[Case Study] Pet Sitter Audited By The State Twice And Told Two Different Things!

IMG_8844In our Case Study Audit series we will go under the hood of pet sitting businesses and do what no one else is doing in the industry. Find out why companies were audited, how they survived, and their reflections looking back. We are so thankful to these companies for helping us to put truth to all of the rumors that fly around.

This audit case study was very interesting. It was one of the case studies that experienced two audits! What you read will surprise you. Some of the main points that I enjoyed learning was that Jennifer learned that with her ICs she should always be cutting checks to the business name of the person, not the individual person. My jaw also dropped when I read the part about her following the suggestions of the auditor, but then on the second audit they faulted her for doing those exact things. There is a lot more that was surprising to find out but I will let you read for yourself!  It was interesting for sure and I am positive you will find it eye opening as well. A very special thank you to Jennifer for participating in this case study!

BEFORE THE *FIRST* AUDIT:

What is your name and company name?  Jennifer Haralson A Pause for Paws, Inc. Lincoln, NE   [I will be discussing] AUDIT 1 in 2010 regarding tax year 2006

When did you start your business?  2003

Tell us if you had legal council advise you on how to set up and what was right and proper (accountant and lawyer) Yes- CPA and an attorney.  S-Corp

Approximately, what was your annual revenue at the time?  Alternativly, would you consider yourself a small (Under 100K) medium (100-250K) or large (250K+) company?   Small, $90,000+ at the time

Did you have ICs or employees at the time? Employees

How long did you have staff and what made you choose that classification of workers?  I switched from ICs to Employees in April of 2006, the year in question and this is what spurred the inquiry from the Nebraska Workforce Development Office.

Were you ever afraid of being audited? Was it ever in the back of your mind?  Not afraid, knew it was a matter of time, always prepared.

TELL ME ABOUT YOUR AUDIT:

How were you notified that you were being audited? What department audited you? How long did the entire process take? I was notified by letter from NE Workforce Development. They gave me 2 week’s notice.  The actual audit took 90 minutes.

What was their reasoning for auditing you?   Switching from ICs to employees in the middle of a tax year.

Tell us about the help that you had going through the audit. Did your lawyer, accountant, another agency/advisor help guide you through it?  No. I felt confident that I could handle the audit on myself as I have had lots of education in the area of IC vs. Employee.

What did they require from you throughout the audit?  1099s, payroll records, Profit and Loss Statements

Did the agency involve your staff?  No

How did you feel throughout the process? What impact did it have on your life? Your family? Your business?  It was stressful, lack of sleep, irritable with people around me.  I had to be away from my business for several hours leading up to the audit to gather paperwork and then on the day of the audit too.  

When you submitted the evidence they requested, how sure were you that you were going to pass through with flying colors?I knew I wasn’t going to “pass” because we switched from ICs to employees after we found out that it wasn’t the right way to go for our level of control.  The auditor was very nice, worked diligently and asked good questions.  She commended me for voluntarily moving to employees after I saw the wrong of my ways.  She told me how to avoid coming up for an audit in the future and I took that advice and did all that she recommended.  She did say that we would be audited again, it was just a matter of time.

AFTER THE AUDIT:

What was the finding of the audit?  No fault.  Employees are classified appropriately and all ICs (used within the business currently for a different purpose) were appropriate as well.  

What to do attribute to the findings? Good defense? Bad record keeping? Out of compliance? Etc? Good background knowledge of the issues surrounding IC vs employees. Having a rock-solid IC contract and a very hands-off approach with my current ICs.  

If you had to make changes, how did you go about making them and what were they?  I made all of my ICs get DBAs. I then started writing checks and 1099s to the IC business name. Never to their personal name.  

Did you have to pay back taxes, penalties, fines, interest, etc? How were you able to afford it all? How long did you have to pay them?  None

Tell me about how you feel about that audit now. Are you happy or sad that you went through it? Did it make you better?  It made me better and verified that what I had learned and the changes I made to move to employees was the right choice, even though at the time it was expensive and I second guessed it often.  

What advice would you give to other pet sitters to try NOT to be audited? There is no TRY NOT TO BE, I firmly believe we all will be.  Be prepared, not afraid.  With the passing of the Affordable Care Act, the IRS has hired over 17,000 more agents throughout the US.  They are looking for ways to get more money, find more faults and classify more people as employees anyway they can.  

What do you think is the biggest misconception you see being passed around about being audited.  “My lawyer will get me out of it.”  “I’m doing it all right, so they won’t come to me.”  “I’m small potatoes, so why would they bother with a company like mine?”

If you knew then, what you knew now, is there anything you would have done differently?  Nope… other than get my ICs to have DBAs sooner.  But it wouldn’t have prevented anything.  It was because I switched in the middle of the year… that the department saw something was amiss.

