IRS Course Material

Cosmetology and barbering industries are regulated at the state level by boards established for that purpose, and most states have laws and rules that regulate each industry. Although state laws and regulations may be helpful to an IRS examiner in analyzing the facts, the examiner is not bound by state regulations.

Which are you? Are you an owner, an independent contractor or booth renter, or an employee? For federal tax purposes, this is an important question. Worker classification affects how you pay your federal income tax, social security and Medicare taxes, and how you file your tax return. Classification affects your eligibility for employer and social security and Medicare benefits and your tax responsibilities. If you aren't sure of your work status, you should find out.

The courts have considered many facts in deciding whether a worker is an independent contractor or booth renter, or an employee. These relevant, and very important, facts fall into three main categories: behavioral control; financial control; and relationship of the parties (defined later under the section, "Employee or Independent Contractor"). In each case, it is very important to consider all the facts - no single fact provides a clear answer.

When You Are an Employee

Your employer must withhold income tax and your portion of social security and Medicare taxes. Also, your employer is responsible for paying social security, Medicare, and unemployment (FUTA) taxes on your wages. Your employer must give you a Form W-2, Wage and Tax Statement, showing the amount of taxes withheld from your pay.

You may deduct non-reimbursed employee business expenses on Schedule A of your income tax return, but only if you itemize deductions and they total more than 2% of your adjusted gross income.

When You Are an Independent Contractor

The business may be required to give you Form 1099-MISC, Miscellaneous Income, to report what it has paid to you. In addition,

· You are responsible for paying your own income tax and self-employment tax, SECA (Self-Employment Contributions Act).

· You may need to make estimated tax payment during the year to cover your tax liabilities.

If you are not sure whether you are an employee or an independent contractor, get a copy of, and file Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

Publication 15-A, Employer's Supplemental Tax Guide, provides additional information on how to determine worker status by defining the following, "Who Are Employees", Independent Contractors, Common-Law Employees, and Misclassification of Employees.

Who Are Employees?

Before your can know how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be an independent contractor (booth renter), or a common-law employee.

This section explains these two categories. A later discussion under "Employee or Independent Contractor" points out the differences between an independent contractor (booth renter) and an employee, and gives examples.

Independent Contractors (or Booth Renters)

In cosmetology, whether people are employees or independent contractors depends on the facts in each case. The general rule is that an individual is an independent contractor if you, the employer, have the right to control or direct only the results of the work and not the means and methods of accomplishing the results.

Common Law Employees

Under common law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed. A discussion of facts that indicate whether an individual providing services is an independent contractor or employee is included later in this booklet under "Employee or Independent Contractor."

If you have an employer-employee relationship, it makes no difference how it is labeled. The substance of the relationship, not the label, governs the worker's status, nor does it matter whether the individual is employed full time or part time.

You generally have to withhold and pay income, social security, and Medicare taxes on wages you pay to common law employees. However, the wages of certain employees may be exempt from one or more of these taxes. Exempt employees would normally be found working in shops established in not-for-profit institutions such as a public school or clinic, or in a facility operated by a religious organization.

Misclassification of Employees

Consequences of treating an employee as an independent contractor. If you classify an employee as an independent contractor, and you have no reasonable basis for doing so, you may be held liable for paying employment taxes for that worker. A reasonable basis protects you, and entitles you to relief provisions.

Relief Provisions. If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker. To get relief, you must comply with the following:

· File all required Federal information returns consistent with your treatment of the worker as an independent contractor, and

· You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977.

Employee or Independent Contractor

An employer must generally withhold income tax, pay social security and Medicare tax, and pay unemployment tax on wages paid to an employee. An employer does not generally have to withhold or pay any taxes on payments to independent contractors (or booth renters).

Common Law Rules

To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business is examined. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence is considered.

Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship of the parties.

Behavioral Control

These facts show whether there is a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done, as long as the employer has the right to direct and control the work. For example:

· Instructions - if you receive extensive instruction on how work is to be done, where, and when, this suggests that you are an employee. The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. The key consideration is whether the business has retained the right to control the details of a worker's performance or instead has given up that right.

If you do not receive detailed instructions about what should be done, or how it should be done, you are, most likely, an independent contractor.

