A client who owns multiple related business entities recently came to me with a simple question. “We’ve got a bunch of loans on the books between our companies,” he said. “How do I pay these back?”
“That’s easy,” I said. “You look at the outstanding loan amount that’s showing on the balance sheets and then transfer that amount from the borrowing company to the lending company.”
But then we pulled up the balance sheets, and things quickly went from “easy” to “weird.” The loan amounts were not matching up from the lending company’s QuickBooks file to the borrowing company’s QuickBooks file. Given the fact that the same bookkeeper handles both, this was extremely odd. Even odder, on one particular loan we saw that the outstanding amount was positive in one set of books and negative in the other. Something was clearly wrong.
I found the needle in the haystack
Figuring out what had happened took some serious forensic accounting work. I knew that somewhere amidst thousands of transactions there was one transaction (or perhaps dozens of related transactions!) that had been improperly recorded, and I was determined to get to the bottom of it.
Unfortunately, eyeballing the books didn’t get me anywhere. So I printed out reports from the two affected companies and compared things line by line until….bam! I found it! On December 21, 2015, there was a $73,000 transaction that was incorrectly recorded by the borrowing company.
When cash comes into your company you need to credit something on the books. Usually the place to put these credits is either an income or an equity account. A loan should be put in an equity account. However, this $73,000 got credited to income.
The error seriously impacted the company’s tax returns
This mistake not only screwed up the books and made it impossible to reconcile things, it also turned a non-taxable loan into taxable income. I amended the company’s 2015 tax returns to correct this error—and got the amended returns in less than two weeks before the IRS’ three-year statute of limitations ran out for a refund.
As it happens, the company was in the midst of an IRS audit. It was really quite fun to inform the auditor, who was trying to nail my client for a bunch of money, that our newly-amended return showed that the IRS actually owes my client $30,000! On top of that, the state owed my client $10,000, bringing the total refund up to $40,000.
Mistakes happen more often than you might think
I love being able to tell a client, “I’m amending your return because I found an error on your books, so expect a huge check from the IRS.” In fact, my ability to go back in time to find mistakes that others have overlooked is truly one of my specialties. If you suspect there may be something wrong with one of your past returns, give me a call. As your “tax doctor” I’m always here for you!