The Three Rules

In (what I'm guessing is) an effort to scare practitioners away from cheating, the IRS announced last Friday that a "Certified Public Accountant has been suspended for twelve months from practice before the Internal Revenue Service by the Office of Professional Responsibility for providing false or misleading information in connection with the preparation of his clients’ tax returns."

Unscrupulous tax preparers come in all kinds: tax attorneys, CPAs, Enrolled Agents (EAs), unlicensed preparers. Everyone should try and avoid a preparer who lacks integrity. Tax bloggers provide good advice for choosing a preparer, including Joe Kristan, Trich McIntire, Bruce The Tax Guy, Robert Flach, Peter Pappas, the IRS Hitman, and many others.

Upon reading the news of this suspended CPA, I thought this might perhaps lead to more debate on the topic of whether a CPA is more qualified to prepare a tax return than an unlicensed preparer. There's been so much written on the topic in the past few months, that I'm honestly not sure where the discussion left off. (One post that includes links to many others can be found at The Missouri Taxguy.)

I posted my thoughts on tax preparer regulation a few months back, and find my opinion has not changed much since then. I do, however, have some new thoughts on the matter of how such a topic is debated.

When reading about this CPA who was suspended, I thought: "Oh dear, I hope people don't start thinking he is representative of all CPAs."

I think most people agree that one bad apple is not representative of the entire bunch. But when in the throws of an argument, we often give undue attention to the one bad apple in an effort to make a point. This happens in debates about matters ranging from types of tax preparer, gender, race, nationality, and perhaps most of all religion. Since people tend to disagree in all such matters, I suggest we can learn from how others address the challenge of engaging in productive debate. Perhaps the most debated topic of all: religion.

The world reknowned theological and scholar Dr. Krister Stendahl is credited with creating Stendahl's three rules of religious understanding, which are:

1. When you are trying to understand another religion, you should ask the adherents of that religion and not its enemies.
2. Don't compare your best to their worst.
3. Leave room for "holy envy." (By this Stendahl meant that you should be willing to recognize elements in the other religious tradition or faith that you admire and wish could, in some way, be reflected in your own religious tradition or faith.)

When considering the strengths and weaknesses of a group of tax professionals, I try to learn about the group from its members, try not to compare the best of one group to the worst of another, and try to stay open to the possibility that another group has aspects that are better than mine.

This may seem to you completely unrelated to the topic at hand, and that is quite all right. I have a tendency to see connections everywhere, and perhaps may even imagine them. I like connecting the dots, even if I'm the only one who sees the line!

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A recent surprise

After delivering several bags of clothes and household goods to my local Goodwill (in December, not January, of course!), I was surprised when the attendant handed me a pamphlet along with my receipt. The pamphlet, titled Goodwill Stores Donation Information, includes a list of "Suggested Donation Deductions."

I was surprised they provided amounts, as my experience has always been that non-profits avoid providing definitive recommendations for deductions when it comes to non-cash donations. I suppose what surprised me most was that they would actually use the term "suggested." Quite daring!

The additional description was more in line with my expectations of a non-profit: "The Internal Revenue Service allows a deduction based on the fair market value (what a buyer would pay for the goods in a thrift or consignment shop). The better an item's condition, the greater its value... Listed below are resale values of items in area Goodwill stores that you may use to itemize your deductions."

(Just to be difficult, I might argue that it technically isn't the IRS that "allows" a deduction, as the IRS does not make the rules, only enforces them. I know, I'm a pain.)

This description made sense to me, as it seems to be saying only that these non-cash items sell for the prices listed. It's like saying: "This is the information about us, and you can do with it what you choose." To me, that is quite different from providing a "suggestion." But I guess since they included the word "suggested" in the title, they are really doing both: stating facts about their prices and suggesting we use those amounts. I'm splitting hairs, aren't I?

I wish we could get this kind of guidance from the IRS. Or is it available, and I've simply missed it? Everything I've read from the IRS uses vague terms, never providing concrete numbers. And I like numbers.

I wonder if other non-profits are providing "suggested" deduction amounts, and how the IRS will factor that information into its efforts (if at all).