· Training - if the business provides you with training about required procedures and methods, this indicates that the business wants the work done in a certain way, and this suggests that you are an employee. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.

Additional facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of:

· When and where to do the work

Financial Control

These facts show whether there is a right to direct or control the business part of the work. For example:

·Significant Investment - if you have a significant investment in your work, you may be an independent contractor. While there is no precise dollar test, the investment must have substance. However, a significant investment is not necessary to be an independent contractor. An independent contractor often has a significant investment in the facilities and/or equipment he or she uses in performing services for someone else.

·Expenses - if you are not reimbursed for some or all business expenses, then you may be an independent contractor, especially if your non-reimbursed business expenses are high. Independent contractors are more likely to have non reimbursed expenses than are employees. Ongoing non reimbursed costs, such as electricity, water, rent, phone, that are incurred regardless of whether work is being performed are especially important in determining that an employee is an independent contractor.

·Opportunity for Profit or Loss - if you can realize a profit or incur a loss, this suggests that you are in business for yourself and that you are an independent contractor.

·Additional financial control - facts that show whether the business has a right to control the business aspects of the worker's job include:

The extent to which the worker makes services available to the public.

An independent contractor is generally free to seek out business opportunities. They often advertise and maintain a visible business location.

How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the worker's wage or salary is primarily earned via commissions. An independent contractor is usually paid a flat fee for the job.

Relationship of the Parties

These are facts that illustrate how the business owner and the worker perceive their relationship. For example:

·Employee Benefits - if you receive benefits, such as insurance, pension, or paid leave, this is an indication that you may be an employee. If you do not receive benefits, however, you could be either an employee or an independent contractor.

·Written Contracts - a written contract may show the intention of both you and the business owner. This may be very significant if it is difficult, if not impossible, to determine the status based on other facts.

·The permanency of the relationship. If you engage a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that your intent was to create an employer-employee relationship.

·The extent to which services performed by the worker is a key aspect of the regular business of the shop. If a worker provides services that are a significant part of the owner's regular business activities, such as hair, nails, and/or skincare, it is more likely that the owner will have the right to direct and control the worker's activities. And since the employee's work helps create the shop's reputation, the owner would have the right to control or direct that work.

INDUSTRY SPECIFIC DEFINITIONS

The following will cover a portion of the information discussed above, but will attempt to define the difference between an owner, an employee, and an independent contractor (booth renter) as they pertain to the cosmetology industry. Restating this information will also emphasize its importance. Your understanding of, and compliance with it will eliminate, to the greatest extent possible, any unwanted involvement with the Internal Revenue Service.

In addition to what you have read above, if the shop owner controls both the method and the result of services the shop offers, the owner is an employer. An employer is any shop owner who retains the right to exercise control over workers, even if they do not perform in that capacity, and gives the workers control of their work environment.

Although a variety of factors may be used to analyze employment status for tax purposes, the regulations provide that employer control over the manner in which the work is performed is probably the most important. The test is not the actual control by the employer but the employer’s right to control.

It is advisable, as early in the planning phase as possible, to declare what kind of shop to own, either one in which the owner will be an employer, or one in which the owner will be a landlord. A shop owner should not attempt to be both an employer and a landlord in the same shop.

A shop in which the owner becomes a landlord is one in which booth spaces are available for rent or lease. The owner/landlord status will be discussed in more detail under "Articles of Separation".

The person who reports to the owner and takes instructions and training from the owner as to the method and results of the services provided in the owner's shop is an employee. If the shop owner willingly gives up the right to control the employee's environment, the employee's status does not change. The employee does not become an independent contractor, nor is the owner relieved of any of his or her legal and tax obligations as an employer.

In some shops, written agreements may exist that spell out the terms between the owner and the people hired to work in the shop. Agreements will not supersede existing rules and laws that define the work relationship. They may, however, show what the intentions are of both the owner and the employee or booth renter. As stated earlier, a contract can carry significant weight when it is difficult to determine worker status based on other factors.

The employee might be called a partner, agent, or independent contractor, but if an employer - employee relationship isn't clearly defined, it doesn't matter what he or she is called, the non-compliant relationship will not be recognized by auditors. A worker must fit within one of the IRS recognized categories, either employees or independent contractors (booth renters). Whether an employer-employee relationship exists will be determined by IRC guidelines, or by long-standing common-law tests.

