lick, because it's an essential part of what they do and who they are. IRS agents do what they do, because they are who they are. Is Shirley MacLaine dead? That's a trick question. You can't kill her, because she'll just be reincarnated. Imagine you did something really bad in your life – not something like running over an old lady in a crosswalk. Something really bad – like shooting up an entire nursing home (or quarterbacking the Dallas Cowboys). Then during your getaway, you die in a hail of gunfire. God hates you so badly that he doesn't just bring you back as something low like Charlie Sheen. He brings you back as an IRS agent. Here is what every day of your reincarnated life looks like. You work on the 1-800-829-1040 IRS phone line. Thirty times a day you answer the phone, “Ms. Purgatory, badge number 666. How may I assist you?” On the other end of the line, some scumbag is trying to bullshit you into why he shouldn't have to pay his taxes like everyone else. He has ignored a half dozen or so threatening notices from the IRS, and his employer has now received a garnishment notice. He asks you why you think you have the constitutional authority to seize his money. He'll quote a legal opinion from some moron, who is now serving five years for tax evasion. Of course, he doesn't know that. He just bought the guy's pamphlet off the internet. After thirty minutes, the guy screams at you one last time and then hangs up. Repeat this another thirty times each day. It's a wonderful life. Out of a hundred phone calls, you probably talk to two or three reasonable people, who have reasonable requests. That's a ninety-seven percent ratio scumbag ratio. How would that influence your regular daily attitude towards the taxpayers who call you? After a while you start treating everybody like scumbags. Welcome to the world of an IRS agent. The bad dream is over, and you can wake up. You are not an IRS agent, but you have learned something essential if you have to call the IRS. You are a scumbag by default. Everything you say is a lie unless you have proof. How can you ever get any issues resolved in this environment? You must differentiate yourself from the normal scumbags an IRS agent talks to every day. The way to differentiate yourself is to be reasonable in all your dealings with the IRS. Call when you receive the first IRS notice – not the sixth. Every time you call about an issue, the IRS agent will log your contact in their seventies era computer system. The next time you call, another agent sees the history and sees that you have promptly responded to every notice. That history of response buys credibility. Also, when given a deadline to do something, do it on time. Every IRS agent you talk to has the ability to help you or screw you. You can persuade an agent to be helpful with a good response history. Filing deadlines will be extended, and penalties will disappear – all because you have separated yourself from the scumbags.

