MONEY Nowhere to Hide

WE QUIVERED AND QUAKED WHEN THE letter arrived in the mail. It was the one you dread the most-ominously thicker than most correspondence from the Internal Revenue Service. Not one of those little one- page slips I get when 1RS clerks misplace the 941 taxes I dutifully pay the 15th of every month. We had already filed for our extension and sent them a load of money per our accountant’s instructions prior to April 15. The check had cleared the bank. Now what did we do? Or not do? We quickly found out:

” Your federal tax return for the above year(s) have been assigned to me for examination.”

Yes, we were the first on our block to experience the much tougher, much nosier, “are you stashing your cash?” 1RS audits. Brace yourself, there’s more on the way. The ERS plans to audit 1.5 million taxpayers this year ton 1994 returns), an increase of 15 percent. Taxpayer compliance, they say, is at 83 percent. Audits and enforcement bump it up to 86 percent, but the 1RS has higher goals: a taxpayer compliance rate of 90 percent. Sole proprietors and owners of small businesses will feel the most heat because these folks write their own paychecks, and hence have more opportunity to slide by deductions than does a salaried employee or an executive. And the 1RS is more than a little skeptical of service firms, because with no inventory to tally, there are many “opportunities for non-compliance.”

The North Texas District office of the 1RS hired 159 additional auditors last year, and the new recruits are rolling up their sleeves for 25,000 audits. According to Glen Duncan, chief of the Examination Division, North Texas District of the 1RS, only a third of those audits will bedevil businesses. Two-thirds will fall on individuals.

There are three general types of audits. In a Schedule A audit, the 1RS verifies your deductions. In the tougher field audit, an agent comes to your business and looks at how well you are complying with the tax laws. The 1RS says the field audit is for taxpayer convenience, saving you from hauling your business records down to their offices.

“Don’t you believe it,” says Bob Davis, a Dallas tax trial attorney who has been rescuing taxpayers from the tentacles of the 1RS since 1960 and who also worked for a while on the inside, with the Service. “This is a way of conducting a search with the taxpayer’s consent. They want to get inside, monitor what’s going on, overhear employee conversations, and compare business equipment with that depreciation schedule.”

And then there’s the Taxpayer Compliance Measurement Program, or TCMP. Last seen in 1988, this mother-of-all-audits is a meticulous line-by-line rehash of your tax return that agents verify. It can take months, even years to complete. Get ready to explain every dot on your return. Or you could get the MSSP, Market Segment Specialization Program, which is a subset of the TCMP, and sort of like a field audit, but different. MSSP investigates 29 different businesses, and the agents poking around have spent one to three years training in your very field-health care, retail sales, etc. They know the nature of your business so well that nothing will get by. Not only does it help the Service collect more unpaid taxes, but the personal questions and lifestyle observations will help them gather computer data on taxpayers in general. This way they can better target potential future audits. If you’re in oil and gas, for example, and you screwed up certain deductions, maybe 11 million other people did, too. So the ERS will know who to audit next.

We were chosen for the MSSP, only we didn’t know it at the time. The IKS first asked to see our 1993 financial life: work papers used in preparing our tax returns; all books and records concerning income, expenses, and deductions; duplicate deposit slips; savings account passbooks; information on all invested funds; records of all loans and payments; capita] acquisitions’ invoices; all records concerning the purchase or sale of real estate or orner property; information on any nontaxable income; and copies of all federal tax returns from 1991 to 1994.

That led to our first key decision: Should we let the agent come to our office, as requested, and just face him ourselves? Or should we call our accountant?

The IRS tells taxpayers you are not obligatcd to be represented at an audit by an accountant, tax attorney, or enrolled agent (see box below). Many folks, they tell you, just handle it by themselves. A friend did that. She met with the 1RS in a Carrollton office building, where she learned that they didn’t believe she had three children. Just because you claim three children as dependents, the agent told her, doesn’t mean you actually have them. So our friend went home and dug out the birth certificates, between nursing her youngest and keeping the older two from fighting. She took the documents to her next meeting with the agent. They still didn’t believe she had three children. She fin ally had her pediatrician’s office fax the 1RS agent copies of office visits for each of the three children. The 1RS likes proof of support, proof of everything.

We let our accountant take over.

Owning a business in the United States today means you have a sword over your head every minute where taxes are concerned. If you itemize deductions, you are responsible for all of them. Use your car for business? Must keep a car log. Take clients out to lunch or dinner to talk about a business project? Better put their names down on the receipt, and you’d better keep the receipt. Your life is crammed with scraps of paper. Contribute to charity? You must have a letter from the charity acknowledging the donation if it s more than S250.

“The purpose of an audit is to check compliance,” says Glen Duncan. “That’s why it is so important to maintain good records.”

But in our case, the 1RS didn’t just want to check addition or records. After his first meeting with the 1RS agent, our accountant called to say they wanted more than a tight paper trail-this was the dreaded MSSP.

They began with 50 questions. First of all, they were very interested in my marital status. They asked so much about former marriages, alimony, and child support that my husband wondered if 1 was holding out on him. They were less interested in my spouse’s marital status but very intent on knowing his educational background. In fact, they wanted to know every school both of us had attended-“from high school on,” our accountant told us.

“Do they want to know if we ever belonged to SDS in college?” I asked.

No, but they wanted to know when we bought our home, how we financed it, how much money we put down on it, and what our monthly payments were. They wanted to know details of all the property we own or have Owned and any improvements. They wasted to know about any major purchases-recreational vehicles, cars, boats, appliances, etc.

“Oh, you’re going to have to pull all your utility bills from 1993,” said our accountant. “Telephone, gas, electric, water, everything. Hope you still have them.”

