Professional ethics and saving taxes

QUESTION:

Every restaurateur hides some cash from operations, so why is my CPA so shocked when he learns about this side of my business?

ANSWER:

For some background, the field of ethics involves defining behavior as good or bad. People in business generally have as their primary motivation increasing profits.

If we assume that people will not behave ethically simply because it is the right thing to do, then there must be some additional incentive or motivation for people to act in an ethical manner. 

One obvious motivation for a CPA is the fear of sanction or punishment that can come with noncompliance, or simply assisting the restaurateur in not reporting cash transactions, for instance. No CPA would reasonably do something that he knew could result in the loss of his license to practice, because such action would threaten his livelihood. 

But there are other reasons that the CPA should follow ethical rules. First, being ethical is the right thing to do. Second, being ethical will often lead to better assisting you down the road in representing you for a bank loan or possibly selling the restaurant. 

For example, if John, a CPA, serves a restaurateur that offers John a cash bonus if he will agree not to report all of the restaurant’s income, John might be faced with a predicament. John might ask, “Who does it really hurt if we underreport income and pay less corporate tax?” 

There is little doubt that to accept the payment in return for signing a knowingly false tax return violates the professional rules of ethics, and you as a restaurateur are placing your CPA or bookkeeper in that position when you ask him to aid you in hiding cash transactions, underreporting income, or other operational deviations from the normal protocol of accounting. Remember, there will come a day when you will need your CPA or accountant to go to bat for you, representing the integrity of your financial affairs, and the last thing you need at this critical time is for your trusted advisor to pass on this request.

QUESTION:

Why does my banker penalize me if I try to pay minimal taxes to the government?

ANSWER:

This is the age-old double-edged sword in building a business. Since most bank loans are based on a restaurant operation’s cash flow, the further you reduce your net income, the harder it becomes to qualify for a loan. 

Reducing your corporate tax obligations to the fullest extent does retain cash in the business to help grow the restaurant operations. But recognize that this strategy lowers the restaurant’s reported net income from operations, which is the starting point that lenders use to calculate whether your cash flow adheres to their lending guidelines. Simply put, coordinate with your CPA or accountant to look into the future and determine if accessing third-party debt is on the horizon, and ensure that various tax saving or deferral strategies match your goals for the restaurant. 

For example, depreciation of equipment and restaurant leasehold improvements is a tax deduction that allows for the expensing of the cost of the asset over a designated period of time. Some methods of depreciation are allowed to “write off” the assets over a shorter life than others, which creates a larger expense against net income in the earlier years of the asset, reducing net income. Most lending institutions will add back these tax deductions to net income to determine true cash flow of the restaurant if clearly stated on the financial statements, and many times they have to be explained to the banker. 

Bottom line: Always look ahead in determining the possible cash flow needs of the restaurant when the IRS starts talking to you about tax saving and deferral strategies. A simple question is, “How will these strategies affect my ability to borrow money
in the future?” 

Michael J. Rasmussen is the owner of Rasmussen Tax Group in Conway, Arkansas. Visit rasmussentaxgroup.com for additional insight into restaurant-specific tax strategies and technology programs. Have a question for Mike? Send it to editor@pmq.com.