Revenue Doesn't Matter

I believe a man should accept the consequences of his actions. Therefore, I freely admit that I am the father of Jennifer Aniston's unborn baby. I am willing to suffer the consequences. You should admire me for that. On another note, Mike Shanahan, the Redskins head coach, has once again refused my wise counsel. He has selected Rex “the Wonder Dog” Grossman as his starting quarterback. I advised him to sign my beloved Jen as a free agent quarterback. Until coach Shanahan realizes and fixes his error, I am boycotting Redskins home games. Actually, I don't have tickets until the second game. That makes boycotting the first one considerably easier. I'll probably even picket the Ashburn practice facility. Or – maybe I'll just drive by it a couple of times and give him a stern glance. It's on my way home from work. Rex and Jen actually have a few football characteristics in common. First, neither Rex nor Jen can avoid a pass rush. Second, neither can throw deep routes. Lastly, neither has won a Super Bowl. OK, that last one is a cheap shot. Rex has been there, but I'll bet Jen has attended at least one – probably with ex-hubby, Brad Pitt. I will gladly take her, and our love child, to the next one. I bet Rex won't be there. Last week, I read a sad story on the front page of the Washington Post. A man, who had immigrated from El Salvador twenty years ago, had lost his house and all of his savings in the recession. He came to the U.S. in the eighties, taught himself English, and graduated from high school. Then he took a series of jobs, starting out as a menial laborer. Finally, after starting a family and saving a considerable amount of money, he started a painting business. He hoped to manage four or five crews of painters working on residential remodeling jobs in our affluent D.C. Suburbs. His first couple years in business coincided with the end of the real estate boom. When the boom went bust, so did his business. He lost his house, his savings, all of his work crews, and most of his working equipment. He is now down to just himself, some broken equipment, and one man he calls on the rare occasions when he has work. He now feels lucky to get one prospect of a job per week. At this point, most of you are expecting a snarky punch line from me. OK – I know I deserve that. I am a repeat offender in the snark department. However, I feel nothing but admiration for this guy. I barely speak English well let alone another language. I am fortunate enough to have been able to afford a college education and start a business that has lasted for more than twenty years. I have had a lot of advantages of which this guy could only dream. However, his story is instructive from a business standpoint. He made one very big mistake from the outset. He assumed revenue as a given in his plans. He probably didn't even realize his assumption. You might reply, “Frank, a lot of people went bust in this recession. Once housing died, a lot of contractors bought the farm.” That is true except that I know a lot of contractors who survived. I know one painting company in particular that has just been sold. His revenue went down, but it didn't go away. Why was his business different from the Salvadoran immigrant's business? Both had four or five painting crews working during the boom. Both served affluent D.C. homeowners. As far as I know, paint even dried at the same rate for both. They differed in their personal focus. My client was focused from the very inception of his business on finding and developing revenue sources. Revenue was his first priority. He joined networking groups and developed relationships with HVAC companies, home remodelers, and other building tradesmen. A lead they developed could become a lead for him as well. The immigrant didn't focus on revenue generation. He relied on his own meager and underfunded advertising. Because he started during the boom, revenue came in easily at the start. He never developed a marketing plan to develop sources of revenue that would continue during a bust. Revenue matters. That's why it's called the top line. Revenue is never a given in a business plan. Lately, I have been spending a lot of time on a business advice web site, www.focus.com. The site features questions from business owners that are answered by a group of experts. I have been designated one of the experts in accounting and taxation. Obviously becoming an expert isn't that hard. Last week, a person posted the following question which was really more of a comment. “I am considering starting a small business, but I am hesitant given Obama's tax policies.” Now you know why I admire the Salvadoran immigrant. How do you even start to answer this question? Snark was oozing from my pores and dripping onto the keyboard. Here is the answer I would have liked to give him along with a punch in the face. I toned it down for the site. If you are interested in Frank writing politely, go to www.focus.com. Hopefully, you have better things to do. Here is my real answer. Dude, Obama's tax policy is about the 4,377,891th thing you should be worrying about if you are considering starting a business. The fact that it made your list at all should not only disqualify you from starting a business but also from the human race. You are precisely the sort of wannabe I chase from my office with a shotgun. (I'll bet you didn't know I am packing heat in the office. The great state of Virginia promotes concealed weapons.) Part of Obama's new tax law should be the forced sterilization of idiots like you – without anesthesia. I feel better now. The drugs are kicking in. This guy is a wannabe politician not a prospective business owner. The first concern and priority of a prospective business owner should be - “Where and how will I earn revenue?” If you can't answer that question, your business won't survive. When a new business owner meets with me and speaks first about anything other than how she plans on creating revenue, I lose interest immediately. If she wants to talk taxes first, she has no chance to succeed. About ten years ago I met with someone who was about to open a food consulting business. He left a salaried corporate job to advise food distributors. He met with me to discuss his business plan. His main concern was that he couldn't accurately forecast his expenses. For instance, he wasn't certain whether his phone bill would be $45 per month or $47 per month. Yes, I am serious. He never brought up the subject of revenue. I had to quiz him. He had one customer, his former employer, and no ideas on getting second or third customers. A few months later I met with him to prepare his tax returns. He had closed his business. His one customer dropped him. Are you really surprised? Revenue has to come first. My wife has just given birth to a bouncing baby business. She is opening an IT services business providing information security services to federal government agencies. Guess what we discussed first? You fail if you answered anything other than where her revenue will come from. The name is LAMAR Security Controls, LLC. Why the name LAMAR? It's my middle name. Laura likes my middle name. My first wife hated it. Maybe she only hated it because it was attached to me. I had never considered that possibility?! I will keep you updated on her progress. As always, thanks for reading. You can get non-snarky tax and accounting advice at the S&K main web site www.skcpas.com.

