Episode 23: Never Fear A Government Audit

Announcer: This is The WealthAbility™ Show with Tom Wheelwright. Way more money, way less taxes.

Tom Wheelwright: Welcome to The WealthAbility™ Show. We’re always learning how to make way more money while paying way less taxes. Hi, this is Tom Wheelwright your host, founder and CEO at WealthAbility™.

So what if you never ever had to worry about a government tax audit? Some people say that the thing people fear most is death. Other people say that the thing that they fear worse than death is public speaking. What’s clear from my 35 years of experience is what people fear more than death and public speaking combined is the government tax audit.

Imagine receiving this envelope in the mail. It’s a white envelope, in the US it’s a white envelope. And it’s from the Internal Revenue Service. You open it up and it says your tax return has been chosen for audit. Immediately there’s fear. What is it that caused me to be audited? What did I miss? What have I done wrong here?

It’s not dissimilar from being pulled over by the police when you’re driving your car, right? Immediately your thoughts go to oh my heavens, what did I do wrong here? What’s going to happen to me? That’s the fear that happens when you receive that white envelope saying that you have an IRS audit.

The good news is there’s a way to never have to worry about it. You can sleep at night. You get that white envelope, no big deal. How do you do that? Well, that’s what we’re going to talk about today.

See the government, all they want is compliance, right? That’s really number one. That’s their number one job, is to help ensure compliance. Now in the US, the US has the highest compliance rate of any tax system in the world, upwards of 85% compliance, which is frankly amazing. There are some countries that don’t even have 30% compliance.

So what are we afraid of? We’re really afraid of the unknown. We’re really afraid because we don’t understand the tax law. That’s what makes you afraid is you don’t understand the tax law. You don’t understand what you might have done wrong. It’s largely a fear of the unknown.

So I’m going to give you three simple rules to follow, three simple rules to follow, and you will never again have to worry about an IRS audit, an audit from the HMRC, an audit from the Canadian Tax Authority, the Australian Tax Authority. Wherever you live, these same three rules apply wherever you live, whatever country you’re in.

Rule number one, and I want you all to write this down. Now, don’t write it down if you’re in the car, okay? But if you’re in the car, just repeat after me, okay? If you’re in the car listening to this, repeat after me. Otherwise I want you to write this down and here’s what I want you write down.

I will never speak to a government tax authority. I will never speak to a government tax authority. That is rule number one. That is not your job. See, the challenge is that people are afraid of the IRS because all these people, they spend all this time learning the law and they’re digging into my personal affairs and what are they going to find?

So the IRS, for example, knows more about taxes than you do. Probably. Not in all cases, but probably, but consider where an IRS auditor comes from, consider this. If you go to school and you go to a good school and you get A’s or B’s, you’re a pretty good student. You come out of there and you’ve got an accounting degree and you’re trying to decide where do I want to go to work?

Now there’s fundamentally three choices. Two of them, which would be public accounting or industry, in two of those, you can be the hero every single day of your life. I love that about my job. Every day of my life I save my clients taxes every single day. So I’m always the hero, always the hero. As long as they communicate with them, I’m doing something that is going to make them money and reduce their stress.

Now consider the third option. The third option is that you come out of school, you go to work for an employer where every single person in the country despises and fears that employer, not one of your customers wants to ever see you or hear from you. You are the enemy. That’s what it’s like to be an IRS auditor.

Now, hopefully you’re getting the idea that being an IRS auditor is not a fun job. It’s a tough job. And because of that, when I meet with an IRS auditor, I always make sure to make them comfortable, make them feel good about themselves and really do my best to help them do their job because I understand they have a tough job. But also consider it is not often that the best and the brightest go to the IRS because it’s not a fun job.

So the best and the brightest end up in industry and end up in public accounting working for clients. What that means is, is that while the IRS auditor knows more than you do, the IRS auditor very likely knows less than your CPA.