Finally, is it odd that I found so much to think about from a basic pamphlet from the Goodwill?

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Yet another scary IRS agent story?

Seems the news is flooded these days with stories of IRS agents and their various shenanigans.

I hope stories like these convince people with IRS trouble to seek the help of a qualified tax professional! In a perfect world, the system would be fair, and people could deal effectively with the IRS on their own.

But we do not live in a perfect world, the IRS system is not fair, and so taxpayers are in much better shape if they hire a qualified professional to manage the process.

Let's just hope the taxpayers realize that.

The TaxProf blogs:

Mark Claybrooks, 41, an IRS agent in Walnut Creek, California, has been indicted on charges that he urged delinquent taxpayers to get the money needed to pay their tax bills by refinancing their home mortgages with a mortgage company. Mr. Claybooks is alleged to have received $20,000 from the mortgage company for two referrals. (With references to the Contra Costa Times, San Frnacisco Chronicle, and Web CPA)

Tax Prof also blogs about...

IRS agent Albert Bront, 49, of Valencia, California, screamed “I’m going to kill all of you!” when U.S. Treasury agents served a search warrant at his home as part of an investigation into whether Mr. Bront had filed false tax return. He is being held without bail pending a July 28 preliminary hearing in Los Angeles.

April 15.com blogs about...

IRS Auditor Jim Liu who claimed to have incurred a loss on selling an apartment complex when he in fact he had a rather large gain. To compound matters, he then altered documents to support his bogus claim. Mr. Liu subsequently pleaded guilty to tax fraud and faces up to three years in a federal penitentiary.

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Fair is fair

As a nation we have grown accustom to certain tax benefits, including the exclusion of health insurance benefits from income.

For most of my life, my health insurance has been provided by an employer (whether my own employer that of my parents or husband), so I've certainly benefited from the provision. But just because I benefit doesn't make it fair.

This is one of those concepts with which some people struggle. When considering the issue, an experience from high school comes to mind. It was back in my semester of Economics. During a discussion on Affirmative Action, a friend of mine spoke out against it. To her arguments, the teacher countered that she should be in favor of AA because it would likely help her (as a white female).

So that teacher lost all credibility with me at that point. Just because something helps me doesn't make it right.

For a good explanation for why it is fair to tax health insurance, I recommend the Taxgirl's post.

Of course, both the tax code and government spending are full of provisions that are not exactly fair, so maybe this isn't the issue to "straighten out" first. And the whole discussion may be irrelevant, since the measure is stalling out in Congress (see the latest post from Taxgirl). But we shall see what we shall see.

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Avoiding the IRS audit

I appreciate The Wandering Tax Pro visiting and commenting on my humble blog. On the subject of IRS "red flags," he poses to me the following questions:

1. Do you believe that by merely claiming any of the 5 items submitted by Mr. Pappas, regardless of the amount, a taxpayer will automatically substantially increase his/her chances of an audit?

2. Would you ever recommend that a client not claim a legitimate and documented deduction because it would increase his/her chances of an audit?

Before responding, I should point out that both Mr. Flach and Mr. Pappas are more qualified to answer these questions, considering they have been in the professional far longer than I. (Mr. Flach has been preparing returns longer than I've been alive, which is impressive to say the least.)

So if anyone decides to stop here, that's really understandable.

On to the questions at hand...

(1) Yes, I do think that, by claiming one of these deductions, a taxpayer increases his/her chance of an audit. I hesitate to say whether the increase is "substantial," as I have limited knowledge of IRS enforcement statistics. (Learning more about them is on my to-do list.) These areas are more likely to have error or fraud, the IRS focuses its efforts on areas especially susceptible to error and fraud; ergo, returns with these items are statistically more likely to be examined.

(2) I am not likely to recommend that a client not claim a legitimate and documented deduction because it would increase his/her chances of an audit. Like Flach, "I do not believe that one should be scared off from claiming legitimate deductions for fear of being audited."

HOWEVER, I believe it's my responsibility to educate the client on the increased risk.

In a perfect world, honest taxpayers would not be subjected to the time, expense, and stress of an audit. They would claim just those expenses and credits to which they are legally entitled, avoid examination, and keep on being honest.

