I got audited! (sort of)

Read The Transcript Below:

Steven (00:11):

Hello everyone and welcome back to the Retirement Tax Podcast, AKA the least Boring tax podcast. I am one of your hosts, Steven Jarvis, CPA, and with me as always, the incredible Benjamin Brandt. Ben, welcome. It’s so fun to always get together and do this.

Ben (00:25):

Yeah, I’m having a lot of fun. I’m excited to talk about our topic today because you did something recently, speaking of least boring tax podcast. You did something that I’ve never done before, something that I’m a little bit afraid of. You did it willingly and it was very much not boring. So could you share with the audience what that was?

Steven (00:42):

Yeah, that’s a great setup. I mean, really, I was thinking of it as I recently went through one of most people’s biggest nightmares to not belabor it too far. I just sat just a week ago as we’re recording this, I just sat through an IRS audit, and here I am smiling on a podcast a week later. So that’s what we want to dive into.

Ben (01:00):

Yeah, so let’s start from the top. How did you know this was happening? Did you get something in the mail, or the client got something in the mail, and you got a panicked phone call on the other end or an email or how do you know this is on your schedule?

Steven (01:12):

Yeah, that’s a great clarification. This was not an audit of my personal or business return. This was an audit of a client’s return, so someone I had worked with to prepare their 2022 tax return, and so they got a letter in the mail that basically said, Hey, your 2022 tax return has been selected for audits. And then it gave them instructions on what to do next. And so the client immediately reached out to me because Ben, as you know, for the clients that we work on together, we tell all of our clients that, Hey, if we’re signing a tax return, we’re there with you. We’re there to support you. If you get audited, we’re going to come alongside you because I put my name next to theirs, which is something to be aware of. If you work with the CPA, that is not always a foregone conclusion that the CPA is promising that upfront. That’s something that you need to understand. And if you’re vetting a new CPA, that might be a question to ask of, Hey, if the IRS ever comes back and asks questions on my return, what’s that going to look like?

Ben (02:05):

Okay, so you get an alert from the client, and the IRS is calling, and they want to do an audit. Is the IRS in the letter saying, we think X, Y, Z is wrong, or are they saying you got selected at random? Is it like a TSA, you get selected at random or the machine beeps? Do they tell you which one it is?

Steven (02:22):

They don’t make that super clear, so that’s a really good question, but they don’t make that super clear. We can kind of infer some things just from how the IRS works, and so there isn’t great data on what are actual red flags for the IRS, but from what I know of this client situation, I was heavily involved in it, and the areas of emphasis they picked, I do believe they just got selected randomly because there is, even though it’s a very small percentage, there are some returns that get picked at random, but this was a client making less than $400,000. For some reason, that number gets thrown out a lot as politicians talk about tax policy and who’s rich and who isn’t, which that’s all subjective anyways, but it was an important reminder that anyone filing a tax return does have the chance that they could be audited.

Ben (03:06):

So, just because you get a letter doesn’t necessarily mean information is wrong, or your advisor did something wrong or something was submitted incorrectly, or you’re being accused of fraud. Sometimes, it’s just your unlucky day.

Steven (03:18):

I would say most of the time, it’s not that you’re being accused of fraud, but it does specifically say, Hey, you have been selected for audit because the IRS sends out all sorts of letters, and I do have clients at times who will send me letters and getting audited, and the first thing I do is pull up that letter and look for, does it say those words? Because the IRS is very specific of, Hey, you have been selected for audit, and here’s the tax year. And then in those instructions for this client, the instructions started with they gave them a phone number to call to get more information to kind of initiate the process. And so they did that call on their own because that’s more of just a fact-finding call. They essentially got introduced to the agent they’d be working with, and then they asked some basic almost demographic kind of questions and then scheduled an in-person interview. And so they did all of that part. And then the IRS actually sent a second letter that said, Hey, based on your situation, here’s the areas of emphasis and they let themselves out the, well, we can ask about whatever we want, but they specifically called attention to a couple of areas to say, Hey, you need to come prepared to show us why you did these.