What loans did we have outstanding, and did we loan money to anyone? (If we did, they wanted the date, amount, and name of the loanee.)

They also wanted to see our monthly budget. They wondered if we made cash advances on our credit cards and were very curious as to how we acquired the cash we dealt out in our daily living, even asking us to estimate how much cash we might have around the house or in the wallet on a given day.

“Like how much do you have in non-deposited emergency cash funds?” said our accountant.

They were pulling a magnet for cash- non-taxable income, gifts, interest in partnerships, and the big no-no-bartering. Any foreign bank accounts? Who has signature authority on all your accounts? Do you retain an attorney? How do you generate new business? Any extraordinary events in your life?

Yeah, this audit.

Then came the one that undid me-did we have a safety deposit box at die bank, and, if so, what: was in it?

Of course they would know about the safety deposit box because they would see the charge lor it on our bank statement. The truth is, 1 don’t even know for sure what is in the safety deposit box! Why, I fumed at the accountant, did they want to know what was in the damned safely deposit box ? Was it really any of their business?

You don’t have to answer the question, he advised. But if you do, be careful: It you tell them there’s five dollars in there and they find six, you might be committing tax fraud.

Now that’s one of many problems I have with the 1RS. One little mistake and boom- tax fraud. And if you commit tax fraud, the 1RS can examine all your tax returns from the day you first filed. Then they find more hangnails and more…-and pretty soon, you’re Willie Nelson, singing for donations.

Another problem: Why us, when we already pay 40 percent of every dollar earned to Uncle Sam? The answer-compliance. Plus the 1RS might get another hundred bucks or so oft an error or find some deductions we should not have taken. That’s the purpose of the economic testing and why they asked even more probing questions: How much did you spend on your daughters wedding? Where do your children attend school-public or private? What kinds of appliances are in your home? What kinds of cars do you drive? What kinds of vacations do you take? If it looks as if you’re living high on the hog but not reporting an income to cover the costs of this life, the 1RS suspects you’re holding out on ’em.

I wanted to tell them to stuff their audit, but my spouse, the pragmatist, said cooperate. There was no law saying we had to answer any question that didn’t relate to income for 1993. But tax attorneys will tell you that if you don’t cooperate, the 1RS might think you have something to hide. The agent can then “punish” you by demanding more information, challenging deductions, or calling unidentified bank deposits income. The agent can even serve an “administrative summons,” although this rakes time and costs the 1RS a bundle.

So we capitulated. Through our accountant, we answered their questions. He screened the original list and passed what he couldn’t answer on to us. I sat down at the computer and wrote our financial autobiography. I told them how many dogs we have. I told them the color of my checkbook cover. I listed every appliance I had in my kitchen and where they came from. I told them what 1 thought was in the safety deposit box. Back to the accountant with the essay, back to me with deletions and changes. When we finished, the 1RS agent would return to our accountant’s office where he would be given a room. There he could sip coffee, read the essay, and ask for whatever personal financial documents he needed. I hauled eight shopping bags full of 1993 papers to the office so everything would be there. The auditor would then go back to his office and start making sure I didn’t tell any tall tales. (With TCMPs and MSSPs, the 1RS checks to make sure you were born where you said you were born, checks the birth records of your children, etc.) I was beginning to see that even though we were squeaky clean, proving our cleanliness was going to cost us a bundle.

One friend was audited by the 1RS on a simple audit, a Schedule A. She actually got a $300 refund. But she paid her accountant $2,500 to handle the audit. Her loss: $2,200. Her family didn’t take a vacation that year- but her accountant’s did.

As for our audit, it’s not yet over. It’s been going on for five months, and I’m not expecting it to be over anytime soon. Another friend said their audit of both home and business lasted for a year and a half and cost them $20,000.

We’ve paid our accountant more than $2,500 thus far. The final bill, we’re told, could be as much as $5,000. It could go to $10,000 plus taxes and penalties if we’ve erred. My 1993 papers are in disarray-even the poor auditor misplaced one month’s bank statement. Our accountant is handling three more audits on other clients. His office is beginning to look like a paper supply warehouse. But the good news for him is that with this new flurry of audit activity courtesy of the 1RS, he may very soon be able to afford a bigger office.

Who Can Help You with an Audit?

ARMED WITH YOUR POWER OF ATTORney, three types of tax experts can represent you before the 1RS in an audit: a tax attorney, a certified public accountant, and an enrolled agent.

Find a Tax Attorney quick if you’ve made a significant error on your tax return or you’ve under-reported income, if you have knowingly withheld information from your return, only a tax attorney cannot be subpoenaed to testify against you-the CPA and enrolled agent can be. Expect to pay: S100 to $300 per hour, plus all expenses.

If a CPA prepared the tax return in question, it’s usually best to let him or her handle the audit. CPAs know what the 1RS will be looking for.

Do not, however, lie afraid to quiz your CPA on his or her experience with audits. Expect to pay: $50to$130per hour, depending on experience level and size of firm.

An Enrolled Agent completes a three-year program in tax preparation and learns from 1RS agents themselves. There are 2,300 enrolled agents in the country, some of whom are former 1RS employees. To be licensed, enrolled agents have to complete the training and pass an exam; former 1RS employees can skip the exam but they need five years of experience as an 1RS manager.

James S. Harris, an enrolled agent and owner of DeSoto-based Taxpayer Advocates, Inc., says to be leery of former 1RS agents-some overcharge and some sport few skills but rely on old-buddy contacts. Expect to pay; $75 to $125 per hour.

Remember, the 1RS agent will spend a lot of time in your representative’s office. Make sure you are only paying for the hours your hired gun spends with the agent, not for the entire time the agent spends at the office. -T. X.