In episode 39 of How Tax Works, Matt Foreman discusses what you should do if you get audited, including discussing the process of an audit, how to politely push back, and why you should never, ever ignore the audit.

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How Tax Works, hosted by FRB Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions. Through this, listeners are treated to a comprehensive breakdown of entity structures, from the robust shield of C corporations to the flexibility of partnerships and LLCs. Foreman navigates through the maze of tax considerations, shedding light on entity-level taxation, shareholder responsibilities, and nuanced tax strategies. Foreman shares valuable insights and practical advice, emphasizing the need for informed decision-making and consultation with tax professionals. From qualified small business stock to state and local tax considerations, no stone is left unturned in this illuminating exploration of tax law and entity selection.

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Transcript:

**This transcript has been prepared automatically by AI and may contain inaccuracies**

Matthew Foreman [00:00:03]:
Welcome to the 39th episode of How Tax Works. I’m Matt Foreman. In this episode, I’ll discuss what to do if you get an audit notice from the IRS or a state tax or revenue agency. How Tax Works is meant for informational and entertainment purposes only. This may be attorney advertising, and it is not legal advice. Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business decisions that we all make. Before we get started, a few administrative things.

Matthew Foreman [00:00:46]:
New episodes every 2 weeks. The next one will talk about tax litigation. I have an exclamation point written on it, so it must be exciting. If you have any questions, comments, or constructive criticism, you can email me at my FRB email address. There are some upcoming webinars. I’m doing one actually. I’m recording this about a week before it comes out. So this week I’m starting my first one talking about 704(c).

Matthew Foreman [00:01:08]:
I have a couple coming up. If you just Google advanced tax something or other, I’m very specific on this, and Matt Foreman, it’ll come up. FRB, it’s free hour of continuing ed credit for CPAs. IRS, enrolled agents, attorneys, and CFPs. So that’s a big one. All right. We’re talking about audits, right? You know, what do you do if you get audited? What do you do if you get that dreaded letter? First off, you know, the first thing you should do is take a deep breath. A lot of people read it.

Matthew Foreman [00:01:43]:
They don’t really read it. They skim it. They get terrified and they go, I can’t do this. This is awful. They’re going to, you know, what’s going to do this? What am I doing? What did I do wrong? What did my accountant do wrong? Everyone’s an idiot, you know, etc. And, and, you know, sit down and read it, right? And go through it, read what’s said. Um, some of them are well written and give you an answer. Some of them are just asking for information.

Matthew Foreman [00:02:07]:
Sometimes it’s literally just asking you, hey, did you make a math error, right? Um, so I think that that’s really important to know. Um, the first thing you want to do is figure out like, what is this audit about? What is it talking about? What is it trying to do? Look at, you know, the topics, the information they want, the year or years at issue, and don’t, don’t ignore it. Don’t blow off the auditor. I get about once a month, I’ll get a letter, an email from someone who has a response due in 2 days. They gave you 30. You can always get that, almost always get it extended. But, you know, don’t, don’t wait 28 days to do something about it. Right.

Matthew Foreman [00:02:47]:
And so, you know, don’t, don’t do that. And sometimes you get ones where like, yeah, I got this letter, but I just ignored it. It was 3 years ago and now they’re doing something about like they’re going to take money from my bank account. Like, can you just, you know, can we do the audit now? And the answer is I have to ask politely if we can do the audit at that point. You know, you can’t force them. There are rules in a civilized society around what you do. So the most important thing to do in an audit, if you get an audit letter, is to ask, right? It is to read what happens and decide what to do. If you want to hire someone, you can call the auditor, establish contact, ask what they want to know, ask if there’s any other information they’re looking for, what they’re trying to find out, etc.

Matthew Foreman [00:03:28]:
And be polite. Yelling at the auditor from the start will never, ever, ever help you. It may not hurt you, but it won’t help. They’re like, oh, I want to let them know I’m not someone to be trifled with. And they’re like, yes. And they have the full faith and credit of the government of the United States of America, they have some, you know, some recourse themselves as well. So definitely, definitely be polite. Um, talk to them, you know, Miss, Miss or Mister.

