Q:

Subject: Interesting tax question

 

Good one for the blog.....

 

I am in the middle of an IRS audit.  I own a small company, real estate, invest in stocks and have a W-2 job.... they have been into all of these items, with no findings.  I try to be very organzied, use quicken for personal and quickbooks for business, I keep all my receipts.  The auditor was impressed.

 

The last item to be audited was my bank statements in which I had to explain "excess deposits".... I was easily able to do this, with one exception.... I found a deposit for a personal item I sold and I think I may have needed to report it.

 

Here is the twist, in 2004 I sold a diamond engagement ring for 10,000, I paid 9,000 for it and have the receipt and check I used to pay for it.  I purchased the ring in 2000.  In 2001 I started my company, a jewelry company (sole proprietor).  How do you think the IRS will handle this... capital gain, business income, or other?

 

Appreciate your opinion.

A:

What is a little strange about the way in which you describe your audit is the order of events.  It's been my experience that the auditors normally begin with an analysis of bank statement deposits and then branch out into other areas.

Either way, it appears that your auditor did find an unreported sale that does need to be added to your 1040.

If you weren't in the jewelry business, a good case could be made for treating the ring sale as a long term capital gain of $1,000, with the lower tax rates applicable for it.

However, since you have been in the jewelry sales business for a number of years, this one should be added to your Schedule C; $10,000 added to gross sales and $9,000 added to Cost of Goods Sold.  This will potentially increase your regular income tax plus SE tax.

While your Quicken and QuickBooks may have impressed the auditor, it should concern you that $10,000 slipped through the cracks and didn't show up in your yearly reports.  This flaw in your accounting needs to be corrected ASAP to avoid future such problems, which could just as easily go in the other direction; causing you to miss legitimate deductions. 

You may also have a sales tax issue to deal with if you didn't report that $10,000 sale to your state. One way to properly balance books and prepare tax returns is to reconcile gross revenues with what was shown on sales tax reports for the year.

From the way in which you described your books, I suspect there is a natural built-in flaw by using both Quicken and QuickBooks.  I'm assuming you are not incorporated; which means that you should have everything entered into one QuickBooks data file, with classes used to keep track of your different businesses and personal items.  Trying to keep track of things in two separate systems is a textbook recipe for items to slip through the cracks.  I have a lot of info on this on my website that you should check out.

My last comment has to do with professional assistance.  It sounds as if you are doing everything yourself without the aid of a professional accountant.  While this will obviously sound self-serving on behalf of my profession, that is a classic example of the "Penny Wise, Pound Foolish" maxim. Any good accountant should be able to help you reduce your taxes by several times as much as their fees, as well as help you stay out of trouble from such things as accidentally unreported income.

Good luck.  I hope this helps.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 8/27/2006 07:02:00 PM Send this post: