A while back, Reg Rowe asked me, "Hey Rich. I know you've done battle with the IRS. Since you've been at this independent practitioner stuff since before the earth cooled, I wonder if you have any tax-related advice for this rookie?" The first thing I said was, "What the hell is this 'before the earth cooled' crap, Reggie?" Disclaimer: Then I told him -- and I tell you -- that I'm not a lawyer, not a CPA, not an accountant, not a tax expert. I'm just a guy running a business who has made some money, paid some taxes, been audited a bunch of times, and has developed a philosophy and some procedures. Records, Records, Records The answer to Reg's question is records. In one early audit, the auditor complained to my CPA that my file was too hard to work with, because my records were too detailed!!!! The CPA loved it! He said he'd heard complaint after complaint that people didn't supply enough information to the IRS, but never -- before me -- that the taxpayer supplied too much! We document and line-item and detail every little thing. I list a one-mile trip to the local blue box to mail an invoice. A 5-cent deposit in a parking meter. A 34-cent stamp and (in some cases) a 4-cent envelope. Get the idea? Pretty anal, I admit, but it protects me from S.O.B. auditors. Deductions Are a Matter of Opinion -- MY Opinion Failing to declare income is illegal. Even you know that. However, deductions are a matter of opinion. And it's perfectly reasonable to be generous in how you interpret the rules and regulations and laws and precedents. Generous to you. Now that's generous, not dishonest. I decide any close calls in my favor, not theirs. But I don't invent stuff, I don't lie, and I jolly well recommend that you don't, either. That said, I'm pretty certain that, if you don't ask for a deduction, the IRS won't find it for you and hunt you down and force you to take it against your will. Except for Jail, What's the Worst That Could Happen? If you DO claim a deduction, one of three things will happen:
They may miss it or ignore it or recognize that it is legitimate or choose not to audit you, and you get 100 percent of the benefit for being aggressive.
They may audit you and look at other things than the area where you were being aggressive and you still get 100 percent of what you claimed.
They may audit you and look at the very area where you were being aggressive. If they do, by the time you are finished arguing with them (remember, the auditor is under pressure to close your file quickly, so it generally is to your advantage for the process to take longer -- much longer -- than he would prefer), they very likely -- no, make that almost assuredly -- will compromise or select a lower figure than their starting point and certainly will select a lower figure than the total of your aggressive claim.
Example: If you were conservative, maybe you would claim deductions of, say, $15,000. However, you choose to be aggressive, and claim deductions of $25,000. You get audited. The auditor never will sock you for $10,000 in disallowed deductions; he's not privy to your strategy; he won't know the areas in which you were being most aggressive. By the time you finish arguing and negotiating with him, the IRS may settle for $2,300 in disallowed deductions. Or $800. So you've successfully -- and, more important, legitimately -- claimed $7,700 or $9,200 more deduction than you would have received by being "conservative." What's the cost? A little more CPA time to deal with the auditor. What's a few hundred dollars when it stands a good likelihood of saving you thousands? It's Just Like Any Other Business Decision With odds like that, any small businessperson is foolish for not being as aggressive as possible (within the bounds of reason). But, to the IRS's glee, too many people are put off by the prospect of an audit (!!!), without stopping to think about the business side of it. An audit is just dollars, economics, a cost of doing business. I assure you, dollars made from the tax side of the equation are just as spendable as dollars made from the client income side. It simply boils down to your own personal balance point: Is the time and aggravation spent with the IRS more productive than a similar "investment" in dealing with a client? Of course, you need a knowledgeable, cooperative CPA as an accomplice. One who isn't scared by IRS intimidation tactics. One who is willing to put up with the annual IRS "terror campaign" aimed at CPAs whose clients are audited "too frequently." One who not only is willing to allow you to be aggressive, but who will assist you by making money-saving tax suggestions (and helping you assess their risk). Brenda speaks highly of McRuer & Weishaar, CPAs. I can't name my guy, because he does corporate work and handles my business on the side. But it's not Arthur Andersen. I Don't Talk to Auditors; I'd Get Too Pissed Rita and I have been audited about 15 times (Yeah, that's too damn many. I'll explain next week.), and I've seen precisely one auditor -- and that was when the IRS was negotiating to keep me from taking them to Tax Court. You don't think Bill Gates goes in to the IRS office each time Microsoft is audited, do you? No, my CPA does it all for me. He knows that I would go into the audit and get mad at the fu@#ing IRS and say something I regretted, so he won't let me go with him. Good advice, huh? Anyway, this gives us an advantage: No matter what the auditor says, proposes, or asks for, the CPA has to come back to us for the additional information, the answer, approval, documentation, whatever. More delay for the auditor, more protection for us, more time to formulate a response or develop strategy. Oh, I don't like audits. Hell, I don't like the IRS at all. But as long as our system is what it is, we have to find the best ways to use it to our advantage. That's what I'm doing, and I hope I'm able to provide a few tidbits you can use, too. Next week, in Part 2, I'll talk a little about some of those deductions and why the IRS is ... er, ... watching out for me.