Play Meter
Issue: 1986 March 15 - Vol 12 Num 4 - Page 85
TIPS
Schedule C
a red audit flag
I
p
If you haven't incorporated your business yet,
here's another good reason to do so. You know that
Schedule C you file every year as a sole proprietor? Well ,
it may say Schedule Con the top of the form, but as far as
the IRS is concerned it spells A-U-0-I-T . That same form
may be leading you straight into the jaws of the govern-
ment's revenue-collecting machine. Here's why.
Over the years , in the IRS audit-selection process, in
which the IRS decides what returns are likely to turn up
irregularities and generate additional tax liability,
Schedule C has become public enemy number one-
especially if the Schedule C reports gross receipts of
more than $100,000.
You may get serious about drawing up those articles
of incorporation after considering these facts: 1.12
percent of incorporated businesses with gross receipt.s
of less than $100,000 were audited in 1983. The audit
chance for corporations does not increase dramatically
until gross receipts reach $1 million. The audit break-
down for 1983 for unincorporated businesses filing
Schedule C was:
Less than $25,000
$25,000 to $100,000
$100,000 or more
1.43%
2.56%
5.3 %
Why the difference in treatment between corpora-
tions and sole proprietors with the same amount of gross
receipts? The IRS cynically assumes that unlike a
corporation that must keep a formal set of books, a.n
unincorporated entrepreneur routinely underreports his
income.
Here's how the IRS auditor will try to catch you with
your underreported-income pants down . First, he'll ask
you how much income other than that reported on
Schedule C you received and where it came from. Next,
he adds up all deposits made to all your bank and
investment accounts. Are you getting a little uneasy?
Loosen your tie . Why? Because the auditor is about to
slam you with unreported income using figures and the
following formula :
Hypothetical example
$210,000
145,000
65,000
15,000
Minus other reported income
50,000
10,000
Minus loan proceeds received
$
40,000
Unreported income
Total deposits
Minus Schedule C receipts
PLAY METER. March 15. 1986
By
Irving L.
Blackmon
The answer you give to wriggle out of this embar-
rassing situation is simple- the excess deposits aren't
unreported income, they're merely transfers from one
account to another. And then you had better be pre-
pared to document that explanation. Otherwise, you're
looking at additional tax, interest, and penalties. So my
word of advice to you Schedule C junkies out there who
still refuse to incorporate is this: keep good bank records
and don't make any deposits you can't account for if
faced with an audit.
•
Hiring spouse
a tax bonanza
Where this shoe fits, you'll want to wear it. This tax-
saving hint is for the thousands of unincorporated family
businesses in which the husband and wife work together .
You'll like the tax benefits .
Here's a typical case: A husband operates the busi-
ness as a sole proprietorship, and his wife helps him.
Either the wife is getting paid wages for her services or
she isn't. If she is being paid, you owe no payroll taxes on
her wages. On the other hand, if you are not paying her
wages, start now .
Let's itemize the tax benefits:
1. The wages are not subject to Social Security
taxes-either the withholding from the employee (wife)
or the employer's (husband) matching share. (See IRS
Circular E, Employer's Tax Guide, Publication 15.)
2. The wages are not subject to federal unemploy-
ment taxes.
3. The wages escape state unemployment taxes,
except in New Hampshire, the only state I am aware of
that subjects these wages to this tax .
4. The wife can put her earnings into an IRA, up to
$2,000 per year.
5. If the business has a KEOGH plan, contributions
can be made for the wife just like for any other employee.
The same benefits listed above apply to your minor
children who work for your sole proprietorship.
O ne warning: Though the tax benefits are terrific,
you can't pay your wife or kids for not working . The
wages paid must be reasonable , the same amount you
would pay someone else for the same work. Failure to
heed this warning could not only burst your tax-benefit
package as enumerated, but could subject you to
interest and penalties.