We all know the world isn't perfect, and that honest taxpayers will continue to be audited along with the cheats. And so taxpayers must address the question: If I claim this tax benefit, my risk of audit will increase -- Is the benefit work the risk?

I suppose we could create a risk/reward mathematical equation using IRS statistical audit data. (Hmmm... summer project? Anyone know where I could get good IRS stats?)

I suppose my risk/reward idea is similar to Mr. Pappas' suggested cost/benefit analysis: "What is the comparative value of the deduction? Taxpayers should weigh the benefit of the deduction against the costs (monetary and psychological) that would be involved should the deduction trigger an audit."

Analogy attempt

I'll wrap up this post with a feeble attempt at an analogy.

I'm going on road trip, and have identified the fastest, most efficient route. Partway into the journey, I hear on the radio that there is a roadblock checking for drugs on my route. I consider my options.

• Modify my route to avoid the road block, and lose time.
  
• Keep on the route, hope the line of cars isn't too backed up and that I'll get through it quickly.

I can't see the future, so I just have to make the best decision I can with the information available. Several things would influence my decision, such as:

• How much time would I lose by avoiding the roadblock?
  
• How much time would I lose if I got stuck at the roadblock?
• Would the police find drugs in my car?
  

So what do I do?

So do I take the safe option and avoid the roadblock, and lose the benefits of a quicker trip?

Do I fail to claim legitimate Schedule C expenses, in the hope of decreasing the chance of IRS audit?

In my practice, I generally encourage clients to claim all legitimate deductions and credits, and inform them of the audit risk.

Nothing too exciting, but there you have my 2 cents.

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When tax preparers attack

The battles continue in the tax blogging world. After a lengthy and thorough debate on tax preparer regulation (tax pros are good at thorough), we jump into the debate of how best to avoid (or at least not invite) an IRS audit.

First, I must say it's great to have experts talk openly about what will and will not get the attention of the IRS. I am much newer to the profession than the tax bloggers, so I value the information they share about "the real world." After all, the IRS isn't going to teach me about the realities of enforcement. During a recent radio show, an IRS representative told a caller that he should, in fact, amend his tax return because he received a 1099 that increase his tax by $40. Hmm... thanks IRS, but I think I'll read what the bloggers have to say.

So Peter Pappas began the debate (perhaps inadvertently) with his post titled 5 Slam Dunk IRS Audit Red Flags. Robert Flach posted a commentary, and the debate ensued.

As usual, I agree with both of them on several issues. And I think they too agree on several key points. The IRS is more likely to scrutinize returns with these five deductions, simply because returns with these deductions are more likely to have error or fraud. It's about probability, and don't we tax preparers love math?

I did not anticipate the change in the debate's focus, which became that of whether a return prepared by a CPA is less likely to have errors than a return prepared by a non-CPA.

Robert is correct that a CPA is not specifically licensed for tax preparation, rather "a CPA is a licensed accountant, authorized to certify audits of financial statements." Just a couple of months ago, I was pondering this exact issue. I was thinking about all the fancy credentials the AICPA offers for CPAs in other specialties - financial planning, fraud examination, business valuation - and wondering how to become a certified tax expert.

So I emailed the AICPA asking about it. Here's the exact wording of the response I received:

"We do not offer a credential in taxation. In general, our approach has been not to develop credential programs around areas for which the public already believes CPAs to 'own'. In addition, we do not endorse a particular tax credential."

And so we CPAs specializing in tax find ourselves in a bit of a quandary. Our CPA designation does not by itself qualify us as tax experts, but there is not another designation available that does.

And now we arrive back at our original issue of debate, that of tax preparer regulation. Is anyone else getting dizzy?

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Tax preparer regulation: Late for the party

Don't you hate it when you thought the invitation said 9, but the party really started at 8?

I figured I'd still come the to party, even though it may mean receiving disdainful looks from those wondering why I'm so slow. So here's my take on the specific issue of tax preparer regulation:

One of my pet peeves (and goodness, there are many) is when a person repeatedly talks about problems but never suggests solutions. Granted, I am always pointing out problems (much to the challenge of co-workers), but all the while strive to find solutions.