Common Law Rules - Restated

The following will further discuss work relationships in a shop or salon, and the employer's obligations under common law rules. The designation of an individual as an independent contractor or an employee is that important.

Once an audit examination of the employee vs. independent contractor issue is undertaken, section 530, where common law rules are found, will be addressed. The auditor uses this section to determine an employer's liability for employment taxes including FICA, FUTA, and income tax withholding.

Section 5309 provides that for employment tax purposes, an individual is not deemed an employee unless the employer had no "reasonable basis" for treating the individual as other than an employee. The purpose of section 530 is to protect employers who have a "reasonable basis" for treating workers as independent contractors from employment tax consequences.

For an employer to be eligible for relief under section 530, the following criteria must be met:

1. All required federal information returns must have been filed on a timely bases (such as Form 1099),

2. The employer must not have treated any other workers holding a "substantially similar position" as employees after 1977, and

3. The employer must have had a "reasonable basis" for not treating the workers as employees.

Employers need a "reasonable basis" for treating an employee as an independent contractor. Reasonable basis is relying on any one of the three safe havens under section 530:

1. Judicial precedent, published rulings, or a technical advice memorandum or a private letter ruling with respect to the taxpayer; or

2. Prior IRS audit of the taxpayer; or

3. Long standing recognized practice of a significant segment of the industry (“industry practice”) in which the worker is engaged.

If an audit is undertaken, the examiner will discuss with the owner the reasons the workers are treated as independent contractors.

The owner must have an established method of designating employee status, and a history to back up that methodology. A letter from a salon owner's attorney or CPA written after an audit begins is much less persuasive than one that was written when the employer first began using workers and treating them as independent contractors. Salon owners have the burden of proving that criteria used in designating workers as independent contractors is a "recognized and approved practice" of a large segment of barbering and cosmetology industries. By claiming, "it's the way our industries have always operated," isn't good enough. Owners must be able to substantiate their claim with proof in order to take advantage of "safe haven" relief.

The Independent Contractor (or Booth Renter)

An independent contractor is a person who usually rents a booth in a shop or salon. The booth renter is an independent businessman or businesswoman who is in control of his or her work environment and work products. And though the independent contractor status is complex, there are guidelines that can be used to establish and identify it. The following are criteria that, in addition to the guidelines stated earlier, can be used to categorize a worker as an independent contractor.

There should be a contract between the independent contractor and the salon owner that defines the parameters of the working relationship, and how the relationship can be terminated. A legal document should eliminate any guesswork on the part of the IRS as to the status of the working relationship. It will also eliminate, to the greatest degree possible, problems that might occur between the owner and contractor regarding the day-to-day operation of the business conducted in the salon or shop.

Articles of Separation

Articles of separation can also be significant indicators that help determine if a worker is an employee or an independent contractor. Articles of separation include taxes, contracts, advertising and marketing, insurance, retail sales, and general salon operation. Where a condition or a situation exists that might qualify as an item for separation and isn't found here, do not hesitate to call on your accountant or attorney to help you. This booklet is designed to provide you with helpful and current information, but it cannot replace expert advice, and we certainly do not recommend that it should.

There should be a contract between the landlord and the independent contractor or booth renter. It should be specific, precise, and address legal allowances according to existing codes. The SS-8 Form should be filled out by both the landlord and the booth renter. This will help protect both parties by showing that they are in compliance with applicable provisions of the Internal Revenue Code.

Booth renters or independent contractors are responsible their own federal, state, and local taxes, as well as obtaining their taxpayer identification number (TIN).

Booth renters must have, and show proof of, all business licenses including state, county and city licenses.

Booth renters must have their own sales tax number for product sales. This is required if you sell any products on which state and county taxes are collected.

Advertising and Marketing

Products used to advertise your business such as business cards, flyers, and brochures should be the sole responsibility of the booth renter. If the booth renter's landlord uses business cards, the booth renter's name should be at least as large as the name of the salon. Booth renters should do their own advertising in such places as the yellow pages, newspapers, promotions, etc. Salon owners can advertise for booth renters if they offer cooperative advertising.

Booth renters are responsible for their own liability and malpractice insurance, and should be required to show the salon owner or landlord proof of coverage. They are also responsible for their own health and life insurance.

