Category: Tax Debt Resolution

One of the concerns many taxpayers have in an IRS audit is the request to turn over the backup files for their electronic accounting software such as QuickBooks. You have no choice but to comply with this request. The IRS has the law behind them on this request. Here are a couple of pointers from the IRS Q&A on Electronic Accounting Software Records.

• You must provide them with an exact copy of the original backup files. Making any changes will smack of fraud. If you have a representative licensed to practice before the IRS who participates in making and producing the modified file, they could be in violation of IRS rules as well.
• Downloading all the transactions to Excel and turning them over to the IRS will not work. They want an exact copy of the files.
• The IRS can also request the data for the month before the audit period and the month after the audit period. If they find this information inadequate, they can expand their request.
• You cannot close the accounting periods before the backup if it will condense the data. They want to see all the transactions, not totals.

Compliance with an IRS Records Request

Now here is an interesting question when it comes to electronic accounting records. The IRS’s latest pronouncement regarding these records was written in 1998 before web-based software became available.

I am a software developer and can tell you that almost nobody does backups to some sort of floppy disk anymore at the client level. As a provider of web-based software, we do automatic backups of the databases daily, but this is not the same thing as backups of a PC-based accounting program. The database backups generally overwrite old backups with all the information from the current database. What’s more, the accounting programs are completely separate from the databases that hold each individual client’s data. The program files pulling the data from the database have undoubtedly been changed many times to improve the input and report screens. There is no way to get back to the previous version from some years back.

If summoned, a web-based software provider can produce a file, but we don’t have a way to guarantee that the database is exactly what it was at the end of the tax year and you can be certain that the program files are not the same.  The result is that web-based accounting software files are not in compliance with IRS electronic records rules as they are written on the IRS Q&A.

You have made your business a success. So much so, that you have been able to hire people to take over the boring stuff, such as writing checks and processing payroll tax returns. What can go wrong with this scenario?

The Scenario

The trusted accountant embezzles some money. Small amounts at first, but his or her perceived needs continue to grow so they continue the embezzlement game.  To keep in the game, they need to provide reconciliations to show that all the money flowing through the bank accounts is accounted for. No problem. Let’s just continue to record payroll tax deposits in amounts equal to amounts stolen. But if we file the payroll tax returns, the IRS will start sending notices saying, “where is the cash?”. Problem solved, lets just not file the returns. After all, the IRS will take forever to follow up on the missing returns, especially if I mark the last one “final”.

The Result

The result is that the IRS eventually does follow up and the missing payroll deposits amount to the hundreds of thousands. The company will most likely not have the ability to recover and go out of business. The IRS will then access a penalty equal to 100% of the employee withholdings and social security taxes on the owner who is now back to being an employee of someone else.

The Solution

There is a new option in town to avoid this kind of disaster. Different tax representation firms use different names, but it essentially involves software regularly querying the IRS databases and reporting to their client business owners when the payroll tax returns have been filed and the amounts of payroll deposits actually paid. This allows the business owner to have a 3^rd party backdoor check on his trusted employees.

If you have any questions about how this service works, just give me a call at (352) 317-5692 or email jim@taxrepgainesville.com.

The IRS got back into the collections business on 6/15/21 with the release of over 5 million Letter 11s. This is the first significant collections activity in over a year due to the pandemic. Letter 11 is the formal announcement of the IRS’s intent to begin levy actions. This means they will start seizing the bank accounts, investment accounts, and some portion of the debtor’s wages.

The letter gives the taxpayer 30 days from the date of the letter to respond. There are three major options:

• • Set up a payment plan,
  • Making an offer-in-compromise, or
  • Provide proof that they do not have the financial means to make any payments.

What should you do?

If you are a do-it-yourselfer type, then the best action is to go to the irs.gov website and signup for a payment plan. If you cannot qualify for the automatic plan or do not have the cash flow to handle the calculated payment, then bite the bullet and hire someone who has experience with IRS Collections. Proving you are uncollectable or making an Offer-In-Compromise is going to require a lot of financial analysis that is out of the skill range of most individuals.

What should you NOT do?

Ignore them. Nobody likes being ignored and the IRS is no exception. Also, they are not going to accidentally forget about you. Sooner or later, they will begin to seize your cash accounts. Letter 11 is the IRS’s way of suggesting that you come to the table and begin negotiating with them.

If you or someone you know has received a Notice of Intent to Levy or some other federal or state tax issue, please feel free to contact me at either (352) 317-5692 or email jim@taxrepgainesville.com.

How should you substantiate your expenses for IRS purposes? The technical answer is – it depends on the type of expenditure and upon the IRS auditor’s evaluation of the situation.

Internal Revenue Code Sections, such as 274(d), specify the requirements to have records, but they do not explain what is adequate. IRS Regulations do provide more detail, but it still comes down to the auditor’s judgment about what is adequate.

Here is a summary of what you should have as the minimums:

• Auto expenses – Keep a log of daily travel if the vehicle can be used for both personal and business. The lack of a log probably makes this the number- one most often adjusted item on tax returns.
• Travel expenses – Meals and other expenses (excluding lodging) under $75 can be substantiated with a log or expense report. See Publication 463 for more information.
• Depreciable Fixed Asset purchases – Keep the purchase documents for at least three years after the asset has been sold or abandoned.
• Operating expenses – These are all the other ordinary and necessary expenses required to operate a business. The big problem in audits is all those expenses were paid with a credit card, such as supplies from Home Depot. The credit card statement just shows that you have bought something, not what that thing was or why it was necessary. Keeping the individual cash register receipts can help convince an auditor that these expenses were legitimate.

A few things to keep in mind when thinking about substantiation.

• Your calendars from years past can help in proving auto and travel if you do not have a log.
• There is the Cohen rule which comes out of case from 90 years ago that does give taxpayers a weak tool to claim expenses based on estimates. This rule does stand up in the courts — sometimes.
• Your testimony also counts. After all, you’re the eyewitness. However, this only works if you have established credibility with the auditor by showing that all your other expenses were reasonable and adequately documented.

Understanding what is at risk can help to justify the pain of keeping all these records. If the IRS examines your return for any one year and discovers materials deficiencies, they will disallow at least part of these expenses. And, they will typically also audit all the other returns for which the statute of limitations has not run out. This means that the one-year tax adjustment is probably going to be times three as a minimum. Caveat Ductus!