How to build a strategy to avoid risk
While the Internal Revenue Service’s (IRS) own figures reveal only one or two percent of all taxpayers have their returns audited each year, one of the more nerve-wracking aspects of taxes for many chiropractic professionals and practice managers continues to be the possibility of being audited.
In reality the IRS, once a large, inefficient federal bureaucracy, is changing to become more streamlined and, most importantly, is catching more tax offenders. Today, the IRS enforces tax law in a number of ways, including the increasingly more common correspondence (examination by mail) audits and the dreaded field (face-to-face) audit examinations.
Even in the face of federal budget cuts, agents in back offices are being replaced by computers with complex algorithms that cast a wide net, one that pulls many law-abiding people into the chaos of an audit. The result is that many chiropractic practices—and their principals—are being scrutinized far more often than the numbers indicate.
According to the latest figures, the IRS audited almost 1.1 million tax returns, approximately 0.5 percent of all returns filed in 2016. The majority of audits conducted during 2017 (70.8 percent) were via correspondence. The remaining 29.2 percent were field audits. Little noted was the fact that of the more than 1.1 million audits conducted, almost 34,000 resulted in additional refunds totaling more than $6.6 billion.
A smaller target
Any chiropractor who hopes to survive and thrive under the new algorithm-based IRS would be well-advised to follow a few guidelines:
Always be prepared for scrutiny. Understanding the tax rules and potential red flags is essential to knowing what information should be saved and for how long.
Be ready to move quickly. Information Document Requests (IDRs) and face-to-face audits now move on a shockingly fast timeline, making an already prepared plan of action a necessity. Build a relationship with an accountant who can step in quickly if you get the dreaded IRS audit notice.
Remember consistency is key. Inconsistencies in paperwork happen even to honest people when the accounting is not handled professionally. The IRS, however, increasingly is viewing even small discrepancies as fraud until proven otherwise.
Expect no mercy. IRS agents are being allowed no wiggle room and no grace. This attitude is being passed on to the chiropractors and chiropractic practices with which they deal.
Employment tax bugaboos
Lawmakers, as well as the IRS, are aware that noncompliance with employment taxes, such as withholding income, Social Security, and Medicare taxes, is a growing problem. In fact, as of December 2016, more than 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties.
Employment taxes, including withheld income, Social Security and Medicare taxes, account for nearly 70 percent of all taxes collected by the IRS. The IRS Trust Fund Recovery Penalty is a weapon that allows the IRS to assess a civil penalty against any responsible person who willfully fails to pay a practice’s withheld employment taxes. A responsible person can be the chiropractic practice’s manager or bookkeeper, its principal(s), its payroll service, its accountant—or all of them. What’s more, the rules also make it a crime to willfully fail to collect or pay these taxes to the government.
In addition to employment taxes being a large target for IRS auditors, taxable wages for worker misclassification and fringe benefits were among the most frequently misreported, leading to the highest wage adjustment amounts on average. Worker classification issues arise when employers misclassify employees as independent contractors or other nonemployees and fail to withhold and pay employment taxes.
Partnership versus partners
The Bipartisan Budget Act of 2015 replaced the old rules governing partnership audits with a new centralized program that, in general, assesses and collects tax at the partnership level rather than from individual partners. Under the new rules that kicked in this year, any income tax resulting from an adjustment is assessed and collected at the partnership level, not from the partners. It is a similar story with any penalty, addition to tax, or additional amount related to an adjustment, which is determined at the partnership level.
The new rules outline the procedure a chiropractic partnership can use to opt out of the centralized partnership audit program. Only an eligible partnership, one that has 100 or fewer “eligible” partners, may opt out of the centralized partnership audit regime.
An eligible partner is any person who is an individual, regular C corporation, eligible foreign entity, S corporation, or the estate of a deceased partner. Unlike other sections of tax law, a husband and wife are not treated as a single partner for these purposes.
Poor documentation is a death sentence
Many chiropractors, even those with no intent to commit fraud, often fall short when it comes to documentation and paperwork. Because the law requires every taxpayer to retain the records used when preparing tax returns, even a chiropractor or his or her practice that pays its taxes dutifully may be penalized for lacking documentation.
The IRS appears increasingly determined to find and audit small businesses and professional practices. Once sent only to those suspected of failing to comply with tax laws, the IRS now is sending Information Document Requests in record numbers as a screening tool.
The Taxpayer Bill of Rights, part of the IRS Restructuring and Reform Act of 1998, requires the IRS to provide a written statement detailing the taxpayer’s rights and the IRS’s obligations during the audit, appeals, refund, and collection processes.
Among the most important of the rights given every taxpayer whose returns are targeted for an audit is the right to decide to be represented by a tax professional or to attempt to answer the IRS’s questions alone. Another important consideration for everyone and every chiropractor or practice being audited is where to hold that meeting.
Should the meeting be in the accountant’s office where all of the working documents are easily accessible? Should it be at the chiropractic practice, the place where all the records are kept, to demonstrate to the IRS auditor that there is nothing to hide and that the practice is a legitimate one? Or should the chiropractor, the chiropractic practice’s manager, and/or its representative trudge down to the IRS office armed only with the specific documents and information requested by the IRS auditor? Not too surprisingly, there is no one right answer.
Hurry and get it over
The IRS’s Small Business/Self-Employed Fast Track Settlement program (SB/SE FTS) was created to provide an expedited process for resolving disputes with small businesses and professional practices. SB/SE taxpayers who currently have unagreed factual or legal issues in at least one open year under examination can work together with SB/SE and the Office of Appeals to resolve outstanding disputed issues while the case still is in SB/SE jurisdiction. Once an application is accepted, the IRS’s goal is resolution within 60 days.
Having the last word
Until a chiropractor agrees with the IRS, the appeals process remains open. Most importantly, from the initial screening for accuracy that each return receives up to when the final appeal has been exhausted, mistakes in the favor of the taxpayer are discovered in about 25 percent of all cases.
Honesty and clarity go a long way toward preventing, dealing with, and surviving an IRS audit. Naturally, every chiropractor should have a strategy for avoiding audits as well as for dealing with an IRS auditor. A fallback position if those strategies fail also should be in place. Setting these strategies should take away the fear of an IRS audit.
Mark E. Battersby is a tax and financial adviser, freelance writer, lecturer, and author located in Philadelphia. He can be reached at 610-789-2480.
Disclaimer: The author is not engaged in rendering tax, legal, or accounting advice. Consult your professional adviser about issues related to your practice.