Where Does the IRS Get Off Telling You How to Run Your Business?

By George W. Connelly

When the IRS audits a tax return involving a business, its agents invariably get involved in questions of recordkeeping and how transactions are conducted and recorded.  All too often, an IRS Examiner will suggest that a taxpayer’s records are not “adequate,” or that in some fashion the taxpayer is not operating in “a businesslike manner.”  This most often occurs in situations where the taxpayer is attempting to operate a ranch and has incurred losses, or claims that shareholder advances to the company should be recognized as bona fide loans rather than an investment of capital.

This naturally gives rise to the question about moral and the intellectual authority of the Internal Revenue Service to criticize any business’s practices.  If one were to look at a scorecard over the last year, in comments by the various watchdogs, one might conclude that the IRS really has no business criticizing anyone else’s business practices:

  • On November 9th, TIGTA released a report noting that the IRS failed to pursue collection activity in cases recalled from the Private Debt Collection program in fiscal 2009, and that as a result an estimated $30.7 million in liabilities will not be paid.  It further concluded that the IRS will unable to collect about $103.2 million per year from cases that would have been assigned to the PDC program because it purportedly now lacks the resources to pursue them.  Imagine what would happen in a business which tried to deduct a debt that it never pursued!  Senate Finance Committee Member Chuck Grassley noted that when the PDC program was being terminated, the IRS assured Congress that the Agency could do a better job with these tax cases than outside firms.
  • In a report issued May 4th, TIGTA found that non-mainframe databases containing taxpayer data were not always configured in a secure manner, and the databases were running on out of state software which no longer received security patches and other vendor support.  It also concluded the IRS had not fully implemented its plans to complete vulnerability scans of databases within its enterprise, and that the IRS had purchased a database vulnerability scanning and compliance assessment tool without first completing adequate product evaluation and testing, thus wasting $1.1 million on software licenses and support costs for a tool that was not fully implemented.
  • In a June 22nd report, the Government Accounting Office (GAO) announced that the IRS faces challenges in resolving material weaknesses in its internal controls and financial management, as well as in developing performance metrics and fixing internal controls related to protecting taxpayer information and resolving unpaid tax assessments.
  • In July, TIGTA concluded that the IRS does not always promptly and properly notify taxpayers when it has inadvertently disclosed their personal information.  If someone hacked a business’ customer data base, just imagine the liability it might face for allowing an “identity theft.”
  • In May 2011, TIGTA issued a report relative to estimates of the so-called Tax Gap (the differences between taxes owed and taxes timely paid) attributable to business employers, but concluded that the audit results for the taxpayers included may not enable IRS management to fully estimate compliance levels for those taxpayers’ employment taxes.  Imagine running a business without keeping better track of its accounts receivable.
  • The Taxpayer Advocacy Panel, in an Annual Report released October 24, 2011, noted that the IRS accepted or partially accepted only 46% of the recommendations made by the panel in 2010 (a drop from 71% in 2009, and 62% in 2008).  The TAP is an independent citizen advisory committee created by the United States Treasury in 2002 to expand its citizen advocacy program.
  • On October 26th, TIGTA released a review of the IRS Incentive Pay Programs – the ones intended to “recruit and retain” IRS employees.  It concluded that these programs are “not processed according to IRS guidelines,” often have insufficient documentation, and posed a risk that the incentives that we taxpayers are paying are not justified.  It also found that retention incentives are not always terminated when not timely recertified.  Finally, it concluded that although the IRS has spent nearly $11 million on retention and recruitment incentives since 2005, it has yet to develop a method to “assess their impact on long-term workforce planning goals.”
  • The National Taxpayer Advocate on May 10th noted that the IRS movement toward less correspondence with taxpayers and more automation is diminishing taxpayers’ due process rights.

It is probably unlikely that the IRS is going to “change its ways” in terms of its prerogative to second guess the way a taxpayer operates a business, but it would be refreshing if the Commissioner could remedy these shortcomings in the next year.  Regardless, this is probably another situation where, if you are a taxpayer or a representative confronted with a negative assertion by an examiner about your business practices, you should bite your tongue and refrain from pointing out these shortcomings about his employer.

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