Corp client received IRS notice of audit for 2006

[cred65]

Client is a C Corp and was part of a tax practice that I purchased on 01/01/07 so I was not involved during the period under audit. The Corp had an internal bookkeeper that is no longer with the company. I prepared the return from the client's QuickBooks financial statements and did not review the records.

The audit is to be performed at clients office next month. Form 4564 has a laundry list of documents requested.

The three stockholders also have interests in four other S corps.

Any sage advice will be appreciated. Should I get a POA and be available at the initial meeting?

[kcjenkins]

Absolutely.

[jainen]

>>a laundry list of documents requested<<

If you tell us a few of the key issues, we might be able to give you some ideas about how to approach them. For example, just because the IRS is fishing for documents doesn't mean you should turn them all over right away.

[cred65]

>>a laundry list of documents requested<<

If you tell us a few of the key issues, we might be able to give you some ideas about how to approach them. For example, just because the IRS is fishing for documents doesn't mean you should turn them all over right away.

They have a list of 15 items but the most relevant items are; Subcontracted work $3,876,764 and Commissions $217,901. The Subcontracted work was for amounts paid to Chinese firms for imported products. The commissions were paid to salemen that were issued 1099's.

The other items requested were ledgers, journals, bank statements, sales records, check registers, minute books, etc. Also requested were the personal tax returns of the shareholders.

[TAXBILLY]

Looks like you have a lot of homework to do to prepare for this audit. I would also obtain a retainer from the client upfront before putting in the time.

taxbilly

[BulldogTom]

From the two items you listed, I would guess they are looking at employment issues to see if they are truly subcontractors. When you mention "product", I would immediately look at the inventory to see if that should have been in the COGS and not in the expense side of the financials. Unicap rules may be in effect.

That is just the first things that popped into my mind. I think you will be working on this for a while. It should generate some good revenue for your practice.

Get the POA and the engagement letter, and most importantly, get a retainer up front. You are going to be working nights on this.

Tom

Lodi, CA

[joanmcq]

If 1099s were issued to the salespeople, that should suffice for the payment of the commissions UNLESS they are fishing for payroll/employee issues. Do you do the returns of the shareholders? I would get the bank statements and do a cash analysis before the auditors get there and research any discrepancies you may find; also look for anything personal that may have been paid. the huge number paid for subcontracted work was probably a big flag.

[kcjenkins]

I'm just sort of wondering why that "Subcontracted Work" was not just listed as Inventory Purchases, myself? clearly that is what it really was. I bet once that is made clear, the audit will become much simpler.

[jainen]

>>the personal tax returns of the shareholders. <<

You can use this demand to convince the clients that this is a seriously deep and far-ranging field audit. They are not likely to escape without at least some changes, so have a soul-searching meeting to decide what they are willing to give up, what they must keep at any cost, and what they absolutely don't want the IRS to even think about.

Might as well start with those commissions that BulldogTom is worried about. Make sure you can DOCUMENT that the salesmen are not employees. I would budget about five hours just to research that point alone. But that's a quickie compared to what joanmcq is advising. If you can offer the auditor a cash analysis that will stand up to random spot checks, you will probably be able to keep the audit under your own control. If you can't do that, the employee status might make a good fall-back position. With careful teasing, the auditor might be so pleased to win on that big point that he will only take a token look at the books.

As a standard tactic, try to get the first day of audit in your own office. You don't want IRS snooping around looking for more things to ask about like how come all the employees drive Corvettes. Once you get the scope of audit tied down, you will know how to prepare the workplace for inspection.

[BulldogTom]

Jainen brings up a point I had not considered at first. What is your relationship with the shareholders? Did the practice prepare the personal returns?

If I was only engaged to prepare the corp tax return, I think I might consider "politely, very politely" informing the IRS auditor that those records are outside the range of documents that you have access to. Express your willingness to provide the detail of related party transactions from the general ledger, but I would really consider if I want to volunteer the shareholder's 1040's that are not "officially" under audit. This of course could lead to the auditor pulling all the 1040's for audit, so consider everything before you communicate anything to the IRS.

This brings a whole new dimension to the scope, as you don't want to be representing the shareholders on their individual returns if you are not the preparer or don't have a good feeling for what is on those returns. And even if you are the preparer, it may not be a good idea to let the auditor go poking around in the shareholder's 1040's on an 1120 corp audit.

