Let’s be real, being audited and paying taxes is nobody’s favorite pastime. So what happens in that off-chance that you win the unfortunately IRS lottery of random selection?
In this last installment to our Tax Education series, listen in as we discuss why auditors get a bad rap, who actually gets special attention in audit selections, and what to do when you open your mail one day and you see the official IRS letterhead. Spoiler: Ignoring it is not an option.
- [02:12] Why people are so afraid of auditors
- [07:11] Who makes for a more likely auditing target
- [11:03] What to do when you actually get audited by the IRS
- [17:57] 3 ways to help protect yourself in an audit
[00:00:00] Intro: Forget the civilized path. It’s time to break the chains of debt and dependency, take control of our financial lives, and live free. This is the Fiscally Savage podcast.
[00:00:15] Dylan Bain: Hello and welcome to Fiscally Savage, soon to be Intuitive Finance. I’m your host, Dylan Bain, and today I want to tell you about a time that I was sitting in a bar in Phoenix, Arizona. I’m sitting at this bar and it had been a long day at work. I was working for one of the Big Four accounting firms. I had a notoriously difficult client. We had filed a couple of days prior to this incident and I just wanted to relax. I literally wanted to go to a bar, sit at the bar, read a book, eat some bar food and have a beer.
[00:00:48] And I’m sitting here reading my book and I’m really enjoying it, when this couple sits down next to me and they are clearly not at their first bar of the evening. And as it happens, the woman of the couple is very flirtatious and decides that the man sitting at the bar, drinking a beer, reading a book, who clearly does not want to be disturbed, really instead would like to speak to her. She starts asking me a bunch of questions, flirting. And then eventually she asked me, what do you do? And I look her in the eye and I say, “Well, I’m an auditor.”
[00:01:22] And as if I had flipped a switch, this woman lost it on me, started yelling about that I was the evil of this world, that I should be stamped out and fired, that I shouldn’t be able to get another job again in my life. And I’m gobsmacked sitting at the bar because all I did was tell her that I was an auditor. I have no idea what the big deal is.
[00:01:46] I tell that story, ladies and gentlemen, because it highlights a fact of the career that I do, which is nobody likes to see the auditor show up. And to be fair, in my job — I’m a corporate auditor — which means I help corporations improve their processes primarily, but I also do a lot of compliance work. In either case, nobody likes you to show up and get into their business and start pulling it apart.
[00:02:12] But I’ve also talked about how the tax guys though are like these little money wizards who make money appear out of thin air. And everybody loves the tax guy. They always say in business school, if you want to be loved be a tax guy, and if you want to be feared, be the auditor. And obviously, I chose the auditing path, even though I had started off in tax.
[00:02:34] But the reason that people are afraid of auditors is because when you say the word audit, you immediately think of the IRS. The tax code in the United States has been designed to be cumbersome and painful. And I have talked about this ad nauseam on other shows, but the TLDR on it basically comes down to our tax code is hypercomplex because it’s profitable for certain companies to act as middlemen in the United States. When a middleman inserts themselves into a process in order to just strip mine profit off of that process that’s inefficient, which required them in the first place, they become like parasitic ticks that are next to impossible to remove.
[00:03:13] And that’s what we have in terms of our tax preparation software companies in the United States. Tax code — and I’ve made this point before — if you’re a W2 employee, there is exactly zero reason why you need to have a tax person or a tax preparation software because the IRS already has all the information. But they put themselves in here because they — and purposely lobby to keep the tax code opaque and cumbersome and painful because it’s profitable for them.
[00:03:44] It’s also politically advantageous for a certain political party to try to make taxes as painful as possible because it pushes their political agenda. This is a uniquely American problem that does not exist in other countries.
[00:03:57] The other issue that people face, particularly with their taxes and the IRS, is this idea of information asymmetry. That is to say that there are people who know a lot about taxes, but we might not know if that person is even being honest with us, but we do know for sure that we don’t know a whole lot. And money is emotional. So the emotions of the money here basically boil down to a fear of the unknown. We have this idea that there’s this boogeyman out there called the IRS that will send the Legion of Doom in terms of their auditors to your front door, and strip mine you of money, and you’re going to go to federal jail if you’re off by four cents on your taxes.
[00:04:34] Ladies and gentlemen, I’m here to tell you that as an auditor, to get my attention, you have really got to mess up by the numbers. And it’s not helped by the media environment that talks about, “There’s going to be 87,000 IRS agents hired. Oh my God, they’re going to be knocking at your doors! Run for the hills!”
