Large Firms vs Small Firms

Reversion to Mediocrity

Or The Law of Averages.

Or Reversion to the mean.

Stunningly to casual observers, statistically, mathematically & realistically, the larger a tax firm is, the shoddier their performance. The smaller a firm is, the more likely they will outperform the larger firm.

But that doesn’t automatically make a small firm better than a larger firm. It depends on the average competence of their staff. In fact, I’d expect, generally speaking, large firms will generally outperform smaller firms. But that’s 100% due to their in-house processes, or operating manuals, and their insistence on operating according too those manuals & operating procedures. But that’s 100% due to my disappointment with the Lack of genuine competence among private practitioners. CPA profession.

Most people believe it’s just the opposite; that you can expect better results from larger firms than smaller firms. But that’s not the case.

Here’s the deal, the more people you have, the more difficult it is to hire top notch people. Eventually, 100% of the time, as your staff grows, your average performance will begin slipping as the talent you hire becomes less & less talented … It’s impossible to staff a large firm without that occurring.

But at Ellis we realized that earlier on, and we had some disappointing experiences that drove the point home. Now we keep our key staff we rely on, we keep it at a dozen or less. All of them are very bright people. That’s our culture. If they’re not bright, they’ll leave.

So we can keep our performance high when larger firms can’t.

A typical firm begins to grow because the owners are bright and outperform most competition. As the firm begins to grow, at first they just let it grow. But, after a few embarrassments, they begin limiting what staff can do. Eventually, they build operating procedure manuals which limit staff even more. Staff gets constrained but the owners sleep can sleep at night. They used to be known for their performance; now they’re known for being big.

The have reverted to mediocrity, just as statistics tell they will.

The lesson is, don’t be so eager to have a large, sophisticated tax & accounting firm. Look for a small to medium firm. Their performance is better.

CA reverses Tax Court’s decision to deny anonymity to serial whistleblower.

Whistle blower

Help them cheat, then turn them in?

I knew there was such a thing as an IRS whistle blower, but i didn’t know it was it’s own cottage industry. Which it apparently is. But I’m really having a hard time figuring out how it worked.

GINSBURGSenior Circuit Judge.

“The Appellant asked to proceed anonymously before the Tax Court when challenging the decision of the Internal Revenue Service (IRS) to deny his application for a whistleblower award. The Tax Court denied his request, concluding the balance of interests weighed against anonymity because the Appellant is a “serial filer” of whistleblower claims, which he bases upon publicly available information. The Tax Court’s rationale was that if it does not “identify serial filers by name, the public will be unable to judge accurately the extent to which the serial filer phenomenon has affected the work of the Tax Court.” Whistleblower 14377-16W v. Comm’r, 148 T.C. 510, 518-19 (2017).

Read more here.

My experience with cheating clients

If you’ve ever had clients tell you how to do your job, you can probably relate to this. Of course when it comes to taxation, it involves criminal charges with jail sentences. So I don’t go there. This year, I had a fairly successful client in the cannabis industry that tried to talk me into cheating in three different ways.

  1. First, he wanted to deduct ah investment he made in a company that was still operating and paying taxes. He claimed, probably correctly, he paid more than it was worth and wanted to deduct the difference. That would work for GAAP, but not for taxes. For tax, that’s a violation of law.
  2. Second he found a tax preparer who was willing to play loosey-goosey with 280(e), which limits the deductions that a cannabis business can deduct. He told me top notch cannabis preparers were paying less attention to 280(e). I checked around and some of the top people in cannabis taxation said it was bullshit, as I expected. It ‘s against the law to ignore 280(e). Of course you can do all kinds of things with 280(e), but you can’t just ignore what it says.
  3. Third, he wanted us to deduct accrued interest in a cash basis company. Accruals can only be deducted in an accrual basis company.

In everyone of those situations, I could lose my ticket. All of them involved thousands or hundreds of thousands of dollars in tax.

I refused, he got angry, left and started bad mouthing me.


If an accredited tax preparer helps a client cheat, they are both liable. The taxpayer for preparing a false return, and the taxpayer for providing false information.  If the client lies to the tax preparer and fails to product the documents, the tax preparer is still liable for not getting the documents. I see no way the tax preparer escapes unscathed.

How it should work

If someone goes to a tax preparer with the intention of cheating, it is the tax professional’s responsibility to tell the taxpayer(s) they could go to jail for cheating. If they persist, the tax preparers should resign from the engagement.

Something else that surprises me is this. The whistle blower bases his claims on “publicly available information.  I’m not sure what that means. Apparently this guy was a tax preparer and used publicly available information to turn in his clients for a reward.

