How the IRS Audits Income for Cash Businesses

A person with a calculator and magnifying glass looking at an invoice

The IRS Has Several Methods for Figuring Out Cash Income

When treasury agents get the scent of unreported income in their nostrils, they always use a variation of the good cop-bad cop routine. Sometimes before they even drop the A-word, IRS auditors begin asking seemingly friendly questions about perceived income discrepancies. If they do not get the answers they like, the IRS will use their own methods to figure out how much income your cash business received (including marijuana businesses).  Read on to find out how the minimum income probe works.

The MIP is more of an audit method that’s been fine tuned over the years. Agents examine the business income records and compare those numbers to things like spending patterns, financial history, wealth accumulation, and access to nontaxable funds. In some cases, an auditor may even inspect a taxpayer’s home, especially if the taxpayer has a home office. More commonly, an auditor will drive through the neighborhood to see how well the target keeps up with the Jonses.

Cash-T Analysis

The above queries are the first step in a Financial Status Analysis. If this cash business audit tool does not reveal a significant income discrepancy, the IRS usually either limits the audit or cancels it altogether. But as one might expect, that’s very rarely the case. Instead, the agent usually schedules a highly confrontational meeting that will last at least two hours. Some common questions include:

  • How many times do friends or relatives “sample” the goods at the marijuana dispensary, and do these transactions appear in the inventory reports?
  • Do you receive any perks from suppliers for large or repeat orders, such as prizes, vacations, or merchandise discounts?
  • What’s the time delay between cash transaction and cash report (the longer the delay, the higher potential for skimming)?
  • Do you have a rainy day cash fund?

If any of these questions sound uncomfortable, be sure you have a lawyer present during this meeting.

The Business Tour

During this phase, the auditor verifies the answers the owner gave during the interview. If employee actions do not jive with the owner’s assertions, expect more questions and expect them to be even more pointed than before. During this stage of the cash business audit tool, the agent is usually only concerned with cash transactions. That includes things like the make and model of the cash register, the size and location of the vault, and so on.

When they learn of an audit, many owners lower their prices, so the income discrepancy will not look as bad. The IRS is wise to this trick, so don’t try it.

Concluding the Cash Business Audit Tool Report

Each Minimum Income Probe basically consists of two information-gathering phases and several verification stages, including:

  • Evaluating income controls to determine the reliability of the taxpayer’s records,
  • Reconciling the income to the books,
  • Analyzing financial accounts, and
  • Examining e-commerce activity.

If the auditor determines that you did not report all your cash income, the audit proceeds to the next step, which usually involves one or more indirect income reconstruction methods.

Venar Ayar, Esq.

Venar Ayar, Esq.

Attorney-at-Law, Master of Laws in Taxation
Principal and founder, Ayar Law

Venar is an award-winning tax attorney ranked as a Top Lawyer in the field of Tax Law. Mr. Ayar has a Master of Laws in Taxation – the highest degree available in tax, held by only a small number of the country’s attorneys.