Matthew Foreman [00:03:56]:
I almost always end up talking to them, calling them by their first, you know, hi Jim, how are you, you know, whatever. Um, give them a chat, you know, they’re human beings, they want to understand it, things like that. Um, don’t answer questions, you You know, they’re going to ask you questions if you call them. So don’t answer them. Just say, hey, I just want to establish contact, let you know I got it. I’m probably going to hire someone. And so I, you know, just want to let you know what I do then. If someone hires me, I establish contact, right? Let them know.

Matthew Foreman [00:04:25]:
But we’ll get to that in a second. So the question is, you know, do you hire a professional? Do you hire someone new or do you hire someone you know, right? Does your return preparer have expertise with that specific area, right? Sometimes you get questions, I get this a fair amount, where someone has moved to Florida, they’re getting a New York State residency audit, and their Florida return preparer is like, oh, I can probably handle this, I know these rules. And like, maybe, maybe they do, maybe they don’t. But find someone who has expertise, who’s done that kind of audit before, or has a lot of expertise in audits, right? And that sort of stuff, just because it helps. Sometimes, you know, not just in that kind of audit, but generally, right? Just because they’ve never done that kind of audit before. There’s lots of audits I’ve done now. Once, right? And I think it’s important to note that I’ve done them once, but I’ve done a lot of audit work and a lot of defense work. So I have an idea about how the flow works, what information to provide, what’s an issue.

Matthew Foreman [00:05:19]:
Sometimes I say you want to hire someone else simply to put a barrier, you know, a level, a buffer, I guess, in between them, right? Expert in the technical area, expert in controversy. This is important to note that, right? There is no, like tax litigation is sort of a bit of a misnomer, even though I say I do it. You know, it’s called controversy because theoretically the IRS is not adverse. I know, or the state. I know that’s kind of contrary to how it happens and how it’s viewed and how it functions. But theoretically, they’re looking for the correct answer. It’s just that the way it’s set up is that the taxpayer is always on one side. So there sort of has to be a counterparty.

Matthew Foreman [00:05:58]:
IRS fills that role, right? They’re just an enforcement agency. So it’s called controversy because it’s a controversy. It’s not litigation quite yet, especially at this point. And that’s why sometimes it can be helpful if you want to hire someone else to kind of blame the return preparer. Oh, they made a mistake, or they didn’t know New York State decoupled from Opportunity Zone, or they didn’t know New Jersey didn’t follow QSBS, or they didn’t know that, you know, whatever. I can name a thousand. You know, each state has its own quirk, right? And you just want to sometimes be able to say, look, like, they made a mistake. Let’s abate some penalties, let’s call it a day and move on.

Matthew Foreman [00:06:32]:
And that can be helpful, right? It can also be helpful to have fresh eyes. Someone looks at it from a different perspective who isn’t in a situation where they’re like, boy, did I mess up, right? We’re all human. We are absolutely all going to make mistakes. I make them, you make them, everyone makes them because we’re human, right? The only thing that doesn’t make mistakes is AI, as we all know, has never made a mistake, doesn’t hallucinate. So that’s perfect. And then people always say, well, maybe I should just represent myself. I’m going to do it myself. I get that a lot from attorneys who are not tax lawyers.

Matthew Foreman [00:07:03]:
And, and, you know, the worst client you can have as an attorney is yourself for the same reason you shouldn’t really, for the most part, represent yourself. You’re emotional. You care. You’re going to bed thinking about this. You’re waking up thinking about this. I think about my client work a lot, and I think about my client work outside of work. A lot. I will 100% admit that, own up to that, agree to that.

Matthew Foreman [00:07:27]:
However, I don’t have that level of emotion because this isn’t me, right? At the end of the day, I have a goal, I’m advocating for it, and I’m gonna fight. You know, anyone who’s ever disagreed with me on really anything knows that I will tell you that you’re wrong and you’re the dumbest person alive and I can’t believe you believe that, you know, um, even about dumb things. This is, you know, I can definitely be argumentative, but at the same time, it’s an impassioned argument, right? It’s not something I’m going to have to go home, sleep about and think about. And it’s not going to rattle in my head for 3 weeks, you know, and I know that. And getting someone in there who’s done a new, who has a new perspective, who’s thinking about things, who has expertise in the area or with controversy can be really helpful. And that’s not just a tax attorney, though there’s a lot of tax attorneys. And as a tax attorney, I always tell you, you know, you should hire a tax attorney, right? You need surgery, tax attorney. We do everything.

