U36 – Auditing the Audit Process
0:03
Why they are doing?
0:05
Pardon me, this is John Jay, and I’m going to talk about audits today.
0:10
I’m going to give you a couple unusual examples, OK, just to illustrate some points.
0:15
Not all audits need to be handled this way. IRS Audits, OK? You can just pretty much for the most part.
0:21
When you file tax returns, do the right thing.
0:23
Don’t try to get more deductions, and you should be getting.
0:27
So maybe you’d like to play it on the edge, that’s fine.
0:30
But typically, you can go to an audit, and you should probably, in my, in my opinion, an audit should not take more than one meeting.
0:39
And maybe it might take a few weeks of IRS agents looking over documents, and things like that.
0:44
Maybe it takes some communication between you, and the auditors, or you’re assistant.
0:49
You’re CPA, EA, whoever you going to want to have help you.
0:54
But for meeting in person, if you’re gonna go to audit an audit, unless you’re McDonald’s, or some big corporation, you probably should only have one meeting, and if you’re having more, especially if you have 6 or 8 meetings, you’re probably being taken for a ride and overcharged by your account. I probably didn’t even have that account. Or he or she doesn’t know what he’s doing.
1:16
So, or he’s just trying to create billable hours. I’ve heard some really crazy thing. So, I just want to share with you a couple of examples. These are literally two audits I’ve worked on in the last 3, 3 years or so.
1:30
And the first one was prompted because the couple had opened foreign accounts in different countries.
1:39
They had ABC’s international business companies. They had trust accounts, they had LLCs in Panama and all kinds of Belize, whatever and there was no real purpose for them other than I don’t know. Maybe they thought they were going to do something with them. They really didn’t do anything.
1:53
It just cost them a lot of money And so, what happened is they didn’t comply with the Financial Crimes Network or FinCEN disclosure reporting rules And I’ll give you a quick reference here.
2:05
It was, If you, if you go look under Form Iris form 54 71, and look under the instructions for that form, You’ll see what I’m talking about. They’re very complicated.
2:17
In fact, it’s so complicated that you can probably never comply now, and I’m gonna get into things, some things here.
2:23
I’m going to, I’m going to show you two examples. OK.
2:25
There’s two categories of audits, I’m going to explain to you.
2:28
In the first example, there are two different cases. I’m going to tell you the different things of what happened here.
2:35
The first example was a couple that I began working with, and so what we did is we shut down these foreign companies and got out of that, but the problem is they had already had all these penalties for, like the last six years, or four years or something where they didn’t meet the disclosure requirements.
2:49
So what we had to do was, there’s a 90 day notice period where the IRS tells you, you know, the IRS enforces Financial Crimes Network, the FinCEN rules.
3:02
That’s how that works. So, the IRS sent this notice, and you have 90 days in which to file your disclosure forms, if you haven’t done that, which we did, and the penalties are huge.
3:10
I mean, it was tens of thousands of dollars per year, and it’s double that because if it’s double that, if you don’t fill out the forms late. So, when we got the notice from the IRS, when we saw that, I had them go ahead and fill out.
3:23
They’re disclosure forms, That’s required, in which they did, and that cut the penalties in half, while they still had probably a quarter million dollars in penalties. It was crazy.
3:33
So, what we did is, we finished that, then there were, they were already in the middle of an audit because of it. So I got it. I got into it right at that point. So, what my purpose was, is to get rid of half of the penalties or reduce the dollar amount, Not that, it’s not really going to matter when I explain you what we actually did in the end. But I’d just like to just do that because in the Financial Crimes Network or FinCEN rules, you actually have criminal penalties that could that. The civil penalties could morph over into the criminal side, but while the IRS is talking with you, there is no criminal aspect to it.
4:07
So just be aware that when the IRS is talking to you about a matter, there is not, well, there’s not supposed to be a criminal investigation or criminal implication.
4:19
So, you always want to ask them to, by the way, but in any case, we did all that. And then, because we’re in the middle of an audit, we had to answer a bunch of questions, and that was all done by the mail. And so I had the clients go to, I think I think they had already been to one meeting in person with the agents.