Ben (04:23):

Okay, so they’re going to at some point give you a list of stuff they want to look at. Is that something that the client is going to prepare, or is that something that the advisor or the CPA already has access to? That’s question number one. Question number two is where do they ask you to meet? Is it like at the post office? Is it the local penitentiary? Is it, do they come to your house? Two questions.

Steven (04:39):

Both great questions. So again, this is understanding the service that your CPA your paid tax professional provides for you. Because we went through that letter together with the client. It was actually a little bit of both. So the things that I had evidence for and documentation for, just because the work we had done together, I said, great news, I’m going to take care of these. I’ll have them ready. Nothing else you need to do there. But there were a couple of things, and for this client, one of the areas of focus was a rental property that they had sold during the year under audit, and specifically the IRS asked about repairs and maintenance that year. And so from the tax preparer standpoint, we are not required to and typically don’t get receipts for every single thing we apply some professional judgments, and I talk to my clients about this all the time that, Hey, if you come back on this rental property, we making 10 grand a year and you tell me that there was $50,000 of utilities, we need to have a different conversation. But there’s some professional judgment applied on the side of the tax repair, but not necessarily those receipts. So I didn’t have all the receipts, so I needed the client to grab them.

Ben (05:40):

And so the receipts are falling really more under a bookkeeping type thing, which some accountants do, but what you do is more about returns and things like that. Is that what separates the two?

Steven (05:50):

Yep. So, if you’re working with a CPA who’s doing your bookkeeping, hopefully, they will have retained those records.

Ben (05:55):

Gotcha.

Steven (05:56):

It was a combination of, and I made that really clear to the client of – Here’s the parts I’m going to take care of, here’s the parts I need you to take care of, and here’s why. The second part of your question, Ben, was okay, but then where did the audit happen? Which is a great question. It reminded me that I want to put this reminder out there that when the IRS reaches out to you, it’s not going to be via email. There’s not going to be anyone trying to scare you or force you into immediate action. They’re not going to ask for payment over the phone. It’s going to be a letter. So that’s the first important reminder. Unfortunately, there are scams that go on around taxes in general, but then they went into basically the local treasury office, the local office of the IRS. So this client was based in Michigan, and so they went to the IRS’s office that was local to them.

Ben (06:43):

And then, are you tuning in over Zoom?

Steven (06:44):

So for that one, I was just conference called in, so I was on a virtual call and the IRS agents were great about letting me participate if it would’ve been a more complex or maybe a more concerning situation, if we looked at the return and said, uhoh, it looks like something went wrong and we need to make sure we address that, maybe we would’ve tried to approach that differently. But we saw the year that was under audit, we saw the areas that they were focused on, we went back for documentation and said, you know what? We’re good on all of this. And so once I saw the letter from the IRS and the client’s tax return, I wasn’t concerned at all going into that meeting.

Ben (07:18):

Okay. So tell me about the duration of the meeting, how many hours, how many days, and then how long until the client found out this is what’s right or wrong and case close kind of are you on pins and needles for weeks, months, how long?

Steven (07:33):

So as we record this episode, the case is technically still open, but when we concluded the interview with the IRS agents, they went ahead and told us, Hey, everything you’ve provided looks great. We don’t have any adjustments to propose. They wanted to go, actually, and this is one of the things I want to touch on, they wanted to go and double-check some IRS guidance because they had never heard of a backdoor Roth contribution before. There were a few really interesting reminders out of this meeting for me just to make sure I don’t skip over it. The meeting was about an hour long and they provided a couple of weeks in between the initial call and then scheduling the interview and getting all those documents together. So again, they’re not trying to rush the process or force you to do something instantaneously. This isn’t a pop quiz that if you don’t know all the answers off the top of your head, you’re in trouble.