Going back and reading my previous post, "Why Regulation Won't Work," I now kick myself for doing just that which I detest -- discussing the problem but not possible solutions. Doh! Let's see if I can get back in my own good graces.

So regulation won't solve our problems. That's simply a fact of life. In all aspects of life, we have a gap between the ideal and the reality. The issue, then, is how to minimize the size of the gap. We must have law and order if we are to avoid anarchy.

A couple of concepts from Economics 101 come into play here. First, we must deal with externalities, both benefits (such as public safety) and costs (such as pollution). And second, we have limited resources.

How do we deal with it? We must decide whether to use our scarce resources to affect an externality, be it public safety, education, law enforcement, whatever.

I'd argue that tax evasion itself is an externality. Most people would not comply with tax law if society did not dedicate resources to its enforecement. Few people argue that we do not need laws or regulations. Rather, the argument centers on the method and extent of regulation.

I think those involved in this debate agree on several things, such as:

• Ideally, all tax preparers would be knowledgeable and honest.
• The reality is far from this ideal.
• The public would benefit if the reality-ideal gap were decreased.
  

If we all agree on those points, then the key issue is: Would the benefits of regulating unlicensed preparers justify the resources required to do it?

I'm inclined to say no. In my experience, government (and the IRS in particular) does not operate efficiently.

Maybe I'm wrong, and someone will present to us a beautiful, inexpensive, efficient system to regulate preparers. If that happens, I will gladly eat my words. But until them, I'd rather the IRS spend its scarce resources on other things.

(Bruce the Taxguy provides a nice list of links to blogger commentary on the issue.)

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Why regulation won't work

A few seemingly unrelated posts from tax bloggers got me thinking (which is always scary). The posts are...

• The Wandering Tax Pro, Robert Flach, discusses the Ethics CPE requirements for Enrolled Agents and CPAs. He writes: "I have been preparing tax returns for about 38 years, without incident. If I do not have ethics by now sitting through 2 hours ain’t going to make me ethical. If I am so inclined to be unethical in my practice listening to a speaker tell me what is wrong is not going to make me 'see the light'."


• TaxVox: the Tax Policy Center blog, by Jacob Goldin, discusses the proposed tax on junk food, posing the question: "Would a junk food tax really reduce obesity?"


• Tax Rascal discusses the California tax credit for purchasing a new home, which lenders will be authorized to advance to buyers towards a down payment.

The connection I see is one of the unfortunate but very real facts of life: We cannot change people's motivation for behavior.

We can regulate behavior, but not motivation. We can educate, discuss, persuade, encourage... but when all is said and done, people can only be changed by themselves.

Here's how this relates to the above blog posts...

• An ethics CPE requirement will not make a person ethical.
• A tax on junk food will not make a person change their lifestyle.
• A financial crisis will not stop people from buying things they can't afford.

I don't think bigger government and higher taxes are the answer, but I'm afraid I don't know what the answer is. Ideally, everyone could agree on some clear goals for American citizens, which might include acting ethically, being healthy, and living within our means. But it's impossible to get millions of people to sit around the table and figure it out, so until then we're stuck trying to regulate behavior.

It's not the solution, but I guess it beats complete chaos.

(As a quick post script, a great book about this subject is Leadership and Self-Deception.)

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Pizza for tax evasion?

WebCPA reports:

"A Texas restaurant owner has been sentenced to two years in jail after he was convicted of trying to bribe an IRS agent by offering her free pizza and a job."

When the agent first figured the taxpayer was offering her a bribe, she reported it.

Subsequent conversations were recorded, during which the taxpayer "offered the agent $2,500 and delivered $2,000 in exchange for having his tax liability reduced from $49,000 to around $500. In addition to financial compensation, [he] repeatedly offered the agent pizza from his restaurant as part of the deal."

If she had taken the bribe, that could have led to one heck of an advertising campaign: "Our pizza is so good, people will destroy their careers and go to jail to get it!"

Unfortunately for the owner, I guess the pizza just wasn't good enough.

But hey, at least this guy didn't try to have the agent killed by a hit man named Reaper.

