Surviving a Salon or Spa IRS Audit – Cash Really Counts
When you get a letter like this from the IRS, they’re not sending you a birthday card.
I was lucky enough to be selected for an IRS audit of my salons. This happened not because they found any problems on my return, but instead, our salons were chosen as part of a Market Segment Specialization Program (MSSP) study. The IRS was updating their information on how to audit “beauty businesses”. This information was then distributed to IRS agents throughout the United States. The IRS also chose two other salons in the area for the study, a 6 chair salon and a 2 chair salon (those lucky owners!).
The IRS agent was a pleasant gentleman and certainly not what I expected. He was polite, professional and had a sense of humor. During our first meeting he stated, “We are not auditing you for anything you did wrong. You just happen to fit the model of a salon we need for our study.”
When my accountant and I sat down with the IRS agent, he made it very clear what they were looking for. These are the exact words from the IRS agent:
- Do you have any staff classified as 1099 employees?
- Do you rent any of your chairs?
- Do you claim employees’ tips in the business?
- Do you claim all of your revenue … including cash?
- Are you properly spending the money that comes into the business … not running personal charges through the business?
- Do you have any illegal operations that you are flushing cash through the business in order to make the cash clean?
- I found this question really amusing, but totally understood why it was asked.
The IRS agent then went through a 50+ question survey.
I was surprised by the questions and, at times, felt they were a bit too personal … but the agent was just doing his job. Questions included:
- Do you have a safety deposit box?
- How often do you go to your safety deposit box?
- Who enters data in QuickBooks?
- Who makes the bank deposits?
- What forms of payments do you accept?
- Do you ever barter services with other businesses?
- Do you have any hobbies and what do you do in your spare time?
For the next several months, the IRS agent and my accountant went through our QuickBooks, point-of-sale software and every bank statement … both business and personal.
Looking at revenue generated, expenses, how employees were on payroll, withholding taxes collected and how we handled tips. There were many additional requests for information and supporting documents including copies of invoices and receipts.
Lastly, the IRS came to the salon and did an inspection. Yes … the IRS walked through my business room by room. He was nice enough to not have his badge out during the walk-through. The agent wanted to verify that what we reported on our tax returns was actually happening in our business. He also wanted to study exactly how salons work.
So … what was the end result of our audit?
The IRS found a small discrepancy related to an inventory error and my accountant sent me a very nice large invoice for the audit. If we were not prepared, it could have been much worse.
Here are six No Compromise Leadership practices to be prepared for an IRS Audit:
- Hire your employees and pay the taxes: The first thing the IRS looks for in the beauty business are employees being paid on 1099’s to avoid payroll taxes. The IRS regards 1099’s as a major red flag.
Do not put an individual on 1099 that is actually an employee, has a set schedule, wears your company’s name tag, has a company business card and cannot work for other companies.
Shifting the tax burden to an employee is just plain wrong. Furthermore, if the IRS determines that you misclassified any employees, you could owe years of back Federal taxes plus interest and penalties.
- Claim all tip income: To the IRS, tips are income earned at work and subject to income tax. Strategies advises that tips added to credit cards go directly into your employees’ paychecks. The added bonus for your employees is when they apply for loans. Tip income that is claimed is counted towards overall income, providing lower interest rates and the ability to purchase nicer homes and cars.
- Deposit all your cash into the bank: No skimming cash. If you think you're going to get away with hiding the cash during an audit … you're wrong. I watched the IRS agent go through my cash register receipts day-by-day and then compare those cash receipts to our bank deposits. Next, the agent compared the supplies we purchased and the number of employees that we had. His computer was buzzing away with all sorts of mathematical algorithms. The IRS has a total understanding of how cash income moves through a salon/spa. And they know that many salons/spas attempt to hide it.
- Keep detailed records and receipts: The process of preparing for an audit is intense and long. The IRS wants to see the paper trail on everything. It can take weeks to gather all the requested documents if you are not organized. The burden is on the salon/spa owner to prove that February trip to Catalina Island, California truly was business related.
- Booth Renters must comply with all the Federal Tax Codes: Too often, booth renters feel that cash does not count. Well it does. Not claiming cash revenue is called “Tax Evasion” and it is a crime … enough said. The misconception of "I get to keep EVERYTHING I bring in" as a booth renter is just that...a misconception.
- Work with a great accountant: Your accountant should know how to work with the IRS and handle audits. You need to work with your accountant to ensure you are fully compliant with tax law and, should it occur, that you’re prepared for an audit. A good accountant will advise you on how to correctly run your salon or spa to comply with the Federal Tax Code.
Too often salon and spa owners try to go it alone. The Federal Tax Code is complicated. Owners need to have an accountant who can navigate it and ensure you are complying.
Lastly … if you do get audited, have the audit take place at your accountant’s office. They are best to handle the process. Keep the audit out of your business or at the IRS office.
Here is my challenge to you: Run your salon/spa as if it was going to be audited tomorrow. Find a qualified accountant and start to implement the above No-Compromise Leadership audit practices. Let me know how you make out at [email protected]