•
Stock redemption
may cause trouble
If you are a shareholder of a closely held corporation
who finds himself strapped for cash, think twice before
83
Schedule C
a red audit flag
I
p
If you haven't incorporated your business yet,
here's another good reason to do so. You know that
Schedule C you file every year as a sole proprietor? Well ,
it may say Schedule Con the top of the form, but as far as
the IRS is concerned it spells A-U-0-I-T . That same form
may be leading you straight into the jaws of the govern-
ment's revenue-collecting machine. Here's why.
Over the years , in the IRS audit-selection process, in
which the IRS decides what returns are likely to turn up
irregularities and generate additional tax liability,
Schedule C has become public enemy number one-
especially if the Schedule C reports gross receipts of
more than $100,000.
You may get serious about drawing up those articles
of incorporation after considering these facts: 1.12
percent of incorporated businesses with gross receipt.s
of less than $100,000 were audited in 1983. The audit
chance for corporations does not increase dramatically
until gross receipts reach $1 million. The audit break-
down for 1983 for unincorporated businesses filing
Schedule C was:
Less than $25,000
$25,000 to $100,000
$100,000 or more
1.43%
2.56%
5.3 %
Why the difference in treatment between corpora-
tions and sole proprietors with the same amount of gross
receipts? The IRS cynically assumes that unlike a
corporation that must keep a formal set of books, a.n
unincorporated entrepreneur routinely underreports his
income.
Here's how the IRS auditor will try to catch you with
your underreported-income pants down . First, he'll ask
you how much income other than that reported on
Schedule C you received and where it came from. Next,
he adds up all deposits made to all your bank and
investment accounts. Are you getting a little uneasy?
Loosen your tie . Why? Because the auditor is about to
slam you with unreported income using figures and the
following formula :
Hypothetical example
$210,000
145,000
65,000
15,000
Minus other reported income
50,000
10,000
Minus loan proceeds received
$
40,000
Unreported income
Total deposits
Minus Schedule C receipts
PLAY METER. March 15. 1986
By
Irving L.
Blackmon
The answer you give to wriggle out of this embar-
rassing situation is simple- the excess deposits aren't
unreported income, they're merely transfers from one
account to another. And then you had better be pre-
pared to document that explanation. Otherwise, you're
looking at additional tax, interest, and penalties. So my
word of advice to you Schedule C junkies out there who
still refuse to incorporate is this: keep good bank records
and don't make any deposits you can't account for if
faced with an audit.
•
Hiring spouse
a tax bonanza
Where this shoe fits, you'll want to wear it. This tax-
saving hint is for the thousands of unincorporated family
businesses in which the husband and wife work together .
You'll like the tax benefits .
Here's a typical case: A husband operates the busi-
ness as a sole proprietorship, and his wife helps him.
Either the wife is getting paid wages for her services or
she isn't. If she is being paid, you owe no payroll taxes on
her wages. On the other hand, if you are not paying her
wages, start now .
Let's itemize the tax benefits:
1. The wages are not subject to Social Security
taxes-either the withholding from the employee (wife)
or the employer's (husband) matching share. (See IRS
Circular E, Employer's Tax Guide, Publication 15.)
2. The wages are not subject to federal unemploy-
ment taxes.
3. The wages escape state unemployment taxes,
except in New Hampshire, the only state I am aware of
that subjects these wages to this tax .
4. The wife can put her earnings into an IRA, up to
$2,000 per year.
5. If the business has a KEOGH plan, contributions
can be made for the wife just like for any other employee.
The same benefits listed above apply to your minor
children who work for your sole proprietorship.
O ne warning: Though the tax benefits are terrific,
you can't pay your wife or kids for not working . The
wages paid must be reasonable , the same amount you
would pay someone else for the same work. Failure to
heed this warning could not only burst your tax-benefit
package as enumerated, but could subject you to
interest and penalties.
•
Stock redemption
may cause trouble
If you are a shareholder of a closely held corporation
who finds himself strapped for cash, think twice before
83
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