I know this wonderful young man. A delightful guy. A great son, son-in-law, husband, and father to four wonderful and well-behaved children. I will call him Fred. Fred came to me one day with a letter from the IRS letting Fred and his wife, I will call her Wilma, know that they had been selected for an examination of their recent Form 1040 personal income tax return! Yep, when Uncle Sam goes fishing there is no telling what he might catch. Well, on this day, Uncle Sam had hooked himself Fred and Wilma’s taxes. Fred knew that our law firm represents clients before the IRS and state taxing authorities. As Fred and Wilma are of very modest means, they were unable to pay legal fees. No worries. Steve Rubin (aka yours truly) was happy to represent Fred and Wilma before the IRS on a pro bono basis. So, Fred and Wilma executed the required IRS Form 2848 Power of Attorney designating Steve as their respective “attorney-in-fact” and we began to prepare for the examination which was scheduled for October 2016, at the office of the IRS. Fun.
Well, needless to say, Fred was very nervous. From the examination notice, and the related Information Document Request (IDR) included with the examination letter, the IRS was interested in particular in the expenses Fred had claimed for his pet grooming business on his Schedule C attached to his tax return. Perhaps chief among these items was the mileage expense claimed by Fred. So, we set about helping Fred compile his records that would support and substantiate the expenses claimed on his Schedule C. Like so much in life, responding to a tax audit is largely about preparation. The good news is that Fred had kept a written calendar that basically kept track of where he went each day in the year in question, and which clients’ pets he groomed. From this record, we were able to reconstruct a very accurate mileage schedule for the year. It tracked what appeared on Fred and Wilma’s tax return very closely. And just as a backup to the mileage schedule, we calculated how many gallons of gas Fred purchased in the year in question. (We divided the amount Fred spent by the average price per gallon of about $3.80 to get the number of gallons). We then determined that Fred’s old beater of a Van got about 17 miles per gallon. We multiplied the number of gallons by 17 miles per gallon and the resulting number once again very closely tracked the mileage number Fred reported on his tax return. In a similar fashion, we compiled the backup and substantiation needed to defend each item of expense reported by Fred on his tax return. We were ready…
Well, the day of the examination came. Fred (but not Wilma) went with Steve to the examination. Well, one of the first items of expense that the examining officer (the EO) asked to review was the mileage. Well, out came the calendar and the mileage schedule. The EO looked through these items and after a brief pause, “accepted” these items as reported. The EO could see we had come prepared and the rest of the exam proceeded smoothly. In fact, the EO could see that we were so well prepared that he elected not to even review some of the expense items and just “accepted” them.
Now, there was one problem. Fred’s business phone was included in Wilma’s account, which also included Wilma’s phone which was not business related. Fred and Wilma claimed the entire expense (both Fred and Wilma’s phones) on Fred’s Schedule C for his pet grooming business. Well, the EO figured this out, and made the ONLY adjustment that he would make that day: he disallowed half of the phone expense. Fred now knows that he should get his own phone account in the name of his business.
And that is how it went. Uncle Sam went fishing and hooked Fred and Wilma’s Form 1040 personal income tax return – but all he caught was half of a phone expense. Fred was relieved and happy that is was over. As for Uncle Sam, well, he never seems to stop fishing.