Written by Abraham Finberg, CPA
Innocent until proven guilty… NOT. When it comes to paying taxes, auditors have an advantage: you have to prove you filed your taxes correctly; once you do, it's their job to show your proof is wrong. You gave them your point of sale records, bank statements (if your company has them), and all your tax returns for other tax agencies, now they take your records to show you didn't pay enough tax.
Here are five ways auditors “prove” you didn't pay your tax:
Mark Up Method
If you have $10,000 in purchases; and for every one dollar you paid for product you sell it for two, then you are indicating $20,000 in sales. That is at least, what the auditor will claim; after all, every retailer charges double their costs to buy a product. But is that true for our industry? Probably not. Case in point - Olive Vs. Commissioner. In that case, the taxpayer's records were so lousy the judge had to decide product costs for the cannabis industry and came up with 75.16% of sales rather than 50%.
Bank Deposit Analysis
If you deposit something in your bank it's because you had revenue, so every deposit should equal a sale -- at least that's how an auditor thinks. Our industry is plagued by a lack of access to banking; even when banking is available most organizations don't deposit all their sales as they need the cash to pay vendors. Most auditors won't use this method for the industry, but if they do, your best bet is to figure out if any large deposits are in fact your loans or investments in the organization rather than a sale.
This is the favorite method for sales tax agencies when they audit storefront dispensaries. They stand outside a storefront for an hour and count the people coming in and multiply the amount by the average sales price, the amount of hours the store is open, and the amount of days the store is open for the year. The best response is to look at the video tapes of the people walking in during the time period the auditor stood outside for the observation count (if the video is still available) since they have to provide the times they made the observation count. You can parse out who came in and actually made a purchase as opposed to someone who happened to just come into the store.
Tax Return Variance Analysis
One of the first things an auditor will do is compare you Federal and State Income Tax Returns to your Sales Tax Returns and Business License Renewal. The auditor will presume the tax return with the highest revenue is the correct amount (ideally they should all match). In the event that there is a variance (and you should aim to not have one without good cause) the best response for this is to be able to explain why there is a legitimate difference. For example, perhaps the income tax return has revenue which includes the sales tax collected as part of the gross balance and the sales tax return and business license renewal does not. Perhaps the business license renewal is lower than the other returns because of out of city sales. Perhaps the business license renewal includes revenue on a marijuana tax and your organization also sells non-marijuana products.
Cash versus Credit
Some people pay in cash and some people pay with a credit/debit card. Either way, most organizations tend to have a consistent ratio of cash to card payments. If the auditor thinks you get $3 in cash for every $1 in credit cards and you show $2 in cash for every $1 in credit cards, they will add $1 in additional cash sales to your tax return. This technique is less common for this industry since it's so hard for marijuana organizations to accept credit cards. The auditor is saying one of two things; you had more customers than you reported, or you “skimmed” part of the payment from your cash customers. Some ways to counter this assumption is to take a sample time period and show the amount of people and average credit card and cash sales matches the amount you are reporting. Your point of sale system makes this easier to prove in combination with your video camera surveillance.
While you can't fully protect your tax return from every examination, you should be mindful of these key issues.