While it’s certainly reasonable for the New Jersey Division of Taxation to expect that a business’s filed sales tax and income tax returns accurately reflect the business’s true financial activities, unfortunately, that is not always the case.

For numerous reasons, there may exist reporting discrepancies and/or deficiencies with respect to the business’s tax returns and associated books and records that may go back several years. Simply due to their small size, many small businesses (e.g., sole proprietorships, single-member LLCs) — particularly those with primarily cash operations —, do not have proper internal controls. Additionally, their bookkeeping and recordkeeping practices are oftentimes less than adequate.  Moreover, implementing reporting improvements, such as a point-of-sale system, are quite costly to purchase and require constant maintenance. Thus, depending on the nature and/or severity of the associated issues, the business’s stakeholders may be at risk when being audited by the Division. The resulting audit assessment may directly and adversely impact the financial affairs of the business and its owners, as well as the business’s ability to remain as a going concern. 

The good news is that many of the potentially adverse issues and concerns can be timely detected and resolved, thus ensuring that the business remains viable. For example, the business’s CPA or outsourced tax specialist should consider spearheading a team effort which, hopefully, will bring the business entity into reasonable compliance with all of the Division’s applicable statutes, regulations, rules and policies. Creating a compliance plan is a good starting point for the engagement. Many of the items within the plan should be already known and quite familiar to the team’s participants These include the nature and tax implications of the industry the business operates within; the business’s existing accounting system and associated recordkeeping procedures; and a host of other miscellaneous items.

Additionally, there are two critical areas to focus on when reviewing a cash business’s compliance with New Jersey’s taxes.

Reconciliation of Gross Receipts

All primary categories of gross receipts as listed below should be totaled annually/fiscally and then compared to each other for the last four years. 

• Monthly bank deposits
• Total sales per business income tax return
• Total sales per books and records
• Total sales per sales tax returns

All material differences should be investigated and reconciled. This procedure may prove to be extremely difficult due to the passage of time, which may result in the loss of what formerly was readily available information. However, on a go-forward basis, perform the applicable steps in this process at least on a quarterly basis and detail/support/retain the information associated with the reconciliation of gross receipts procedures.

Additionally, the reported taxable receipts as listed on the business’s sales tax returns should be scheduled and analyzed for the same four years with all issues reviewed and further investigated if required. By performing the above procedures, you may be directed into various other areas that may require further investigation and analysis. 

For example, the business’s CPA may file the entity’s income tax returns while the business’s owner may file the entity’s sales tax returns. Since the sales in a cash business (e.g., restaurant, bar, landscaping company) are usually fully subject to sales tax, the totals for each year should be approximately the same. By performing this procedure, material weaknesses in the business’s recordkeeping procedures and/or sales tax compliance processes (among other areas) may be detected. Once an issue or error is detected it can usually be corrected. Choosing to wait for the Division’s auditor to inform you about this type of discrepancy during an audit may prove to be an extremely costly decision.    

Analysis of the Business’s Cost of Goods Sold (COGS)

Reviewing and analyzing the business’s reported COGS is another important area. An appropriate test period to perform this procedure would be the last fully completed year. Generally, the records that should be reviewed are the purchase journals listing all COGS purchases, the bank statements evidencing the payment of all purchases and the purchase invoices from the associated supplying vendors. Additionally, all purchases paid in cash should be fully detailed and also supported by purchase invoices.        

Note: The Division obtains a report directly from New Jersey’s alcohol distributors fully listing all of the business’s purchases of alcoholic beverages (beer, wine and liquor) for all periods under audit. Additionally, auditors generally seek and obtain a report from the business’s additional suppliers detailing all of the COGS purchases for the audit period.

Should any issues be detected when performing this procedure, they should be fully investigated, resolved if possible, and a procedure/system put in place to ensure compliance on a prospective basis.

While the above information only scratches the surface, it’s a start in assisting and safeguarding your clients, so they can remain your clients. Instead of hearing (right or wrong) from small business owners, “Why didn’t my accountant tell me that?” I am looking forward to hearing, “Yep, made it through the audit in fine shape.”