December 2, 2022
  • December 2, 2022
  • Home
  • Expenses
  • “If you’re playing the audit lottery as a taxpayer, you’re looking for trouble.” There is a price for what you claim as “business” expenses.

“If you’re playing the audit lottery as a taxpayer, you’re looking for trouble.” There is a price for what you claim as “business” expenses.

By on February 8, 2022 0

Headlines about the coming tax season nightmare have been hard to miss. The IRS has warned Americans to expect safeguards in processing returns and delays in refunds.

With the IRS in crisis, some taxpayers may conclude this is the year to test the limits of what’s legal — or ethical — when filing their federal returns. This can put financial advisors and paid tax preparers in an uncomfortable position.

Many advisors act as fiduciaries, which means they are committed to putting the client’s interest first. If they are required to act in the client’s best interest at all times, what are they supposed to do if a client insists on adopting a very aggressive or questionable tax strategy?

“If it’s blatantly unethical, I’ll fire the client,” said Don Grant, a certified financial planner in Wichita, Kan. “I will not go against the rules of the IRS.”

Although Grant does not provide tax preparation services to clients, he can work with their accountant to resolve certain tax issues. If clients want to play around interpreting the tax law in terms most favorable to them, he will urge them to consult with their tax preparer to make sure they are clear.

“There are ambiguous rules,” he said. The involvement of an experienced and knowledgeable CPA helps their clients make an informed decision on how to proceed.

When considering tax shelters or certain reportable transactions, tax preparers have a duty to follow a “more likely than not” standard. This means that they must have a reasonable belief that the position would more likely than not be upheld on its merits.

Even if they sift through the ambiguity and conclude that a particular reporting decision is acceptable, the outcome can still sting. Just because an understaffed IRS struggles with budget constraints and processing delays doesn’t mean cheaters will come out on top.

“If you play the audit lottery as a taxpayer, you’re in trouble,” said Mark Prendergast, a certified financial planner in Huntington Beach, Calif.

Prendergast, who is also a CPA, used to provide tax preparation in addition to financial planning for his clients. Today, he offers general advice but is not involved in filling out tax forms. When clients mention a questionable tax filing strategy, they may respond, “Here’s the right way to do it.”

Ultimately, he says, it’s up to his clients to determine how they complete their returns and whether they heed his advice.

Read: The IRS already knows how much tax you’ll have to pay, so why do Americans have to pay so much to file their taxes?

A common space for fudging involves professional expenses. Small business owners and self-employed people can apply a broad definition to what constitutes a deductible business expense.

Prendergast recalls a client who considered “almost everything a business expense,” he says. Because it often involves judgment calls and gray areas, taxpayers may not be flagrantly breaking the law in their attempt to justify what they consider business expenses. Advisors could therefore accept such behavior as long as it is defensible.

“People are going to do what they are going to do,” Prendergast said. “But if they’re going to fool the government, they’re fooling me too.”

At the very least, he suggests that tax preparers educate filers about business expenses. If taxpayers intend to deduct meal and entertainment expenses, for example, their accountant should ask, “Do you understand what documentation is required for this?” and “Do you have all the receipts?”

Many advisers are warning clients of the risks of extensive tax reporting, even as the IRS struggles to deal with growing operational challenges.

“If we thought a client was being too aggressive, we reminded them of the financial and other ramifications,” said Doug Lynch, a licensed financial planner in Dublin, Ohio. “You can repay very high taxes and penalties. And you could face difficult legal issues with significant attorney and accountant fees. So we do our best to steer them away from an overly aggressive situation.

Following: The party is over for some investors at AMC and GameStop, while luckier meme stock winners brace for a massive tax bill

More: The IRS will be asking every taxpayer about crypto transactions this tax season — here’s how to report them