[00:04:54] Okay, okay. Here’s the deal: that 87,000 IRS agent number comes from the Inflation Reduction Act that increased the budget for the IRS to replace the retiring workers in the system. That’s what this is. That’s what that funding is. There’s plenty of reasons why we might not want more IRS agents, and there’s plenty of reasons why the IRS might be a corrupt institution that should be abolished, but we don’t have to lie in order to make that point.
[00:05:25] So when they say that we’re going to hire 87,000 agents, they make it sound like it’s going to happen tonight. But first off, there isn’t an 87,000 unemployed accountants who are willing to take that job. And if you’ve actually read the text of the bill — and the show often is Dylan reads things so you don’t have to — you’d know that it’s going to take place over the course of about a decade and a half. But never let the truth get in the way of your politics, I guess. All this is to say is that the reality is completely different than the perception. There’s a lot of fear of the unknown. There’s a lot of fear the IRS will come after you.
[00:05:59] But the reality here is that the vast majority of Americans, particularly if you don’t own a business or getting most of your income from foreign assets or other capital gains, you’re probably never going to interact with the IRS outside doing your tax return. In fact, out of all the returns that are filed, and keep in mind, ladies and gentlemen, this includes both personal returns and corporate returns for all of the businesses that are operating in the United States, less than 1% of those returns are audited. Which means just out of the box, your chance of getting audited is incredibly slim.
[00:06:39] The IRS, on a lot of levels, relies on your fear of getting audited to ensure that you’re going to be honest on your returns. And of course, there’s also the software companies and the tax guys who are also, for the most part, going to make sure that you’re being honest on your return. It’s a weird system. It’s really almost an honor system so long as you’re actually filing the return. But again, this is #NotTaxAdvice. I am not a tax CPA and nothing I say can or should be considered tax advice.
[00:07:11] But let’s talk about what you might have in your tax return that would make you a more attractive target for the IRS. The biggest one is being higher income. There’s a lot of hay made about low-income individuals being audited by the IRS more than high-income individuals, but keep in mind that when you’re talking about the income of individuals in the United States, it ranges greatly. So what’s considered low income here is basically less than 250,000 a year, whereas in terms of how we consider like middle class, upper class, those types of things, 250,000 a year is actually doing pretty darn well, and we would consider that higher income levels.
[00:07:50] So it’s a kind of a nebulous thing, but basically the higher your income is, the more interesting things you’re going to have in your tax return. Like for example, you might have a business or be self-employed. And I talked about in last week’s episode — link to that in the show notes — that if you have a business or you’re self employed, there’s a lot of expenses that you can count as losses in the business, that will then reduce your taxable income.
[00:08:13] So if you’re like me, where you’re a W2 employee and you run a business where you’re doing financial coaching in my case, and I’m generating revenue through that side business, and then I have my expenses in the business, and I generate a loss. Okay. That might look weird, and that makes me higher on the hierarchy of things that the IRS might be interested in.
[00:08:34] A third reason is complexity. When you get overly complex, this is where you can get into trouble. And this is why the YouTube finfluencers drive me up the wall, particularly the ones who talk about “this neat trick in the tax code that your tax guy doesn’t want you to know.” Okay, what they’re going to advise you to do is create a convoluted system and that complexity is going to throw a red flag.
[00:08:57] I already talked about the fourth thing, which is foreign assets. When I lived in Taiwan, this is not what they were talking about. I lived in Taiwan, I made money in Taiwan, I paid income taxes in Taiwan. I did not make enough money to pay back taxes back in the United States.
[00:09:11] The thing that would actually throw the flag is if I was, say, living in Long Beach, California, running an import export business, and a bunch of my income is being generated, say, in Singapore. That’s what would actually throw the flag.
[00:09:25] It’s also worth noting — this is my fifth one on this — is that the IRS does do a random spot check. Every year, there’s a bunch of people in the United States who win a terrible lottery, which means that they are randomly selected to have their tax returns audited. This is more than likely, if you do not have any of those other things where you’re higher income levels, you have a small business, you have a complex tax return of foreign assets, and you find yourself being audited? Chances are good that’s because you were randomly selected. That means you won a really terrible lottery.
[00:09:58] So part of my goal in the show is to be able to give you the information, you as the decisionmaker, to help put your mind at ease, particularly around taxes. I don’t make decisions for people as a financial coach, but I do help them make decisions. I do that through education, by presenting them the facts and letting them make the decision based upon that.
[00:10:20] In this particular case, the tax equation is really quite complex. And this is why I always say you should get a tax professional. But money is emotional, taxes are stressful and audits are terrifying. And we do not go and make our money so that we can do our taxes and focus on net worth and create a bunch of spreadsheets. We go make our money to facilitate our life, the thing we’re on this planet to do.