Special Earthquake Edition

Yesterday when the earth began trembling, I did what I do every time I am in a life threatening situation. I asked myself, “What would Jennifer Aniston do?” So I kicked off my high heeled pumps and ran screaming from the building. Then I went shopping. What really happened isn't as interesting. I was working at a client's office in Manassas when the building started shaking. I was entering a couple of journal entries into their accounting system and didn't see a need to interrupt that. One of the owners came by and remarked, “Wow, Frank didn't even stop working.” I replied, “Did you really want me to keep billing you as I ran screaming out of the building like a little girl?” When I was done at that client's office, I rushed back to my office to make certain none of our Jennifer Aniston pictures had fallen off the men's bathroom wall. That would have been a real tragedy. We can rebuild the Pentagon, but an autographed picture of Jen is irreplaceable. Thanks to all of you who expressed your concern for Jen's pictures on Facebook. I tried calling Jen on her cell phone to make certain she was unhurt, but all of you wussies were busy calling your families and prevented me from getting through. As I drove back to my office post-quake, I listened to WTOP news on the radio. They had someone from everywhere call in to share their experiences – even Woodbridge. Who gives a damn about how people in Woodbridge feel? The Loch Ness monster called in from Scotland to tell us his lake shook. Big Foot probably couldn't get through on his cell phone. AT&T service was down – as usual. If you've made it through my earthquake diatribe, you at least deserve some real business advice. I wish I had a good stock tip to pass on – say what to buy when the earth is shaking, but I don't. There is a punch line in there that eludes me. If I find one, I'll post it on Facebook. If you have a good one, let me know. I'll take the credit for it – but not the blame if it bombs. Last week, I was preparing a set of financial statements for a client. This was no big deal. I spent a few hours working on them and then send the owner a draft. After reviewing the draft, he called me, “Frank, I need you to make me look good for the bank.” You might reasonably inquire why he would make that statement. I might reasonably answer that his company's financial statements weren't very impressive. By that, I mean that he had small losses, not profits, for both years presented in the financial statements. He was hoping to get a new bank loan. The financial statements certainly would not look great to a bank. I hear this owner's plea about a dozen times per year. In each case, a company owner is looking for something from a bonding company or a bank and needs financial statements prepared by a CPA. I prepare the financial statements as requested and then get the phone call. “Frank, can you make my financial statements look better?” Apparently, there is some trick I missed in CPA school that will magically turn losses into profits. Jesus turned one loaf of bread into many. That is a miracle. I dare him to turn some of these ugly-assed profit and loss statements into something a banker might believe. Take a guess why banks and bonding companies want financial statements prepared by CPA's. No that isn't right. That isn't either. You get half credit if you guessed that banks just want someone to sue when the loan goes bad. The real reason is that banks trust CPA's to present financial statements that are truthful to the best of our abilities. That reason would seem to eliminate the possibility of my fudging the numbers to make the company owner happy. I should mention, however, that in the past I have had mortgage companies ask me to falsify financial amounts. We all know where that practice led the mortgage industry. In case you haven't guessed by now, my answer is “No.” My job isn't to make a company's financial statements look good. My job is to make them look accurate. The owner's job is to make the financial statements look good – by managing his company well. Now that you have accepted my plea not to ask me to commit fraud, let's discuss the types of financial statements a bank or a bonding company might request. There are three basic types of financial statements a CPA can issue. They are compiled financial statements, reviewed financial statements, and audited financial statements. These three types of statements differ in the amount of responsibility the CPA takes for the accuracy of the numbers and consequently the amount of work the CPA performs. A quick explanation of the three types of financial statements is as follows. If it looks like a duck, it is a duck. That describes compiled financial statements. If it looks like a duck and quacks like a duck, it is probably a duck. That describes reviewed