Sch C Sales Tax audit 2 years after it was closed. Is payment a deduction

[DMICPA]

New Client operated a building cleaning service on Sch C. for several years.

Client closed business in 2010 and took a W-2 job full time and gave up the cleaning business.

Client had sales tax audit on closed business in 2013. Sales Tax Board in Iowa said services of this type are taxable for Sales Tax purposes.

Client paid $1,400 in Sales tax in 2013 to close out audit.

Now I am preparing the 2013 taxes and I am thinking that this is a business deduction. I would again file a Schedule C and deduct the payment minus penalties.

It is a post closing expense directly related to the trade or business.

Does this sound plausible?

[Uncle Sam]

Sales Tax Assessment

I would base the decision on what the nature of the tax increase was due to.
Was it a change of gross sales or only taxable sales?
Was part of it purchase use tax?

It may be that you'd need to amend the tax returns of the year(s) involved
that would adjust gross sales and to be "accruing" the tax liability-since it's
presently still within the three year statute period of the earliest year.
So the liability of the additional tax wouldn't be a current deductible item.

[taxxcpa]

In Texas the tax is usually 8.25% which includes 2% local tax. If someone sells a taxable item for $ 1000 and does not break down the price for the item sold and the tax, the proper procedure is to assume $1000 is 108.25% of the item's price, so you divide $1000 by 1.0825 and consider the sale as $923.79 and $76.21 as tax.

If he never charged tax, then you could amend the return to show the reported sales mistakenly included the sales tax.

[Koss]

Cash or Accrual?

Uncle Sam's proposal, to amend the Schedule C for the year in question, certainly seems reasonable, and, at first glance, more appealing than filing a 2013 Schedule C for a business which supposedly no longer exists.

But if the business used the cash method of accounting, it doesn't feel right. The sales tax was not actually paid in 2010; it was paid in 2013.

Which brings me to this observation:

Schedule C has a box to check when it is the first year for the business. However, unlike Form 1065 and Form 1120, Schedule C does not have a box to indicate that it is the final year. And there is a reason for this.

You can't dissolve a sole proprietorship. And you can't sell it, either. You can sell the assets, but you can't sell the sole proprietorship itself. A sole proprietorship, by definition, cannot be separated from the individual who operates it.

The taxpayer in this case may have "closed his business" in other ways. He may have cancelled his "doing business as" name registration with the state, and closed the business bank account. He may have even closed his sales tax account with the state. But that didn't stop the state from conducting an audit, and holding him personally liable, for precisely the same reason: the individual is the sole proprietorship.

The sole proprietorship may have stopped doing business. But that does not necessarily mean that it ceased to exist for federal tax purposes.

Suppose he decided to start up the business again. Would he have to get a new EIN? Absolutely not. An EIN is never "cancelled" by the IRS.

If it was a corporation that had been formally dissolved under state law, that would obviously be very different. But that's not what happened here.

I would probably take the position that the sole proprietorship, under federal tax law, never ceased to exist; it simply ceased operations, and had no income or expenses to report for a couple of years. However, in 2013, technically speaking, there was some economic activity, and an expense was incurred. So I would probably go ahead and file a Schedule C to report the sales tax paid during 2013.

FYI: I recognize that this particular sole prop may not have had an EIN. That doesn't matter, and it only strengthens my argument. A person can have two or more sole proprietorships, with different business activities, with no EIN. You can file multiple Schedules C, with only your SSN on each one, and never apply for an EIN if you don't have employees. The sole proprietorship is the individual. It is not a separate entity. It cannot be "closed" or "dissolved."

Unless the person dies, of course.

Which allows me to draw another analogy. Homemakers and college students often have one year where they have to file a tax return, followed by another year where they had no significant income, and no filing requirement. But that doesn't mean that the individual ceased to exist for tax purposes. The fact that they did not file a return for one year does not make the previous year their "final return." [LMAO] The next year, if they have income, they simply file a tax return for that year. They don't have to get a new SSN.

Same goes for Schedule C. One year you have it, next year you don't. And then you can have it again, when it becomes applicable.

BMK

[taxxcpa]

Uncle Sam's proposal, to amend the Schedule C for the year in question, certainly seems reasonable, and, at first glance, more appealing than filing a 2013 Schedule C for a business which supposedly no longer exists.

But if the business used the cash method of accounting, it doesn't feel right. The sales tax was not actually paid in 2010; it was paid in 2013.

BMK

Although you can't deduct a 2010 expense paid in 2013, I would consider the sales tax as a tax payable (liability) which had been misclassified as sales. Whether you are on a cash basis or accrual basis, money collected for sales tax is not income nor is it an expense when you pay it. The only argument I could see to this concept would be that he didn't consider it to be partly sales tax when he collected it. But, according to the auditor, he owed it and it has to come out of the same pocket it went into.

[Uncle Sam]

Sales Tax Assessment

As I first posted - from what does the sales tax audit assessment come from?
An increase in gross sales? An increase in taxable sales - not effecting gross sales?
Purchase use tax - that has no effect on sales?
Combination of all the above?
If related to sales, then it's a hidden liability that existed for the period assessed,
trust fund money - so no deduction is in order.
If purchase use - then it's an add-on cost to items already expenses (and or
depreciated).

Until the source of the additional sales tax is known - no reliable answer is possible.

[ATSMAN]

I agree with Burton Koss's logic and I did some thing similar few years back when my client who "ceased operation" because he started working for someone as a plumber got sued 2 years after he filed a schedule C from a project that he worked on before and incurred substantial legal fees. Did a Schedule C with 0 gross income and I think $14K in legal expenses and so far no audit. It has been 3 years I think.

[DMICPA]

I am the Guy

I ended up just reinstating the Schedule C and calling it post closing expenses after discussing it with the client. This happened many years ago on another client and we deducted it and there were no notices from the Federal or California.

For some reason, I did not get an email response to read all of your answers so I figured you just went on to something easier. I do not know why I did not get a response to my email. I always have in the past and wait for your seasoned responses before me doing anything.

I was so glad for all of your responses. They really make a difference.

Now I base my actions on the will of the client. If the client is not 100% willing to do a particular action, I don't do it as the client is the primary responsible party for the return. Each client has a tolerance as to what and how much they believe in the deduction or other course of action. Some clients would never do anything that could remotely be questioned whereas other clients want to push the envelope and defend a reasonable position. In this case, the client knows the risks and knows the tax effects and since it is a reasonable position, the client agreed to list it on the return for a tax savings of slightly over $300 bucks.

Thank you for taking the time to help me.

[taxea]

what year was the audit for? Should that year have been amended?

[Burke]

As I first posted - from what does the sales tax audit assessment come from?
An increase in gross sales? An increase in taxable sales - not effecting gross sales?
Purchase use tax - that has no effect on sales?
Combination of all the above?
If related to sales, then it's a hidden liability that existed for the period assessed,
trust fund money - so no deduction is in order.
If purchase use - then it's an add-on cost to items already expenses (and or
depreciated).

Until the source of the additional sales tax is known - no reliable answer is possible.

My take on the OP was that he simply did not collect the sales tax at all and that the Tax Dept determined he should have. So he had to pay it himself out-of-pocket. Therefore, it appears no change is due on prior returns. And he has a business expense for 2013. Sche C. Taxcpa's response regarding adjusting the prior sales downward on an amended return is a tactic I had not considered. If he were to do that, then there would be no current deduction, obviously. Is it worth the trouble? These audits often cover more than one year's operations.