A car wash is a cash-intensive business therefore, it is more likely to be audited by the IRS and have a particular problem when audited because it is difficult to verify income received in cash. IRS auditors are trained to find out the truth about your business’s income and tax liabilities. But generally, their main concern is the tendency for misappropriation by those who handle cash or who is in charge of the business finances. In line with this, the IRS issued an Audit Guide which highlights the importance of reviewing cash receipts and cash register. Here are some areas which could be the likely targets of IRS scrutiny:

1. Unreported Income

Due to the cash-intensive nature of the car wash business, it would be easy for a portion of the taxpayer’s gross receipts not to be deposited and, therefore, not reported. The IRS will assess tax on any “missing” amounts, plus interest and penalty charges, regardless of whether the omission was accidental or intentional.

There are various direct and indirect tests that may be used by the IRS auditor. So, make sure that you report all required income on your tax return. The IRS computers are pretty good at matching these forms received with the income shown on your return. A mismatch sends up a red flag and causes IRS computers to spit out a bill.

2. Wage Expense – Employee Vs. Independent Contractor

Declaring all of your employees as independent contractors may be tempting to avoid up-front costs, but you can get into trouble if you inappropriately label full-time employees as independent contractors for tax purposes.

There are two types of wage reporting forms for the two types of workers. You will use Form W-2 for employees if you need to train the employee and direct them to do their task. On the other hand, if you hire somebody to do work for you and they do so without your direct supervision, they’re probably an independent contractor. You will have to use form 1099-MISC.

3. Repairs

As more customers go through your car wash business, your building will eventually need repairs and routine maintenance that keep it running efficiently. Car wash equipment generally requires ongoing maintenance and repair to keep it in good working order. Therefore, the repair expense may be significant should it represent these upkeep expenses.

The amount of the deduction will also vary depending upon whether the shareholder(s) or hired tradespeople performed the work. An examiner will inspect invoices and canceled checks for this expense and ensure that there are no capital expenditures deducted currently.

4. Depreciation

This deduction most often represents depreciation of the building and/or the equipment when you own the assets. The IRS auditor will be interested as to when was the equipment purchased, installed, and what depreciation methods are being used. Most car wash buildings, both self-serve bays and full-service tunnels, are considered real property and assigned to specific class lives and depreciation methods under ACRS and MACRS. Certain car wash tunnels, usually associated with gasoline stations, have a shorter class life.

In this case, the examiner may want to inspect the contracts relative to the purchase and/or construction of the buildings (including electrical and plumbing components), purchase and installation of equipment, and any other documents relative to asset acquisitions. So, it is highly recommended that you keep all the receipts and contracts related to such transactions and you’re good to go.

5. Rent

Several issues may arise when examining this expense. Typically, if you own the land and building and you are leasing it to the car wash business, it is called a self-rented property. In this situation, you will report net rental income or loss while rent payments are expensed on the car wash tax return.

In addition to this, lease payments made to companies concerning the installation of car wash equipment may also be deducted as rents. In some instances, the lease payments represent payments toward the actual purchase (not lease) of that equipment, in which case the lease payments may be capitalized and the equipment depreciated. The IRS auditor will examine your documents. These documents include the lease agreements, deeds for the land and building and sales/lease contracts for equipment. Again, you should have all of your business records organized in a neat and logical manner.

As an owner of a car wash business, these are only some of the valuable insights that you should know about. But then again, the best and simplest way to mitigate the risks of being subject to an IRS audit is to keep accurate records and be as accurate as possible when filing your return. Be sure you can document every deduction and credit you claim so that if asked, you can back it up.

If you need guidance on establishing and maintaining a bookkeeping system that can help you support the income and deductions you report on your tax return, contact us today.