Tax Benefits of a Home Business AND a Tax Audit

Last Update: July 15, 2019

Beware the Tax Man

Mel Waller (fellow WA member) wrote a blog about the tax benefits of running a home business. You can claim all sorts of things including a percentage of rent, power, tea and coffee, phone and Internet, business travel and much more. But you need to be careful. Mel's blog brought back some bad memories for me and I have a cautionary tale to share with you. I'm able to laugh about it now, but I had some sleepless nights at the time.

A random audit

Many years ago, in my first reasonable sized company called Mission Control, I got a call from a tax inspector saying they wanted to do a random audit on my business. I agreed as I felt I had done everything by the book and had nothing to worry about.

Side story: I had the URL for Mission Control and when I sold the business, the buyer didn't want it. An advertising company came to me and asked if they could have it. I was being well paid for the business and told the excited person that they could have the URL for free. Stupid me! It was a great name!

So this guy, aged maybe late 50's, turns up on my doorstep with a pretty, young intern. I only mention this because it was clear that he was trying to impress her with his forceful ways in being able to scare the hell our of people.

He went on to tell me that there was nothing to be worried about, but if they found I had knowingly committed any sort of tax avoidance, that this was a serious crime and punishable by large fines or even prison.

Missing Invoices

Next thing I know he finds about 4 or 5 invoice numbers with no data to go with them. He asked me to show him copies of them. I couldn't find them. He agreed to come back the following week to give me time to locate them.

I looked all over the place, on the accounting program, print copies I kept on file, and even on backups of the software.

He then determined that I had perhaps created invoices, been paid, but hadn't paid tax on the transactions. He then gave me more time to find the missing invoices, and finally came back to me with his intern, telling me that as a ratio of my business, he estimated I owed the tax department around $30,000! He worked that out by dividing my total billed invoices for the year by the total amount I had invoiced out for the year.

I knew I had done nothing wrong but he had obviously told his bosses that he had found a tax evader and was now a bit of a hero in the office and I couldn't prove my innocence.

"Don't stress but tax evasion is a serious crime"

Each time he visited me, he made comments like don't stress about this, but if it turns out that you evaded tax, this is a serious crime and you could be sent to jail. But don't lose any sleep over it. I can tell you that I was losing sleep!

On about his 5th visit, I suddenly had an idea which neither of us had thought of. I vaguely remembered that I had made mistakes on a few of my transactions early on in the first year of my business, had cancelled the transactions and re invoiced them correctly.

Then I remembered how I had decide to buy that accounting software product, which came from a fairly new company recommended to me by a friend who had sales automation software that interfaced to it and knew the developers.

A bug in the software

So with the tax inspector and his new assistant, same young woman but no longer an intern (I guess he had impressed her), I put my phone on speaker and rang the help desk for the software company. I asked them what happened if you made a mistake with invoices, as I had, and then cancelled them. The invoice numbers themselves didn't appear anywhere in my ledgers. They said, oh yes that was a known bug in our software. It has been fixed and we can recover those invoices.

So recover them they did and it could be seen that the invoices had never even been completed. The problem was that I didn't know how to edit them, or cancel them. To be fair, you shouldn't be able to create an invoice ever and delete it, you should be able to credit it and reinvoice, but not delete.

It's not good to embarrass a tax inspector

The tax inspector was embarrassed that he hadn't thought to ask the software company himself.

He asked me to write a letter quoting what the software company help desk had written, so he could explain things to his boss without looking like an idiot, which I did, and eventually I got an official letter telling me that they were happy that their inquiry was now over and thanking me for my cooperation.

But I was innocent!

I lost a lot of sleep over that. I knew that I had been squeaky clean with all of my transactions, but I wasn't able to prove it. Imagine doing nothing wrong but having to pay thousands of dollars and risk a criminal conviction, when you are innocent.

Moral of story, if anything happens like canceling an invoice, or making a mistake, make sure you have plenty of notes. If necessary create a journal record for your ledger and ask for advice or support from your accountant or software provider.

It's the sort of thing that you would think will never happen to you, but I can tell you, it does!

You should also think twice about buying any accounting software that doesn't have loads of users.

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firstlearn Premium
What excellent advice you give Luigi.

LuigiCappel Premium
Thanks Derek, we shouldn't all have to learn the hard way:)
RAFStuart Premium
Excellent advice.
LuigiCappel Premium
Many thanks for commenting:)
RAFStuart Premium
You are most welcome.
CarlaNavarro Premium
Great advise!! Had a few home businesses over the years keep ALL RECEIPTS no matter how many write notes on them to remind from where they came.
LuigiCappel Premium
Thanks Carla, I was thinking of mentioning this too:)
Scwebu Premium
Good advice.
alisterbrede Premium
Or live in a .more tax friendly country!
LuigiCappel Premium
Is there such a thing? Besides, I want to live in the country my family lives in...