Last month, the owner of a popular restaurant in Pittsburgh’s South Hills was sentenced to two years home detention and five years of probation for evading federal income taxes.  He was also ordered to pay a $10,000 fine and perform community service.  His story should serve as a cautionary tale to those individuals who have the ability to determine their own reported income.

The IRS is well aware that some small business owners do not always report the cash they receive.  To help uncover unreported cash income, the IRS has developed an extensive resource for its agents, the Cash Intensive Businesses Audit Techniques Guide.   The Guide contains detailed, industry-specific guides for agents to use in investigating unreported income.  Guides have been developed for bail bondsmen, beauty shops, car washes, coin operated amusements, convenience stores, laundromats, scrap yards, and taxis.

When might the IRS suspect that a business or individual is not reporting of all their income?  According to the Guide:

The most significant indicator that income has been underreported is a consistent pattern of losses or low profit percentages that seem insufficient to sustain the business or its owners. Other indicators of unreported income include:

• A life style or cost of living that can’t be supported by the income reported.
• A business that continues to operate despite losses year after year, with no apparent solution to correct the situation.
• A Cash T shows a deficit of funds.
• Bank balances, debit card balances and liquid investments increase annually despite reporting of low net profits or losses.
• Accumulated assets increase even though the reported net profits are low or a loss.
• Debt balances decrease, remain relatively low or don’t increase, but low profits or losses are reported.
• A significant difference between the taxpayer’s gross profit margin and that of their industry.
• Unusually low annual sales for the type of business.

Businesses and independent contractors should report all revenue, whether received in cash or reported on a Form 1099.  If cash or other income was not reported, the business or individual should consider filing amended returns before the IRS initiates contact.  Filing an amended return can have serious consequences, so the taxpayer should seek the assistance of a tax attorney before filing an amended return.  Likewise, if the IRS has contacted a business or individual and that business or individual believes there may be unreported cash or other income, that individual should seek the help of a tax attorney.

Attorney Stephen J. Pieklik of the Pittsburgh tax law firm Williams Coulson regularly defends clients at audit before the IRS.  Additionally, he regularly represents clients before the IRS’s Appeals Division and at United States Tax Court.