This does not sound like the entire story. i’m guessing there is more here than meets the eye.

And why would the preparer want anonymity?

I have no inkling what the underlying facts are in the court case that started this blog post off. It raised some interesting issues that I don’t understand how the preparer got around. Of course, I’m not going to turn my client in, but I wouldn’t feel bad if someone else did.

One other thing.

I know a person who was very high profile in American politics that was convicted of tax fraud 15 years ago, and he is still in prison. He is likely to die there.

Don’t go there.

A better approach that I suspect is used from time to time, is to simply not pay your taxes. Wait a few years and settle for pennies on the dollar. I don’t ever advise that, but I know it happens.




Selecting a Top Tier CPA Firm is Counter Intuitive

A prospective client asked me how many CPAs we had. I didn’t think much of it at the time. Later I realized he was probably evaluating us on that number.

This is a common error, assuming quantity is identical to quality. Big mistake.

I started my public accounting career with the biggest & best public accounting firm in the world, Arthur Andersen. They were the only firm that was a true international firm. Today’s Big 4 are all associations of firms. When Enron killed them, they were the largest auditing firm in the world, Accenture (formerly Andersen Consulting) was the largest consulting firm in the world and Arthur Andersen Consulting was the 2no largest consulting firm in the world.

When I started at Arthur Andersen, every recruit at my office had graduated at the top of their college class. The major daily newspaper published a story about us saying, “The firm had to widen its halls so we could walk by each other, such a collection of egos we were.”

So Andersen hired the best people and were the best firm in the world. But we didn’t have a lot of CPA’s on staff. Out of a hundred professional staff, no more than 15 were CPAs. Most of our professional staff were still aspiring to become CPAs. But we cycled them through pretty fast. It didn’t take more than two or three years to figure how bright they were. You move out those who will never be what you want them to be. And you bring in a bunch of new people looking for that one. For those who were nearly the best but not not good enough for the firm, they generally got executive placements at our clients. This is the way good CPA firms  work. “Move up or move out”. The only people we kept at Andersen were best of the best; the kind of person who could move the needle.

Here’s where I’m going with this diatribe.

If you see a “CPA Firm” with a lot of CPAs, that’s a bunch of individual CPAs sharing an office and overhead trying to give the impression of a real firm. These are the people who get moved out by the Big 4 but weren’t good enough for an executive placement, or never got to the Big 4 in the first place. In other words these are the drones taking up office space and clogging everything up so that if a really good person would actually come along, he could never advance through the seniority system. All his drive would be killed long before he ever got there.

The more CPAs per capita, the greater the risk of getting an incompetent firm. The fewer CPAs the greater chance of excellence. This is because at every firm, the strategies & complex ideas come from the very top. That is not happening at every person in the firm. They are either developing or on the way out.  The worst thing you want to do is select a firm with 17 CPAs and two other employees. The better firms go through accountants like they were water. And most of their staff haven’t yet become CPAs. But they’re better accountants. They’re actually doing something other than just cluttering up an office and collecting a check.

You’ve been warned.

Update On The IRS

This stuff is obvious …

The IRS is auditing fewer and fewer returns every year
The IRS will never be able to police the tax laws by auditing
If it wasn’t for CPAs and other tax professionals, the entire tax system would collapse
235 million tax returns will be filed this year
The IRS employs 92,000 people (growing steadily)
Only a few of them are auditors
General competence at the IRS is declining
General competence among tax professionals is declining

Accounting Today reported recently that the IRS audit rate hit a new low. But like most stuff in the news, there’s more than meets the eye here. Let’s dig a little deeper and see what’s going the IRS.

First of all, is this the only problem the IRS is dealing with?

No. We have problems with the IRS in every area. Think of it as a roulette wheel. When you deal with the IRS it’s like spinning the wheel in one direction and spinning the ball in the other direction. The quality of IRS service depends on which of the 38 pockets the ball lands in. If you get the best pocket, you get generally polite, courteous and reliable service. If you land on the worst pockets (there are more ‘worst’ pockets than ‘best’ pockets) you get the cruel psychopaths who just got off the ship from Venus. On all the pockets in between you get unusual and generally disagreeable people.

Or they transfer your issue from one department to the next until they run out of departments and begin all over again. Or they just drop you in a hole and forget about you.

So what is really going on at the IRS.

If you ask them they will tell you budget cuts are causing the problem. But you know what, it ain’t budget cuts. IRS budget and staffing has been growing for years. As far as I know there has never been a budget cut at the IRS.