Matthew Foreman [00:08:16]:
It’s great. So, you know, that, that’s the process and that’s the question. And that’s really how I think about it. I’m going to assume for this that you’re going to hire a professional. And I’m also assuming and knowing, you know, the emails I get and the comments people make, that the vast majority of the people who listen to this are attorneys or accountants or financial professionals otherwise. So I’m assuming the underlying client, right? I’m going to say you but the underlying client has hired a professional. Let’s say it’s me, right? I’m an attorney. I have a couple of fancy degrees.

Matthew Foreman [00:08:51]:
I’m licensed in two states. I’m licensed in front of the U.S. Tax Court. Really exciting, right? The first thing I do is get a power of attorney, federal or state, on the issues at hand, on the years at hand, and I fax it in. Yes, you know, fax is still used. Then I call the auditor. I want to establish contact. I want to say, hi, my name’s Matt.

Matthew Foreman [00:09:12]:
I’m going to be doing this. I need more time. Even if everything’s going to happen and I’m going to get it in 30 days, I ask for 90, ask for 60 more. Generally get 30 more, sometimes get 60 more. But I’m a big fan of that. I will tell you, I’ve had numerous instances, you know, let’s say we get to get it and I call them on, you know, November 1st. Like, I can get it to you by the end of January. A lot going on.

Matthew Foreman [00:09:33]:
A lot of times I’ll get it to them, you know, by Thanksgiving or shortly thereafter. It’s not even about hitting that. It’s about setting the expectation, hitting your deadlines, giving the information. And, you know, I ask questions. I was, hey, what are you looking for? What are you thinking? You know, why did this audit happen? Do you know? I had a client where the— we were an IRS independent office of appeals, which I’ll talk about actually in the next podcast, told me why the audit happened. So that was, you know, that was really helpful to know why it happened. It’s become a sort of fascinating tale. A slightly esoteric area, but it’s interesting to hear how things come about and why and just establish rapport.

Matthew Foreman [00:10:14]:
The bulk of New York State auditors, for example, not the bulk, a big, significant number are in Albany, New York. They’re at the, the, this one campus and it is literally next to where I went to college. Right. And so I’m like, hey, you know, I went to SUNY Albany. It’s right next to where you are. Oh, that’s great. you know, talk about restaurants, talk about stuff in the area, you know, etc. And things like that, you know, being human really helps.

Matthew Foreman [00:10:41]:
A lot of, you know, IRS, one of their offer and compromise centers, for example, is out on Long Island. It’s in Suffolk County. You’ll hit auditors, you know, Pennsylvania, a lot of them in Harrisburg. I went to law school near there. Appealing to a human side really works. And I think a lot of people really underestimate how much it helps to just talk to a person and treat them like a person and how much that really helps and try to dig into the issues. Look, they’re trying to resolve something. You’re trying to resolve something.

Matthew Foreman [00:11:07]:
You’re actually working to the same goal. You just have different views of what the goal is, but it’s the same general goal. Be done, move on and let everyone move on. So talk to them like that. And that’s what I do. That’s a big thing I do. Just be conversational, be polite. And I also know that a number of people who work for states and the IRS listen to this podcast.

Matthew Foreman [00:11:25]:
Both from comments and the fact that I have a, you know, when I do webinars, I have to see your emails. So I see that sort of stuff. I don’t look that hard at them. But, you know, it’s tough to not see, you know, treas.irs.gov, things like that. So it’s interesting to see. So hopefully I’m, you know, doing an okay job here. The next step is the process, right? What is the process of an audit? The first letter you get and all the other letters and all the requests for information are what’s called an IDR. Information Document Request.

Matthew Foreman [00:11:56]:
The IRS uses Form 4564. Every other state, every state has their own form, or D.C., I guess they’re not a state where they request information via IDR. Please, please edit that one out. That was gross. Sorry. It gives you the opportunity to look at what they want, right? And you can ask the auditor questions like, look, you know, you’re asking for this that doesn’t really exist. Can I give you this instead? Call them up, have the conversation. Don’t just say, well, I have to give them exactly what they want.

