Originally created 09/08/02

Cheating the IRS will hurt business



Never before have accounting scandals so greatly affected the nation's economy and the personal lives of Americans.

The unethical practices of large, publicly traded companies, such as Enron, WorldCom and Adelphia, was done to drive up stock prices to create wealth for upper management.

The disasters of these companies should serve as an accounting wake-up call for small businesses that may be using inaccurate accounting to minimize profits, thereby reducing the owners' income tax liability.

There is no harm in taking full advantage of the tax code as it is written. However, some techniques push the envelope too far, including:

  • Under-recording sales figures. All sales - cash or otherwise - should be reported in the appropriate period according to whether your business is on a cash- or accrual-based accounting system.
  • Expensing inventory before it is sold. Inventory should only be expensed after it has sold. Do not expense inventory purchases as supplies. Take accurate physical inventory counts at least annually to properly calculate your cost of goods sold. Do not estimate.
  • Expensing personal expenditures as business expenses. Keep business funds separate from personal funds.
  • Expensing capital purchases as operating expenses. Follow Internal Revenue Service tax codes when expensing or depreciating capital expenditures that generally must be deducted over multiple years.
  • Calling employees independent contractors. If you have care, custody, or control over people, they are considered employees, no matter what type of written agreement you may have with them. Review the IRS's list of 20 guidelines when making this decision.
  • These techniques can have adverse affects on a small business in the long run.

    The apparent reduction in cash flow created by these actions limits an owner's ability to borrow money against his business.

    It also reduces your ability to create value in your business beyond the value of your assets because the value of a business is determined in large part by the value of expected future cash flows.

    Lastly, but most importantly, violation of tax codes can result in business closure and jail time. It is not just the owner who might suffer adverse consequences. Family members and employees are likely to suffer, also. If you have questions about how your tax professionals are accounting for your business, by all means ask them.

    Take this opportunity to evaluate your individual situation and correct it if necessary.

    David Lewis is a business consultant in the Brunswick office of the Georgia Small Business Development Center network. Call the Augusta SBDC office at (706) 737-1790.