Booth renters can sell their own products in their booth. Salon owners can also provide products to the booth renter, who, in turn, sells the products for the owner. When this is done the owner owes a commission to the booth renter for the resale of products, and the owner must give the booth renter a Form 1099 that reflects commissions paid.

General Salon Operation

Salon revenue is generated, primarily, from four sources: services performed, retail sales, booth rental, and tips. As will be discussed later, all businesses, large or small, need to keep good records. When an owner or independent contractor fails in this important area, there is very little hope that the business will survive long.

Service revenue includes the salon owner's revenue plus that of the employee. It can be broken down into the specific employee’s revenue and thus segregating the salon owner's. The salaries/wages of the employee are normally based on productivity, and productivity records are generally used to determine compensation. Compensation is based on a commission, a straight salary, or a salary/commission combination.

Retail revenue is based on Cost of Goods Sold (COGS). Most products are marked up 100 percent, according to IRS calculations. An examiner can take COGS and double the expense, which can then be used as a gauge for determining retail revenue. A second method for reconstructing retail revenue is based on commission. A common practice in the salon industry is to pay a 10 - 15 percent commission to the seller.

If the salon has all booth rentals, the salon owner is a landlord. An auditor will verify the available space and the amount that is occupied.

Of the four main revenue-generating sources, tips can be the red flag on tax returns. For that reason, the following information on tip reporting should be carefully noted.

Workers in the salon industry supplement their base compensation with tip income, and tips have been reported as high as 22 percent of gross sales. Today, average tip rates range anywhere between 7.5 to 15 percent. Salon owners may state that they do not receive tips and thus have a “0” percent tip rate. But, generally speaking, the IRS won't accept your word on this issue. If you do receive tips, and don't report them, the IRS has a formula that can prove their case, and prove you wrong. So beware, being forewarned is being forearmed.

All tips you receive are income and are subject to federal income tax. You must include in gross income all tips you receive directly from customers, tips from charge customers that are paid to you by your employer, and your share of any tips you receive under a tip-splitting or tip-pooling arrangement. Additionally, the value of non-cash tips, such as tickets, passes, or other items of value are also income, and subject to tax.

Reporting your tip income correctly is not difficult. You must do three things:

Keeping a Daily Tip Record

A daily tip record will enable you to report your tips accurately to your employer, report your tips accurately on your tax return, and prove your tip income if your return is ever questioned.

There are two ways to keep a daily tip record. You can either write information about your tips in a tip diary, or keep copies of documents that show your tips including credit card charge slips. You should keep your daily tip record with your personal records. You must keep your records for as long as they are important for administration of the federal tax law.

If you keep a tip diary, you can use Form 4070A, Employee's Daily Record of Tips. To get the form, ask the IRS or your employer for Publication 1244, Employee's Daily Record of Tips and Report to Employer. Publication 1244 includes a year's supply of Form 4070A. Each day, write in the information asked for on the form.

If you do not use Form 4070A, start your records by writing your name, your employer's name, and the name of the business if it is different from your employer's name. Then each workday, write the date and the following information.

·Cash tips you get directly from customers or from other employees.

·The value of any non-cash tips you get such as tickets, passes, or other items of value.

·The amount of tips you paid out to other employees through tip pools or tip splitting, or other arrangements, and the names of the employees to whom you paid the tips.

Do not write in your tip diary the amount of any service charge that your employer adds to a customer's bill and then pays to you and treats as wages. This is part of your wages, not a tip.

If you use an electronic system to record and report tips to your employer, you must keep a paper, or hard copy of all the records and reports.

Reporting Tips to Your Employer

·Your employer can withhold federal income tax and social security and Medicare taxes,

·Your employer can report the correct amount of your earnings to the Social Security Administration (which affects your benefits when you retire or if you become disabled, or your family's benefits if you die), and

·You can avoid the penalty for not reporting tips to your employer (explained later).

What tips are you required to report? Report to your employer only cash, check, or credit card tips you receive. If your total tips for any one month from any one job are less than $20, do not report them to your employer. Do not report the value of any non-cash tips, such as tickets or passes, to your employer. You do not pay social security and Medicare taxes on these tips.

