Volume 43, Issue 2 - February 2008

Guest Book

Getting Smarter Than the IRS
Recognizing the Red Flags
by Lance Wallach


Have you seen the commercials where certain companies advertise they can settle an IRS debt for “pennies on the dollar?” Usually the offer is too good to be true. Besides, you never want to have the problem in the first place. Unfortunately, the chance of an individual being audited has just about doubled since 2000. IRS officials say research has shown that tax “noncompliance” typically is highest among people who work for themselves, who deal in large amounts of cash, who don’t have taxes withheld from their pay and whose income isn’t reported separately to the IRS, such as by their employer.

Another area that the IRS has been focusing on for noncompliance is S corporations. With a typical S corporation, profits or losses flow through to the individual owners, who in turn are supposed to report those items on their individual returns.

Capital gains taxes could also command the attention of the IRS. The reason: IRS officials suspect the government is losing billions of dollars in tax revenue because many investors inflate the cost basis, or the price they originally paid for stocks and other securities, in order to report lower capital gains when the securities are sold. 

Waving Red Flags
There have been some significant changes in the way the IRS targets businesses for audits and how it conducts them. Audits are up this year and will continue to increase, but the numbers are very misleading, because the IRS is getting much smarter about how it chooses returns for audit and how its examiners conduct their audits.

Examiners are told specifically to look for certain red flags. The result: examinations are more sharply focused on potential areas that will generate increased taxes, penalties and interest. Fortunately, there is a positive side to all of this—it’s very easy to obtain a free copy of this information from the IRS.

Always engage an accountant who specializes in your type of business. One of our long-term retirement plan clients recently retained our firm to perform a self-audit. The client, a successful businessman, was concerned when one of his colleagues was found liable for back taxes and penalties because of some mistakes by his accounting firm. Nervous that he might become an IRS target as well, our client hired us to do an audit of his income taxes for the last three years. What we found was shocking. Even though this client had used an accounting firm for his various returns, the taxes he had paid were far from what he owed. Luckily for him, it was an overpayment. This client will get a refund of almost $200,000.

Deductible Plans
Now let us turn to more positive alternatives, on which you can take the initiative.

  • Rent a Captive: Small companies have been copying a method to control insurance costs and reduce taxes that used to be the domain of large businesses: setting up insurance companies to provide coverage when they think outside insurers are charging too much. By renting a large captive, participants are insured under group policies, which provide for insurance coverage that recognizes superior claims experience in the form of experience-rated refunds of premiums and other profit sharing options made available to insured. 
  • Cash balance plan: A cash balance plan is a retirement plan that allows large contributions for owners. The deduction for owners sometimes can exceed salary. It can be combined with a 401(k) plan.
  • SEP-IRA or basic profit-sharing plan? Many small business owners have used a SEP-IRA or basic profit sharing plan for their retirement needs due to the simplicity and low cost. However, recent changes to the Internal Revenue Code have made these designs virtually obsolete. The K is a retirement plan for the small business owner that allows him or her to achieve greater potential contributions; “catch up” deferrals over age 50; increased current tax savings; plan loans up to $50,000; expanded survivor benefits; complete flexibility; and low costs. Unlike a SEP-IRA, a K will allow you to borrow up to 50 percent of your account balance (not to exceed $50,000) as long as you pay yourself back. 

The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.

Lance Wallach speaks and writes extensively about VEBAs, retirement plan and tax reduction strategies. He can be reached at 516/938-5007 or by visiting www.vebaplan.com. Mr. Wallach’s opinions are solely his own and not necessarily those of this magazine.


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