4:36
And so I told him, let’s just have one more meeting. And I think we did that. I think maybe we had to go to two. I don’t remember it as a general rule. I try to keep it at one.
4:44
So in this case, I figured that because of what had transpired previously and judging by the communications from the IRS agents, I felt it would be a prudent two, have a court reporting service take the transcript of the audit. So they went to the audit.
5:02
And I explained to them to not use the Fifth Amendment to go ahead and answer all the questions. And we had some strategy about answering the questions you always want to tell the truth, and, but you don’t want to give out too much information. And what we’re just trying to do is get through the audit without creating more drama.
5:16
Let’s just call it, all right, with the least implications as possible.
5:21
So, lo and behold, they complete the audit, and the IRS didn’t like it because it didn’t get any more information we did.
5:29
In my opinion, we did a pretty good job of complying with the summons and then not given the IRS a lead into some other new investigation. That was my purpose. So, well, but the thing is, we had a transcript from and a transcript.
5:43
Mean, that was probably an all day audit.
5:45
six hours, I mean, I’m sorry, but sometimes that happens. And so we had the whole thing transcribed. It was expensive, was probably, I don’t know, maybe a thousand maybe $1500. I didn’t want to get into too much detail there, but, I had the clients do that, and then we had, that we bought the transcript. Because I figured my calculation was that those agents, we’re going to go to the Department of Justice.
6:06
They have to do referral and the Department of Justice would then go to the US District Court and claim that the people they were being audited relied upon the Fifth Amendment at the audit, OK, which you cannot do because it’s a civil matter.
6:19
Even with FinCEN criminal penalties, OK, that you still, You can’t just say Fifth Amendment. There are other ways of dealing with that and I can’t provide them attorney client privilege and it wouldn’t have helped them anyways. So, what we wanted to do is document the fact that we didn’t use the Fifth Amendment because I figured that they would try to use that to intimidate them and to getting more information. Which there was really nothing else to give anyways. It was, you know, there’s harassing people, so, anyways. Sure, enough, I took a few months. They got Sued civil summons for refusal or failure to comply with an Iris summons. That’s what it was all about, OK.
6:53
And they were telling the US District Court judge that they that the two people use the Fifth Amendment and refuse to comply.
7:02
That’s the only thing they can say.
7:04
And so we filed a motion to dismiss, and we provided a copy of the transcript, and we said, hey, judge, look, we complied, we answered all these questions, and here’s the transcript, and you can see and hear that not one time that one moment throughout all those hours of transcript did the defendants’ rely upon or state or claim the Fifth Amendment as a response to any information requested.
7:28
And as a side note, because I I like to have a bit of a sense of humor, I did say, and you all know, you should know, if you don’t already that. The US.
7:35
Constitution does not apply in an IRS audit. Why are you even mentioning that?
7:41
This is a frivolous claim period that was hit in my motion. And the took about maybe two months, maybe a month.
7:51
And the IRS Department of Justice, dismissed the case with a two line motion to dismiss, end of it.
7:59
That was the end of it, not the end of the debt. Just the end of the examination, whatever.
8:05
Now, what they’re doing is something called running the clock, we just arrive at a dollar amount that they owe. You’re not going to get around it because the penalties. I’m not going to get there’s no way around it.
8:16
But what we can do is file returns and stay current and not pay.
8:22
And just you can either work out a payment plan if you, if you want, or you can.
8:27
if you’re uncollectable, which, a lot of times, people qualify for that.
8:31
You can submit a payment plan or a proposal to say that you’re not collectable right And have the IRS agree with you. Sometimes that happens in this case.
8:39
We just, we didn’t want to do that, because it requires all kinds of new financial disclosure. So, we don’t want to go that route. We just got out of that situation.
8:46
So, what we’re what they’re doing is they’re going to file and stay current, but not pay that amount of money, not even try to pay it.
8:54
They’re subject to levy with wages, but it’s only 15% of the wages, the rest of their property and income or whatever it is protected. So, it’s it’s optic. It’s called off the radar, so to speak. It can’t be levied.
9:04
So they’re pretty well protected.
