This is the last installment of a three part series discussing the basic tools business owners and managers need to be successful in tax audits. Part I discussed the need for business owners and managers to understand the financial details of the business. Part II explained why owners and managers should actively participate in decisions concerning how financial results are reported to government agencies. This final segment focuses on how to use professional advisors effectively in a tax audit situation.
Using Competent Professional Advisors is a Must.
Even with proper preparation and knowledge, today’s tax laws are far too complex to navigate without competent accounting and legal advice. When a business owner engages in a significant transaction, or knows ahead of time that the tax treatment of a transaction is likely to be reviewed by the government, he or she should involve a qualified accountant and tax attorney early in the planning process to ensure the maximum protection in the event of an audit.
Accountants are trained to understand tax rules and regulations, and how taxing agencies expect to see transactions reported on tax returns. For example, simply choosing the correct form of reporting can significantly reduce audit risk. Tax returns communicate the tax results of transactions to the government; therefore, tax laws limit the time that the government has to challenge the position taken on a particular tax return, as long as the return discloses sufficient information to advise the government of the transaction and its treatment. There is an art to providing enough information to satisfy that standard, while keeping the information succinct enough to minimize the risk of further questions from the government. Remember, even an audit that finds no errors in reporting can be costly to defend.
Hiring a competent tax attorney is also a critical part of successfully navigating today’s complex regulatory environment. Tax attorneys understand the tax laws and nuances of regulatory and judicial interpretations of those laws; therefore, working with a tax attorney when planning transactions with significant tax implications is critical so that the structure and documentation of the transaction supports the desired tax result. Also, while attorneys may or may not prepare tax returns, they can help to establish the legal basis for a return reporting position by offering research, advice, and formal opinions regarding proposed or completed transactions. Attorneys are particularly trained to understand when a tax reporting position may be developed in anticipation of litigation. In that circumstance, it may be appropriate to engage a tax attorney to handle a matter and to have that tax counsel employ the services of an appropriate accountant. The result of this arrangement is that the accountant’s work is attorney-client privileged work product and not generally available to the government or third parties. For the same reason, owners and managers should employ a competent tax attorney early in the audit process when an they have reason to know or suspect that reporting positions may not be resolved at the administrative level.
Any tax audit can result in disputed issues, which can end up in litigation before the U.S. Tax Court, U.S. Federal District Courts, or state or local courts. Such cases are won only with admissible evidence skillfully applied to demonstrate to taxing authorities and the courts the correctness of the taxpayer’s position. In this context, a tax return is evidence of a taxpayer’s position, but does nothing to establish it as correct. The taxpayer’s right to take a reporting position must be established with credible source documents, testimony, bank records, other similar evidence, and legal authority. Once an issue is supported in that way, it is the burden of the government to disprove the taxpayer’s entitlement to the claimed position. A tax attorney can be invaluable in identifying the particular items of evidence that support a return reporting position and in persuading an agency or the court to accept that position. Often, accountants and enrolled agents are not licensed to practice before the courts, and the assistance of a tax attorney will be critical to the success of the case. If litigation is likely to be the end result of an audit, business owners and managers should employ tax counsel early so that counsel has the opportunity to assemble the evidence. Bringing counsel in at the last minute to argue a case without that opportunity is not likely to be effective and many attorneys will not accept such an engagement because of the low likelihood of success.
Today’s regulatory environment is filled with complex rules and procedures enforced by government agencies. Tax laws in particular contain many complexities and nuances that are not necessarily intuitive to the untrained observer. Many current tax rules can be fully understood only by comprehending the historical context in which they arose. The marketplace is replete with a variety of advisors willing to offer tax advice or to resolve tax debts. Many are reputable and some are not. Using advisors because of the tax savings they promise is often a path to financial disaster. While some tax collections cases can be resolved through relatively simple procedures, most businesses must take a much more proactive approach to avoiding costly fights with the government and the associated professional costs, interest, and penalties.
Successful business owners and managers need to understand the financial aspects of their businesses in depth and must be able to identify allegations of a tax auditor that do not match the financial realities of the business. Successful business owners and managers will also take an active role in determining how transactions affecting their businesses are reported to government agencies. Finally, successful business owners and managers will establish professional relationships with competent, reputable accountants and tax counsel to plan transactions, support and develop reporting positions, prepare audit and litigation evidence and make persuasive arguments before administrative agencies and the courts.