How do you report tips? If your employer does not give you any other way to repot your tips, you can use Form 4070. If you do not use the Form, give your employer a statement with the following information:

•Your name, address, and social security number,

You must sign and date the statement, and keep a copy with your personal records.

Your employer may require you to report your tips more than once a month. However, the statement cannot cover a period of more than one calendar month.

When do you report tips? Give your report for each month to your employer by the 10th of the next month. If the 10th falls on a Saturday, Sunday, or legal holiday, give your employer the report by the next day following the days mentioned.

Penalty for not reporting tips. If you do not report tips to your employer as required, you may be subject to a penalty equal to 50% of the social security and Medicare taxes you owe on the unreported tips. The penalty amount is in addition to the taxes you owe.

You can avoid this penalty if you can show reasonable cause for not reporting the tips to your employer. To do so, you need to attach a statement to your income tax return explaining why you did not report them.

INFORMATION DOCUMENTS

Below are seven revenue-establishing sources that are found in shops. If an owner's or booth renter's tax returns are ever questioned, these are the sources an IRS agent will request and carefully examine during an audit. They are:

· Appointment books

During an initial audit interview, the agent will follow an interview guide that will help establish rental revenue, service revenue, how the salon owner's income is derived, whether or not retail revenue is generated, and whether the shop is an employee based operation or staffed with booth renters.

The best way to get along with an IRS agent is never have to officially deal with one. And when it comes right down to it, it's easy. Comply with the laws and rules governing taxes, and reporting procedures. Make good record-keeping and compliance integral parts of your business. If you do that, chances are very good that you will never be audited, but if you are, the records you produce that back you up will thwart the audit ─ dead in its tracks.

Once you make a decision to become a barber or cosmetologist, becoming familiar, as soon as possible, with all facets associated with making your business succeed will be the next thing you should do. In addition to obtaining your license and choosing the method in which you will operate, setting up and practicing a good record-keeping system is equally important.

Everyone in business ─ whether a shop owner, or an independent contractor or booth renter ─ must keep records. Good records will help you do the following.

Monitor the progress of your business. You need good records to monitor the progress of your business. Records can show whether your business is improving or what changes you need to make. Good records can increase the likelihood of business success.

Prepare your financial statements. You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors.

• An income statement shows the income and expenses of the business for a given period of time.

• A balance sheet shows the assets, liabilities, and your equity in the business on a given date.

Identify source of receipts. You will receive money from clients for your services and products. Your records can identify the source of your receipts. You need this information to separate business from non-business receipts and taxable from nontaxable income.

Keep track of deductible expenses. You may forget expenses when you prepare your tax return unless you record them when they occur.

Prepare your tax returns. You need good records to prepare your tax return. These records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statements.

Support items reported on tax returns. You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.

Kinds of Records to Keep: Except in a few cases, the law does not require any special kind of records. You can choose any record-keeping system suited to your business that clearly shows your income. The business you are in affects the type of records you need to keep for federal tax purposes. You should set up your record-keeping system using an accounting method that clearly shows your income for your tax year.

Your record-keeping system should include a summary of your business transactions. This summary is ordinarily made in your books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook (discussed later) is the main source for entries in the business books. In addition, you must keep supporting documents, explained next.

Supporting Documents. Purchases, sales, payroll, and other transactions you have in your business will generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain the information you need to record in your books.

It is important to keep these documents because they support the entries in your books and on your tax return. Keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.

Gross receipts. Gross receipts are the income you receive from your business. You should keep supporting documents that show the amounts and sources of your gross receipts. Documents that show gross receipts include the following:

Purchases. Purchases are the items you buy and resell to customers. Your supporting documents should show the amount paid and that the amount was for purchases. Documents for purchases help you determine the value of your inventory at the end of the year, and include the following:

Expenses. Expenses are the costs you incur (other than purchases) to carry on your business. Your supporting documents should show the amount paid and that the amount was for a business expense. Documents for expenses include the following:

A petty cash fund allows you to make small payments without having to write checks for small amounts. Each time you make a payment from this fund, you should make out a petty cash slip and attach it to your receipt as proof of payment.

Assets. Assets are the property, such as equipment and furniture that you own and use in your business. You must keep records to verify certain information about your business assets. You need records to figure the annual depreciation and the gain or loss when you sell the assets. Your records should show the following information:

· Deductions taken for casualty losses, such as losses resulting from fires or storms.

