One of the most common misconceptions business owners have about their tax returns is that their liability ends once they hand their financial information to their CPA or tax preparer. This could not be further from the truth.
Each year business owners everywhere make a mistake in assuming their hastily prepared business financial documents are error-free (i.e. profit and loss statement, balance sheet, and general ledger). But disorganized financial documents almost always result in disorganized tax returns, even if they have been submitted to a tax professional. And that’s a big red flag to the IRS. Read on to understand why these mistakes happen, and what actions to take to ensure that your documents remain CPA-safe.
Where the Problems Start
Taxpayers tend to place the blame on their CPAs for filing incorrect tax returns. What they fail to consider is the taxpayer’s job is to report accurate numbers to their tax professional, and the business owner should hold themselves personally accountable for anything that appears wrong on a tax return.
If your CPA is not reconciling your books, it is difficult for the CPA to identify errors on a return they prepare for your business. For instance, your CPA will have a difficult time finding an error when you are deducting your meals and entertainment expenses as advertising where you believe your lunch meetings are more likely to bring you business.
A Government Accountability Office (GAO) study, however, showed that tax returns filed by a paid preparer often included more errors than those that were self-prepared by a taxpayer. CPA errors extended from failure to include all business income from 1099s, and improperly reporting an expense as a business deduction. Some preparers overstated expenses, by improperly deducting all costs of goods purchased in a year without adjusting for the starting and ending inventory balance, and offsetting losses from one business or investment with income from another business.
In terms of the frequency of CPA errors, incorrect reporting of sole proprietorship expenses was identified as the most frequent mistake made by a large margin. This was followed by incorrect depreciation deductions which could be explained by the difficulty estimating the amount of cash received by a business.
Why You Should Use a CPA
Despite the findings of CPA errors, GAO still points to the taxpayer as the ultimate fault for any inaccuracies in their business financial records. It is the business owner’s duty to provide accurate and complete records to their tax preparer. If the business owner does not submit accurate documentation to a CPA, it is the business owner who will ultimately be liable for additional taxes, penalties, and interest.
Furthermore, GAO found that those who used a paid preparer often found themselves with larger tax refunds. Though this varied by the complexity of each tax return, it adds merit to the false claim that most taxpayers are better off filing their own taxes without professional help.
Reviewing Your Own Financial Documents First
The best way to produce an accurate and complete tax return is to review your own documents for accuracy before handing them over to a CPA.
Start by checking your financial records for non-business deductions, additional income (including adding up income from your 1099s), and identifying mathematical errors. Be sure to crosscheck your financial statements with your bank statements and credit card statements to ensure you capture all of your income and expenses.
An open dialogue with your CPA is another important step. Along with discussing your business financials, your CPA should also check that your books and records are reconciled every month. Most importantly, ensure your CPA is familiar with your business transactions, your revenue model, and your routine deductions. This can prevent mistakes that stem from incorrect assumptions and miscommunications.
If you have any doubts about what income or deductions should be reported on your tax return, make a list of specific questions before meeting with your CPA or a tax law specialist. If you are unsure about potential legal exceptions to reporting income (i.e. deferred income or the legitimacy of an expense) contact an attorney.
The following article is provided only for informational purposes and does not constitute legal advice or consultation. This information is not intended to create, and receipt of this information, does not constitute an attorney-client relationship. The reader should not rely or act upon any information in this site without seeking professional legal counsel. Every case poses a unique set of facts, legal issues, and legal authority, which can and will vary the outcome of your case. If you have a legal question or need legal advice, you should contact an attorney to discuss your matter and review the unique facts of your case.