AccountingIRSTaxes

Why small business taxpayers must use QuickBooks

Note: Throughout this post the term “QuickBooks” means any electronic accounting system, not specifically the brand name product. There is evidence, as cited in the story, that the market dominance of the branded product has caused the term to be used to describe a class of electronic accounting products. I am accredited with QuickBooks and several other accounting systems but the use of the term is not intended as an endorsement of the product.

Yesterday I was engaged for more than 80 minutes on the telephone with an Internal Revenue Service agent about a small business taxpayer matter that is headed for tax court. My job is to attempt to reach a reasonable settlement prior to the trial. Trials are a waste of time and money for both the taxpayer and the government. The goal is simply to get a settlement offer on the table so that I can then work out payment arrangements to allow the taxpayer to get back on track.

In this case, the tax issues are straightforward and the taxpayer admits fault for not keeping a concurrent travel log in his automobile and for not keeping detailed concurrent records of his travel and meals expenses aside from the receipts. The taxpayer incorrectly assumed that receipts and credit card statements were sufficient. As we (tax accountants) say again and again, that is a false perception. IRS can and will deny these deductions without concurrent expense logs. So I thought that be conceding this point we could be on our way to a settlement discussion.

But the stumbling block in our settlement discussion came when the IRS agent pushed his questions about the taxpayer’s record-keeping methods and other accounting methods. He asked for QuickBooks electronic accounting records several times, as had an early agent working on the case. QuickBooks records do not exist. The taxpayer uses paper receipts and bank statements to compile his tax records. Legally, there is nothing wrong with the taxpayer’s method. But that does not prevent the IRS agent from being skeptical and offering resistance to settling the examination. I said several times that I was willing to trace any transaction that comes into question, but the IRS agent made it clear that he is not willing to do that.

In this case, it turns out, the taxpayer’s records are accurate. He just can not afford to go to court to prove it if the IRS remains skeptical. As unfair as it may be, the IRS may use the cost of litigation as a weapon in refusing to make a settlement offer.

This is not the first time I’ve run across this issue. IRS agents distrust unprofessional accounting methods and are often unlikely to even look at the taxpayer-prepared information, regardless of the law. The distrust can lead to lack of cooperation in negotiating a settlement. Sometimes the IRS is simply unwilling to make a settlement offer; I also found that to be the case in an earlier tax court case.

My point is this: there is no law saying that you must use QuickBooks for your small business tax reporting. It is legal to rely on bank statements and handwritten accounting records. Unfortunately, if the IRS opens an examination, your accountant can not defend your lack of electronic records and you likely can not afford to pay for a tax attorney to argue your case in court that paper records are legal.

I am aware that other tax professionals disagree with my position. I’ve heard “I fought and won” many times. But there are likely far more unspoken examples where the taxpayer lost. In most cases I see where the amount in dispute is less than $50,000, the potential tax savings are simply not worth the cost of the fight.

My conclusion, based on this and other recent experiences, is that going forward, I will only accept tax representation work where there are appropriate QuickBooks records or where the engagement agreement specifies that the lack of such records is acknowledged as a risk that may render the entire effort mute and ineffective. With the wholesale cost of QuickBooks being only about $20 per month and the bank services that populate the accounting records are mostly free, there is simply no reason to not use this system of record-keeping.

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