Question

Assume that Laverne and Shirley have incorporated their business. One afternoon, an old college friend visits Shirley at the office. Shirley and her friend decide to go out for dinner to discuss old times. Shirley, being short of cash, takes money from a petty cash box to pay for dinner. (She first obtains permission from Laverne, who has done the same thing many times in the past.) Over dinner, Shirley learns that her friend is now an IRS agent and is investigating Shirley’s corporation. What problems does Shirley face in the investigation? Why?

Answer 1

Money from the petty cash box can only be used for paying for supplies or small expenses directly related to the operation of the business. In the above case, Shirley used money from petty cash box for paying for dinner. As Shirley's corporation is under investigation she will have to go through an audit, during which the burden would lie on her shoulders to establish the expense in question as valid business expense. Since she won't have valid proof regarding the same, in case of a C-Corporation, the tax return would be recalculated with all of the expenses added back. She will also have to pay interest and penalties on the unpaid portion of the newly calculated tax liability.
In case of an S-Corporation, the expenses will be added back to the tax return, and Shirley will have to have her individual return recalculated, and the new income tax liability will be computed. She will also be charged penalties and interest on the unpaid portion of this new tax liability. Furthermore, the chance for future review and audits will increase.