Insights for CPAs to Minimize Audit Risk for Their Clients
If you are a CPA, here are 4 things to help your client reduce the risk of an EDD, IRS, or SBA audit:
1. Confirm that your client’s 1099-K (provided by a merchant processor) does not report gross proceeds from credit card sales that are higher than the amount you are reporting as “gross receipts” on a business income tax return.
If there is a difference, you may consider adding a statement to explain a legitimate difference. For instance, chargebacks and returns are not subtracted from the amount of “gross proceeds” on the 1099-K form.
2. If you have a client who has more 1099 contractors than employees, have your client provide facts to support these workers have a legitimate and independent business i.e. EIN, business entity, website – something to establish a legit business.
EDD and IRS typically look under one the following expense categories for contractors to identify contractors that paid by a business:
- Schedule C: “commissions and fees”; “contract labor”; or “Legal and professional”;
- 1120S (S corp) and 1065 (LLC): typically find these are reported under COGS or under “other deductions” with a label such as “outside services” or “contractors.”
If you prepare a business return where the business has, for instance, 10 independent contractors and only 2 employees (i.e. where the business owners are also officers of the corporation), you should spend time with the company’s management team to analyze whether the 1099 contractors are legitimate under your state’s law and federal law.
California recently passed a new law called AB5 (effective as of 1/1/2020) that changes the analysis of a worker’s status. AB5 now has a 3-part test that is more difficult for companies to satisfy.
You will want to review your client’s general ledger and confirm they are properly reporting ALL 1099s. You should confirm that every independent contractor who provides services (over $600) receives a 1099. If one is missed, the Employment Development Department (EDD) may extend a 3-year audit to 8 years and assess an additional penalty, where the penalty may be higher than the tax.
When reviewing the general ledger, confirm the payees are truly contractors and not workers that should be reported as employees.
3. If your client is selling a business, the buyer will require the current owner to produce a “tax clearance certificate” from the California Department of Tax and Fee Administration (CDTFA), the agency responsible for collecting and regulating sales tax in California.
We have had numerous audits that commenced during escrow, possibly a result of the Tax Clearance Certificate application that was filed with the tax agency. So, you may want to review your client’s general ledger and confirm that the amount of sales tax reported and paid to the state is accurate and the proper correct sales tax rate was used (that includes both local and city tax), as well as confirming that exempt sales are truly exempt.
4. If your client applied for a PPP loan, and receives a request for information and documents from their bank to substantiate their financials, consider calling a tax attorney to review SBA’s regulations and any questions from the bank.
The Small Business Administration (SBA) is currently investigating all SBA Payment Protection Program (PPP) loans, regardless of the dollar amount of the loan.
Based on information obtained from SBA, once a request has been made for additional documents following the funding of the loan, there is an active investigation. The response from you, the CPA, and your client will affect whether the case is referred to for potential criminal investigation. This would be the case when the information simply does not support the financials or the requirements of the PPP loan.
Issues that have come up in some of our cases include:
- Not having a legitimate work visa
- Using PPP funds obtained by one company that another company applied for and obtained through SBA
There are significant benefits to a CPA working with our firm. Some include the following:
- Our law firm does NOT prepare tax returns. We work with CPAs referring clients to those who need a business/personal tax return.
- We typically have joint representation during an EDD or IRS audit.
- We also handle criminal tax investigations to protect you and your client because your communications with an IRS Criminal Investigator are NOT protected by any privilege. However, having an attorney represent your client will ensure the communication and evidence your client provides are protected.
For more information or to get started working with us, contact us today.