Matthew Foreman [00:12:27]:
If you talk to them and you establish communication, they’ll tell you what they want to get and the question they want to answer. And, you know, I’ve had it where an auditor asked for emails. I said, look, there really aren’t emails. There’s 6 people use the same email. It’s not going to show who actually sent it because it’s not signed. And we can’t locate an IP because it’s people who use one computer or whatever. You know, everyone has a phone, but they’re often in the office. So it’s the same IP.

Matthew Foreman [00:12:54]:
But I can give you WhatsApp. I can give you a phone log. I can give you things like that that go to the same one. So asking the auditor questions as part of the IDR process really gets better information for them. So that’s really helpful. You always have to assume there will be more questions and you answer the questions directly but narrowly. It is a lot like dealing with a small child, 4 or 5-year-old. They’re precocious.

Matthew Foreman [00:13:17]:
They ask a lot of questions. They want to know stuff. They think they know what’s going on, right? They really do. But they effectively just want to answer their questions and they’re going to keep asking and assume they will. Right. And I’m not calling auditors small children, but that’s how you have to view it, right? You answer the questions directly but narrowly, because if you give a small child too much leeway in your answer, they’re going to ask questions about what you just said. And boy, you are stuck in a circle and you don’t want to be in that, right? So that’s it. Provide documents, you know, whenever and wherever requested.

Matthew Foreman [00:13:50]:
I’m going to talk about this a little more later. And the goal is to support your position. However, you don’t always provide every single document. You don’t provide documents beyond what’s required. You can redact, you know, people like, oh, I have to send a 200-page operating agreement. I’m like, why? They asked you for who owns it and what the allocations and distributions are. Just send them the COVID page and send them the 4 or 5 relevant pages. Just remove the rest.

Matthew Foreman [00:14:15]:
Redact it, black boxes, redact it, remove the page, whatever you want. They don’t need to know everything. And if it’s not relevant, they’ll say, oh, I need the whole document. They don’t. And that’s really important. And you don’t need to provide, for example, like, you know, 3 years of bank statements to show stuff. What are they trying to get? What are you trying to understand? You need one. We’re going to do one.

Matthew Foreman [00:14:35]:
We’ll see how it goes from there. They ask for more and they provide a compelling reason. You can do it. You can tell them to go away. It may cause them to tell you that You know, this audit’s not going so well, etc. So, right. So ask what they want, narrowly tailor to the response. This is where I always talk about Cohen versus Commissioner, episode 30.

Matthew Foreman [00:14:54]:
I talk about Cohen v. Commissioner in detail. It’s about substantiation, right? Verbal testimony or affidavits from related parties is absolutely admissible. The IRS and every state ignores them. They say we don’t consider them because you’re lying. We know you’re lying. We don’t believe you, etc. And I’m like, look, like If nothing the taxpayer provides can be believed, then why are we having a conversation? You already have all the information you need.

Matthew Foreman [00:15:17]:
You’re just going to skew everything wrongly so you can push back. Auditors know that’s not true, that they can— they should actually listen to what you write. But the key is to have, have contemporaneous documentation that’s supported by other estimates, other testimonial evidence. Right. And then you only need to show correct, not the only answer. Right. You know, there are different methods and a lot of times it’s a reasonable method, not the only method. So you need to show that your method is a reasonable method, not the only method.

Matthew Foreman [00:15:46]:
And I think that’s important to note. All right. Let’s get some music in. I’ll be back in just a moment. All right. So we’re back in the process of the audit timeliness, right? I discussed this before. IDRs typically say you have a response 30 to 60 days. That’s really common.

Matthew Foreman [00:16:15]:
They’re like, oh, 30 days, that’s so few. And I’m like, yeah, it’s possible. I’ve gotten, I’ve gotten letters from the IRS that have like 4 days left on a 30-day timeline. I call them up and I demand, I demand 90 days. I’m like, look, look, you need to give me time. And they do. They’ll give you at least 30 days, sometimes 60. IRS, New York State, reasonable, whatever.