financial statements. If it looks like a duck, quacks like a duck, and is genetically proven to be a duck, it is a duck. That describes audited financial statements. Let's look at the three types in a little more detail. When a CPA prepares a set of compiled financial statements, he takes no responsibility for the accuracy of the financial statements. The CPA is required to read the financial statements and gain an understanding of the company, but that is all. There is no assurance whatsoever that the financial statements are correct. This, obviously, is the lowest level of assurance a CPA can provide in that no assurance is provided at all. The only responsibility for correcting the financial statements arises when the CPA notes an obvious departure from accounting principles generally accepted in the United States. Then he can either correct the financial statements or note in his report the departure. From a practical standpoint, most CPA's including me, don't issue compiled financial statements without performing at least some work to determine that the numbers in the financial statements aren't total garbage. We will normally make certain the bank accounts and a few other important balance sheet accounts have been reconciled. But – we aren't required to do that. Compiled financial statements are the least expensive set of financial statements a CPA will issue. Compiled statements normally run from $500 to $2,000 depending on the complexity of the statements and the amount of work the CPA performs. Reviewed financial statements provide a higher level of assurance than compiled financial statements. A CPA is required to do at least a little more work before issuing reviewed financial statements. We have to perform all of the procedures for a compilation, but we must also make inquiries as to the balances in the financial statements. In other words,we might inquire as to whether the bank accounts have been reconciled and whether all accounts receivable are collectible. From a practical standpoint, most CPA's will prepare workpapers that support the balances of all the significant balance sheet accounts and some of the accounts on the income statement. We aren't required to actually test any of the transactions that make up the financial statements. In other words, we don't examine canceled checks or confirm accounts receivable balances with customers. We also do not do any testing for fraud. A set of reviewed financial statements gives some assurance that a company's financial statements are accurate, but certainly not absolute assurance. A set of reviewed financial statements will typically cost between $1,000 and $5,000 for a small business again depending on the complexity of the financial statements. The highest level of assurance that a CPA can provide comes with audited financial statements. An audit includes all of the compilation and review procedures but also includes testing on a sample basis the transactions in the accounting system. For example, in an audit, a CPA will test count year end inventory and confirm bank account balances with a company's bank. The CPA will also evaluate the risk that fraud may have occurred and perform some fraud testing. However, testing extensively for fraud isn't part of an audit. This surprises most people. The general public perception is that an audit is primarily about detecting fraud. It is not. An audit for a small business will typically start at not less than $15,000 and could run to over $100,000. Audits aren't for most small businesses. Audits are also risky for CPA firms from a liability standpoint. We don't perform them for that reason. They also aren't nearly as much fun as preparing tax returns. Yes, I take medication for this condition. What type of financial statements should you want for your small business? Banks and bonding companies love audits for obvious reasons. They also understand that most companies can't afford them. For companies with less than $10 million in annual revenue, most banks and bonding companies will accept reviewed financial statements. For very small companies with less than $1 million in annual revenue, banks will typically accept compiled financial statements. In most cases, I recommend selecting the least costly service that your bank or bonding company will accept. Yes, I would love to bill you for reviewed financial statements. However, if I ask myself what Jennifer Aniston would do, I realize that she would probably go shopping. So she is no help there. I try to put my clients' best interests first. I sleep better that way. I end up with plenty or work to do anyway. As always, if you want non-snarky tax and accounting advice, please visit our main S&K web site at HTTP://www.skcpas.com. In the meantime, make certain your life insurance bill is paid. With the next earthquake, we will all surely die!

