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Introduction:

Audit-Proofing and the IRS

Let's begin with a true story: In December 1979, Revenue Agent Richard Boandl of the Philadelphia District was assigned to examine the 1977 tax return of Thomas Treadway. Agent Boandl subsequently audited the 1978, 1979, and 1989 tax returns of Mr. Treadway.

In February 1982, Agent Boandl came to a final assessment of approximately $247,000 in additional taxes against Mr. Treadway, who did not agree with the assessment. Because Agent Boandl became concerned that Mr. Treadway was selling his property and giving the funds to his companion and good friend, Shirley Ann Lojeski, the revenue agent recommended a jeopardy assessment against Mr. Treadway. An extreme measure, a jeopardy assessment allows the IRS, in certain circumstances, to make an immediate assessment and a demand for payment, and, if necessary, to proceed immediately to collect the tax by whatever means necessary.

Agent Boandl testified in court that he never checked the real estate records, nor did he know what funds Mr. Treadway had actually received from the sale of his property.

Even though it was Mr. Treadway who owed the tax, on or about August 3, 1982 Revenue Officer George Jessup (a revenue officer collects delinquent taxes) filed a tax lien against Ms. Lojeski in the amount of $247,000 and seized $24,000 from her bank accounts. Jessup testified that he had no approval from his superior before filing the tax lien. Prior to seizing her property, Jessup gave no notice to Ms. Lojeski.

On September 23, 1982 an IRS appeals officer, after conducting an administrative review, determined that the $247,000 assessment was not reasonable and proceeded to abate the tax. But the tax lien against Ms. Lojeski was not released until November 30, and the seized funds were not returned until January 1983, five months after seizure.

Ms. Lojeski testified that after the IRS filed the lien:

  • She was threatened with foreclosure on her farm because she didn't have the money to pay her mortgage.
  • She couldn't rune her horse business because when didn't have the money to buy feed and other items.
  • She lost her health and life insurance policies because she did not have the funds to pay the premiums.
  • She was sued by one supplier BECAUSE she did not have the money to pay the bill.
  • She had to borrow money to buy groceries.
  • She was humiliated, degraded, and withdrawn.
  • She didn't leave the farm because she was ashamed to meet people, and because she was afraid that Jessup would come back to the farm and remove her personal property.
  • She could not sell her farm because purchasers were leery of the IRS lien.

The U.S. District Court ruled that the IRS had violated her constitutional rights under the Fourth Amendment prohibition of unreasonable searches and seizures, and under the Fifth Amendment guarantee of due process of law. The court granted damages against Agent Boandl and Officer Jessup in the amount of $67,000. (U.S. District Court, East. Dist. Pa, C.A. No. 84-3591, 01/23/85)

The IRS appealed the decision to the Third Circuit Court of Appeals, however, where the IRS argued that Ms. Lojeski had no rights of constitutional protection against what they did to her. The court agreed and ruled that the IRS had not violated her Fourth Amendment rights against warrantless seizures for the "simple reason that such actions violated no privacy interest." The court totally ignored the fact that Ms. Lojeski did not owe any taxes. The case was not appealed to the Supreme Court.

This is the same case you may have seen on ABC's Nightline show on April 4, 1987.


Who's Afraid of the IRS?

Most people! They fear the awesome power of the IRS; they are afraid of being audited and dread the consequences. It's a fear that comes legitimately, though. For fear is the main ingredient in making voluntary compliance work, the result of an image-building process cultivated by the IRS for decades.

By now you have probably heard horror stories about IRS agents, from backyard neighborhood gossip to Parade magazine articles and "60 Minutes" on TV. You are probably already aware of the IRS's reputation for being tough, uncaring, and bureaucratic. You may even have heard of taxpayers who faced burly, growling auditors with the sympathy of a moon rock and the understanding of a doorstop. If you ever had an encounter or unpleasant dealings with tax agents or officers, you've probably already developed fairly strong feeling about them. If you never had an experience with the IRS, you probably have serious questions and concerns about how tough and demanding they are.

After all, everyone knows what the IRS did to Al Capone, the country's most notorious gangster who could not be touched until the IRS got him. That one legendary act has probably done more for voluntary compliance and the image of the IRS than any other event in its history. Fifty years later, taxpayers still remark that they don't want to tangle with the IRS because of what it did to Al Capone.

One of the more memorable IRS incidents involved Spiro Agnew, former vice president under Richard Nixon. Here was the second highest ranking government official in the United States government, only a heartbeat away from being president, brought down by the IRS.