Matthew Foreman [00:16:32]:
I always ask for 90 additional. Sometimes you get it, sometimes you don’t. But you can also, you know, if you need more time, you can provide what you have. You can provide the timeline for the remainder. Be direct, be polite. You don’t have to be like, you know, your deadline sucks, so I can’t provide it all right now. Just say, look, like the deadline’s tight. I have a lot of other stuff going on.

Matthew Foreman [00:16:52]:
Client’s really busy, especially during like tax season when I have to get information from the client’s accountant. I’m just like, look, like they’re struggling to get it with deadlines. Can we push this to November 15th? And the auditors who are really— I mean, they’re going to be CPAs and they’re going to be attorneys or enrolled agents, right? And you have those two generally, CPAs and enrolled agents. They understand the concept of a deadline and they understand that you may need part information from third parties. So I think that’s really important. Be direct, be polite, say, look, I’m going to get this to you in the next week. Here’s 80% of it. Go through it, go through this and we’ll do it.

Matthew Foreman [00:17:26]:
Most auditors are really fine with that. You know, they have a number of audits going on at any given time. So if you say, look, I’m going to get you 80% on time, the other 20% the next week, that hits their deadlines anyway, allows them to review it when it comes in, or they can review what they have and then go back. So that’s really important. The submission itself, you know, your actual responses to the IDR, I always use the acronym NAP. It’s stupid, but it’s easy to remember, right? Narrative, accurate, and polite. The narrative. So you want to tell the auditor what you want the auditor’s findings to be.

Matthew Foreman [00:17:57]:
This is what happened. My client lives in Florida. My client is active in the trade or business of real estate. This is why they can take accelerated depreciation, whatever it is. Accurate. Have a citation for every point, whether it’s a legal point, citing the law, regulations, whatever, or a factual citation, right? This is where having affidavits from clients, or you’re saying, you know, look at the general ledger. Look at, look at the bank statement, whatever it is you want to do that you want to be accurate and you want to do it. The best submissions have receipts.

Matthew Foreman [00:18:32]:
Right. And I think that that’s a really important thing that I think a lot of people overlook is the idea that it’s much, much, much harder to refute something if you then have unrelated third-party documentation. And finally, polite. I’ve talked about this a lot. Golden rule. Do unto others as others as you would like others to do unto you. Right. But don’t be afraid to push back.

Matthew Foreman [00:18:55]:
Don’t be overly aggressive. Don’t take overly aggressive— you know, I get it all the time. Like, I want you to fight like a bulldog. And I’m like, that’s just— that’s not helpful. I will absolutely push back and I will absolutely advocate for a position. But I’m of the opinion that you should be unfailingly polite. I have on a few occasions told an auditor that their position is entirely wrong. And then I’m disinterested in going back and forth on it.

Matthew Foreman [00:19:20]:
Say, I want to talk to your manager. That’s it. We’re moving on. I have within states, because it’s easier to get an email address and phone number for people. I have contacted the head of audit within states and said, look, you need to wrangle your auditor. They’re taking ridiculous positions. I’m not doing this. And they do.

Matthew Foreman [00:19:37]:
They bring them back in. But you have to be polite. Please and thank you go a long way. Don’t call them stupid, at least not to their face. Right. And so don’t take the overly aggressive position unless you’re going to stick with that position forever. Right. If you’re taking a position that something you’re like, this is ridiculous, this is my position, you can be really aggressive.

Matthew Foreman [00:19:55]:
You just can’t go to the aggressive position, then roll back because that’s just not going to work. They’re going to be like, we’re done here. This is over. A return has, you know, if a return has a mistake or misunderstanding or miscommunication, just admit it. Right. We’re all human. I said this before. Except for our rules, we’re all human, right? He’s a machine.

Matthew Foreman [00:20:13]:
Uh, one person got that joke. But anyway, look, look, we all make mistakes. Be direct, be honest. That it really works. It really does. And people don’t get it. And I’ve had clients, I had a client once go like, you know, you’re being too nice. They’re taking ridiculous positions.