9:07
Equity is stripped out, and so the IRS can’t levy. And so they’re going to continue filing and for it’s going to take probably another eight years.
9:15
And by that time, the debt will probably be approaching three quarters of a million dollars. It might be $700,000. And then on that 11th year, it’ll turn into zero.
9:25
It’ll have expired because of the statute of limitations and you can only do that when you file returns.
9:31
So, that’s an example of how we, I like to say, we ended the problem.
9:35
I mean, really, it took a year and a half for the whole thing to end with a court, but I think we ended the problem in about a week.
9:43
They’re never going to have to pay, We cut the bill in half.
9:47
Know, by catching up the filing, and just a word of caution, don’t do things off shore, and identify yourself as a US citizen. Get a second passport. Or use nominee directors, OK?
9:58
Pretty much anywhere in the world, except probably Taiwan or Iran isn’t isn’t is going to report on you.
10:03
All right, so that was way different than this other case. Very similar set of facts, very similar.
10:12
Now this other person did have business in another country and ran into the same situation. Didn’t do the proper disclosures.
10:22
In this case, she hired an attorney, and for 6 years 6 years, that attorney took a fifth of a million dollars to represent her and to guide her to the point where he created drama. He created litigation. He created the need for him to keep being involved and keep billing her.
10:39
And he got her into a situation where the Department of Justice, Souter, Justice Souter, and claimed that she Wilfully and fraudulently refused or failed to disclose these facts.
10:54
And the, the reality is is that she, they are correct that she didn’t use the right form, but she did disclose the fact. So there’s just saying that because you use the wrong form, that was fraud. That’s what their their claim is.
11:06
Well, the attorney got her to a point where they sued her and after about five months of not answering the complaint the attorney didn’t answer the complaint.
11:14
He told her that, he should just give up, and default on the case, because the United States always wins.
11:21
And when I heard that, I was like, Oh, no, no, no, no. You don’t want to. You want to default. On a case where there’s criminal implications, not that, that’s gonna manifest in crime. An indictment of some kind but with Financial Crimes network involved. You’re looking at Title 18 penalties.
11:37
But, at this time and it never has turned into that, neither of them have but they just wanted property. They thought they could get some big windfall from this person and they just, They were wrong, in any case.
11:48
So, we we went ahead and made, we got permission from the court to answer late. And then we force the government to go ahead and present its case and meet its burden of proof, which it really has struggled. And I don’t know which should probably end up owing some money, but it’s way better than defaulting. And so, she’s probably got a claim now against the attorney for actually being competent and being kind of a jerk. And he should have told her in the beginning that he wasn’t competent to help.
12:14
In any case, that can happen. I’m not saying all attorneys will end up in that situation, but it just, it just happened. I’ve seen a lot of it, a lot of times. It happens like that.
12:26
I guess the lesson from that is document what’s going on, understand what the law is, understand that the US Constitution doesn’t pertain to IRS audits? I know you guys are probably gonna get angry when you hear this.
12:39
Just, I’ve been to a lot of these, probably 100 around the, around the country.
12:44
I used to travel to people’s places, and I would sit with them for a couple of days, I would stay over their place, and I would help them with their audit. Sometimes idea, actually go into court, and talk to the judge and try to work it out. And just say, Look, what this person is. You know, he’s my friend, and I’m going to help him. He didn’t quite understand, he hates the IRS like everybody. But I told him it has to be done, and he’s, he’s OK with that, and I’m gonna help them with you, that’s OK with the court. And the judges are always amenable to that. I’ve never had a problem with them.
13:12
And it’s funny, because they don’t care if I’m an attorney or not, in many cases. So, but any case, I don’t do that too much anymore, But, that’s why I’m doing this video. I want to explain that. You don’t have to be afraid of it. Just document an audit. Yeah, you might end up with a bill. Lots of times. You can negotiate out of it.
13:28
You know, just try to do the right thing, But document everything.
13:31
Don’t be afraid of these guys, OK, and then.
13:36
You don’t need to protract an audit it that there’s a tendency to have that happen.
