The Human Element

The Human Element

Sometimes I complain (mostly to myself, and sometimes to other people who don’t care) that the IRS customer service employees are like robots. They tend to go by the book even when there presents itself a more common sense and just solution. There is very little emotion or sensitivity for the struggling taxpayer who is burdened by a bank levy or wage garnishment. However, sometimes I am reminded that the flip side can be just as bad: the human response can at times be ugly too. The employees who make up the IRS are actually human beings with all the same passions and foibles as regular folks, and there’s no better reminder than when we hear of IRS agents accepting bribes.

After IRS Agent, Paul Hurley, allegedly saved a medical marijuana dispensary owner a million dollars in an audit, he suggested that, in exchange for the good deed, the owner give him $20,000. As if he thought he was being wire tapped, or as if it is somehow less obviously bribery when no words are used, the IRS agent rubbed his thumb over the top of his index and middle finger in the universal sign for “cash money.” He should have gone with his gut on this one because later, when payment day arrived, the FBI would be watching the whole thing. These kinds of deals almost always end badly for the IRS employee because as much as the IRS doesn’t trust taxpayers with delinquent tax accounts (especially when tied to a medical pot store), taxpayers trust IRS agents even less. As you can imagine, our guy in this story didn’t take long to decide before he was on the phone with the authorities tipping them off. Hurley’s trial begins this week.

The puzzling thing about this story is that Hurley demonstrates a significant amount of remorse in his resignation letter but his attorneys state that he denies soliciting a bribe. In fact, his attorneys say that Hurley was actually being offered a job to assist with the company’s books and the $20k was just up-front payment for this little side job! Even though I am one, I find it incredible what attorneys will say sometimes.

Coca-Cola's $3.3 Billion Tax Bill

It’s official, nobody has any right to complain about the taxes they owe.  Oh you owe $10k? $20k?  You think you’re in dire straits with your $50k or $100k tax debt?  That’s small beans.  The Coca-Cola company owes $3.3 billion!  The additional assessments came after a 5-year long audit associated with tax years 2007-2009.

Many of the tax disputes between the IRS and multinational corporations have to do with these companies trying to shift reportable income away from the US to avoid high domestic tax rates.  I say “avoid” and not “evade” because they all do this and they all claim that it is completely legal. However, I can’t imagine there is much legal precedent due to the fact that the vast majority of these cases settle, never making it to trial.

There are good reasons for settling, and they are all the standard reasons why parties in a lawsuit often choose to settle. One reason is to avoid the “hazards of litigation.” You never know with 100% certainty which way the judge and/or jury will go.  You can weigh the relative strengths on both sides, you can compare the evidence, and you can apply the law to the facts as done in similar cases. But surprises are common in litigation, and you can never predict for sure what will happen. Another good reason for settling is to avoid the high costs of litigation. Hundreds of thousands of dollars can be saved when parties agree to settle complex litigation cases. Of course the key is to settle early enough, before too much has been spent and before huge investments of time and emotion. Coca-Cola will need to decide whether it can justify the legal fees and risk the hazards of litigation.

Coca-Cola insists that it has been doing its taxes the same way for 30 years without any problems from the IRS.

IRS Audit Percentages Still Dropping

I have written before about the federal budget cuts and reduction of IRS personnel and what sorts of implications this has on the typical taxpayer.  One of the most noticeable consequences is that when you pick up the phone with a tax question or an inquiry into your tax account, you have about a 50/50 chance of getting through and speaking with someone.  Customer service is at an all-time low.

But something else has hit a record low, at least in the last ten years.  And that something is Audits.  Less than 1 percent of tax returns were selected for audit in 2014, and even fewer will be audited this year.

Obviously this is very good news for the taxpayer, but very frustrating for IRS executives, including Commissioner Koskinen, who stated that this trend “carries serious implications for our tax system and the nation.”  I can’t say for sure, but I’d assume that at least one implication is less revenue.  That’s my attempt at a joke.  Of course that’s one of the implications.  They are the Internal Revenue Service.  What’s the point if they’re not bringing in revenue?  Which leads me to an interesting question: Assuming it is true that your chances of being audited are the lowest they have been in 10 years because there are only about 11,600 revenue agents (and dropping) conducting audits, if you are selected, what are the chances of walking away unscathed?

