IOBA Standard - book Selling On the Internet

Book Selling on the Internet Part 2

By Pat Ahearn

In the US, if IRS comes calling, you can never have too many business
records. I would think that this same rule would apply to all countries.

When Allen and I were audited a number of years ago, our accountant's advice
was to drown them in paper. In other words, have documentation for
anything they had a question about. Her words saved us $45,000. We were
flagged for audit because we closed our open shop and began to operate from
our home. In order to be able to have room to run our business from home, we
added a 2-story library with a cat-walk around three sides. Since our
children were grown and not living at home, we lined their old bedrooms with
bookcases and were using them as offices for our catalogers, a wrapping
room, etc. Our basement family room was lined with bookcases and we wrote
that off as well. We claimed 50% of our home as a write-off (we were
actually using more) and that brought up the red flag.

I remember well the day the two auditors showed up at the front door. I was
greeted with Congratulations, you have won the lottery, unfortunately, it
is the tax lottery. Funny, huh? Just what we needed - an IRS comedian. They
were there to do an on-site global audit on all our records for three years.
This global audit was an option that IRS could arbitrarily determine. It was
a true lottery in that the IRS would just pick someone who came up for some
individual question and do a global audit. This meant that they wanted to
see every piece of business-related paper. Over the course of a year, the
auditor spent 175 hours going over our records and in the end decided we
owed the government $60,000 in additional taxes. To make a long story short,
we appealed and ended up paying the government $15,000.

We won a number of points because the auditor was new and making some very
basic mistakes. The auditor informed us that we could not write off our
library in its entirety because a picture had been seen of our grandchildren
gathered around a Christmas tree in the library. We also had a small bar
built into one corner, and we didn't have bookcases on all four of the
walls. Appeals ruled that "incidental use" was allowed in the library, and
accepted that it was hard to put bookcases against a wall which had a
12-foot wide sliding door in it and a circular staircase next to the doors.
We won the point because the IRS Appeals Officer had offered us a
beverage while in the IRS office and we pointed out that was why we had a
bar in our library so we could offer our visitors a beverage. The auditor
also said we couldn't write off our basement book room (even though there
were over 3,000 books shelved there) because our daughter's exercise bicycle
was stored in the room. The Appeals Officer just laughed at this one and
crossed it off.

IRS measured the space we were using and gave us a 54.8% write-off of our
house instead of the 50% we were claiming that had triggered the audit in
the first place. A fact that we delighted in noting on our tax forms for
rest of the time we were in that house ("54.8% as determined by IRS
auditor").

Where we lost was on how we were writing off our book purchases. We were
using a cash basis (and had been for the previous 25 years) which many
bookdealers also use. IRS required that we use the accrual method. Accrual
requires that you account for both expenses and income at the time they are
billed. Cash basis meant we recorded expenses when we paid them and revenue
when payment was actually received. So, if we had sold books in December
that weren't paid for until January, we counted them in the next year's
sales. IRS said we couldn't do that because their rules state that if you
maintain an inventory you must use the accrual method. That meant that even
though we didn't get paid until the next year, we had to include those
orders in our sales for the current year.

However, we won on a couple of big points when they were readjusting our
taxes from the cash basis to the accrual basis. The auditor had moved back
cross-over sales (in the auditing period) from the year they were paid to
the year the invoice was written. Since they were only auditing for three
years, the auditor argued that we should pay taxes on what they moved but
not be given credit for the year previous to the audit period, thus
inflating our sales for one year. Also, even if you haven't paid the debt,
under the accrual method you can write-off expenses the year they are
billed. The auditor didn't want to give us credit for those expenses.
Appeals said they had to give us the credit.

We lost on a point we knew we were going to lose on all along. Because we
tend toward being obstinate when we feel something is obviously unfair, we
wrote off the health insurance policies we were supplying for two of our
daughters that work for us, as well as our own. Employee's policies can be
written off, our own could not because we weren't incorporated at the time.
The tax law has changed and you can write off some of the owner's insurance
now but it is a tax deduction that is being phased in over time. The write
off will eventually be a 100%.

We won on business travel expenses. The auditor said we couldn't write off
our daily expenses in states we visited on a cross-country book buying trip,
unless we bought books that day. The Appeals Officer agreed that just
because we couldn't find books we could mark up for resale that didn't mean
we weren't conducting business. Therefore, if we had evidence of having been
in a shop in a particular state (we had business cards from the shops we had
visited) or had to drive through one state to get to a state where we could
do business, we could write that day's expenses off. The auditor also said
that we couldn't write off a trip if we stayed in someone's home instead of
staying in a hotel or motel room. We argued that if we had a friend in the
same town where we buy books, the IRS should be glad. The Appeals Officer
agreed and also agreed that we could write off the dinner we bought our
friends for their hospitality.

We talked to three or four dealers that had been audited in other states and
they were also initially told that they would have to change from the cash
basis to accrual. At the end of their audits, their auditor's said they
could stay on cash basis as long as they were consistent but we weren't so
lucky.

All in all, we came out smelling like a rose when you consider the
adjustments involved in changing us from cash basis to accrual. The good
news for everyone is the "kinder and gentler IRS" global audits are no
longer done, at least on an arbitrary basis. They can still do line-item
audits. But, it's important to keep in mind that because you never know
which line they are going to question, you will need exhaustive records to
back you up.

Records to keep for tax audit

- Supporting documentation for business-related expenses, including all
checks written, credit card charges, and cash receipts.

- All bank statements. IRS looks at these to see if your deposits are in
line with what you are reporting as income (in other words, don't claim
$300,000 in sales and deposit $400,000).

- All receipts for any fixed business assets (e.g. bookcases, desks and
chairs, computers, copiers, mailing scales, etc.)

- All sales invoices you have issued to customers.

- All sales-tax reports. Resellers are required by most States to collect
and file sales tax reports.

- Resale tax numbers. You should have Resale Tax Numbers for all in-state
customer on invoices where you have not charged tax. While we understand
that this is not always easy, your State's tax office probably will not be
quite as understanding.