Matthew Foreman [00:20:26]:
And I was like, yeah, but their manager is going to see my emails and they’re going to see that, that they’re, you know, or the appeals officer, whomever. And they’re going to see, even though that the auditor was taking a bananas stupid position that had nothing to do with it, and I was citing law and fact, that I was nice. And they’re going to say, you know, I’ll give them a little benefit of the doubt, I’m going to be nice to them, etc. If you come across as a jerk, I promise you the manager will not like you. No one wants someone who, who’s a jerk. No one likes the jerk. Don’t be too— anyway, back to the process, right? Assume, one, the auditor has more information and is basically cross-examining you. One of the greatest scenes in any movie— great movie, My Cousin Vinny.

Matthew Foreman [00:21:08]:
I’ve probably referenced it before. I talk about all the time when he’s sitting in the courtroom and the, the, the prosecution’s expert witness has just testified. He’s looking at the picture and he realizes there were two sets of tracks. If you’ve never seen My Cousin Vinny, go see My Cousin Vinny. Amazing movie. It’s on probably every streaming platform and probably not for a whole lot, right? You need to see it. Great movie. And he brings back in Marisa Tomei, Mona Lisa Vito— great name, by the way.

Matthew Foreman [00:21:32]:
And he brings her in at that moment. The moment he brought her in, he knew everything he was going to ask her. He had the whole arc. Assume the auditor has that picture and knows the answer to the question. I get stuff all the time from in the crypto space where they’re like, well, I’m not giving them this account. I don’t think they have it. I’m like, they have it, they have it, they know they have it, and they’re seeing what you give them. And I’m like, you do not want to be in a situation where they say, what about this account? And you have to say, oh yeah, that one.

Matthew Foreman [00:22:02]:
I don’t want to be there. You don’t want to be there. The auditor doesn’t want that, right? So just be honest, be direct. That’s it. Especially in crypto where they have the information anyway. Second, you know, remember, assume there will be more questions and multiple IDRs, right? Assume this is going to be a grind of a process for good, mostly for bad, but, you know, assume it is. And remember, You know, auditors don’t care about litigation risk. That’s not their job.

Matthew Foreman [00:22:27]:
They’re told don’t consider it, but they are aware of the fact that sometimes they make kind of crappy arguments and that’s just a product of sort of what they’re told to do. People lie to auditors. Remember this? So, you know, auditors often assume you’re lying. So this is why you need citations. You need the fact sites, you need the legal sites. You need to explain why you’re right. You can do that and you can show yourself direct and honest. You will get many benefits of the doubt.

Matthew Foreman [00:22:53]:
There have been many audits I’ve resolved where I have 92%, you know, for example, sales tax and it’s a certificate for sale for resale and I’m at 92% and the auditors go, yeah, that’s fine. You know, I believe your business. You’ve given me 92%. We’re just going to say zero. If there’s another audit, make sure you’re at 100%, right? Honesty, direct, being direct will work really well. And remember, the burden of proof is almost certainly on the taxpayer. I get, well, they have to prove to me that I’m wrong. No, no, no, no, no.

Matthew Foreman [00:23:23]:
If you can’t prove it, you will likely lose. So you have to show the information. Can you take that deduction? Are you this? Are you that? That’s on it. All right. Let’s get some music in here. We’ll come back. Bring it on home.

Matthew Foreman [00:23:48]:
All right.

Matthew Foreman [00:23:52]:
The other concern, the other, I’ll say, biggest concern, I don’t know if the right term is, in an audit is what’s called an eggshell audit, right? And an eggshell audit, right, is eggshell, right? It is a concern where there’s an audit that could bring up sensitive issues. Okay. There’s a lot of them. 469, you know, whether you are active in a trade or business to take a deduction, right, in excess of a loss. State tax residency can really, you know, bring into a lot of ones. You know, any audit of a business or an individual can expand into other areas. You know, one thing I get a fair amount is I do a decent amount of work for a number of litigators. You know what firms, they don’t have tax, not a big deal, they’re litigation.

Matthew Foreman [00:24:37]:
And they’re like, well, what’s the tax consequences of this? You know, of this settlement. And I’m like, look, like, there’s two ways to view it. This is what it is, you know, this is how I view it. Here are the risks. And they’re like, well, you know, do we actually have to negotiate with them? You know, they’re jerks, they’re, they’re idiot heads, you know, whatever. Do we actually have to negotiate with them? And I’m like, yes, and I’ll tell you why. Because you don’t want— because if you disagree with how they characterize it and there’s an audit, right, then that audit could spark an audit of their business entirely. And you don’t really want that because they’re not gonna be happy with you, and they definitely don’t want that.