Now, I caveat that because one of the things I hear all the time is I hear people tell me that their tax preparer said don’t take this deduction even though it’s legitimate, because it might raise a red flag and get you audited. Well, what that tells you is your tax preparer is afraid of the IRS. So if they’re afraid of the IRS, who should be and typically are, the B minus and C students, and no offense intended to the IRS here, but typically they’re not the A students. Then what does that make your tax preparer? It means that they feel like the IRS knows more than they do.

Now, if that’s the case, your response to that should be next. Who’s next? Who’s going to be my next tax preparer? Because that is not the tax preparer you want on your team. Because rule number one is you never speak to the IRS, the government tax auditor. That is your tax advisor’s job. And they should be comfortable and willing and actually very engaged with the idea of handling an IRS audit.

I remember right out of school, my very first IRS audit. I cannot believe, I mean I was literally a year out of graduate school at the University of Texas and I was given this assignment to handle this audit. I look back and I’m going, Oh my heavens, I don’t know what the partner was thinking to give this audit to me.

And I met with the IRS auditor and he was not a nice man. Now I’ve met a lot of nice IRS auditors. This was not one of them. And he really had a chip on his shoulder and he wanted to get this client. The transaction that he was auditing was a very complex transaction involving derivatives. And that was back before anybody knew what a derivative was. That was long before the 2008 meltdown and too big to fail and all that kind of stuff where people started understanding a little bit about derivatives. Nobody understood derivatives. This is back in the 80s.

And so I’m looking at this, I’m going I don’t understand this. I didn’t. But I thought, you know what, this guy, this auditor is so intent on winning this. I really ought to run the numbers and see what if we lose. What’s the consequence if we lose?

And I ran the numbers not just for the year of audit, because for the year of audit it would have meant a big tax payment from the taxpayer. But what I figured out was in the year subsequent to the audit, it meant a huge, huge tax refund if the auditor won. And in fact in total when you combine the two years, the tax payer was better off losing.

So I can honestly say with great pride that I lost my first IRS audit. I was not afraid of it. I tackled it. I was happy to get into it and I learned a lot. What I learned most is that guess what, sometimes you win when you lose. And that’s not the only time that’s happened to me. It happened a second time about 10, 12 years ago where I had one of our clients was audited and the partner in charge of the client came to me and said look, I’m having a real trouble with this auditor. Can you help me out?

And I said, sure. So we figured out, I actually figured out a way to help the client and actually meet with the appeals officer in person, even though they were a long ways away from our office. Well, it turned out, again, this was one where I said, have you run the numbers to see what would happen if you lose? He says, no, I haven’t done that because everybody just wants to win the IRS audit. I said, run the numbers. We ran the numbers and the client was better off losing the IRS audit.

Now this is twice, okay, I’ve handled several other IRS audits where we won, right? But this was twice where I looked at it, I’m going, we need to figure out a way to lose just this issue because just this issue would benefit the taxpayer.

So you’re looking at your team, so rule number one is you have the best tax advisor on your team that you can because they’re the ones who are going to interface with the tax authority, not you. You see, you can give them a power of attorney in the US that’s a form 2848. In other countries they have their own power of attorney, but all countries allow you to have a professional representative.

Now in the US you are not required to appear before the IRS or speak to the IRS unless they issue a subpoena. And I’ve actually never seen a subpoena issue. That’s not to say that they won’t do it. I’m just saying that they have to go through a lot of red tape to get that subpoena and they’re unlikely to do it. So you’re far better off if you just say look, I’m represented, just like you would if you were in a lawsuit, you would say, I’m represented. Talk to my lawyer.

In this case you’re going to say, I’m represented. Talk to my tax advisor. And you let the tax advisor handle the audit. And that doesn’t matter whether this is a simple request for information. Because some audits are what we call a correspondence audit and all they did was they found a mistake or what they think is mistake. Now, if it’s a true mistake and you go this is a true mistake, just pay the bill. That’s easy.

But if it’s not a mistake, in other words your records say something different than their records, then that’s a time to turn it over to your tax advisor. Now your tax advisor has access to different people at the government than you do, right? Just because it’s more efficient for professional tax advisors to talk to other professional tax advisors than it is for you to speak to the IRS.