[00:10:49] So what I want to do is be able to give you some tips and tricks if you were to get audited. And hopefully, it will be a less stressful experience and will help you return to living your life faster. Okay, so let’s just jump into it.
[00:11:03] For starters, the vast majority of audits conducted by the IRS in the United States is something called a correspondence audit. This is a fancy way of saying they send you shit through the mail, okay? So this typically starts when you get a notice from the IRS. It will come on official letterhead, and some people immediately start saying, this kind of sounds like it could be a scam. Yes, it could. We’re going to go over what to do with that, it’s fine.
[00:11:26] But the IRS isn’t going to call you. So if somebody calls you and says they’re from the IRS, just hang up the phone. If you get an email saying, this is the IRS, click this link here, you should mark that as spam and then delete it. The IRS will send you something through the mail and it’s going to come on official IRS letterhead. It’s going to have a case number on it. It will spell out exactly what they’re looking for. And there will be a phone number at the bottom of the page.
[00:11:53] Now, if you want to protect yourself from a scam, what you should do is go and independently find the helpline for the IRS for audits. If you go to their website, you can find it, and then call it and then give them the case number. Because that’s going to give you all the information you need. Now you’ve independently found it, but the case number was on that letter. If they say, hey, we don’t have that case number. Guess what? It was a scam, okay?
[00:12:19] But the vast majority of people are going to first be given a notice of the audit. Typically, that notice is just going to come through the mail. If you were to get this notice, don’t ignore it. If you get anything through the mail from the IRS, and it looks official, you need to respond. Not responding is not an option here, okay? It’s like a jury summons. If you get a jury summons in the mail, you need to respond. You can’t just ignore it and hope it goes away because it’s not going to go away, but the problem is going to get bigger. And so if you do get that notice, don’t ignore it. Like I said, go to the IRS website, find the right number, call them, give them the case number, and get the ball rolling.
[00:12:58] The next step you should be doing is that if you look at the correspondence and they start using terms that you don’t fully understand, that is to say, if you don’t know exactly what information to give them, you need professional help. That means that if you followed my advice and you have a tax CPA, you should give that guy a call. And so you can call him up and be like, hey, I need to be able to get this done. Here’s what’s happening. Let’s get something on the calendar, let’s meet.
[00:13:23] Part of the thing when you go to a CPA or a tax professional is they’re going to sign the return as the preparer. That means that they’re representing that you didn’t do this. They did this and you signed off on their work. That means that they’re going to want to defend their work because it’s their reputation and license if they find you at fault. So, call your tax guy.
[00:13:46] But you say, Dylan, I don’t have a tax guy. I just, I did a tax software program. For the love of Christ, I hope that the software program came with auto protection. Intuit’s TurboTax is the most common one that people think of when they think of tax software. A lot of those programs will come with auto protection. They like to sell it to you like insurance, but like Expedia’s trip and travel insurance, they expect you to never actually have to use it. Well, you should be using it if you find yourself in an audit.
[00:14:14] But let’s say that you’re one of those people who printed off all the forms in your home printer and filled them out by hand and sent them to the IRS. If this is the case, I’m not going to say you’re fucked, but I am going to say that you probably want to go find a tax guy and engage them at post-haste. Do not screw around with a software company. Find a CPA in your town and get on it.
[00:14:38] The next step on this is you should review in question, any findings that come out of an audit. Auditors are human, okay? What they’re doing is they’re — I’ll pull back the curtain because again, I am an auditor. What they’re doing is they’re looking at the numbers that are on the tax returns and looking for what’s called reasonable evidence or assurance that those numbers are accurate and correct.
[00:14:58] So they might say, you charged off 6,000 on meals against your small business, I want to see those receipts. So you should be producing those receipts for them. And if you can’t, they’re going to disallow that expense, which of course is going to increase your taxable income because your expenses came back down. But you should question them if they disallow the receipts. Don’t just go quietly in the good night. And sometimes, not always, but sometimes the auditor will just wave on it because you start becoming a bigger pain in the ass than they want you to be.
[00:15:26] The last thing about being audited is that being audited is scary and paying more taxes sucks, and you are not on this planet to pay taxes. You’re on this planet to live your life. And so even if you truly, at the core of your heart, believe that you did that tax return 100% correct and you don’t owe a single cent more, but you could pay a thousand dollars to make the IRS go away? Just pay the money. Cut your losses and move on with your life. You do not want to be in a situation where you’re going to knife fight this unless it’s really dire.
[00:16:04] Now to be fair, we all know some cases or we’ve heard of some cases where that one person, just on principle, was going to go to the mat, and they went all the way to the Supreme Court, and they had a great outcome, and now they’re a hero in the tax world! Okay, great. But chances of that actually being you are diminishingly small.