BEFORE THE 2nd AUDIT

[All of the first few questions were answered the same as above]

Approximately, what was your annual revenue at the time?  Alternatively, would you consider yourself a small (Under 100K) medium (100-250K) or large (250K+) company?   Medium $170,000

Did you have ICs or employees at the time? Both

How long did you have staff and what made you choose that classification of workers? Have had staff since 2004.  Pet Sitters are employees, and boarders are ICs

Were you ever afraid of being audited? Was it ever in the back of your mind? No afraid, knew it would happen (again.)

TELL ME ABOUT YOUR AUDIT:

How were you notified that you were being audited? What department audited you? How long did the entire process take?  My letter, given 2 weeks notice.  NE Workforce Development

What was their reasoning for auditing you?  They don’t tell you in the letters, but you can ask the auditor what caused the inquiry.  She was honest this time and the last time and told me that it was TIME for me to come to audit again.  And I was paying myself as an IC for boarding dogs in my home without a DBA.  And I am the main office of my S-Corp.

Tell us about the help that you had going through the audit. Did your lawyer, accountant, another agency/advisor help guide you through it?  No, just me.

What did they require from you throughout the audit? 1099s, IC contracts, Client invoices (as samples), IC invoices/bills (as samples) all payroll records for the year and the payroll records and check stubs from one employee who worked in EVERY pay period for the audited year.

Did the agency involve your staff?  no

How did you feel throughout the process? What impact did it have on your life? Your family? Your business? Stressful.  Didn’t sleep much and had to take several hours to gather documentation and then the actual meeting.  There was a discrepancy and that caused more sleepless nights after the meeting.  I was very sick leading up the meeting with a terrible cold (probably due to stress.)

When you submitted the evidence they requested, how sure were you that you were going to pass through with flying colors?  I was confident it would go well.  Shocked that they found 1 issue.

AFTER THE AUDIT:

What was the finding of the audit?  No issues except that I was paying myself as an employee and an IC.  I was giving myself a 1099 for boarding dogs in my home, the same way that I do for the other ICs.  This practice was explained to me by Workforce Development in 2010, during my first audit as being “appropriate.”  As the owner/shareholder/director of the company providing a service similar to others by the company, I could be paid in the same way for the same work.  

What to do attribute to the findings? Good defense? Bad record keeping? Out of compliance? Etc?  In 2013, the “administration” is “interpreting” the laws different.  I asked a LOT of questions.  Basically the auditor (very friendly and professional) admitted that the laws have NOT changed, but the way the current administration views the laws HAS changed and therefore I should not have been paying myself as an IC, regardless that I was following the advice given to me by the same office, now saying a completely different story.    By paying myself as an IC, I am avoiding paying Unemployment insurance (2.4%) and therefore shorting the government their due money.  The irony is this: I can’t claim unemployment benefits, if I was to lose this job.  There are MANY reasons for me to not benefit from unemployment insurance, but still I need to pay for it by way of a paycheck as an employee of the corporation.  

If you had to make changes, how did you go about making them and what were they?  I stopped paying myself as an IC and started taking disbursements instead. It all ends up in my pocket the same way.  

Did you have to pay back taxes, penalties, fines, interest, etc? How were you able to afford it all? How long did you have to pay them? I had to pay Unemployment insurance for any money that I took according to my 1099 and pay interest from 2010 to the present.  It was less than $150.  The auditor did “feel bad” for me, knowing that she was the one in 2010 that gave me the advice, that I followed and then I got fined with interest anyway.  My husband later, after all of the findings and an appeal to her superior had a very curt conversation with her.  She promised (not in writing) that we would not be fined for my 1099 in the following 2 years (2011 & 2012) as long as I stopped giving myself a 1099 in 2013.  

Tell me about how you feel about that audit now. Are you happy or sad that you went through it? Did it make you better?  I’m neutral about it.

What advice would you give to other pet sitters to try NOT to be audited? There is no avoiding it and once you are audited, you are on the radar and will be audited again.

If you knew then, what you knew now, is there anything you would have done differently? VOTED for different government leadership and encouraged others around to be involved in local and national politics, as to be educated on WHO will be “interpreting” the laws next time around.  

Anything else you would like to add?

I also was personally audited in 2007 for closing an IRA account from a previous job and transferring it into a non-IRA account.  But because of that transfer the IRS that time did a nice long look into my income from my business and all of my deductions.  No fault was found.  This was the IRS!  And because I had an S-Corp, they could not without formal inquiry look into my business.  The “veil” between personal and Corporate really saved me from the headache of an additional audit by the big guys.  

My Thoughts…

Wow!  Just that last paragraph alone would make me want to have an SCorp and have the protection of a corporation. As you can read Jennifer did a lot of research, learning, and gathering to make her defense. It amazes me how the “interpretation” of a auditor can change from one to the other. This means, for those reading these case studies…. you can not just read these and directly apply to your business because it is all up for interpretation and each situation is different. These case studies are here to make you think.

Keep in mind, Jennifer’s case study was the state, NE Workforce Development. What do you think of this? How does it make you feel? Ever thought about this? Sound off below and at the very least, thank Jennifer for helping to educate our industry! 🙂

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