(08:20):

But so we did this hour long interview. It really started with just kind of some general, almost get to know you questions, which I look at talking to IRS agents the same way I look at talking to a police officer. If I get pulled over, I’m going to be respectful, I’m going to be friendly, I’m going to answer all their questions, but I’m going to be as succinct with my answers as possible. And so that’s how we approached the conversation with the IRS agents. And then we got into a couple of areas where I was glad that the client had immediately looped me in so that I could provide context because the tax code is 80,000 pages long for all of us, including the IRS agents. And so you can’t go into a situation like that expecting this IRS agent to have committed the entire tax code to memory and to know every in and out. And by starting the conversation from a friendly and professional point of view, we were building rapport throughout that hour. So we got to the part where they said, Hey, I’m not familiar with what you did here. Then we can have a friendly and constructive conversation as I help them understand how that works and where they could verify that as opposed to coming out and saying, geez, you dummies. Why don’t you guys know this stuff? It’s your loss.

Ben (09:28):

Yeah, yeah. That’s probably not going to earn you any favors. You probably want to leave your taxation as theft coffee mug at home too, I suppose for those meetings.

Steven (09:36):

Well, mine just says, don’t tip the IRS, but yes, I would probably leave that at home as well.

Ben (09:40):

Excellent, excellent. And so it was just one day, one hour. That was the extent.

Steven (09:43):

And so this was for a married couple. They have a 1040, they have a rental property. They did backdoor Roth contributions, W2 income, so it wasn’t an overly complex situation. But yeah, we sat through this hour interview, and got everything really well addressed. It was kind of a fun moment for me because the client is the one getting audited. My name is not on the audit. I’m there because I helped them with the original return, and that was part of my commitment to my client. The questions were directed to the client and they responded first. It was just kind of a fun moment for me to hear them repeat back the things that we had talked about previously. Even when we got to the backdoor Roth contribution, they said, I know we had to do this a little bit different way because our income was too high, but this was a way that Steven helped us with to be able to still contribute to a Roth. Steven, can you help explain more how that works? I was like, oh, so this is exactly the outcome I want that we talked about it enough that they understood why we were doing it, why it was important, but they were still relying on me to be the expert.

Ben (10:41):

So one day, one hour, by the end of the one hour they said, we think we’re in the clear, so hopefully the client’s at ease, but when are we going to get official documentation that this is case closed? Did they give you guidance on a couple days, couple of weeks, couple of months?

Steven (10:56):

In other dealings with the IRS? I expect it to be weeks or potentially a couple of months, not days, just because of the timeline they normally work on, and unfortunately they don’t commit to any sort of timeline. So they didn’t say, Hey, as we leave this by next Thursday we’re going to have this all wrapped up for you.

Ben (11:10):

Okay, interesting. Yeah. But I’m sure the client is breathing a sigh of relief that your next meeting won’t be between plated glass.

Steven (11:18):

Yeah, the client was really positive throughout it, and really Ben, for me, what I’m trying to do is as soon as that letter comes, this is why I reinforce my clients all the time. If you get an IRS letter, I want to be the first to know because then I can immediately reassure them, Hey, we’re going to be there every step of the way for you and reinforcing how the audit selection process works to let them know that, hey, just because you’ve got an audit letter doesn’t mean you’re being accused of fraud or crimes. This is the verification process. And then I also always reinforce that this is why we like to talk about the straight face test, that when we prepare, when I prepare a tax return, I don’t do this math of, Hey, less than 1% is going to get selected for audit, so I’m probably okay, maybe I won’t get caught.

(11:58):

Every single tax return I do, I apply this logic of is what I’m putting on the tax return something I could sit down with an IRS agent and with a straight face explain what we did and feel confident that that’s going to pass the straight face test for them as well. So that way when a return inevitably gets picked for audit, I don’t have to go into it worried. I know that we took the right approach and that we had our documentation upfront, and that if there were to be some question that came out of that, if the client was missing a receipt, if who knows what it might have been, we’re still not coming from a place of, Hey, we tried to pull one over on the IRS because like any regulator or someone who is charged with investigating something, if they smell blood, they’re going a lot harder. So if right out of the gate you’ve got something in your return that’s like, ah, well, I just kind of thought that that was okay, and I have no real explanation for it.

Ben (12:48):

I saw it on TikTok.

Steven (12:50):

I saw it on TikTok, it was on YouTube. They are going to dig harder. I was at a conference recently, Ben, and I was surprised that this advisor was so willing to share that his approach was that he would tell his CPA, Hey, if we get selected for audit and we don’t have any adjustments, you’re not trying hard enough. Nope. I guess everyone can take their own approach. That is not my approach. I want to be able to go into that audit knowing that we did a good job.