Deduct Your Spouse

A friend from Facebook, Angelina J. writes, “Frank, I am taking a business trip in a month with my husband, Brad P. How can I make his travel expenses deductible?” That's a great question. I am in a similar situation. My future wife, Jen A., and I are opening a sex toys business. She needs to find a way to make my travel expenses deductible. In her new movie, “Horrible Bosses”, Jen demonstrates her knowledge of sex toys. She plays a cougar dentist, who enjoys seducing / torturing her dental assistant. I would have been great in that role.

The key to making spouse travel expenses or any other spouse related expenses is involvement in the business. In other words, your spouse must have some substantial, active role in your business. In my case, I plan on being Jen's sex toy model. She can test the toys on me.

Angelina J. runs an adoption agency. She has to find a way to make Brad P. a contributor to her business. She could have Brad fill any of a number of roles like bookkeeping, searching for orphans to adopt, or marketing foreign kids to rich, useless American actors. For Brad's expenses to be deductible, his role in the business must be essential. The I.R.S. has seen and rejected all sorts of schemes. The more Brad's arrangement in Angelina's business looks like something an unrelated employee might do, the better the changes of sustaining deductions related to Brad's involvement.

A second factor Angelina must consider is Brad's compensation. His compensation must be commensurate with his involvement, and his expenses must be reasonable based on his level of compensation. You wouldn't spend $10,000 in travel expenses on an unrelated employee making $15,000 per year. We CPA's say, “Pigs get fat. Hogs get slaughtered.” If you get greedy, the I.R.S. will disallow your deduction.

You have some choices in how you structure your spouse's involvement in your business. If you already have employees, putting your spouse on the payroll with a salary is a great idea. If you own a pass thru entity such as an LLC, partnership, or S corporation, your spouse's salary will increase your personal income but be offset by your business's deduction for his salary. There can be some Social Security tax and Medicare implications. So you have to actually work out the numbers to make certain the additional spouse travel deductions are worth the hassle.

If you don't have employees already, you can make your spouse your only employee. However, then you begin to incur the additional administrative expense of processing payroll. That expense eats into the benefit of deducting your spouse's travel. A way around having to process payroll is to make your spouse a minority owner. If you are the only owner of an LLC, now you have created a partnership for income tax purposes when you add your spouse as an owner. If your spouse is involved in your business, his / her expenses are deductible to the business since he / she is an owner.

There is a definite downside to making your spouse an owner in your business. If you get divorced, the consequences aren't happy. If you think your marriage isn't on solid ground, give up the deductions. I am only addressing deductions in this article. I ain't no Dr. Phil. Your marriage is your business. I was bad enough at my first one that I shouldn't be giving marriage advice.

There is a more aggressive way to make spouse travel deductible. If you have a legal entity such as an LLC or corporation, you can make your spouse a member of the board of directors. Corporations are required to have annual director meetings. Hold yours someplace nice like Hawaii.

The key to successfully defending your spouse travel deduction is documentation, documentation, and more documentation. If you go to Hawaii to hold a directors' meeting, meet every day of the trip for some substantial period each day and keep detailed meeting minutes. Don't think you can create the minutes after the fact. Your computer file creation dates had better be consistent with your trip dates. If your spouse is an employee, keep the same time records you would keep for any other employee.

Arranging your business affairs to make spouse travel deductible is definitely an aggressive income tax reduction technique. If you are audited, expect the I.R.S. to question the deductions. However, if you can prove through solid documentation that your spouse is actively involved in your business, you will be able to defend your deduction successfully. But, expect a fight. If you aren't willing to have the fight, pass on the deduction.

If you are looking for not so snarky tax and business advice, please visit our main S&K web site www.skcpas.com. Thanks for reading.

Blame Your Customers – Santa Closes Up Shop

Here's how you can tell the last recession was a severe one. Santa Claus closed his shop at the North Pole. The elves pension trust held the mortgage note on the workshop. They threw Santa out on his ass, when he fell six months behind on the mortgage. Santa applied for federal stimulus money to save the shop, but like most Americans, the loan to value ratio didn't work even with lower payments. What happened to the reindeer was just wrong. They didn't just lose their jobs. Wegman's told us they were selling bison, but we really know the truth. Make mine medium rare, please.

Santa fell on hard times in 2007 when he had a falling out with his main benefactor, Osama Bin Laden. Santa refused to deliver suicide-bomber Barbie dolls to girls in Israel. Santa packed up his tools and fixtures from his shop and moved to Danslowne, where he opened a retail toy shop in 2008. Danslowne is an affluent residential community twenty-five miles west of Washington, DC. Shortly after opening, Santa's toy shop won the prestigious small retailer of the year award presented annually by the Douloun County Chamber of Commerce. Santa was proud of his award and thought he was on the way to financial success.

