TAX RETURN GONE WRONG
We all make mistakes at work. If we're any good, and if we take care, we probably don't make many. And we hope that the few mistakes that slide through are never recognizedso we can get away with a mistake. And we hope that if Someone Else catches a mistake, nobody gets hurt.
When it comes to professional Tax Preparation, the worst mistake is the one that IRS catches that no one saw coming. I want to tell you about a big one we saw last month, and then talk about what happens when Someone Else catches the mistake.
Almost everybody who operates a small business stands behind their work. Their reputation is built on honesty and integrity, especially when things dont work out the way they should.
The business owner who stands up and says, I blew it, but I'll make it right is the one who ultimately wins, not the owner who says, I'll get it right every time.
I'm telling this story on someone else, not here in York County, and thoroughly disguised so you can't possibly tell who it is. And I'm telling it as someone who has never been able to get through a Tax Season without saying to someone, I blew it, but I'll fix it.
This is a story about what can happen when things go wrong, and Someone Else catches the mistake.
Here goes. Way back in 2003, a successful businessman buys a fairly good-sized business. Actually, he buys the assets of the business, rather than the business itself, which is the right way to do it.
The business is worth more than the assets, though, and he pays way more than the assets are worth, which is also the right way to do it.
And he engages a well-respected and experienced accounting firm to do the accounting, which is also the right way to go about things.
And here's where things go wrong.
The assets that he purchased will be depreciated according to various schedules, which is what was done. Fine so far.
The difference between what was paid for the business and the value of the assets is called Goodwill, and in this case Goodwill was about half the price of the business.
Goodwill doesn't mean that the previous owner was universally loved and respected in the community. It is just a commonly accepted legal and accounting term that recognizes the intrinsic or inherent value of a business that is present but can't otherwise be measured.
Goodwill is amortized which is similar to depreciation. Divide the Goodwill, which in this case was about $325,000 (not the real value) by 15 years, and you've got the annual amortization expense that could be claimed on the tax return. Over $21,000 per year.
OK, so here it comes. That Goodwill has never been amortized in 7 years. 7 times $21,000 = $147,000 of missed expenses, which is another way of saying too much profit and ultimately too much tax.
How's that for a mistake? No one writes a check for Amortization, so it just got lost in the transition from the accounting to the tax return, and it's just been sitting there for all these years. And this is a reputable and long-established firm, which just goes to show that We All Make Mistakes.
There's a way to fix all this so no long-term harm will come to the Owners. It's a little complicated, but not too bad.
Let's talk about the Someone Else who found this issue. In my world, the worst Someone Else you can have is called the Internal Revenue Service. How would you like it if you were subpoenaed to explain a $147,000 error in your tax accounting?
In this case, the error is in the IRS's favor, so they're not likely to come calling. They like things the way they are
The second worst Someone Else to find a mistake of this magnitude is the attorney who is suing you for some problem unrelated to the accounting error. A charge of fraud or negligence is surely not far behind.
The best Someone Else to find this mistake is the Owner. Owners are not expected to have the knowledge and insights of an accountant, but I think its reasonable for the owner of a $3 million dollar business to ask why the Goodwill value remained the same year after year. That question would probably have done it.
We all make mistakes, and sometimes somebody gets hurt. That's when you find out about character and integrity.