When times get tight, people moonlight. When people moonlight, they often get paid in cash. When people get paid in cash, they don’t always tell their tax preparer right away – if at all.

“Usually I find out about it by accident,” said Susan Floyd , an Enrolled Agent with Paducah, Ky.-based Egner’s Tax Service. “Even though I ask every year if they have any other income, they usually say no. Once I was talking about my roof and one client said, ‘Oh, I do roofs as a supplemental income.’ He had done that for years without ever turning it in to me. I prepared his return correctly and advised him that he should amend his past returns to reflect the income and expenses. After paying me for the return, taking it with him and not returning the signature forms, I assume he took the return somewhere else.”

Sherry Whah of Sherry Whah EA & Associates in Anchorage, Alaska, works with many small-business clients, from handymen, snow plowers and lawn maintenance workers to craft sellers and others. “Clearly this is income to supplement the household income. The folks who do outside sales for cosmetics, household items and investment sales always believe they have [personal] deductions that they want to take as business deductions. They generally always have losses and are convinced they can take a very aggressive stance. Other clients talk about cash-under-the-table income and how if it is somehow below $600 per customer they don’t have to report it or they are simply hiding cash. Others are so disorganized and don’t pay attention to the business they don’t claim all their income. Intentionally? Maybe.”

Whah’s response? “The law is very clear about reporting all income regardless of how a client might have heard some of it isn’t taxable.”

“I can relate to them because my tax practice is a sideline business,” said Walter Johnson, an EA in Bunker Hill, W. Va. “I’ve found the vast majority of my clients to be quite honest about their income and expenses, but often confused about how to account for them on tax returns. These clients often know their own business but have had no bookkeeping or tax education. While they’re honest, they also tend to be stubborn and independent and sometimes resent being told by a distant government how to account for their cash business.”

The problem is widespread and most preparers draw a firm line when needed. “We don’t handle clients who moonlight for cash and fail to declare it,” said EA June Lynham Pina of Massachusetts-based AmeriTax. “Cash dishonesty is rampant. The IRS does a terrible PR job: Many believe cash is not taxable income. That said, cash for small partnerships and corporations is just as likely to [not be on] a return.”

“After 33 years in practice, I realize there are more taxpayers breaking the law by not filing cash income than there are who do file the income,” said Teddy Prioleau of The Tax & Mortgage Shop of America in Hunt Valley, Md., “from the neighborhood backyard mechanic who gets off his regular job and who doesn't really have his own business to the photographer at the wedding to the little boy who shovels your snow. Don’t even mention the home repairman who offers a 20 percent discount if the customer pays cash. A tremendous number of people want to make it in life any way they can. Not reporting cash is one way.”


Sticker shock
Many W-2 employees are shocked at how much tax they might owe on self-employment income, said Floyd. “You also have the W-2 employee who thinks they’re going into business so they can take off all their expenses,” she added. “I then explain hobby rules and they’re mad as wet hens. Then there are the W-2 employees who are really trying to start a small business and grow it. I see those people as being more honest and more understanding of the tax situation.”

“I inform them that they are self-employed and provide them with a spreadsheet template to help them keep track of their income and expenses,” said EA Alan Pinck of San Jose, Calif.-based A Pinck & Associates. “I have always taught my clients that as long as they are straight up with their taxes, the worst part of any audit, if they get audited, is paying me to represent them.”

Kristin Roberts, an EA with The Roberts Tax Group, Torrington, Conn., has many clients “who moonlight in order to pay their bills. I believe, for the most part, they are honest about recording all the income,” she said. “Once I explain the types of expenses that they can deduct from the moonlighting income, they’re often happy to report the income.”

“I get a sense of my clients want to be compliant with their tax filings but not get burned, either,” Roberts said. “Being able to write off expenses such as mileage or even home office expenses is enough incentive to come clean. Others aren’t so easily swayed. In cases like that, when I know that they have income they aren’t reporting, I tell them that I worked too hard to earn my license and reputation, and as much as I would enjoy continuing our relationship, I must decline the engagement. I’ve never had a client leave: They always end up reporting the income.”

“This area creates the greatest challenge for me because the client may have no idea what my responsibilities are,” said EA Frank St. Onge of Total Financial Planning, Brighton, Mich. “I take special precautions. If I have any concerns about the completeness of the information, I ask the client to produce bank records. I also explain how the IRS will approach an audit of a client who it suspects isn’t reporting all income. Yes, I’ve fired clients and turned business down because of these issues.”

One builder client claimed to have lost all records but “knew exactly the income and expenses of the business as well as the amounts he had to report on Schedule A,” St. Onge recalled. “A cursory review of the schedule of all this indicated the profit of the business was less than the items to go on the Schedule A. The obvious question was, how did he eat and pay utilities? His response was that he was able to live off the cash flow of the business. I told him that wasn’t possible since he was a cash-basis taxpayer. He said he would provide bank statements, which he did. But the statements showed even more lifestyle expenses than what I had estimated. He decided to go elsewhere two seconds before I was going to tell him he needed to see someone other than me.”

In a second case, a 1099 Misc. worker “who probably should have been a W-2 from our discussions,” according to St. Onge, was a salesperson claiming mileage and “also was a manager of people who were working for the same company (as 1099 workers) that he was. He was estimating miles to be claimed and the net income for the return would raise questions about what his lifestyle could be on that income versus what it really was. He introduced me to a co-worker and the two of them were going to start a landscaping business that, as the story went, was going to have the co-worker as the only person in the business. My client was only going to guide this person on how to run a business and help get customers for the landscaping, all out of the goodness of his heart and with no payment. As time passed, I needed someone to cut my grass and called this person. They cut my grass for a month and the invoice arrived. The invoice indicated that I should make the check out to my client, not the landscape company. I called my client to discuss this and he again indicated he was just helping out his buddy. I ended the conversation by saying I would not need the grass cut anymore and he should look for another preparer.”

“I try to take into consideration who the client is and their knowledge level of tax rules,” St. Onge added. “I’ll work on education of the client to make sure they see the rules differently than before getting to me. I believe the rules are way too complex for the average person, so I want to be fair. But if that fails, they need to go elsewhere.”


Educating the client
St. Onge starts with such clients by providing what he called “an education that all income is subject to being reported. I then explain that from that income they are allowed to deduct ordinary and necessary expenses to arrive at net income subject to tax. I also explain the long-term impact of that cash income on their retirement that they should consider when deciding what they’re going to report. In most cases, people haven’t understood how their Social Security benefits are calculated until I explain it to them.”

“I have some clients who do some work on the side in addition to their regular W-2 jobs. I do my best to probe and make sure they are reporting all of their income,” said EA Stephen DeFilippis of the DeFilippis Financial Group, in Wheaton, Ill. “I have a questionnaire that all of my clients complete prior to their appointment. One question they’re required to answer.”

“Our office addresses the reporting of additional sources of income on our client questionnaire, which each client must complete and sign,”’ added EA Twila Midwood of the Advanced Tax Centre in Rockledge, Fla. “If we know a client has cash income and doesn’t want to report it, we advise that we’re unable to prepare that return. If a client appears hesitant in reporting cash, we educate them as to the IRS rules regarding the reporting of all income from services, whether reported by a payor or not. We also discuss with them the various methods of determining if there is unreported income such as unidentified deposits, lifestyle and others.”

Whah uses a publication and brochure to help clients understand taxable income and business deductions – and as a last resort will do what often happens to a bad client. “If the clients insist on taking deductions or not reporting the income,” she said, “I end the engagement and return their documents.”

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