13:41
Given that, I’ve had this a few times where a person comes to me and is already in that situation, he’s going into his third audit, No meeting. And I’m asking why, and he says, I don’t know. My enrolled agent says, I have to, and I’m thinking, or are you building a paying by the hour, you know.
14:00
Sometimes that happens, and maybe they don’t mean to do it that way, but, you know, it’s the nature of the beast.
14:05
And so, I just tell the IRS, I, you know, I get the permission first, You know, the person’s permission, I’d just say, hey, I read alleged the IRS. And I say, Hey, I’m not gonna go to any more of your meetings. if you can’t determine whether or not I owe more money or whatever the deal is, you can’t conclude the audit.
14:20
With the information you already have, then you don’t know what you’re doing.
14:23
And, you know, have a nice life, that’s the end of it, and then, of course, the enrolled agent or whoever gets scared and quits and sends a letter of termination and my clients like, yeah, we don’t need if anymore, you know?
14:35
And so, either you get a bill or not, and if you get a bill, so why don’t you just negotiate it out?
14:41
In the meantime, you know, you want to strip assets and income if you can, and all that sort of thing. So, I don’t want to get too far into that, You’ll see a lot of my other videos, I talk about that.
14:49
I don’t say the reasons, but this would be one of the reasons.
14:53
All right. So.
14:55
And so, and in that case, those are two examples.
15:00
FinCEN issue was OK, not a great situation to be in FinCEN Issue, that was a disaster.
15:07
Exhausting really took a lot of this this woman’s time.
15:11
Uh, but she was a good sport about it. She did a pretty good job and I think we did pretty good there.
15:17
Now, here’s where it’s the most practical.
15:20
Now, keep in mind, I’m not saying that every audit should be undertaken in this way.
15:25
Remember, I get cases where it’s there’s an abuse going on, someone’s being exploited. I’m trying to protect somebody, put out a fire, so to speak.
15:34
This is not your typical Joe Smith that just has a business or no a website, and he’s getting a routine audit.
15:43
This is an abusive situation.
15:44
So now, here’s a case where a person who was a high net worth person did it file for more than three years.
15:53
And when you don’t file for more than three years, when you get into that fourth year, there’s a presumption of fraud for every year that’s beyond the three.
16:00
And so when there’s a presumption of fraud, that doesn’t mean you’re going to get arrest hit or anything like that. It just means there’s a presumption of fraud.
16:07
And so, to protect the client, what I had them do is go to a tax attorney.
16:12
We do not need the tax attorney for tax advice.
16:15
What we’re going to use the tax attorney for is the attorney client privilege. I can’t provide that. So, we go to a tax attorney.
16:22
We take all that. And this is a case where we’re going to file. There’s a reason why we do this. Sometimes, we don’t, but sometimes, if you want to catch up and file for those years, you didn’t file for it, for whatever reason.
16:33
There’s a strategy there. In this case, we had to file.
16:36
So it was more than three years out, so we go to a tax attorney. It probably costs. it was like $900 to do this.
16:42
It’s worth it. You’ll see why?
16:46
High net worth person?
16:48
We did a re-organization of his assets, and that’s kind of a side issue, but to confront the reached the initial problem, we had to get him back into filing, and we wanted to get the attorney client privilege so that what happens is, when you file after so many years of not filing, it generates an audit. Now, the reason why this happens, it’s not only I know it because I’ve seen it.
17:09
It also is, if you look at the Internal Revenue Manual, OK, it’s on, It’s on the Internet, I think it’s called the 6209 Internal Revenue Manual. You can look at it, It’s kind of really extremely boring reading, But anyways, if you’re, if you’re motivated, you can find out what these guys do. So, anyways, I know what they do, what they do, so, I knew they were gonna audit him and, so, we went to the attorney, We got the attorney client privilege.
17:29
We gave all the documents, we had the attorney pay a CPA and now, I think the CPA worked in the attorney’s office. That’s probably the better situation.
17:38
So, most attorneys will qualify for this criteria. They’re not, they don’t have to be smart. They don’t have to be specialists. They just need to be an attorney who’s working with a CPA. Maybe that does accounting, That really helps, but not necessarily. anyways.
17:51
So, we give him all the documents. The accounting accounting person prepares all the returns.
