Last Updated Feb 16, 2011 5:15 PM EST
This article is part of a series this week on how three entrepreneurs survived run-ins with the IRS. Today's story: Diane and Cal Carrier started up ExcellaDerm Corp. in Dana Point, Calif., in 1998. The company manufactures and sells a device, which Cal invented, that dermatologists use to exfoliate patients' skin. Below Diane describes, in her own words, how an accountant's carelessness led to a full-on assault from the IRS.
My husband Cal and I relied on an outside accounting firm to take care of the books for us three days a week and to do our taxes quarterly. Even so, we always thought we had a good handle on how much money we were making. It turns out we weren't paying nearly enough attention.
In 2006, our accountant told us that we owed about $90,000 in taxes on profits of $335,000 for 2005. It didn't seem possible. We had sold more of our product in 2004 than in 2005 and were certain we had earned lower profits. All she could say was, the numbers don't lie.
We decided to contact the IRS to work out arrangements to pay what we owed, because we couldn't come up with it all at once. We bounced from person to person for months. The last agent we spoke with by phone requested a lot of information, including bank statements from the previous four years. We probably provided six inches of documents. He wanted to know every dollar it cost us to live. He dissected us. We're not extravagant people - we rent a little house, and I drive a 2002 Honda Civic - but he questioned every expense, including the medicines we were taking. When I said I took pills to help me sleep, he snarled, "Maybe you'd sleep better if you paid your taxes."
Still, we thought we were on our way to resolving the matter. We were flabbergasted in early 2007 when we got a letter from the IRS saying it had put a lien on our business for $89,132, plus interest. It added up to about $110,000. Once that lien went on, our credit started to dry up. We had a $25,000 line of credit with the bank as our emergency fund, but the bank immediately reduced it to $14,000. We had to start paying for all of our supplies with cash up front.
'Like Being Buried Alive'
We were paralyzed more than anything. I kept thinking, `We're not deadbeats. We pay our bills. This isn't happening.'
We had our accountant set up an appointment with a local IRS agent at our house. He was horrible. He threatened us. He said he could arrest us. Our accountant was more intimidated than we were. At that point, our only option was to pay the government whatever we could, which was about $3,000 a month.
In 2007, the economy started to slow down. Our business started drying up. We knew we were headed for a huge disaster, given the debt to the IRS. We had 12 employees on payroll at the time and were doing everything we could to keep them working. The situation was so painful - it was like being buried alive. We withdrew from our social life for four or five months before we had the wherewithal to tell our friends we were having tax problems.
It became more and more difficult to come up with the money we owed. The IRS pressured us to move to a cheaper house, which we did. We had to lay off six employees. We relocated our business from 8,600 square feet of manufacturing space to our home and put all of our inventory in storage. The remaining employees worked out of our spare bedroom.
The Careless Mistake
My husband finally called another accountant in December 2008. By that time, we had paid the IRS about $30,000. We handed our books over to the new accountant and his team. It took only a few hours before they realized there was something horribly wrong with the costs our former accountant had recorded. The costs for 2004 and 2006 were triple the costs for 2005. Our previous accountant had not recorded all of our costs for 2005, which made it appear that we had higher profits. It turned out that when she had transferred our records to QuickBooks from our previous Peachtree Accounting software, some of the expenses hadn't been moved over - and she hadn't noticed. By January, with the new accountant's help, we had worked out the problem with the IRS. When we found out we had to write just one more check for $1,400, Cal and I looked at each other and burst into tears.
Even though we have great accountant now, I'm done relying on financial people to take care of things completely for me. Now I know every dollar that comes into and out of our business, down to a level of detail I never knew before.
BNET asked Philip Liberatore, a CPA based in La Mirada, Calif., for his advice on dealing with the IRS when trouble arises.
- Don't assume any IRS notice is correct. Some notice letters, which are generated through computer matching, advise taxpayers of discrepancies between their reported income and income that employers, clients, banks, and other sources have reported for them. Liberatore says his firm has found that of these types of notices that his clients receive, about half are incorrect. "A lot of times people go ahead and pay it, and they shouldn't," he says. If you don't understand exactly why you owe money to the IRS, ask your accountant to review the notice first. Even if you do owe some money, it is possible that your accountant may be able to find a deduction to offset it.
- Never represent yourself if you have a problem with the IRS. "Even simple, innocent questions are landmines," says Liberatore. A smart accountant will be able to read between the lines of the IRS's questions to help you understand what the agents are trying to determine, so you don't inadvertently cause worse problems for yourself. -- As told to Elaine Pofeldt