The fact is some tax return audits result in zero liability.  But I could see that becoming a thing of the past.  First, I could see the IRS becoming more selective in the returns it picks for audit.  They will pick the returns with more obvious issues; ones that will more likely result in additional revenue for the government.  Second, I could see the IRS becoming more rigorous in their audit techniques.  If the overall number of audits is low, then the IRS has to be more “effective” in their audits to keep the revenue flowing.  I apologize in advance for this obnoxious analogy, but a boa constrictor often goes months in between meals, so when it does capture its prey, it is not going to let go before it squeezes the life out of them.  We’ll keep an eye on the IRS and see if these snaky predictions come true.

IRS Audits and Public Perception

We know there is at least some rhyme or reason to who gets selected for an IRS audit.  If we knew all the criteria, we could position ourselves to avoid audits 100% of the time, but, for obvious reasons, the IRS hasn’t been so generous when it comes to publishing their audit selection criteria or algorithms.  One thing that we can be sure of is the IRS flags tax returns that possess certain risk factors because, if they’re going to spend resources auditing a certain number of returns each year, it might as well be those that are more likely to contain errors or “problems.”

So far, so good.  That much makes sense.  The IRS flags cases that it considers to be good audit material.  But, based on a news story that broke today, maybe the IRS should also be flagging cases that should not be audited.

Of all the “do not audit” entities out there, shouldn’t Logan Clements, the producer of “Sick and Sicker: ObamaCare Canadian Style,” be near the top of the list?  I haven’t seen this film, but I’m gonna guess that Clements is not a big fan of Obama, and not a big fan of the Affordable Care Act.  And I have absolutely no idea about the integrity of his taxes, but it just doesn’t look right for the IRS to audit somebody like this.  Meanwhile, Clements is using the media attention from the audit to catapult his film into the spotlight quite nicely.  I understand the IRS faces a catch 22 here: if they audit this guy, it looks very fishy, but if they let him go, it sets a weird precedent and makes a whole segment of society (notable conservatives) exempt from audits.  In fact, I think a strong case can be made that public perception should not even enter the equation.  But the IRS better hope they find something seriously wrong with this guys taxes.  Or if it turns out to be a “no changes” kind of audit, they had better close it quickly and hope this story fades away quietly.

 

Audit Resistant Partnerships on the Rise

The IRS generally can include returns filed within the last three years in a tax audit.  There are exceptions, but the IRS normally does not go back further than three years.  What you may not know is that the IRS has the same amount of time to audit large partnerships.  According to a recent report from the Government Accountability Office (GAO), it takes the IRS about 18 months of preparation and fact finding before they can even begin this type of audit.  GAO considers a partnership large if it has more than 100 partners and $100 million or more in assets.

The GAO report underscores the necessity of tax reform.  There are some 20-year old provisions, such as this one, that don’t make sense anymore.  Large partnerships can be very complex, with multiple tiers of partners, making it very difficult to determine where to start.  Many of today’s large partnerships are finance and insurance firms, and it’s great for them, but the IRS really hasn’t been able to effectively audit them.

This problem has become more acute in the past 10 years or so since the number of pass-through entities such as partnerships has been on the rise and the number of corporations has been declining.  Very interesting statistics from GAO:

The number of large partnerships has more than tripled to 10,099 from tax year 2002 to 2011. Almost two-thirds of large partnerships had more than 1,000 direct and indirect partners, had six or more tiers and/or self reported being in the finance and insurance sector, with many being investment funds.

Friday Night Recap

There have been several interesting IRS-themed stories in the news this week.

For one, the IRS recently missed its deadline to appeal an adverse federal District Court decision that denied them the authority to regulate all tax preparers under the Registered Tax Return Preparer program.  This is a big win for tax preparers specifically and a win for small businesses in general.   Perhaps the IRS is going to turn to some kind of voluntary scheme instead.