17:57
The client signs them and files old old school style by mail. That’s just my way of recommending it. I don’t like doing the online stuff.
18:06
And so sure enough, we get an audit.
18:09
So before we get to the audit part, I’m going to explain what I had them do is claim standard deductions and everything. That means, now this person was a high net worth person because he was a real estate investor, so he had all kinds of really cool deductions. He could have lowered the debt quite a bit.
18:24
And I told him, make it as reasonably high as possible.
18:29
So that means be naive, complete your tax returns, and only claim standard deductions. Don’t take advantage of all your deductions that you could easily take advantage of.
18:38
And he didn’t really, except that when I told him and I explained why not and you guys will hear why I’m doing it this way, because by making the debt higher, it was easier to negotiate a payment plan later on like a year or so later.
18:53
But, I explain this. And it was a very uncomfortable situation, because he didn’t know me very well, and I said, please, if you’ll just trust me, it will work out really well.
19:02
Anyways, so, it was funny, As I got a call from his wife shortly after that she was a little upset. Why are you telling my husband to do this? And so, I try to explain myself again.
19:13
I said, if you’ll just please be patient, trust me, it’ll work out just fine.
19:17
So, anyways, we got the debt as high as possible, OK, with standard deductions, and it was ugly.
19:24
And, uh, we did the returns, we got a bill. OK, we sent the returns, and with No money. And, got a bill. And I saw title them every step of the way. I said, OK, here’s what’s going to happen next.
19:34
And so he gets this bill, and he goes, Hey, I got the bill, and, so we go to the, we go to the audit, Actually, I’m sorry, we will get the bill later, but we go to the audit, after filing, and they wanna look at his books and records. And so he goes in there, and he says, one thing. I heard him say one thing, now, he brought his books and records.
19:53
And I told him to explain that these records, the tax returns, OK, we’re prepared under the attorney client privilege, and the communications between himself and the attorney are privileged.
20:07
And, and of course, the accountant as well because he was paid under the same retainer.
20:13
And that what you see is what you get, OK. This is what we told the IRS on Form 1040, on the four corners of the form.
20:21
What you see is what you get, because all of the communication was to prepare those returns, and it’s under the attorney client privilege.
20:28
Now, apparently, they’ve heard this before, because he didn’t even finish the sentence, and they were so polite to them, They said, It’s OK.
20:36
Thank you for coming in.
20:38
Have a nice day. We’ll be in touch.
20:40
And it was funny, because he didn’t even open up anything. He’d even sit down.
20:44
He left, it was like one minute, less than one minute, he left, he was calling me on the phone, on his way to his car in the parking lot and he was laughing, and I said, Hey, hello, is laughing, and he says, Man, how did you know they’re going to do that? I said, I didn’t really know they’re going to do that, but that’s was, that was likely.
21:01
I mean, worst-case scenario, you would have sat there for awhile, they want to be jerks, but I’m glad you’re out of there. So we’re done with that, because what’s going to happen next? I said, you’re gonna get a bill.
21:10
It’s going to be ugly.
21:11
Don’t tell your wife, I don’t know.
21:13
And it’s like, you laugh it again, and sure enough, he gets a bill. It was, it was a bill for them, was called examination changes. I believe you can find the form on the internet. It’s called form 4549.
21:24
So he gets a big, fat bill, as I like to call it, and so then he calls me. He goes, OK, I got the bill, it’s, it’s bad, it’s bad, And I said, OK, so, let’s do this. Now, remember, I’ve worked with him for this is, we’re about a year into it now by year and a half or so.
21:37
And so, we had re-organized everything so that it’s amenable to making an offer with the IRS. Let’s just say it that way.
21:45
And I said, Well, let’s make an offer in compromise based on doubt as to collectability. And the way you do that, you guys want to check this out. Right now, it’s form 6, 5, 6. It’s actually a booklet used to come in a great booklet. Now, it’s on the Internet, So it’s a large PDF file. In the PDF file. The most comprehensive one you’re gonna find, it’s going to be a PDF.
22:07
I believe you can fill them out online, but I think you can print them and do it by pen. I don’t think you can do both.