[00:16:22] And so it’s worth our time here to ask ourselves, how much money would I pay to just make this problem go away? And if the amount of money the IRS wants from you is less than that, just pay it, move on. I hate to say it like that. And quite frankly, your tax guy, he will probably give you the same advice. And how do I know this? Because I worked in a tax office.
[00:16:44] And while I wasn’t the one who signed the return because I wasn’t a CPA at the time — and again, I’m not a tax CPA now — I did do audit support, and we did get to a point where we thought if we have to go to tax court on this, we are more than likely going to win. However, that’s going to take three more months of everyone’s time, with three more months of stress, with three more months of billings, and we could just pay it and just be done. And chances are good, the extra three months of paying the lawyers and paying the accountants and paying me, it’s not going to be worth it. You’re actually going to end up spending more money.
[00:17:20] Now, if you are looking at the emotions of your money around the situation and you say, I will not be able to sleep for the rest of my life through a night again, then by all means fight it. If you feel a need that you have to fight it, like I’m not going to tell you no. But I’m also going to say that sometimes it’s better to do the good old cut and run, and move on from something. Because at the end of the day, we’re not here to pay our taxes. We’re here to live our life. And so our goal should be to make this process as easy and as comfortable as humanly possible.
[00:17:57] Before I sign off today ladies and gentlemen, I’m going to talk about three tips you can use to help protect yourself.
[00:18:03] Number one, hire a professional. The IRS is going to look at your tax return. If they see — if it looks weird but there’s a professional attached to it, chances are good that they might just say, yeah, maybe not. I don’t know if I want to go dance with that person. But if it’s you who signed it, and if you go through a software system, it’s you who signs it. They might actually think that’s an easier target. So hire yourself a professional. They’ll stand behind you in these situations and it basically makes them worth their weight in gold.
[00:18:37] Number two, don’t be cute. And again, I hate to say this. Everybody wants a good tax strategy, and like I’ve said in previous episodes, there’s so many different times in which people have said to me, Dylan, I got to have a good tax strategy. And my first question is always, do I have a tax problem here? Or do I have an income problem here? What’s the core piece of anxiety that’s actually driving the person sitting in front of me? And nine times out of 10, it’s an income problem.
[00:19:04] Because people are looking at it and saying, if I could just find a way to use the tax code. Rich people, they use the tax code and loopholes, and I want to be rich, so I’m going to do the same thing! And they always forget that you have to get rich first before those things work. So then they start doing the cute things that they think are gonna get them the workaround, and that’s how they get audited. Don’t be cute. Just hire the professional and do what they tell you to do.
[00:19:29] And number three, don’t treat the tax code like a source of income. Again, do you have a tax problem or do you have an income problem? If you’re looking for tax loopholes to solve an income problem, it’s a great way to find yourself into some serious trouble. The tax code has a lot of things that will help lower tax burdens, and there are refundable tax credits that there are plenty of people in this United States who are actually getting more money back than they’ve ever paid in taxes. And that’s the truth.
[00:19:57] When I was a teacher, that was absolutely true for most years. Because again, I was very poor. But if you’re trying to treat the tax code like a source of income, that’s going to relate to number two, where you’re going to start getting cute on things. You’re going to try to find a way to cheat the system, and that might work for a while. It might feel great for a while. And then it’s not. Because you might get randomly selected for an audit, or you might throw a red flag. And when they come knocking on the door, and sometimes they can do that, they can look back a whole lot of years and that can lead to a whole lot of trouble.
[00:20:34] The bottom line when it comes to dealing with our taxes, and dealing with the IRS, and dealing with the emotions of money around it all is to keep perspective on why we’re here on this earth. It’s not to pay our taxes. It’s not to punch a time clock. It’s not even to collect a paycheck. It’s to experience life. To build relationships. To enjoy our time here on this beautiful planet. Taxes should be the furthest thing from your mind 99% of the time.
[00:21:04] And so, I hope that you’ve enjoyed the tax series when we move on to something next week. But I understand how stressful this can be. Because when I was, that night, sitting in the bar with this lady who was losing her mind on me, I started to see the other side of it. I was proud of what I did, and I still am. I’m proud to be an auditor. I like my job. And I also induce anxiety whenever I talk to people. And that experience in the bar that night made me start to really see a more human-centered approach to everything from income to expenses to taxes, because all those things are add-ons to the core human experience.
[00:21:54] Outro: Thanks for listening. If you like what we do here, please hit that subscribe button, leave us a rating, review, and share the content with somebody who would benefit from the message. You can follow us on Instagram, Facebook and Twitter, all @FiscallySavage, and head over to FiscallySavage.com to get our free tools, suggested reading, and everything else you need to take control of your financial life and live free.