CASE STUDIES

 



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AUDIT

Tax - Investment - Estate & Trust
Planning - Audit

My objective is to create tangible financial benefits for my clients. I have found many ways to do this over the years. In the following paragraphs I have provided some representative examples.

Estate Tax Audit

I have had very few income tax audits of returns that I have prepared over the years. There are various techniques that I have used when preparing returns that I believe have been effective in reducing audit exposure.

Most of the audits I have been involved with are of estate returns. This makes sense since all estate tax returns are reviewed by an experienced examiner, while income tax returns are computer scanned with only a fairly low percentage of returns flagged by the computer subject to review by an examiner.

In the 1990s, I prepared an estate tax return that was subject to audit. I expected an audit since the estate consisted mainly of a business and rental properties, the value of which were based on appraisals. I prepared the business appraisal and obtained appraisals of the real estate. Generally, the final estate valuation comes down to a negotiated settlement with the IRS. It is therefore important to stake out the appropriate negotiating position with the objective of minimizing the ultimate estate tax and minimizing the risk of penalties from understating the tax.

It is also important that the executors and heirs understand that there will be more tax to pay and are prepared to pay it. The ultimate resolution of the audit was a very favorable valuation of the estate assets. Several years later the business was broken up and sold in pieces for a price substantially in excess of the estate tax value.

NYS Non-Resident Tax Audit

An executive client lived in Connecticut and worked in New York. He traveled 70% - 80% of the time through out North America and Europe. He had exercised a substantial amount of options making his wages particularly high. Therefore, the amount of taxes NY was losing as a result of his traveling was substantial. Accordingly, the State of New York decided to audit his tax returns for the prior two years.

I realized that not only was the audit result a big deal in terms of tax liability for the years under audit, but it also affected the then current tax year. The client had changed companies resulting is the exercise of a substantial amount of stock options. This income was to be allocated based on travel days from the grant date to the date he left his employer, which included the years under audit. An audit change would mean a much higher tax in the current year.

Of the two years selected for audit, the client had reasonably good documentation substantiating about 75% of the travel days for one year, but had no documentation for the previous year. This was a problem.

The first thing I did after a preliminary review of the documentation was to negotiate the use of the data for the year he had records for both years under audit. Rather than concede the 25% of the travel days I did not have documentation for, I convinced the auditor that the balance of the days were legitimate travel days for which documentation could not be located. My strategy was to provide overwhelming documentation supporting the days I could support to demonstrate that this executive really did travel most to the time both domestically and internationally as part of his job and thus the days claimed were reasonable.

The ultimate result was a no change for both years under audit. In addition, the audit result created a big benefit for the then current tax year and provided insurance against an audit for the current and years in the near future.

NYS Non-Resident Audit

A new client – a Connecticut resident who worked as an executive in New York -- came to me because his former accountant had reported days worked at home as part of the days out on the client’s New York tax return for several years. This is a trick question since New York disallows days worked at home by non-residents as travel days. This cost my new client several thousand dollars for each of three years adjusted by New York State.

While I agreed his accountant should have been aware of New York’s “trick question”, I was amazed to find out that no amended returns had been filed for Connecticut. Since New York’s taxes had gone up the taxpayer was entitled to a higher credit on his Connecticut tax return for taxes paid to New York. I amended the Connecticut returns I could to get refunds. The statute of limitations had expired on one of the returns.

Income Tax Audit

Most of income tax audits I have experienced over the years I expected in advance and I certainly expected this one. The taxpayer built a multi-million dollar house with the intent of selling it for a profit. He was an entrepreneur who had built a successful business unrelated to real estate development. He was nearing retirement and was interested in a new career in real estate development.

He lost a substantial amount of money on the house, which ended his aspirations to develop real estate. At issue was capital versus ordinary loss treatment. My initial research indicated based on the facts and circumstances that attempting to claim ordinary loss treatment was an uphill battle. The client wanted to go ahead. The IRS audited. The auditor ultimately accepted the amount of the loss as reported, but determined it was a capital loss and assessed taxes, interest and substantial penalties. We brought in an attorney who had worked for the IRS to assist us negotiate a deal. Ultimately, we obtained a settlement with the IRS (at the appellate level) to treat the loss as 50% capital and 50% ordinary. This amounted to a huge tax savings for the client