And, as if President Nixon didn't have his hands full with Watergate and the Spiro Agnew problems, the IRS had over thirty agents conducting the most exhaustive audit ever performed. They literally raked him over the coals with several hundred thousand dollars in additional taxes.

The most recent media event concerning taxes and politicians involved Geraldine Ferraro, the first woman to run for vice president. Her accountant had not reported her husband's real estate transactions properly, prompting immediate filings of amended returns and payments of over $53,459 in additional taxes. Even major politicians take the IRS seriously.

These events have left their lasting impression on tens of millions of taxpayers who have nothing but the utmost respect and the utmost fear of the IRS. Even though the IRS says it does not know why people comply with the tax laws, it knows it has a good thing going. It wants taxpayers to be afraid. Voluntary compliance, though fragile, is the major support of our tax system. There are those inside the IRS who think it is their mission to make people afraid of them, believing the more people are afraid, the more they'll comply with the tax laws. Events like those in Pennsylvania are designed to project a "firm enforcement image."

IRS auditors won't go out of their way to dispel taxpayers' notions about their image. You will find them courteous and polite, but don't expect them to be friendly. First names are a no-no, and so are lunches and dinner. Bringing flowers with you to the audit will not enhance your image. Instead it will cast suspicions upon your motives, and result in a more vigorous audit.

Remember that IRS employees are basically suspicious individuals. They don't trust anyone, not even co-workers, so they could hardly be expected to trust taxpayers, particularly those being audited. Forget all the business techniques you've learned about social communication skills. When you walk into an IRS office, you enter a different world.


The IRS in a Nutshell

The IRS is a gigantic agency with gigantic powers. Consisting of over 102,000 employees, the IRS is undoubtedly one of the government's largest. It has 7 regions and 63 districts with hundreds of posts of duty all around the country. These are the enforcement people you need to be familiar with:

  • Tax Auditors conduct the audits that are usually handled in the local IRS office. For the most part, tax auditors only conduct audits of 1040 tax returns and related schedules. Occasionally, they may audit 1040s with uncomplicated Schedule C's.
  • Revenue Agents conduct audits of the more complicated 1040s and business returns such as 1040s with Schedule C's, forms 1065, Partnership Income Tax Return, and 1120, Corporation Income Tax Return. Most audits conducted by revenue agents are done on site at the taxpayer's place of business.
  • Revenue Officers collect delinquent taxes. You will only need to know more about them if you can't pay your audit assessment.
  • Special Agents conduct criminal investigations. They sometimes carry guns, and sometimes make arrests. If one reads you your rights, you'll know you're in serious trouble.

Tax auditors and revenue agents belong to IRS's Examination Division. The term "examination" relates to what they are really doing when they are challenging your deductions: They are "examining" the return. The IRS does not use the term "audit," but because they did use it at one time, it has stuck and the entire country still uses it. Therefore, we will continue to use it in this book.

The term "tax examiner" is also frequently used by the IRS in its internal publication, the Internal Revenue Manual (IRM). Because tax auditors and revenue agents use the same IRM, the term "tax examiner" is used to refer to both categories. We will also use that term throughout the book.

Many taxpayers go into an audit totally unprepared and hope for the best. Some think that if they can impress the auditor that they are nice, law-abiding, decent human beings - not common criminals - then the IRS auditor will mellow, be sympathetic, and politely let them off the hook. Forget it! Tax auditors are nice, decent human beings too, but most importantly, they pay their taxes. And they don't think too kindly of others who don't. So right off the bat you have two strikes against you in the sympathy and understanding department:

*First, you're not one of them.

*Second, it's assumed that you haven't done everything right on your tax return, otherwise you wouldn't be there!

In the IRS world there is only one mentality that perseveres: Us against them. This attitude permeates the organization, from top to bottom. Indirectly, it will even affect your audit, and your relationship with your auditor. There may be times during the audit ordeal and its aftermath that you will come to believe that these people are unreasonable, that they are unconscionable, and they do not belong to the "brotherhood of man."

This is all part of the game and part of the process of "promoting voluntary compliance."

So how do you deal with it, you ask? The answer is, through preparation.


AUDIT-PROOFER'S STRATEGY RULE

A good audit-proofer prepares for an audit, and when "invited" to an audit, plans strategy beforehand.


If you think about it, this is the same technique that you probably use in every other aspect of your life. Planning and preparation are the key ingredients of any successful endeavor, but if you've never been through an IRS audit before, you need to know what to plan, and what to prepare for.

  1. Audit-Proofing and Tax-Saving
  2. Exhibit 0-1: How Classifiers Identify Significant Issues
    on Individual Nonbusiness Returns


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