We Trust Our Clients
Tell me something, how do you see your business clients?
I suspect that we all see our clients as good, hearted, essentially ethical, business people. They are just slogging along, trying to keep their heads above water in today's economy; trying to keep their employees on the payroll - and just making a good faith effort to get it right. Or they are brilliant business people, rising stars, glowing brighter - but stil, ethical, good people, operating their business in good faith (perhaps being too busy soaring to keep records). But we tend to believe in our clients. Don't we?
How many times have you passionately battled IRS over a client's expenses - with absolute faith in their integrity?
And been humiliated?
I remember the first time.
I prepared the partnership returns for my brother and his buddies who have bought a three-building apartment complex in Canada. Within two weeks after buying it, one of the buildings burned down. That partnership return was pulled for a TEFRA-type audit instantly - within 3 months after it was filed. My first big audit. And I learned a lot about reporting casualty losses from that audit. (this was a couple of years before TEFRA, though.)
I was passionate, earnest, young and cute back then. That helps a LOT! I got the numbers right - that helps even more. What did I get wrong? The timing.The insurance wasn't settled until the following year (before I completed the tax return), the examiner accepted all my numbers, but insisted that the loss be reported on the subsequent year's tax return. Well, I was young. And relieved that the numbers were accepted. We were able to convince the partners to amend their returns for the timing difference. Today? Casualty loss rules are a little different.
But, then there was the first humiliation. The Architect.
A client tells me he's being audited. I had not heard from him for about 3 years. Turns out, he had not filed a tax return for those 3 years either. IRS had visited his office. I asked if IRS had been given any records or access to his files? Oh no! Turns out, the examiner had been living in his office and records for two whole weeks before he called me. What was the issue, the purpose of the audit? "I don't know!" Turns out he had $100,000 more worth of 1099-MISC that the total income we had reported. (This was early in the life-cycle of 1099s. And taught me to be sure to collect them all from clients.)
I was stunned. OK, so this is an audit about unreported income. The examiner wanted to know what happened to the money. Well, I know this fellow. I have been in his home many times over the years. He was a neighbor. There was nothing in that house, their lifestyle, their vehicles, their travels or savings, to account for a missing $100,000. Their furniture, rugs, artwork - very ordinary stuff. Nothing of significant value. And no, they did not have offshore money.
I remember sitting in the auditor's office, literally in tears (usually works when you're a cute little girl), insisting that the 1099s must have been in error. They were overstated. She was very sympathetic. And believed my sincerity. She commiserated with me. Then she pulled out photocopies of the deposits for the year - that she had subpoenaed from the bank. EACH one of them showed $1,000 - $2,000 cash pulled out of the deposit when they were presented to the bank. WHAT?????????
Upon chatting with my client, I learned that he didn't know about this. This was as much news to him as it was to me. It turns out that his wife had been pulling cash out of the deposits without his knowledge. What had she been spending the money on? Heaven only knows! Perhaps all those un-worn clothing in their daughter's closet? Perhaps acting lesssons for an ungainly, talentless little girl? Perhaps a lot of lunches out with her friends? I have no idea. But there wasn't a thing of value to show for $100,000 worth of squandering.
Yes, the examiner did waive all the penalties that she could (accuracy, fraud, etc.). Even so, with the taxes and interest, (and my client's reluctance to BK the taxes later on), it took him nearly the full 10 years of the statute to pay the taxes on this - including all the proceeds from two inheritances (parents who died while the statute was still open).
A friend's first humiliation. The Doctor.
At least this guy didn't let the IRS in the door - but sent the examiner to my friend - let's call her Anna.
Once she collected his records from him, she started to get heart palpitations. She found quite a few surprises among the records and receipts - that didn't quite jive to the printouts he had given her to do prepare the tax returns. But, with a bit of digging and searching through third-party records, we were at least able to substantiate the correctness of the income - there was no unreported income.
For a moment it looked as if there was a LOT of that. But, like many medical practitioners, the places he works uses his SSN to bill Medicare for the whole facility's medical care. He only reported the money he received - MediCare reported several hundred thousand more under his SSN. But we could prove the rest of the money went to the medical facility, not him. Whew!
But the expenses. The credit card expenses - uh oh. This fellow maintained several offices of his own, with staff and doctors working for him. He provided a certain amount of food and snacks for the staff and patients. He had written off about $100,000 worth of Costco bills that were on his credit card, as food or supplies or some such. Upon examination (ours, not IRS's), we learned that ALL of that was personal! No amount of digging or sweet-talking was going to substantiate or justify more than $5,000 (and that's stretching it), as business expenses.
We read that man the riot act! I saw to it that before we were done, he was in fear for his license. Yes, he ended up paying tax on all that 'casual fraud'. Somehow, we managed to convince the examiner to waive all the bad penalties and preparer penalties (accuracy, fraud, etc.). (Anna is a cute, petite, sweetie, with a wonderful smile.)
Note: TaxMama has received many horror stories like that from tax pros in shock, during their audits. Sometimes, we find ways to salvage the situation. Usually, we manage to get the penalties waived.
And what prompted this rant?
A friend is going through the audit from H*E*double-hockey-sticks. The examiner wants to see all the receipts behind the charges on the credit card statements. My friend is CONVINCED the charges are 96% business.
Should I tell her what she's apt to find?
What have you learned about your clients during audit?
Eva Rosenberg, MBA, EA, is the publisher of TaxMama.com, and author of the weekly syndicated Ask TaxMama column. She provides answers to tax questions from taxpayers and tax professionals worldwide.