Ben (13:16):

That sounds pretty aggressive. There needs to be adjustments if we because you’re kind of just rolling the dice and hoping it doesn’t come up with a six or something. Gosh, I don’t know if I can handle that kind of anxiety when I put that tax return to bed for the year. I want to hope that it never comes up again.

Steven (13:33):

To be clear, while that audit wasn’t a painful experience for me, it wasn’t a scary experience for me. It certainly was inconvenient. I don’t go around volunteering for more audits. I would just assume be left alone and have my clients be left alone. But if they do come up, yeah, I’m not going to be scared or worried because I know the approach we took when we filed the return.

Ben (13:52):

Yeah. Well, that makes me feel a little bit better about the whole process that me as one of the co-hosts, but then also our listeners, somebody else went through it and survived, and not a big deal.

Steven (14:04):

Yeah, absolutely. Like I said, not a fun experience, not what I’d volunteer for, but if we take this approach upfront of, Hey, we understood the rules, we did our best to follow them, we have clear documentation for what happened. It doesn’t have to be this scary process, and it’s important to remember that the person on the other side of that table is also a person, A person who most likely did not grow up dreaming of someday becoming an IRS agent, but they’re doing their best to do their job the best way they can to support their family to provide for their life. And so you are not going to gain anything by walking into the office and trying to prove how stubborn you can be because we also need to keep in mind that the IRS agent sitting across that desk is not the one who made any of the rules. Regardless of your feelings about the tax code or what should or shouldn’t be changed, it is not that person’s fault or responsibility to make those changes happen.

Ben (14:53):

So, anything behind the scenes now that you’ve been through your first audit on the RTS side, anything that’s going to change as far as assistance and processes to prepare for the next one, or you feel like you pretty much had it in hand from the start?

Steven (15:06):

That’s a great question, Ben. We help clients with IRS communications on a fairly regular basis just because of the number that we work with. It’s still a relatively small percentage of the total clients. I was really pleased that coming out of that, there wasn’t anything on my list that I felt needed to be changed. We went through the process as far as we could tell, this got randomly selected for audit, which is going to come up at times. We provided the support, we explained our position, and like I said, that meeting concluded with, Hey, this all looks great. We don’t have any adjustments for post.

Ben (15:34):

Excellent. That’s excellent. Any other thoughts for us on this exciting excursion you had?

Steven (15:38):

Ben? I know I’ve already said it a couple of times, but I travel a lot as well, and so the piece of how we interact and deal with the IRS, I think is an important reminder. And the reason I mentioned travel is because it seems to always come up as I’m going through TSA and I see people taking out their frustration of airport security on the TSA agents, and so I get it. I think the rules are silly as well. I actually worked at an airport for a while, so I have behind the scenes firsthand knowledge of just how silly some of those rules are and how little they do to actually protect anyone. But all of that aside, that particular TSA agent, that particular IRS agent, whoever you end up dealing with on the other side of that three letter government agency, that is not the person to take your frustrations out on, and you are going to have a much different and a much more positive outcome if you just play nice, if you treat them as a person with respect and dignity and all those things. And I wish I didn’t feel the need to reinforce that so often, but the stories I see and the stories I hear makes it worth repeating a few times. That’s a piece of this process you can control.

Ben (16:43):

I feel like that wisdom is applicable in lots of areas of life. You catch more flies with honey than vinegar. Is that what our grandparents would’ve said?

Steven (16:49):

Absolutely.

Ben (16:50):

I guess that’s a great place to leave it. I think a good title for the episode would be, I survived an IRS audit. Is that a clickable title? And Well, until next time, don’t let the tax men hit you or the good Lord split you.

Steven (17:03):

Hi everyone. Quick reminder before you go. While Ben and I feel very strongly about the information we’re sharing on this podcast, it is for educational purposes only and should not be taken as specific tax, investment or legal advice. You need to make sure that you are working with a professional to evaluate how these concepts apply to your specific situation before you take action.