Large or frequent cash transactions may make a business at higher risk of an IRS audit. While cash transactions are completely legal and a convenient industry standard for many businesses, frequently accepting cash payments can pose several challenges when it comes to preparing for tax season.
Business owners should note that cash-intensive businesses are more likely to be audited by the International Revenue Service (IRS) because IRS wants to verify income to ensure the business owner is paying the correct and full amount of taxes due.
If you accept cash payments, read on to learn how to avoid red flags in your business taxes to ensure you stay compliant and avoid an IRS audit.
Document Cash Transactions
The federal government is committed to keeping close tabs on anyone who takes large cash payments. This helps prevent underreporting, tax avoidance, and fraudulent crimes.
When you handle cash payments as part of regular business operations, be cognizant of the requirements associated and always document transactions.
By documenting all transactions, you will be prepared to answer questions IRS asks. For instance, a business owner should be prepared to answer the following questions:
- How is incoming cash handled in your business? What is the exact procedure for handling cash?
- Are large cash payments being properly recorded? How are these transactions being reported?
- If you are making large cash payments for necessities such as equipment, where is this cash coming from? Do you have sales records to show this?
- Does your business use petty cash receipts for small purchases?
- Is your business income proportional to your current lifestyle?
Record All Digital Cash Transactions
IRS will also be looking for digital cash since it can be used for tax avoidance, money laundering, and other illegal activities.
If your business participates in online transactions, be sure to keep these records complete and up-to-date. Forms of digital cash may include:
- Electronic cash
- Services like PayPal and Electronic Funds Transfer
Submit Form 8300 Within 15 Days
Reporting large cash payments involves filling out specific paperwork with IRS. Form 8300, the IRS large cash payments form, includes a few essential details, including your address, tax identification number, name, and transaction details.
Unlike other tax documents, Form 8300 must be submitted within 15 days of receiving a large cash payment, not only at year-end tax filing.
Report Large Cash Transactions
Federal law requires businesses to report cash payments over $10,000 to IRS. If you currently receive cash payments over $10,000, consult your CPA on your legal obligations for reporting.
Report Foreign Cash Transactions
Even if your larger payments aren't in American dollars, IRS requires reporting. IRS includes foreign currencies in its considerations of cash payments.
If you accept large cash payments in any currency, you will need to keep track of those items. This may include:
- Bank drafts
- Cashier's checks
- Traveler's checks, and
- Money orders
Inform Your Customers
As a business owner, you should inform customers that you have reported the transaction to IRS. Your customer maintains the legal right to know that you have shared the details of their payment with the government.
Keep Personal Funds and Business Funds Separate
If IRS chooses to audit a business, they will review both the financials of the business and the business owner. Because of this, business owners should keep their personal and business financials separate.
Further, business owners should record the correct transactions coming out of each account and be able to justify business transactions.
Business owners may choose other methods to separate their personal cash transactions and business transactions, such as:
- Using a business credit card
- Applying for trade credit with vendors and suppliers
- Getting an Employer ID Number (a business tax identifier) and using it for banking, loans, and other business transactions
- Utilizing a business accounting software system
Hire a CPA
Business owners may choose to enlist the support of a registered CPA to help manage cash transactions. CPAs will be aware of IRS rules and regulations—and how these rules apply to your business.
How to Prepare if Your Business is Audited
If you do end up the subject of an IRS audit, remember that documentation is everything. The more thoroughly you document your transactions, the easier it will be for your tax advisors to craft a strategy that will navigate an IRS investigation smoothly.
A business owner may choose to prepare for an audit by:
- Gathering records to document income and expenses, such as bank statements, credit card statements
- Collecting payroll records
- Obtaining receipts from vendors and/or suppliers
- Organizing documents for tax-deductible expenses like insurance, rent or mortgage payments, utilities, etc.
- Hiring a tax professional to guide them through the IRS audit process
Read on to learn how to respond to an IRS audit.
Hire a Tax Professional
Seeking expert legal counsel is essential in the event of an audit or other investigation. While your CPA can provide general advice and accounting expertise for filing your returns, you will need a tax attorney who is well-versed in tax law to represent you in legal matters involving IRS.
The attorneys at Milikowsky Tax Law have years of experience addressing legal tax matters, IRS, audits, EDD audits, and more. On top of our legal expertise, we have been small business owners ourselves—so we understand firsthand the challenges and requirements of managing small business taxes.
If you need support in navigating your IRS audit or for legal advice to help reduce your risk of being audited in the future, contact Milikowsky Tax Law today.
Interested in learning more? Read on for our ultimate guide to tax law for small business owners.