And if you pay any attention at all to financial news, you wouldn’t have been able to avoid all the press about the IRS paying out something like $15 billion in improper claims for the Earned Income Tax Credit.  Anything that shows how the IRS is wasting our tax dollars or is staffed with incompetent boobs is usually going to remain in the news a few days longer than necessary.  However, this time it really is a big deal.  The IRS admits that about 25% of all EITC payments are issued to people who should not qualify!  What’s worse is the IRS has made little progress on fixing this over the past 4 years.

The last thing I noticed today is not something that everyone will find incredibly captivating, but it caught my eye.  Anytime I see the words “compliance initiative program” it makes me uneasy.  The IRS is going to begin a CIP that will last approximately 12 months and will focus on IRC Section 409A which governs deferred compensation plans.  Thomas Scholz, an IRS executive speaking at an ABA meeting, indicated how many people would be selected for this audit program (less than 50), from what group of taxpayers they would be selected (from an existing pool of employment law cases), and how the IRS will begin the process (through document information requests).  Although stated in off-the-record comments, the IRS revealed some specifics about this CIP that I would love to see them give in ordinary audit situations.

The Internal Structure of TIGTA

Most of the time the Treasury Inspector General for Tax Administration (TIGTA) is described as a government watchdog; an entity charged with keeping tabs on the Internal Revenue Service.  The Honorable J. Russell George, the guy in charge at TIGTA, describes TIGTA’s role as follows:

[W]e provide the American taxpayer with assurance that the approximately 95,000 IRS employees who collected over $2.9 trillion in tax revenue, processed over 241 million tax returns, and issued $364 billion in tax refunds during FY 2013, do so in an effective and efficient manner while minimizing the risks of waste, fraud, or abuse.

~ J. Russell George’s testimony before the Senate Appropriations Committee on April 30, 2014

Besides providing a neat little collection of IRS statistics, this description very succinctly describes TIGTA’s role in U.S. tax administration.  But the organizational structure of this “watchdog” is more complex than would appear in this description.  There are three offices within TIGTA, each with different, but overlapping, responsibilities.

TIGTA Office of Audit (OA)

OA recommends improvements to IRS systems and operations, with an emphasis on detection and prevention of waste, abuse, and fraud.  OA is also charged with ensuring that the IRS strikes a balance between aggressive tax collection on the one hand, and the fair & equitable treatment of taxpayers on the other.

TIGTA Office of Investigations (OI)

OI has two primary responsibilities.  One is to investigate allegations of IRS employee misconduct (including extortion, theft, taxpayer abuses, false statements, financial fraud, and identity theft), which poses a significant threat to the idea of voluntary compliance and trust in the US government.  The other is to investigate and (in cooperation with the Department of Justice) put a stop to harassment and threats levied against IRS personnel by disgruntled taxpayers and tax protestors.

TIGTA Office of Inspections and Evaluations (I&E)

There is definitely some overlap in the functions of I&E  compared to the functions of the two primary offices (Audits & Investigations) described above.  However, I&E can be seen as a “lower-level”  investigative arm of TIGTA that provides in-depth reviews and assessments so both TIGTA and the IRS have a better idea of how specific programs and functions are progressing.

You may not think TIGTA has much to do with you as an individual taxpayer, but I’m not sure how much the IRS would care about customer service and average hold times if TIGTA wasn’t monitoring and auditing that and a thousand other daily functions.

Supermodel Gisele Blames IRS Audit on her Forbes List Ranking

Are you not making the millions you planned to make?  Is your face not occupying magazine covers? Is your name nowhere to be found on any Forbes lists?  Well, the silver lining is that you are not subject to any extra scrutiny by the IRS.  Supermodel Gisele Bündchen was audited recently and believes that her 7-year stint at the top of Forbes’ “Highest Paid Supermodels” list was at least partly to blame.  Perhaps Gisele gets a double dose of said scrutiny, being married to football star Tom Brady, who also sits atop his respective Forbes highest paid list.  Maybe living life in relative anonymity isn’t such a bad thing after all.

