From Thin Air: Reconstructing Records Eric L. Green, Esq. 1 Brought - PDF document

From Thin Air: Reconstructing Records Eric L. Green, Esq. 1 Brought to you by Bench Accounting Dealing with Non ‐ Filers 2 2 Eric Green, Esq.  Managing partner in Green & Sklarz LLC, a boutique tax firm with offices in Connecticut and New York.  Focus is civil and criminal taxpayer representation before the Department of Justice Tax Division, Internal Revenue Service and state Departments of Revenue Services.  Has served as a columnist for CCH’s Journal of Practice & Procedure.  Attorney Green is the past Chair of the Executive Committee of the Connecticut Bar Association’s Tax Section.  Eric is a Fellow of the American College of Tax Counsel (“ACTC”). Dealing with Non ‐ Filers 3 3

Eric Green, Esq.  Eric is the host of the weekly Tax Rep Network Podcast, available in ITunes, Apple Podcasts and Google Podcasts  Eric is the founder of Tax Rep Network, an online community designed to help tax professionals build their IRS Representation Practice  He is the author of the Accountant’s Guide to IRS Collection and the Accountant’s Guide to Resolving Tax Issues Dealing with Non ‐ Filers 4 4 Release of the New Accountant’s Guide Payroll taxes are the number one reason why small businesses get into tax trouble. In addition, the IRS will begin pursuing the owner and other responsible employees personally for the trust fund portion of the taxes! Payroll Tax cases also are an opportunity for practitioners to make money while saving businesses, their owners and hundreds or even thousands of employee jobs. Pick up the newest guide and learn how to add this service to your practice and make money helping businesses turn things around and solve their most vexing payroll issues! www.TGPublish.com Dealing with Non ‐ Filers 5 5 So the Phone Rings….  Audit  Non ‐ Filer with a Contact Letter  Taxpayer who cannot sleep at night Dealing with Non ‐ Filers 6 6

Does the IRS Know?  If they do, contact and buy time  If not, consider voluntary disclosure IRS announcing a new More than 7 million initiative to go after them Dealing with Non ‐ Filers 7 7 Normal Filing vs. Voluntary Disclosure • Good records and little risk – just file • Issues like potential fraud? Voluntary Disclosure 1. Cash Payments 2. No records 3. Undocumented workers 4. Prior false returns IRS announcing a new • IRS Memo: November 20, 2018 More than 7 million initiative to go after them Dealing with Non ‐ Filers 8 8 Voluntary Disclosure Fax in pre ‐ clearance While you wait get the returns done Get pre ‐ cleared, complete the Voluntary Disclosure Get pre ‐ cleared, complete the Voluntary Disclosure Letter Letter Submit everything through Voluntary Disclosure More than 7 million Should we submit the state returns first/State Voluntary Disclosure? Dealing with Non ‐ Filers 9 9

Pre ‐ Clearance Request IRS announcing a new More than 7 million initiative to go after them Dealing with Non ‐ Filers 10 10 Pre ‐ Clearance Approval IRS announcing a new More than 7 million initiative to go after them Dealing with Non ‐ Filers 11 11 Voluntary Disclosure Form IRS announcing a new More than 7 million initiative to go after them Dealing with Non ‐ Filers 12 12

Records Less than Stellar?  Use what they have (Bank Statements, Credit Card Stmts, receipts)  If they don’t have, recreate what you can  Remember the Cohan Rule  Case: Cohan v. Commissioner of Internal Revenue, 39 F .2d 540 (1930)  433-A analysis? IRS announcing a new More than 7 million initiative to go after them Dealing with Non ‐ Filers 13 13 Requirement to Maintain Records  Taxpayers are required to maintain books and records  When a taxpayer is audited by the IRS, the burden of proof falls on the taxpayer to support the information on his or her return.  The United States Tax Court has ruled that the taxpayer must keep IRS announcing a new More than 7 million initiative to go after “contemporaneous” records, per Reg. § 1.6001-1. them Dealing with Non ‐ Filers 14 14 Income Reconstruction  Generally necessary when records either no-longer exist or cannot be easily located  Books and records are not maintained  Books and records were destroyed by flood, fire, etc.  Books and records are incomplete IRS announcing a new  Generally relies on one or more of the formal indirect methods More than 7 million initiative to go after them Dealing with Non ‐ Filers 15 15

