What happens when a taxpayer operates a cash based business and lacks adequate books and records according to the IRS? The IRS can use any reasonable method to reconstruct the taxpayers income and expenses. (See, Estate of Rodrigo F. Fenta, et al. v. Commissioner, TC Summary Opinion 2015-4 )

In the opinion the court states the applicable rule:

“Taxpayers are required to maintain such “permanent books of account or records, including inventories, as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of such tax or information.” Sec. 1.6001-1(a), Income Tax Regs”

Where the taxpayer fails to maintain adequate books and records the court stated:

“When a taxpayer fails to keep adequate books and records, the Commissioner is authorized by section 446 to reconstruct the taxpayer’s income using any reasonable method”

There is an enormous temptation among operators of cash based businesses or businesses that pay expenses in cash to minimize reported revenue or overstate legitimate expenses to hide the cash receipts or payments.

In particular, some cash based businesses have difficulty opening or maintaining bank accounts so they must conduct their affairs in cash. That necessity does not excuse the taxpayer from maintaining books and records that meet the following test:

“The records must “include the taxpayer’s regular books of account and such other records and data as may be necessary to support the entries on his books of account and on his return”

The risk to taxpayers who fail to maintain adequate books and records ranges from additions to tax and a 20% Accuracy Related penalty to civil fraud penalty assessments of 75% and of course, prosecution.

If a taxpayer has failed to adequately report cash based income and expenses and wishes to come forward and avoid prosecution and possible asset seizure, then we at MillarLaw can help.

Depending on the nature of the tax, (such as sales and use, or income tax) and which taxing agency is involved, various alternatives programs are available. We can help you evaluate how to come forward and the best method to use.