​How I Beat the IRS

Rodney Johnson |

A month ago I got a love letter from the IRS. Well, it didn’t exactly express emotion, but it definitely made clear that they wanted to see me...and soon.

I was being audited.

The tax year in question was 2013, and they wanted to focus on K-1s, basis for stock transactions, charitable contributions, and health insurance payments. I did what anyone would do. I called my accountant.

He asked me to return all my tax documents to him, at which point he recalculated my taxes. The end result was a difference of $107, and a change in how two numbers were reported.

He was stumped as to what they were after. So I called the IRS, made my appointment, and went in with an armful of documents and my accountant on speed dial.

The agent was a nice guy who clearly wanted to make the experience as pain-free as possible. We sat down, finished the pleasantries, and then he launched into the first topic.

His opening salvo was, “The K-1s filed with us do not match what you reported on your return. The royalties and interest from one partnership, which sent us two K-1s, have higher amounts. So the flow through of funds from Schedule E to your return doesn’t match our records. Is the missing balance reported elsewhere on your return?”

That’s when it struck me. The typical taxpayer is dead meat.

I’m not a novice when it comes to things financial. I’ve got an undergrad in finance, lots of hours of accounting while in college, an MBA, and many years of experience in the securities industry.

It is because of all this that I would never do my taxes. The enormity of the task, coupled with the changing laws, makes the process not only lengthy but fraught with danger.

I know about K-1s. I had an inkling of the difference that he was talking about. But I still whipped out my cell phone and called my accountant.

The three of us talked through it and I figured out that the second K-1 had to do with my IRA, not my taxable investment account.

Since it was a smaller amount inside a tax-deferred account, the income and royalties fell under the threshold of what had to be reported. The IRS agent said the second K-1 didn’t show as being for a retirement account, but that the amount was small enough we could put it aside for the moment and see how the rest of the day went.

What Would a Typical Taxpayer Do?

The agent told me that he gets a lot of people through the door who are living paycheck-to-paycheck, and have either done their taxes the best they can, or paid a preparer who did a poor job.

Even if they correctly followed the directions for calculating their taxes, typically they don’t have all of the documentation necessary to substantiate the deductions. So they end up with a hefty tax bill, even if, in theory, they did everything correctly. The agent said he felt the worst for people who pay way too much for simple returns to be prepared, and still end up with messed up filings.

What I got out of both of these things – me not filing my own returns and many people doing their best and still messing it up – is that the system is too complicated.

Think about it: Why should we collectively spend billions of dollars each year simply trying to figure out how much we’re supposed to be sending to Uncle Sam? Doesn’t it seem idiotic that it takes a lot of money to determine how much money we owe?

Of course, we don’t spend big bucks to calculate taxes. We spend the money to find deductions.

I recently read that politicians who argue about tax rates are silly. Anyone can apply a percentage to income. The hard part is determining what counts as income in the first place, which is where the thorny issue of deductions comes into play, and where all the craziness happens on our personal returns.

Time for Reform

We are now less than a year away from the 2016 presidential election. So far, only a couple of candidates have put forth clear proposals for tax reform.

We should demand such plans from all of them, as well as the speaker of the house and the senate majority leader. It’s time we quit penalizing our citizens because they didn’t comply with a tax code that, along with history, regulation, interpretations, and prior versions, now spans some 70,000 pages.

Anything requiring that much interpretation is meant to support just one industry – lawyers.

That shouldn’t be the basis on which we build the annual funding of the US government. We deserve to treat ourselves better by demanding that our elected officials develop meaningful reform.

As for my own audit, it went quickly.

I only called my accountant twice. At the end, the IRS agent said my preparer did good work, that I was organized, and that by his calculation I would owe them just $39. Since that’s below the $200 threshold to change a return, mine was determined to be a “no-change” audit and I didn’t have to pay.

In my mind, I knew the $39 was because of the K-1 for my IRA, and I almost pulled up the supporting documents on my laptop to prove that I didn’t owe the money.

Then I reconsidered. Should I possibly annoy this pleasant agent who just gave me a “get-out-of-the-IRS-without-paying” pass just to prove I am right, or should I just say, “Thank you?”

I thanked him for his time, wished him a merry Christmas, and made my getaway as fast as possible.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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