The IRS actually sets up a special group of people in the IRS that are specifically for tax professionals. It’s called the tax practitioners hotline. If you call them and you’re the taxpayer, they won’t talk to you, but they will talk to me. And frequently I can get that question answered very easily and most times over the phone.

So whether it’s a correspondence audit where they’re just asking for information, again, I’m going to know what information to give them. You’re not. Or whether, let’s say it’s an office audit where they want you to come down and meet with the IRS auditor because they’re looking at your charitable contributions. They’re looking at some particular expense. In the old days it was the employee business expenses, which are no longer deductible, but they used to be and that used to be a big issue for audit, right?

So it’s an office audit, meaning you’re supposed to go down to the IRS, in other words, your tax advisor goes down to the IRS. I go down there for you. Is really typically a condensed audit. And again, I’m going to know what information to give them.

And the other advantage I have is that if they ask me a question I can say, I don’t know. Let me go ask my client. Let me go ask the taxpayer and I will get back to you on this because I may not want to answer that question right then and there. Even if I do know the answer. I can say you know what? I’m not going to lie to the IRS. I’m going to say, you know what? Let me go talk to my client about that. I don’t have to say I don’t know. If I know, I’m not going to say I don’t know. But I will say that’s a good question. Let me go talk to my client about it.

So I’m a professional dealing with the IRS and your tax advisor should be a professional at dealing with the IRS. So you should never have a time where you’re worried is my tax advisor going to handle this properly? If you’re worried about that, then you really need a new tax advisor.

And it doesn’t have to be me or anybody from the Tax-Free Wealth Network™, just you need to have a tax advisor that you are confident and they are going to go to bat for me before the IRS. And I’m confident that they know the law better than the IRS and that they know how to handle the IRS and work with the IRS.

I’ve seen a number of tax advisors who treated the IRS very poorly. And I’m embarrassed to say that I’ve had former partners that treated the IRS poorly. I would never do that. Never on purpose. I might make a mistake, but never on purpose would I treat the IRS any way but with the greatest respect because they have a tough job to do. My job is to help them do their job. And when I help them do their job, I want to limit their scope of their audit.

So I can tell you story after story, which I’m not going to do because I promised you three ways to never be afraid of an audit.. I just told you number one, you will never speak to the IRS, the HMRC, the Canadian Tax Authority, whoever it is, okay? Australian tax office, you’re never going to speak to them. That’s going to be your CPA, your chartered accountant who’s going to do that? Your tax advisor. Now, that’s number one. And that is the most, that is rule number one. And that’s a really important rule that people forget.

Number two is it’s all about documentation. In the IRS these days, and I presume this is the same in other countries, there are very strict rules about documentation. In other words, the rule is that no expense is deductible unless it’s approved in the tax law, okay? That’s the rule. The general rule is nothing’s deductible. They have to provide an exception to that rule.

So one of the rules that goes along with deductibility is documentation. So keeping proper documentation of your expenses that you’re going to deduct on your tax return is critical. Now you’re not going to turn those over to your tax advisor until, unless and until, probably, at least most of them, until you get audited. So that means you have to keep them. We always say if you want to change your tax, change your facts.

Well, one of the facts you have to change is keeping better documentation. My adorable wife has her own CPA firm and she had an audit a few years ago where the auditor was only looking for documentation because they didn’t understand the law. So they kept looking for this documentation, that documentation and more documentation. Well, so if you know my wife at all, Luanne, you, you know that she is like all over documentation and this client happens to be of all of her clients, the one who’s best at handling documentation.

Over the course of audit, she turned over for three inch loose leaf binders of documentation to the auditor. In the end, he had nowhere to go. He kept asking for more information, they kept giving more information. In the end his supervisor says, we have to let this go. And they dropped the audit. So that’s because there was great documentation.

So documentation. Rule number two is you must maintain, you must maintain documentation. You cannot expect that your tax advisor or tax preparer is going to have all the documentation you need. But that leads to rule number three.

And that is that when you do your tax return, when your tax preparer prepares your tax return, I never liked to see people prepare their own tax returns. This is a mistake. It’s as bad as people doing their own bookkeeping. It’s a mistake. It’s not your profession. WealthAbility™ is all about building the team around you so that you can increase your ability to create wealth. That’s what WealthAbility™ is all about.