Matthew Foreman [00:25:13]:
And that is actually a point of leverage I found, um, in negotiating settlements, is negotiating the tax consequences of a transaction or a settlement. And you negotiate it so that there isn’t inconsistent reporting, because inconsistent reporting, especially if there has to be a W-2 or 1099 or you know, 1099 for cancellation of indebtedness income, right? For example, that disagreement will trigger an audit and then they’ll talk to the other side, right? And then the employer’s like, well, you know, this is how we did it and this is how we always do it. And they’re going to say, okay, can we see more records? So they’re going to dig in. So it actually can be a fairly, um, successful negotiating tactic to say to the business, you know, do you want that audit? You know, so, so let’s be reasonable here, right? Um, you can go into other types of taxes. So employee, you know, whether someone’s an employee versus a contractor, if you don’t declare sales, right, and you’re having a sales tax audit, it can become an income tax audit because if you didn’t declare sales for sales tax, it can, it can be an issue for income tax. So that’s something to think about. All right. So let’s go through some other concerns.

Matthew Foreman [00:26:15]:
Responsible person, responsible party. There are certain taxes that inherently become the problem of responsible persons. They’re called trust fund taxes. Sales and use payroll are the two most common. Or if you don’t follow corporate formalities, you pierce the corporate veil, you use the business return for personal expenses, right? Don’t do it. Don’t do it. Business credit card for personal expenses. So don’t do that.

Matthew Foreman [00:26:42]:
Don’t do that. That’s a bad idea. You don’t respect corporate formalities. You don’t respect the bank account. You don’t properly update things, etc. So the question is always, who’s a responsible person? Owners, almost certainly. New York State has a limitation. If you own less than a third, you’re only responsible for your percentage.

Matthew Foreman [00:26:59]:
Many officers, especially executive type officers, you wanted that big fancy title. Congratulations. You get that big fancy liability. Any employee with a role where there’s control. So a CFO, right? Their CFO, but also the bookkeeper could be a responsible person for sales tax audits, for payroll taxes. So, you know, talk through that. That’s a big issue. A lot of times what you get, and I deal with this a fair amount, is you get foreign businesses coming to the US and they have an employee who is a US citizen or person.

Matthew Foreman [00:27:31]:
You know, they got a green card, they have a green card, they’re the one coming over, whatever. And they’re like, oh yeah, Jim will sign it to get the EIN and he’ll sign up for sales tax. No big deal. I keep picking on Jim, but what I always point out is Jim is now saying that they are a responsible person and I don’t know if Jim wants that. So I tell the company that they should indemnify that employee for these. And 99.99% of businesses do indemnify, or they just don’t use Jim. Jim’s like, I don’t know if I want to do this. That’s fine.

Matthew Foreman [00:27:59]:
You know, the name request with an EIN name when you register the business or collect or remit sales taxes can be— it’s broad. States are really, really broad. New York State, I’ve had some issues with it over the years, can be really aggressive and at the same time lazy. They don’t want to find all of them. They want to find the one they can squeeze really quickly. And that’s not necessarily the deep pockets. That’s the person with the CEO or CFO title. So watch out for that one.

Matthew Foreman [00:28:24]:
That’s a, that’s a fun one. Next is penalties and interest. I’m going to talk about this a lot in a couple, in 2 episodes, but I want to talk about this, right? Penalties and interest. Interest is statutory. It cannot be abated. The rate for federal, 6, 7%, somewhere in there, generally a bit higher at state level than the 6, 7%. But you know, that’s where interest is. Penalties are generally the same rate.

Matthew Foreman [00:28:48]:
They can be higher if you are a bad person. I don’t want to say you’re an awful person, but penalties can be 25% if you get, you know, do certain things. So kind of watch out for that. That can be really important to watch out for. But anyway, penalties can be abated. The federal government has what’s called first-time abatement. Certain penalties such as late filing, late payment generally are automatically abated if you haven’t had a problem in a couple of years and you ask politely. There’s a form.

