RTS #043 Two IRS Agents walk into a bar (lessons from IRS audits)

Two IRS agents walk into a bar.

The third one ducked.

**Please forgive the dad jokes. This newsletter was written by Steven’s brother, Matthew Jarvis, CFP®.**

Cheesy ‘dad jokes’ aside, most Americans are terrified of being audited by the IRS. So, much so that the IRS estimates that 86% of tax returns are filled accurately. This despite less than 1% of the population being audited in person and less than 6% being audited by correspondence.

While the IRS does not break out this data by demographics, based on the analysis conducted by Tax Help Software (the tool we use to access client tax data directly from the IRS), the average advisor might have one client in their entire career subject to an IRS audit.

In my 20-year career, I, too, have only had one client audited, and beating all odds, this client was audited twice. Both times their CPA (NOT Steven Jarvis), told them ‘Good Luck.’ Both times I assisted the client through the entire audit, which all things considered, went perfectly.

The first audit was triggered by the client asking for a six-figure refund due to a rollover strategy we implemented. Mostly, the IRS wanted to make sure this client was actually entitled to the refund before cutting a six-figure check. This audit took place at the Federal Building in Seattle, took all of about an hour, and ended with no material issues.

The second audit, several years later, was ‘random’ (the IRS never discloses their audit selection formula, so don’t believe anyone telling you otherwise). This audit included a visit to the client’s home to confirm their home office deduction and an entire day spent with the client in my office, mostly focused on a $400k carry-forward loss the client had incurred during the financial crisis (prior to working with me).

In both situations, the client was freaked out about being audited. However, in both cases, thanks to great record-keeping on our part, it was simply a matter of answering a handful of questions, providing documentation, and correcting a few minor items (auditors always have to find something).

Key Lessons:

  • While the statute of limitations is typically three years, carry-forward items such as losses, charitable contributions, and qualified plan contributions have no limitation. In other words, the IRS COULD ask you to prove every IRA contribution for the client’s lifetime. This is super unusual, but for sure keep records of carry forward losses.
  • Don’t claim/deduct anything that you can’t explain with a straight face when sitting across from the auditor. Having your kids on the payroll as actors? No problem if you have supporting documentation. Doing a ‘due diligence’ trip to Disneyland? Let me know how that works for you.
  • Never volunteer information. The best auditors are super friendly (both of mine were) as they want you to volunteer mistakes. Be friendly, but remember you are not friends.
  • Don’t Fight City Hall – Similar to being pulled over by the police, the IRS is holding all the cards. I once talked to an advisor who got in a shouting match with an auditor, and then mid-audit filed a complaint to the IRS. I’ll let you guess how that ended. Yes, you have rights, but is this the hill on which you want to die?

Hopefully, neither you or your clients will ever be audited by the IRS, but it’s a great value add during your next client meeting or when asking for tax returns, to explain that one of the reasons you keep so many records is to help protect the client in the event of an Audit.

Happy Planning!

Matthew Jarvis, CFP®

About The Newsletter

The tax code is 80,000+ pages and Google has 875,000,000 results when you search “Tax Planning”, so each week we are going to help you wade through all of that noise and get to the Relevant Tax Stuff.