Gisele’s beef with Forbes is that they don’t have the details of her accounting, they don’t have her bank statements, and their estimates are too high.  She obviously makes a lot of money, but nowhere near the $42 million that Forbes has her making.  Forbes countered by citing all the various sources of their income estimates: editorial shoots, independent licensing ventures, spokesperson gigs, and contracts from beauty and fashion companies.

For all we know, she may have been audited anyway.  There are many different factors (or “red flags”) that are considered when selecting cases for an IRS audit, but one of the biggest factors has to be an extremely high income.

Still, Gisele doesn’t think too highly of Forbes.  She says “[t]here should be a magazine to quantify knowledge, understanding and love for people: that is power.”  Not a bad idea for a magazine, and she better get on that quick before the government figures out a way to tax knowledge, understanding, and love too.

1st Grade Tax Tips

Do you endorse the "shoe box" strategy of document storage?

This is usually the time of year when people start digging through their file, or shoe box as the case may be, in an effort to get started on their dreaded Form 1040.  If you wait until the eve of tax day, then you’ll find yourself furiously rifling through said shoe box.  And if you really use a shoe box to secure your important records, then chances are you not very organized, and you have other records scattered all throughout the house or in multiple files on your computer.

I know that nobody ever taught you about income taxes or finances in grade school; my kids haven’t had that class yet either.  But as they get older, I do intend to impart some wisdom on them, even if by force.  And for now, there are many habits I can help them develop that will hopefully carry over into their adult life and will make their future April 15ths that much more bearable.

1.  “Get started on your homework right after school.”    If you at least begin the process with a few weeks to spare, then when things come up that inevitably pull you away from the task at hand, you will still have time to put out those fires and get your return filed on time.  And, if due to your personal high principles, you refuse to pay Uncle Sam a nickle before the 15th, at least have it ready to go, then you can hit “send” at 11:59pm.

2.  “Keep everything in your backpack.”    It really doesn’t matter if you’re using a shoe box for your tax docs.  A shoe box works just fine if all your stuff fits in there.  One disorganized shoe box is way better than having multiple piles around the house.  The key is to keep everything together.

3.  “Once it has been graded, throw it out.”    Sometimes we want to save a particularly well-made craft or an A+ essay, but most of the stuff that comes home from school each day goes directly into the trash.  We couldn’t possibly save everything, nor would we want to.  Same with your tax records.  If you can access it online, then why keep a paper copy?  The “three-year rule” should generally suit you just fine.

Beware of the “Turbo Tax audit”

With advancements in tax software and technology, it’s rare to find tax returns that are filled out by hand; without the assistance of a tax preparer or tax preparation software. These advancements have given rise to a whole market of self-preparation software. The most popular is Turbo Tax, but there are others.

With the popularity of these self-preparation tools and software, have come the aftermath, the Internal Revenue Service (IRS) tax audit. I personally like self-preparation tax software tools, like Turbo Tax, because they have led to business for me in what IRS examiners refer to as a “Turbo Tax Audit”. The key with the do-it-yourself software is whether you, the tax preparer, know what you’re doing because you don’t get the professional representation you didn’t pay for.

The software is advertised as easy to use and typically uses question and answer formats. To prepare your tax return, you answer questions posed by the tax preparation software, and plug in your data, and then your taxes are done. When there is trouble, it’s usually rooted in whether the tax preparer (you), answered the questions correctly for the purposes of the tax return. Because the computer software doesn’t know you or your situation, this is where you need to have some knowledge of taxes in general to ensure that you’re not taken on a path that will lead you to an appointment with my office, and eventually the IRS.

The self-preparation software sometimes offers “audit protection.” However, be sure to read the fine print as to the limitations and conditions of such “protection” should you want it, as there may be circumstances where your audit “insurance” is not covered. And, you’re again in my office or facing the IRS alone.