Well, you can’t do that if you don’t have a team around you because there’s no way you can learn it all. It would be suicide. I mean, why would you even want to do that? I don’t understand. I mean, I don’t want to learn all the other aspects of law. I don’t want to learn real estate law. I don’t want to intellectual property law. I don’t learn those things. So I hire lawyers to do that, right? I hire other professionals. The same thing is true with your tax return.

But when you do that, when you do prepare your tax return, remember, remember folks, that that tax return is the basis for two things. First, it’s the basis for an audit, okay? That’s, by the way, and it’s kind of weird, but the first thing the IRS asked for is a copy of your tax return. You go, what do you mean you don’t have a copy of my tax return? Well, it’s kind of a different department. It’s easier for them to get it from you than to get it from going through their channels. So the first thing he asked for is your tax return. Well, that tax return, guess what? That is the basis of that audit.

So it, first of all, it must be prepared accurately. But second of all, you have to look to your preparer and say, what is it that, what information are you keeping preparer, tax preparer, that I’m paying this money for. What information are you keeping that you could use to defend an audit?

When we prepare a tax return in the Tax-Free Wealth Network, we insist that every one of our members of our network maintains good work papers for their clients. Now I’ve had new members said, I don’t do work papers, do I need to do work papers? And I said yes if you’re going to be a member of the Tax-Free Wealth Network. And not only that, do you have to do work papers, you have to do complete work papers.

So we’re adamant about the work papers and work papers includes some of the documentation. For example, your W2, that’s your wage statement. Your 1099, your general ledger, your balance sheet, your income statement for a business. We’re going to maintain all that because we’re not just going to put that on the tax return. We’re going to maintain it in our files because guess what? When it comes time for the audit, we want to have as much information as we can to be prepared for the audit before it ever happens.

And I told you there are two reasons for you’re prepared to have all that information. The second is, the second big impact of that tax return is actually has an impact on your taxes. How high are your taxes? There are dozens, dozens, and dozens of ways to reduce your taxes while you prepare your tax return, right?

That’s why you see these commercials during tax season that says, we’ll increase your tax refund. They literally can, but when you have a really, a really good tax preparer, they will find things that nobody else will find. And the reason is, is because a tax advisor or any advisor’s number one job is to ask you questions. Now we have a whole podcast on team. We have another whole podcast on documentation, so be sure to review those podcasts as well.

Remember this though, you want to never worry about an audit. You want to take away the number one biggest fear of most people on the planet. That is most people in developed countries on the planet, their number one fear because they’re not starving. Their number one fear is an audit by the government tax agency because they don’t understand the law and they don’t have a team member who understands the law.

The key here is, three keys. Remember, make sure that your team member is not afraid of the government. If they’re afraid of the government, you need a new team member. I am adamant about that.

Number two, make sure that you are keeping the documentation and that your tax preparer is telling you what documentation to keep. Go through the podcast on documentation and listen to it over and over again.

And third, make sure that your tax return preparer, who by the way should also be your tax advisor, make sure your tax return preparer maintains good documentation on your behalf. So they don’t maintain all of that, but make sure to ask them, so what documentation do you need from me? What documentation do you retain?

Because like for us, we’re not going to keep anything. You’re going to get it all back. In fact, you’re good just going to upload it to our secure portal. We’re not going to actually take any physical copies. You need to maintain those physical copies realistically for at least seven years. You need to maintain those physical copies. You need to maintain scanned copies of your receipts because receipts fade. So make sure you could do scanned copies of the receipts.

All of the documentation that’s required, you must maintain. When you have the right tax advisor who can handle the IRS and you never talk to the IRS, when you have great documentation and when your tax return is prepared in such a way that it is as audit proof as possible, you’re always going to have way more money while paying way less taxes.

Announcer: Now you’ve been listening to The WealthAbility™ Show with Tom Wheelwright. Way more money, way less taxes. To learn more, go to wealthability.com.