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Knowing When to Walk Away

January 02, 2012 | Written by: Karen Reed, EA
mortgage broker holding up model house with paperwork on the desk
Hearing this story from Audit Representative Susie E. made me think of “The Gambler,” a song released and made famous by Kenny Rogers in 1978. Over the many years she’s been representing our members in IRS office audits, Susie has learned a lot about reading a situation and how to achieve the best possible outcomes for her clients. She understands the importance of knowing when the member needs to walk away, because sometimes to continue playing the game means it will only get worse, not better.

When the member first contacted TaxResources for help, Susie could see he was “out of aces.” The letter he’d received from the IRS included a long list of items on his 2009 tax return for which they wanted more information. He had no understanding of what he’d done wrong or why they were asking.

He was a real estate mortgage broker, and also in the business of lending money. When the housing bubble had burst, there were a few people who owed him money, and he owned several properties purchased at the top of the market which had declined drastically in value. Unable to collect on the debts or keep up with payments on the properties, he had filed for bankruptcy in 2009, and his debts had been discharged in the proceeding.

To Susie’s experienced eye, the reason for the IRS inquiry was immediately clear. On his 2009 tax return she saw a business with no income and more than $80,000 in losses. There was a bad debt deduction of $67,000. The IRS was asking about the business and the bad debt deduction, and they wanted a detailed explanation of the business activities.

Susie was even more concerned about the 1.5 million in 1099-C’s for cancelled debt mentioned in the IRS letter, as they were nowhere to be found on the member’s return. She did find the Schedule D property loss of $70,000, for which they were questioning the cost basis of the building sold.

Susie went to her first audit meeting with all of the information requested in the letter. While she had been able to establish a good rapport with the examiner, she left the meeting with more questions than she’d started with and a preliminary assessment of more than $90,000.

Among other requests, the examiner wanted proof that the member had loaned out $116,000 as he had claimed. The examiner disallowed expenses for an insurance activity that she did not believe existed, since the member had reported only one business for the broker activity. The loss on the property sale was also disallowed -- it had been more than offset by the unreported cancelled debt and, furthermore, did not belong on his personal return at all since it was part of the bankruptcy estate.

Susie went to her next meeting armed with all of the answers and, most importantly, evidence that the taxpayer had wired the loaned funds out of his business account. The examiner agreed to leave the bad debt as it had been originally reported on the tax return, and Susie left the meeting with a bill for $1,049, down from the original $92,689. No penalties were assessed, several items that are often questioned or disallowed had been allowed, and Susie believed that the outcome was fair, and even better than she had anticipated.

The member’s initial response to the result was not quite what Susie had expected. He wanted to know if there was a way to have the interest abated, and he said that since he did in fact have an insurance business, he wanted to keep fighting for the $591 in expenses that had been disallowed. Susie explained to the member that interest is a statutory item and cannot be abated, and that the examination had been fairly conducted and a more than favorable outcome was achieved. She reminded him about other items that could have been questioned that had been allowed and that the examiner had not opened audits for surrounding tax years as they often do.

An experienced audit rep knows when the best possible result has been reached, and when continuing to fight will only make matters worse for the taxpayer. An experienced audit rep knows when to advise the member to walk away. After a few emails and telephone conversations she was able to convince the member that this was one of those times, that gaining $300 at the most was not worth the risk of going through another audit or giving the examiner a reason to change her mind. In the end, the member was more than happy with the result.

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