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Bias disclosure

Since this blog is about tax developments, it will include government news. I hope the reader (if there is a reader out there) will not find it terribly partisan. I don't think of myself as political, as I tend to only read news about the economy and tax policy. (Although I did hear about the swine flu. My bubble is not entirely impermeable.)

Of course, I've got opinions. And I'm usually too quick to share them. In the spirit of full disclosure, I figured I'd share my philosophy on taxes. And I hope that I'm not breaking any copyright laws by stealing the idea from Tax Attorney and CPA Peter Pappas.

• Everyone should pay their taxes. “Taxes are what we pay for civilized society.” (U.S. Supreme Court Justice Oliver Wendell Holmes). “Taxes, after all, are dues that we pay for the privileges of membership in an organized society.” (Franklin D. Roosevelt)


• No one should pay more than they are required. “The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.” (US Supreme Court, Gregory v. Helvering, 55 S Ct. 266, 1/7/1935)


• Figuring out your taxes shouldn't be so hard. The average taxpayer should be able to figure out their taxes, since the average taxpayer has to pay them.


• Raising taxes won't fix all our problems. If we are to encourage innovation, industry, and entrepreneurship, we must let people keep most of their income.
  

So that's my philosophy in a nutshell.

Back to tracking tax developments...

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IRS playbook for 2009-2013

The IRS recently published its Strategic Game Plan for 2009-2013. The mission of the IRS is to: "Provide America’s taxpayers top-quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all."

The plan spells out 2 overarching goals for the next 5 years:

Goal 1: Improve service to make voluntary compliance easier.

Goal 2: Enforce the law to ensure everyone meets their obligations to pay taxes.

A few specified objectives for meeting these goals are to:

• Consider the taxpayer's perspective
  
• Improve issue resolution
• Make it easier to navigate the IRS
  
• Provide targeted, timely guidance and outreach
  
• Strengthen partnerships with tax practitioners
• Proactively enforce the law
  
• Respect taxpayer rights and minimize taxpayer burden
  
• Expand enforcement approaches and tools
  
• Target emerging high-risk areas
  

So what does this mean?

Obviously, I don't know for sure. My psychic powers are nonexistent. And I've never worked at the IRS, I've only dealt with the IRS.

Based on what I know (which, admittedly, may not be a lot), these are my suggestions to my fellow taxpayers:

• Try to get it right the first time. The best way to avoid trouble with the IRS is to file accurate, on-time returns.
  


• Don't expect leniency. One of the many rules I live by is to hope for the best, but plan for the worst. For several years, we've been told we'll be seeing a "kinder, gentler" IRS. However, many (perhaps even most) tax practitioners and taxpayers have not found this to be the case. In January this year, the National Taxpayer Advocate reported to Congress that the IRS is too harsh. The hard-line enforcement was identified as the second biggest problem facing taxpayers (with tax complexity being the first). This leads to my next suggestion for those facing tax trouble...
  


• Consider your options. In general, you can't completely avoid paying a tax debt, but you can work to minimize interest and penalties, and can work out agreements to pay over time. Tax attorney Peter Pappas provides a great summary of the forms of tax relief. We've all seen the commercials where people claim: "I owed $60,000, but this company made it so I didn't pay anything!" In reference to these types of claims, I recently heard an IRS representative respond simply that you'll only have that kind of debt forgiveness if you really have absolutely no assets available to pay. Now, I have no expertise in bankruptcy law, so I can't comment on when taxes can be discharged in bankruptcy. I can refer you to another post by Peter Pappas.
  


• Be proactive. If you have not paid your taxes, your situation will not improve if you just wait. Those problems do not just go away. The IRS can take a long, long time to move forward with an issue (so painfully long) -- but if you owe money, they will get to it sooner or later. And they will add penalties and interest. You'll be much better off if you hire a tax professional to take proactive steps to resolve the problem.

I would be very happy to see the IRS be successful in meeting the goals outlined in its Strategic Plan, as that would help the average, honest taxpayer and tax professional. It would not help the average tax cheat, which sounds good to me, since tax cheaters make my tax bill higher.

We'll see how the next 5 years go. For now, I'll just keep working to help my clients navigate the existing system, painful as it is.

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