A local construction company, seeking to expand their business, went to their long-time banker to apply for a loan. To their surprise, the bank could not approve their loan application. Why did this happen? The Company’s business was good, they were current on their bills, and they had recently acquired a significant amount of heavy equipment with the cash flow that was coming in.
The bank stated that the denial of the loan application was due a substantial loss shown on the Company’s latest income tax return. Because this “tax” loss bewildered the Company management, their banker recommended that they pay a visit to Berry Talbot Royer.
BTR poured through this tax return and instantly found the source of the “tax” loss. It turns out that the Company’s tax preparer never reported their “work in process” as a company asset. The result of this omission was an understatement of the Company’s net income by over $300,000 over the previous five years. By not including the work in process at the end of each year, the Company’s profit in each of these years disappeared from their tax returns. From these incorrect returns, the bank reasonably concluded that a company without profits was not a good loan risk.
Of course, the IRS frowns on underreporting net income on a tax return. To make matters worse, the IRS can go back three more years, and assess additional penalties, when the underreporting is more than 25% of gross receipts. After an IRS audit, the Company could have really had a net loss due to the additional tax penalties.
To make matters worse, omitting the work in process did not save one nickel of taxes for the Company or its shareholders, as tax losses can only be taken up to a shareholder’s investment in the company, or to offset future net income.
The Company managers told BTR that they had used this tax preparer because their fees were low. By trying to “save a little money” on their tax preparation fees, the Company received the following results:
- A denial of a bank loan that would be used to grow their business
- A tax loss that did not save any taxes
- A tax bomb that the IRS could set off at any time
Fortunately, BTR was able to amend the affected returns to include the work in process. Not only did this “defuse” the IRS tax bomb, it also gave the Company’s bank the information needed to approve their loan application.
This is yet another example of “Cheap can be very expensive”. At BTR, we believe that professional knowledge, accuracy, and client education are the cornerstones of a successful relationship and outstanding results for our clients. Give us a call to see if your “cheap” tax preparer is actually “very expensive”.