Matthew Foreman [00:29:13]:
You don’t have to be that polite, but, you know, again, be polite. Works. Sugar, sugar, sugar is better. If you don’t have first time, you voted before, or there’s some issue, there’s multiple years, there’s what’s called a reasonable cause abatement. Um, I’m not going to go into what is reasonable cause, um, because candidly, I don’t know what is reasonable cause. The IRS takes a position that I found absurd and ridiculous, and it is largely that nothing is reasonable cause except for a couple things they like. Um, I disagree with that. I’ve had that as the screaming for quite some time, but it kind of is what it is.

Matthew Foreman [00:29:45]:
There’s nothing I can do about it. But, you know, illness, sickness in the family, things like that generally go into it. And that may be an episode, maybe an episode for the future, but not today. I might talk about in 2 weeks. I haven’t outlined that one yet, so we’ll see. Penalties are not mandatory. The auditor can space not impose them. It doesn’t mean the auditor isn’t allowed to impose them.

Matthew Foreman [00:30:08]:
It means the auditor is permitted to not impose them. New York State does this thing where they are using— they use penalties to force resolution, and they borderline admit they do. By borderline, I mean they admit that they do. And it’s really— only is a stronger word, but it’s poop is the word I’ll use, because New York always imposes penalties and they won’t abate them unless you agree to pay. So what happens is if you’re fighting something, whether through next process, or you’re litigating it, penalties are accruing, right? Then they always get abated by the courts, but they’re sitting there and the client sees the number. Displeased. Not a fan. I think it’s crap that they do it, etc.

Matthew Foreman [00:30:51]:
Maybe I’m allowed to say crap, maybe not, but I get fired up. I have complained about this to New York State. I’m not the only one who’s complained about this, and I’m not the only one who’s complained about this to New York State. You know, in front of them. I do get to talk to people in New York State every so often through committees where I’m a member. And it’s contrary to the law. They are permitted to impose penalties. They are not required.

Matthew Foreman [00:31:14]:
They don’t care. They do it. A lot of states do things like this. The IRS generally doesn’t, despite its reputation of being a little bit of a grumpy Gus. So, you know, we’re going to bring it on home for the next little part. So what to do if the IDR keep coming, right? Have a conversation with the auditor. What are you looking for? How much longer is this going to go, etc.? You know, I’ve been a part of audits where the audit goes for 2 years and has 42 IDRs. I’m making that up.

Matthew Foreman [00:31:41]:
I don’t think I’ve ever hit 42, at least not one since, you know, I left, I started my career in Big 4 and you would see audits with like 80 IDRs, but they were, you know, over 30 different areas. You know, there were 6 auditors involved. So that’s its own animal. But for most of my clients, you know, 3, 5, 7. It depends. Sometimes you get an IDR with 2 questions and they’re like, look, I’m going to do another one, but I want to kind of get you moving on this. Um, and sometimes you’ll get an IDR with, you know, 18 questions, right? So it depends. Um, I’ve seen 40-question IDRs, so depends what you want to do.

Matthew Foreman [00:32:16]:
Has, you know, have that conversation. If they keep coming, what are they looking for? What’s going on? Try to talk to the manager. If you feel like you’ve answered the questions, don’t be afraid to say, you know, I’ve already— I’ve answered this in IDR 6, question 6, 7, 8, not answering it again. Not looking to negotiate against myself. That’s the correct answer. That’s fine. Asked and answered is a reasonable response. When the IDRs stop, it is the end of the audit.

Matthew Foreman [00:32:38]:
Always extend the statute of limitations. I am throwing this in here at the end, but I think it’s actually really, really, really important even though this is a long episode. Always extend the statute of limitations. Not worth the fight. Agree, disagree, negotiate. That’s where you sit. So the next episode I’m going to talk about appeals. More appeals and litigation.

Matthew Foreman [00:32:57]:
So we’re going to do that. But for now, here’s some music. I’ll be back in 2 weeks. So thank you. That was the 39th episode of How Tax Works. Hope you learned something. Again, 2 weeks, 40th episode about tax litigation.

Matthew Foreman [00:33:16]:
Thank you. Mm-hmm.