22:14
I, for myself, I like to do them by pen. So Form 656, basically, it’s a financial disclosure statement. It’s a balance sheet.
22:22
Now, there’s some detail in there, one has to do with your individual master file and one has to do with your business master file. Business master file just means things like 10, ninety nine’s.
22:30
Individual master file means, things like W, fours, W twos, OK? So there you have employment income, you have independent contractor or business income, or investment income.
22:41
So those two categories are covered by Form 656, which is a General Balance Sheet, financial disclosure form, And the supplemental disclosures are on Form 433, A.
22:53
That’s your individual master file disclosure documents pertaining to your W two type situation and then Form 433 B, that pertain to business 1099 K 1, things like that.
23:05
So we fill all that out.
23:07
I know it’s, you don’t want to fill it out, but if you’ve already been, you know, prepared for an audit and you’ve already, the IRS says you owe some money. It’s and we’ve already done the proper re-organization.
23:16
When we disclose all that, the IRS is going to, if you’ve done it correctly, if you’re able to do it, the iris will usually conclude.
23:24
That’s your uncollectible and this is what happened in his case. So, it took a few months. We did the often compromise based on doubt as to collectability, not liability, collectability.
23:34
It doesn’t matter because he’s never gonna pay him anyway. So we did the offer. Iris came back, send them a letter and said, we’ve examined your offer and concluded that you’re uncollectible at this time and we will review your file in six months, which I don’t know if they did, or not, because nothing’s ever come of it. So, what’s happened since then?
23:52
And it’s been about nine years, I would say, nine years.
23:56
We did that 8 or 9 years, Um, the debt went from about a half a million dollars. It’s probably about $700,000 now.
24:05
It’ll be close to $750,000 in a couple of years, Well, by the year 20, 23, I suppose, 2024, maybe, 2023, it will expire.
24:17
Those debts will expire, or they’ll start to expire. He’s got a period of time where they’re going to start to expire. And hello them, nothing, and he’ll have paid them nothing because of the statute of limitations. And the only way to do that is to, like I just described. You do the best you can to mitigate the debt. You use the attorney client privilege and it kind of didn’t matter anyways because we only have standard deductions. We didn’t care about arguing over deductions, right? We don’t, we want the debt to be higher.
24:41
We don’t want to be annoyed with an audit or risk disclosing something that might give the iris a lead for something else. I had, I didn’t know if that were, what’s going to happen, so we try to eliminate having to answer more questions, right?
24:53
So they, they made that conclusion, and since then, from what I understand, there’s been no change.
24:59
However, he does file a return every year, he reports his income, and it’s just a nominal amount, which is reasonable for his demographic, and that’s the end of it, his assets are not, no, they’re not his anymore. We’ve, we’ve taken care of all that.
25:13
So, that’s a general description of some of the things that I’ve used over the years with the kind of results that are typical.
25:23
Those are the few most recent examples.
25:28
Let’s see here. I’ll make sure I didn’t miss anything.
25:30
Yeah.
25:31
So, yeah. We cover pretty much everything.
25:36
Anyways, just, you know, be pragmatic.
25:38
Know that you can document things, you can bring a court reporting service. I would not recommend just using a tape recorder or a recording device like your phone or something. I mean, you could do that. Ultimately, if you need the transcript, like I just explained, if you need the transcript, you’re going to have to get the official transcript from the core reporting service.
25:55
And then you’re gonna enter it into the court if it’s if that’s what you’re using it for. If you just need to take notes, OK, fine, Just make an audio recording. And also like you would in college, just, you know, make notes with your your pen, OK.
26:07
So in any case, my, my purpose here is I hope that it dispels some fear, OK.
26:15
It is manageable manageable to do an audit, and yeah, I know audits in most people’s mind is probably accurate, equal, audits equal having to pay more money.
26:26
Um, if it’s a lot more money, that’s actually better, as I just explained, OK, That’s the way I look at it. Anyways.
26:34
All I care about is my client has the most access to the most money possible, and not break any laws.
26:41
So All right.
26:42
Well, thank you for listening. I hope this helps.