What went wrong with the IRS?

The American system of taxation is a complex undertaking. It is so complex it relies on the willing cooperation of the population and the willing assistance of tax professionals. With an estimated 85 million taxpayers paying federal income taxes and an equal number filing only to receive welfare payments, without the willing participation of everyone, the system would soon crumble.

The managing partner of a fairly large regional firm once told me that the IRS relies on the accounting profession to keep people on the straight and narrow. That seemed a novel idea at the time, but it’s perfectly obvious. They can’t audit every return and they can’t put everyone in jail. They can’t even handle Obamacare.

It is the accounting profession that holds the system together.

But the system is showing signs of decay … of a government that no longer trusts its citizens and a citizenry increasingly concerned it won’t be treated fairly by the IRS and other federal agencies.

For this system to work, people must feel they have competent advocates in their corner protecting them from the unbridled aggression of the IRS. They’re willing to put up with aggression as long as they think there is someone in their corner protecting them. You can argue that the IRS aggression is not unbridled, but in my experience as a tax professional, it is. Anecdotally, I recently ran into an appeals agent who suspected I wasn’t myself because my signatures didn’t match. Whatever that means, but she effectively barred me from representing my clients in a tax audit. Because the contact information of supervisory levels at the IRS isn’t published, it took me several days to get the number of someone above her. Once I found that person, the issue was quickly resolved. Field agents and appeals agents sometimes run wild. I could entertain you all afternoon with stories along these lines.

This kind of aggression has been increasing for several years, not due to Congressional mandate mind you, but due entirely to internal actions of the IRS: either at the agent level or the service level in changing the regs, changing enforcement action, etc., etc.

As the IRS is ramping up their aggression on the one hand, they’re simultaneously threatening professional tax preparers by attempting to make tax professionals part of the enforcement arm of the IRS on the one hand, and attempting to police professionals for incompetence on the other hand. This makes professionals very concerned about the penalties and sanctions the IRS could levy against them for actions appropriately is the responsibility of the client. Penalties can be severe, including losing your right to practice before the IRS or going to jail. What this is effectively doing is making tax professionals afraid to undertake a vigorous defense of their clients in the event of tax controversy. Some professionals have completely bailed on this issue. This is an ugly spiral that is feeding on itself and is not likely to end well.

Now I am one who thinks that policing professionals was not a bad idea. I cheered the concept when it was first disclosed because there has always been a lot of incompetence and shoddiness in the profession. But it seems to be getting worse rather than improving. Policing actually made the profession less competent. Why? … because today tax professionals are less likely to understand the constitutional underpinnings of the tax system and are therefore are less likely to take substantive stands for their clients.

The fundamental aspect of taxation is that you can only be taxed on profits. You are constitutionally protected from government attempts to tax you for receipts that are not profits. For instance if you buy something for $17 and sell it for $5, you can’t be taxed on the $5. This concept can be traced from the 16th amendment to the Supreme Court case Glenshaw Glass to section 162 of the internal revenue code. As long as a deduction is ordinary and necessary in the pursuit of profits and meets the requirements of economic substance and profit motive, it’s deductible. And whether it’s deductible or not is not decided by the tax code or the IRS, it’s decided by you. In fact the tax code doesn’t detail what is deductible and what isn’t. Depending on this formula, the exact same thing could be deductible for some taxpayers and not deductible for other taxpayers.

This seems to be getting lost in the process. I have had to push cases all the way to court to get fair treatment for some of my clients. I will say that, in a limited number of cases I got fair treatment for my clients at lower levels. But I used to say, to find a reasonable person at the IRS you had to push it up to appeals. Now I am saying more and more, that sanity now resides at the courts. For how long, who knows?

The result, and I can guess the intended result is, tax professionals are less likely to take legitimate deductions when they know they may have to explain them to the IRS. They toe the company line, as it is, as though they’re working alongside the IRS to increase revenue collections, never even mentioning their new attitude to their clients. Probably because they don’t realize it, but you can bet they’re thinking, “I don’t want to lose my ticket.”

And you can’t blame them.

Perhaps.

But this development has certainly made it easier to differentiate my practice from my competitors. If you’re a business owner, this is not a good time to rely on a professional that came to you via relationship marketing. This is a good time to rely on a results based or value based marketer.

We will come back to this subject often on this blog.

This will serve as an appetizer.

http://www.elliscpa.us

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