Case Study: Dodging a Bullet
Introduction
I just wrapped up a case for a business owner who almost found himself in a black and white stripped suit (jail for those who don’t get the reference). This gentleman represented himself during an IRS audit and said and did some things that upset the IRS agent. The client then hired us to handle the rest of his audit. It became apparent that the agent was considering a criminal referral based on some unreported income and unsubstantiated deductions. He ran a multi-million-dollar business himself, which employed about 60 employees. He handled marketing, sales, and managing his teams all while also handling the paperwork and bookkeeping. A recipe for problems. In short, the IRS agent thought these issues amounted to tax evasion; we thought it was poor management and recordkeeping.
We carefully responded to the IRS agent’s requests and cooperated with him as far as we could without jeopardizing my client’s rights. Ultimately, the IRS agent had to concede that there was not enough to prosecute BUT he felt there was enough to whack my client with what is called the 75% penalty or civil fraud penalty.
This 75% penalty is assessed at 75% of the additional tax assessed during the audit, which resulted in a penalty of $157,000 for the two years under audit. Not only was this a stain on my client it was a huge financial burden. We spoke several times on what to do and eventually we agreed that we would appeal his case to US Tax Court. This was a long-shot as the IRS agent alleged some damning facts against my client but we decided that we needed to try. We felt that the IRS unfairly painted my client as a tax evader.
US Tax Court
I filed his case in court and we waited for the IRS to respond. In the meantime, I had my client take steps to fix the bookkeeping issues that resulted in the audit adjustments. I also educated him on the requirements for taking business deductions so he would not make the same errors as before. I need to state that regardless of the outcome of this appeal he was a marked man. He is much more likely to be audited and if the IRS finds any issues again he will not receive any grace like before. So I wanted to make sure that we set him up for success in this appeal and in any future audits.
When the IRS responded to our appeal it was clear it was not going to give an inch. The IRS’ reply was 30 pages long listing every alleged error and touting it as proof my client was a tax cheat. It was a bit disheartening to the client but we forged on. I sat down with the IRS agent’s audit paperwork and keyed in on what he considered “badges of fraud” justifying the 75% penalty. I then did some digging in the case law to find possible defenses to these badges. I found numerous cases that discussed cases similar to my client’s which provided some hope that we could mitigate the IRS’ claims.
IRS Appeals and Victory
At this stage, our case was sent to IRS Appeals to see if it could be settled without the need for trial. A settlement officer was assigned to the case and armed with case law, I wrote up a brief which poked holes in the agent’s audit findings and pushed back against the badges of fraud. What the IRS considered clear cut indications of chicanery I showed had innocent explanations or which the court typically did not hold against the taxpayer.
Ultimately, the IRS agent found my arguments persuasive enough to gave her some pause that the IRS may not prevail. This is called arguing the hazards of litigation. I had poked enough holes in the government’s case that the Appeals Officer agreed to cut the 75% by more than half to 35%, which reduced it down to $73,000, a $84,000 reduction.
While I was not able to get the whole penalty removed, I was able to mitigate the damages caused by the audit. My client can now focus on his business again and I have helped set him up for future success in case he is audited again.
Summary
In short, no case is every truly hopeless and with professional help you can find ways to reduce or mitigate the damages of a bad audit. Which includes if you were assessed the civil fraud penalty. My client is now able to get back to his business better informed, albeit a little lighter in the pocket, and having avoided jail time.
If you or someone you know has an IRS problem and you have some questions about what your options are, you can reach my firm using the contact information below.
Beacon Tax Advocates, LLC
57 Portland Road, Ste. 3
Kennebunk, ME 04043
207-502-7181
jwade@beacontaxadvocates.com
www.beacontaxadvocates.com