I am just thinking out loud, but if there is any other issues on the 1040's not related to the corp, it might make the auditor more suspicious of the 1120.

Think about this. Talk to your clients. Get a good strategy in place ahead of time.

Protect yourself.

Tom

Lodi, CA

[OldJack]

>>Form 4564 has a laundry list of documents requested.<<

I would assemble the documents requested and prepare a summary analysis or detail worksheet that the auditor would be satisfied to accept as part of his workpapers. If you provide the analysis for his workpapers he might only have to take the time to "review" your work and hopefully accept it as his own. That gets him out of the clients without digging around and asking more questions. Good advice from the others on here.

Your preparation time should be much more than you spent preparing the return. I have a policy that if the auditor is at my clients.. so am I, even if I am not getting paid for it.

[jainen]

>>those records are outside the range of documents that you have access to<<

I just meant use the document request to light a fire under the clients. For some reason, people tend to think the IRS is not serious on the grounds that they haven't done anything wrong (as if that was relevant).

The auditor doesn't really expect you to produce the shareholders' returns at the first meeting--he is just fishing. Simply say the shareholders have engaged other counsel who should be contacted separately. In representing the entity under examination, you have no reason to know if they have even filed. Say something awkward about how capital accounts are not your strong point but you will do your best if it comes up in the audit. That should be the end of it (unless, of course, this audit is actually the background to a developing criminal case).

By the way, Bulldog Tom says you will be working nights but even so I doubt that you have time to prepare for this audit. You don't even know what you're looking for yet, and it's a good guess that your clients won't tell you. That's why you should move the meeting to your own office where you can go over joanmcq's cash flow and OldJack's summary and make the auditor narrow it to specific issues. Then request another 30 days to get the rest of the information. You want to run the calendar on this because he is naturally anxious to settle before the end of the year.

[cred65]

I'm just sort of wondering why that "Subcontracted Work" was not just listed as Inventory Purchases, myself? clearly that is what it really was. I bet once that is made clear, the audit will become much simpler.

This item was actually purchases of machined castings made from foundries in China. These parts were drop-shipped to the client's customers throughout the USA. The company maintains no inventory. The company is a manufactures rep. and in some instances works on a commission.

I have had a meeting with the client. The owner, with assistance from an AccountTemps employee use QuickBooks for their accounting. I will be printing off the Purchase Orders and Vendors Invoices for the upcoming audit. Client maintains records in an orderly fashion so I will be assembing records requested for the audit and there will be a conference room available for the IRS. At present the only employees of the company that will be on site are the owner and the AccountTemps employee.

I have prepared the returns for two of the shareholders and the other shareholder has yet to file. I am trying to run him down.

The ownership of the companies has changed dramactically during this year and only one shareholder remains. One of the companies that was sold in 12/07 was serviced by a high profile local CPA firm in the city. I only serviced the fledging companies which I acquired in Jan. 2007.

Thanks to everyone who responded, Tom, KC, Jainen, joan, old jack, billy. I will keep you updated.

[cred65]

I have just been informed that the third shareholder has not filed any returns since 2004. He is no longer with the company. He brought over his W-2 and other records and I entered the data into ATX. He will owe $20K for 2006 alone. He will also owe for 2005 and 2007. He claims his recent divorce has made him insolvent and will not be able to pay his taxes. He currently is unemployed and lives with his girl friend. He will not be able to pay his alimony and probably faces bankruptcy.

Should I prepare his return for 2006 for the audit or should I decline the business. How should I explain him to the auditor. He had been a client of the person from whom I purchased the accounts in 2007 but was not on the client list.

Thanks for your advice.

[lbbwest]

I have just been informed that the third shareholder has not filed any returns since 2004. He is no longer with the company. He brought over his W-2 and other records and I entered the data into ATX. He will owe $20K for 2006 alone. He will also owe for 2005 and 2007. He claims his recent divorce has made him insolvent and will not be able to pay his taxes. He currently is unemployed and lives with his girl friend. He will not be able to pay his alimony and probably faces bankruptcy.

Should I prepare his return for 2006 for the audit or should I decline the business. How should I explain him to the auditor. He had been a client of the person from whom I purchased the accounts in 2007 but was not on the client list.

Thanks for your advice.

Warning Will Robinson Warning. Be afraid. Be very afraid. (Translation, stay away from this "client." If he is truly insolvent, he doesn't have the money to pay YOU. lbb