A Challenge Met Head-On

March 01, 2012 | Written by: Dale Howell, EA
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The IRS was auditing these members for two years, but they had only purchased a membership for one of the years in advance. As a result, instead of the low membership fee that most of our members enjoy, our services were $1,885.95 for the year for which they did not have membership. I wanted to save them more money than they had paid us for the help, so this case was a real challenge.

The audit was focused on the members’ businesses and itemized deductions. They had attempted to handle the uncovered year on their own and had met once with the IRS examiner. But the meeting hadn’t gone well at all, and by the time I started working the case, the examiner had disallowed the entire Schedule C business loss under the Internal Revenue Code section 183 hobby loss rules.

It was a 2008 and 2009 audit, and since 2006 they had been reporting only minimal income and had not shown a profit. They had claimed expenses for a handyman business, a house and car painting business, and a classic car restoration side business. Of course, the classic car restoration was the real problem. I asked the members to create a spreadsheet showing the expenses separated according to the three activities. Then we worked together to combine the handyman and painting businesses and removed some of the expenses that seemed personal and not business in nature and could be considered “unreasonable” by the IRS agent. Needless to say, I was able to reverse the sec 183 decision and keep a small loss each year on the business.

The members had deducted a lot of medical expenses incurred but not paid, so there was nothing I could do to help them with that issue. There were high employee business expenses which were substantiated, but the examiner wanted to reduce the members’ mortgage interest and real estate tax deduction by the amount he thought was allowed for the employee office in home deduction. It was my job at that point to explain to the examiner that the mortgage interest and real estate taxes were not included in the employee office in home deduction, and that he was confusing the employee home office deduction with the self-employed home office deduction, which is calculated differently. It took quite a bit of persuasion and education to get him to finally agree with me and allow all the mortgage interest and real estate taxes as originally deducted on the return.

I convinced the examiner to abate the 2009 penalty of $600, but not the penalty for 2008. The reason he said he wouldn’t abate the 2008 penalty was that the member had deducted a lot of medical expenses in 2008 that had been paid by a loan in 2007. During her initial meeting with the Revenue Agent, the member had told him she had worked for a very large and well-known tax preparation chain as a tax preparer some years ago. The examiner felt that, because of this experience, she should have known better. This is a perfect example of why taxpayers should never represent themselves in audits. If they had called us first, the examiner would never have received that information, and most likely we would have been able to have the penalty removed.

Once we finally came to an agreement, the examiner told me that he had been in my position for most of his career and that he wanted me to know that he admired how hard I had fought for my clients. He said I’d done a very good job.

The overall amount of savings the members received, based on the bill they had when they came to us, was $4,229.48. Even though they paid $1,885.95 for audit defense instead of the usual low fee that is available when it is purchased in advance, the members were thrilled with their decision to get us involved.
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