Early in the summer of 2011, the president of the Douloun County Chamber of Commerce, Hony Toward, sent a message to past winners of the small business award. He asked each of the winners to provide a few words explaining how winning the award benefited their businesses. Hony was shocked when Santa replied that he couldn't provide a quote, because he didn't believe winning the award had helped his toy business at all. His business was struggling.

Santa explained that Douloun County residents had changed their buying behavior between 2008 and 2011. Residents ignored small local retailers, like Santa, in favor of big box stores like Wal-mart and Best Buy. He couldn't understand why consumers would forsake the incredible customer service he provided in favor of the rock bottom prices of Target and the other large discount chains. He told Hony that someone, presumably the Douloun County Chamber of Commerce, should start the fight for the little guy in Douloun County. Someone should convince county residents to buy local. Santa explained that he was too busy trying to save his business to participate in his proposed program, but that somebody should do it. Hony presented Santa's message to the small business committee of the chamber. One of the members was a stunningly handsome, young CPA, named Srank Ftitely. Srank brought Santa's message to my attention.

Santa thought winning the small retailer award validated his business expertise and anointed him a small business leader who would surely succeed. The award judges were forward thinkers, who understood the genius of his business model. That model was selling upscale toys to affluent consumers in Danslowne. A toy from his store would have your little Timmy solving Einstein's relativity equations by combining data from the Hubble telescope and the Large Hadron Collider. His toys would have your child graduating from Harvard by age twelve.

Here's the truth about the small retailer award. The award isn't judged based on the viability of a business's model or its financial results. The judges review packages submitted by award nominees. The best package wins. Santa had submitted a beautiful brochure featuring Stephen Hawking brand toys. The brochure was produced by an amazing printer, named Mave Dorey. Mave owned M & M Printing. Yes, I switched the M & M. You still get M & M. Santa won based on his package.

Let's take a look at Santa's actual business plan. This isn't how he would express the plan, but we will be closer to reality. Here is Santa's business model. Rich people are willing to pay too much for toys. The underlying assumption is that rich people are stupid. They are willing to pay more for a pedophile Ken doll or slutty Barbie to Santa than they are willing to pay Wal-mart. Santa thinks his outstanding service will be the difference. How much service do you need to buy toys?

To compete with big discount warehouses, small retail stores have to offer something the warehouses can't offer. That seems obvious. What wasn't obvious to Santa is that customers have to want that something. That something isn't service in the case of a toy store.

If I could retool Santa's business model, I would eliminate the retail part completely. Small retail toy stores can't exist any more than the Loch Ness monster can exist. Santa needs a niche market. Osama Bin Laden might have had the right idea. Santa could sell suicide bomber Barbie dolls over the internet to the children of Al Quaeda terrorists. The reason he can't do this with a brick and mortar location is that there aren't enough terrorist families in Danslowne. The market isn't big enough to support a store. However, an internet business with almost no inventory and overhead could work great selling internationally. He could have a customer loyalty program. If you buy suicide bomber Barbie, you get a free Taliban Ken.

What really offended me about Santa's message to the chamber of commerce was the implication of entitlement. He is a small business. Therefore, we owe him. If Santa had been at the meeting, Srank Ftitely would have told him Stitely's rule of seven billion. There are seven billion people on the planet,who don't give a damn about his business, and not a single one owes him anything. I quoted George Thorogood two weeks ago, but the quote applies to Santa as well. “Get a haircut and get a real job.”

A good friend and client, Ken Irish, passed away tragically in an accident this past week. Ken was a former military guy, who had created a really amazing business. Every moment I spent discussing business with Ken was a real joy. Ken was no Santa. He not only had a great business idea, but he knew how to make money with it. He will be sorely missed by all who knew him.

Thanks for reading. For real tax and accounting advice, please see the main S&K web site at http://www.skcpas.com.