The Cohan Rule  In 1918, George M. Cohan was a theatrical manager and producer doing business in partnership with a gentleman by the name of Harris.  Cohan had originally been an actor, like his parents.  The parents with their two children, Cohan and his sister, divided their earnings – one- quarter to each of the children and one-half to the parents.  Cohan was in charge of the collection and distribution, collecting for all and IRS announcing a new More than 7 million initiative to go after distributing to the others. them Dealing with Non ‐ Filers 16 16 The Cohan Rule  When audited by the IRS, The IRS fixed Cohan’s income as the whole of what he received from the firm of Cohan & Harris, while it lasted, and later as the whole of his own profits.  In the production of his plays, Cohan was obliged to entertain actors, employees, and dramatic critics.  He also had to travel a lot, often with his attorney. These expenses amounted to substantial sums, but he had no accounting of these expenses.  At the trial, in 1930, Cohan estimated the amounts spent on putting on the shows. IRS announcing a new  The IRS had refused to allow him to claim any part of this based on the grounds that it was impossible More than 7 million initiative to go after to tell how much he had spent, in the absence of any accounting records. them Dealing with Non ‐ Filers 17 17 The Cohan Rule  The 2 nd Circuit held that because it was obvious that Mr. Cohan had spent substantial sums on the shows, those expenses could be approximated and allowed (hence THE COHAN RULE!)  This rule does NOT apply to those expenses that require specific documentation, such as travel, entertainment, business gifts, EITC, R&D Credits, etc. IRS announcing a new More than 7 million initiative to go after them Dealing with Non ‐ Filers 18 18

Methods of reconstruction  Specific Item Method – IRM 4.10.4.2.7 (08-09-2011), Easier for a jury to understand  Indirect Method - IRM 4.10.4.2.8 (08-09-2011), Difficult to match reported income with specific items/sources IRS announcing a new More than 7 million initiative to go after them Dealing with Non ‐ Filers 19 19 Formal Indirect Methods  Used when direct comparisons of income, expenses, assets, liabilities and equity cannot be made; infers taxable income  The formal indirect methods are audit techniques used to determine the tax liability based on the amount of unreported income.  IRM 4.10.4.6.3 , Source and Application of Funds Method  IRM 4.10.4.6.4 , Bank Deposit and Cash Expenditures Method  IRM 4.10.4.6.5 , Markup Method IRS announcing a new More than 7 million initiative to go after  IRM 4.10.4.6.6 , Unit and Volume Method them  IRM 4.10.4.6.7 , Net Worth Method Dealing with Non ‐ Filers 20 20 433 ‐ A CIS Approach  433-A is for collection  Has IRS guidelines (IRS cannot really argue with that)  Back into the income (expense analysis, really) IRS announcing a new More than 7 million initiative to go after them Dealing with Non ‐ Filers 21 21

The Clients  The Non ‐ Filer who died without records  The house flipper who paid cash  The Day Care that did not respond  The auditors that observed for 2 hours Audit Horror Stories 22 22 The Non ‐ Filer Who Died Without Records Called by the court appointed administrator Man died in his 80s No children Has not filed in at least 15 years He has $5,000 in his back account and $20,000 in a safe Audit Horror Stories 23 23 The Non ‐ Filer Who Died Without Records  Little went through the bank  No credit cards  No 1099s reported in the Wage & Earning Reports  Created a 433 ‐ A based on IRS standards and the expenses we know he spent (mortgage, utilities, etc) Audit Horror Stories 24 24

The Non ‐ Filer Who Died Without Records  We used that as his income, and increased it for the $25,000 cash hoard spread evenly over 6 years  Prepared 6 years of federal income tax returns and 3 years of CT returns  IRS Compliance/Vol. Disclosure is last 6 years, CT is 3 years Audit Horror Stories 25 25 Record Reconstruction ‐ Rules  Cohan Rule: When the TP establishes that the TP paid or incurred deductible expenses but does not establish the amount of the deduction to which TP is entitled, TP may be entitled to estimate the amount allowable. Cohan v. Comm’r, 39 F.2d 540 (2d. Cir. 1930)  IRC § 7491(a) shifts burden of proof to IRS when the taxpayer Introduces credible evidence with respect to any factual issue relevant to ascertaining the taxpayer’s liability and cooperates with the audit Audit Horror Stories 26 26 Record Reconstruction ‐ Rules  Section 274 prohibits claiming the following deductions unless substantiation requirements are maintained: – Meals and entertainment – Travel – Gift Expenses – Listed Property Expenses  Why we use SmartVault – stuff is backed up in the cloud forever Audit Horror Stories 27 27