One of America’s best (and most quotable) judges, Learned Hand said, “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”
What happens when the IRS disagrees with the way you’ve arranged your affairs?
What do you do when you receive “fan mail” from the IRS (or the State Taxing authority)
KELLEY C. MILLER, ACTEC Fellow and Partner at Reed Smith in Washington DC. helps us understand the process of an IRS audit, good practices in dealing with an audit, and inside knowledge of how the process works at the agency.
This episode is full of good information on an uncomfortable, but vital, topic for families that are pursuing complicated planning that may catch the attention of the taxman.
Background and Good Conduct Rules of Thumb
- Be Honest
- Be Prompt
- Be Complete
- Be Clear/Organized
- Be Consistent and coordinated with other tax and gov’t authorities
- Be Quick to Alert the IRS if issues come up
What is the IRS / State looking for?
In a word, UNDERPAYMENT . . . or “more revenue.”
- Listed Transactions (ex. syndicated conservation easements)
- Unreported income
- Mischaracterization of gain vs income
- Filing status (ex. Domicile / Residence – esp. at state level) and Dependents
- Itemized deductions (Business vs Personal)
- Eligibility for credits / treatment
Sources of “referrals”:
- Data (Demographics, Internal Data, HNW, UHNW patterns, Social Media, AI in the future?)
- Other Agencies (Corporate Transparency Act Implications)
- Past conduct
How is the IRS to deal with? Other states?
- They are professional and sophisticated but under-resourced
- Whom are they looking for?
- Improvements? Potential new staffing and technological investments
- Is not incorporating your advice team ever a good idea?
- Civil vs. Criminal vs Collections Departments
1) Open the Letter! (Not a good time to stick your head in the sand)
- Is it an audit or a request for additional information?
- What person or entity is being audited?
- What is the focus of the audit?
- What documentation is being requested?
- What kind of audit?
- Correspondence Audit: The IRS requests additional information regarding a part of your tax return, such as receipts or canceled checks.
- Office Audit: The IRS requests that you bring specific documentation into your local IRS office- the audit happens there.
- Field Audit: An IRS agent shows up at your place of business to conduct a face-to-face audit.
- Taxpayer Compliance Measurement Program Audit: The mother of all audits- one that requires full documentation down to birth certificates to test the Agency’s scoring systems.
2) Notify the team and decide on the response strategy
- Who is quarterbacking the response and the interaction?
- Accountant / Attorney / Wealth Manager / COO
- When should the tax preparer run things vs an attorney?
- Do you need other expertise?
- Should you have Attorney / Client Privilege? Very likely.
- Who is compiling the information?
3) Responding to the request
- You should respond to the IRS/State within 30 days of receipt
- How should that occur?
- Call / letter?
- Crafting the response letter
- Supplying the requested information
4) No Action or additional payment?
- If it’s determined I owe more, what is the process of appeal?
- What if I don’t have it?
- Payment plans?
5) Closing the file
- Documenting the outcome
- Post-mortem –
- What practices were audited?
- Should we do anything different in tax planning
- Any other storm clouds on the horizon?
- Lessons Learned- Updating documentation and administration process going forward