Documents that may show this information include the following:

What if I don't have a canceled check? If you do not have a canceled check, you may be able to prove payment with certain financial account statements prepared by financial institutions. These include account statements prepared for the financial institution by a third party. These account statements must be highly legible. The following is a list of acceptable account statements.

IF payment is by...	THEN the statement must show the...
Check	· Check number · Amount · Payee's name · Date the check was posted to the account by the financial institution
Electronic funds transfer	· Amount transferred · Payee's name · Date the transfer was posted to the account by the financial institution
Credit card	· Amount charged · Payee's name · Transaction date

Proof of payment of an amount, by itself, does not establish that you are entitled to a tax deduction. You should also keep other documents, such as credit card sales slips and invoices, discussed previously.

Recording Business Transactions. A good record-keeping system includes a summary of your business transactions. (Your business transactions are shown on the supporting documents just discussed.) Business transactions are ordinarily summarized in books called journals and ledgers. You can buy them at your local stationery or office supply store.

A journal is a book where you record each business transaction shown on your supporting documents. You may have to keep separate journals for transactions that occur frequently.

A ledger is a book that contains the totals from all of your journals. It is organized into different accounts.

Whether you keep journals and ledgers and how you keep them depends on the type of business you are in.

For example, a record-keeping system for a small business might include the following items.

Business checkbook.
Daily summary of cash receipts.
Monthly summary of cash receipts.
Check disbursements journal.
Depreciation worksheet.
Employee compensation record.

Whichever system you use to record business transactions will be most effective if you follow good record-keeping practices. For example, record expenses when they occur, and identify the source of recorded receipts. Generally, it is best to record transactions on a daily basis.

Business checkbook. One of the first things you should do when you start a business is open a business checking account. You should keep your business account separate from your personal checking account.

The business checkbook is your basic source of information for recording your business expenses. You should deposit all daily receipts in your business checking account. You should check your account for errors by reconciling it. Consider using a checkbook that allows enough space to identify the source of deposits as business income, personal funds, or loans. You should also note on the deposit slip the source of the deposit and keep copies of all slips.

You should make all payments by check to document business expenses. Write checks payable to yourself only when making withdrawals from your business for personal use. Avoid writing checks payable to cash. If you must write a check for cash to pay a business expense, include the receipt for the cash payment in your records. If you cannot get a receipt for cash payment, you should make an adequate explanation in your records at the time of payment.

Use the business account for business purposes only. Indicate the source of deposits and the type of expense in the checkbook.

Careful record keeping can be a major contribution to your success as a businessperson whether you own the shop or elect to work as an independent contractor. If you start in the beginning keeping good records, you substantially reduce the odds of an IRS audit, and substantially increase the odds of establishing a sound and prosperous business.

When you think you might be able to get away with hiding income, or cheating on the taxes you owe, you might want to take another look at the following. It comes from a handbook used by IRS auditors to establish income and sources of income.

"There is case law in which ONE indirect method can by itself be used to determine income and substantiate the civil fraud penalty. IRC section 446(b) states that the IRS can compute income if the taxpayer’s method does not clearly reflect income. There are TWO burdens of proof in a civil fraud case. The first is on the taxpayer to rebut the proposed deficiency. If the taxpayer cannot rebut the proposed deficiency through a plausible explanation for the discrepancy and adequate records, the court should find in favor of the government. The second burden of proof is on the government as to the imposition of the civil fraud penalty. Where the understatement is proven by one indirect method alone, the civil fraud penalty has been sustained where:

3. The tax court is not satisfied that the books and records reflect actual profit

5. The taxpayer engages in activities to hide the facts as to his or her income, such as:

f. Making misleading and false statements during the audit in an attempt to conceal income

While penalties for being convicted of fraud are not discussed as a part of this booklet, you can be sure that they will be substantial and may include paying back taxes, interest and penalties, and in extreme cases, possible incarceration.

Making honest mistakes in calculating your tax obligations can easily be corrected by filing an amended tax return. It's a common practice. But practitioners who knowingly attempt to deceive the IRS may not get caught immediately, but you can be sure that it will only be a matter of time before the IRS comes for the "dough" you owe.

COSMETOLOGY AND THE IRS