Something else is the problem.

You may remember a few years I began complaining (though I do it less nowadays) that the really competent people at the IRS had begun retiring and they were being replaced by less experienced and generally unreliable staff. Believe me, it’s tons better to work with an knowledgeable and sharp adversary than an incompetent who is driven by emotion. For the last several years, the problem has simply exacerbated.

Recently, one of our staff got lucky and her ball landed in the ‘best’ pocket. She was told the problem was the budget (ha, ha). But he went on to say the IRS has been cutting back on training. The need is so great the IRS is pulling people off the street and putting them right to work on your case. That’s the real problem.

IRS called to account.

Briefs were filed today in a case against the IRS for retaliating against taxpayers who refused the IRS request to extend the statute of limitations. Extending the statute of limitations is standard procedure in an audit. They’ve extended the statute in most of the audits I’ve been involved in. In this case they issued a court summons. And this case is about whether that summons should be quashed because if it was enforced it would be a abuse of the ‘due process clause’ in the constitution.

This is good news. Perhaps the Supreme Court will put an end to this practice.

This exact threat has been used to force taxpayers to sign extensions for years. If we’ve represented you in an audit, you may well remember this happening, and me telling you if you didn’t sign, the IRS would retaliate big time. Finally someone with the bucks to do it, has stood up to the IRS.

Tiger by the tail

As the revenue collecting arm of the U.S. government, the IRS has a tiger by the tail. They’re frantically trying to automate everything because it’s difficult to replace all their good people at once. Plus, as I’ve said for years, the tax law would never have gotten so complex if it weren’t for computers. The IRS has been unable to deal with that triple edge sword.

On the other side of the coin, the same thing has been happening to the tax preparation profession. Since quality really does rise to the top, this development has been a boon to our firm, but the general quality of returns filed has deteriorated. We’ve been at this long enough that we’ve developed the competence to deal with it effectively. But most firms haven’t, and the level of incompetence rose dramatically until the IRS had to get involved to police the profession and try to restore order. As odd as it may sound, I was in favor of that because I see a ton of incompetence out there. But a lawsuit killed that. So the profession will continue to go wild and incompetence will continue unabated.

Protecting Clients From the IRS

To protect our clients, we closely follow what the IRS is saying, what it’s doing and what it’s auditing. We know what the IRS is auditing and we pull any audit triggers off your returns before we file them. Two audit triggers we monitor constantly are (1) S corp tax officer wages and Schedule C’s filed with your 1040.returns. The way we deal with them may be surprising to many, but our approach has been effective. For the last three decades no tax returns filed by us that followed our advice has been audited. If you don’t follow our advice, then you may very well get audited. That has happened at least twice in the past decade. That number appears low because most of our clients follow our advice.

If you do get audited, we’re prepared with strong arguments ready and waiting for your defense. These arguments and defenses have been thoroughly tested in the cauldron of actual tax audits.

Our Approach

Some people think we’re aggressive because we’re so effective at cutting taxes. But we’re not the least bit aggressive. We never stray into the middle of the dreaded gray areas. We stay right smack dab in the middle of the tax code. Everything we do is built on the solid rock foundation of the tax code and actual court cases. We are confident enough to say we will save you more than we cost.

Thus far we’ve ‘won’ all of our audits. Not that there are winners and losers, but no client has ever been dramatically dinged in an audit, other than those that didn’t take our advice. And even then we were prepared to push it further, and thought we had a winning case, and the client decided otherwise. In every case, the taxpayers paid SUBSTANTIALLY less than what the IRS wanted.

We’ve pushed only one tax return all the way to court, and that one was settled satisfactorily before it even got to court. We won that one on all the major issues. The IRS may be pulling some administrative maneuvers, but they won on every issue. We don’t love going through audits, but we are decently good at it. However, I personally tend to be a little bit impatient with the IRS.

Back to Incompetence

Sometimes the issue here is that sometimes the incompetence at the IRS is so egregious they simply don’t understand the law. More times than I would like to mention, I have had to explain the law to auditors or appeals agents.

Or it may be just that they turn a blind eye to it. It used to be that the IRS didn’t want cases pushed up to appeals or all the way to court if they could prevent it. So they would come to their senses about contentious issues whenever they could. But that’s not the case any more. One agent took a dislike to our client and pushed us up to court out of vindictiveness.

I used to say you generally got a sane agent at the appeals level. But I no longer believe that. I am always pleasantly surprised whenever I encounter a competent, gracious IRS agent. The are some, but I don’t think that’s the culture there any longer.