Decision Vision Episode 174: Should I Fight the IRS? – An Interview with Bruce Wood, Brady Ware Arpeggio, LLC
The decision to dispute, negotiate or litigate with the IRS is a difficult one, given its reputation and power. Bruce Wood, a principal at Brady Ware Arpeggio, is a business appraiser specializing in tax issues and a former CPA tax advisor. He and host Mike Blake looked at many of the considerations surrounding a tax issue with the IRS, from how to avoid them in the first place through how your returns are prepared, to what to expect from an IRS agent, the importance of having a professional interface with the IRS for you, the appeals process, the costs of litigating, and much more.
Brady Ware Arpeggio, LLC
At BWA, they value your business – literally. They recognize the gravity and complexities of decisions facing individuals and businesses, and that bad decisions are often consequential and difficult to repair. BWA’s evidence-based decision systems enable businesses and their owners & executives to avoid pitfalls and blunders and accordingly successfully capture value opportunities more effectively than via mundane approaches to decision making.
They ultimately deliver decision clarity and confidence in decision-making based on well-analyzed, relevant data. Brady Ware’s team consistently delivers decision clarity via our proven processes for evaluating critical decisions. This unique insight to help make decisions has a profound impact on the result. Incorporating this decision process creates an advantage from what used to be pain points and barriers.
Bruce Wood, Principal, Brady Ware Arpeggio, LLC
Bruce’s business appraisal practice focuses primarily on tax-specific areas such as: (1) Tax Controversy – executing business appraisals and litigation support in United States Tax Court cases, as well as settlement efforts between the IRS and taxpayer, under the direction of tax and estate litigation attorneys from national and local law firms. These cases most often arise out of IRS audits of estate, gift, and trust tax returns, as well as IRS challenges of C corporation reasonable officer compensation, etc. (2) Estate, Gift and Trust Tax & business transactions -planning and compliance. Closely held businesses (S corp, C corp, LLC, and family limited partnership issues), M&A, etc.
Bruce brings over 30 years of experience to the marketplace, spending the last 20 years in business appraisal after 12 years as a CPA/tax adviser. Often faced with decisions or situations impacting the value of a transaction or business, Bruce helps navigate the complexities of those situations. He has helped in industries such as meat processing, professional services, manufacturing, distribution, food service, mining, technology, retail, and other business sectors.
While he can assist clients nationwide, most of his career has been spent in and throughout the Atlanta metropolitan area including Atlanta’s southside. With an exceptional network of contacts, Bruce can also help clients connect with other areas of expertise such as within the legal community.
Mike Blake, Brady Ware & Company
Michael Blake is the host of the Decision Vision podcast series and a Director of Brady Ware & Company. Mike specializes in the valuation of intellectual property-driven firms, such as software firms, aerospace firms, and professional services firms, most frequently in the capacity as a transaction advisor, helping clients obtain great outcomes from complex transaction opportunities. He is also a specialist in the appraisal of intellectual properties as stand-alone assets, such as software, trade secrets, and patents.
Mike has been a full-time business appraiser for 13 years with public accounting firms, boutique business appraisal firms, and an owner of his own firm. Prior to that, he spent 8 years in venture capital and investment banking, including transactions in the U.S., Israel, Russia, Ukraine, and Belarus.
Brady Ware & Company
Brady Ware & Company is a regional full-service accounting and advisory firm which helps businesses and entrepreneurs make visions a reality. Brady Ware services clients nationally from its offices in Alpharetta, GA; Columbus and Dayton, OH; and Richmond, IN. The firm is growth-minded, committed to the regions in which they operate, and most importantly, they make significant investments in their people and service offerings to meet the changing financial needs of those they are privileged to serve. The firm is dedicated to providing results that make a difference for its clients.
Decision Vision Podcast Series
Decision Vision is a podcast covering topics and issues facing small business owners and connecting them with solutions from leading experts. This series is presented by Brady Ware & Company. If you are a decision-maker for a small business, we’d love to hear from you. Contact us at firstname.lastname@example.org and make sure to listen to every Thursday to the Decision Vision podcast.
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Intro: [00:00:02] Welcome to Decision Vision, a podcast series focusing on critical business decisions brought to you by Brady Ware and Company. Brady Ware is a regional, full service accounting and advisory firm that helps businesses and entrepreneurs make visions a reality.
Mike Blake: [00:00:23] Welcome to Decision Vision. A podcast giving you, the listener, clear vision to make great decisions. In each episode, we discuss the process of decision-making in a different topic from the business owners or executives’ perspective. We aren’t necessarily telling you what to do, but we can put you in a position to make an informed decision on your own and understand when you might need help along the way.
Mike Blake: [00:00:43] My name is Mike Blake, and I’m your host for today’s program. I’m the managing partner of Brady Ware Arpeggio, a data driven management consultancy which brings clarity to owners and managers of unique businesses facing unique strategic decisions. Our parent, Brady Ware & Company, is sponsoring this podcast. Brady Ware is a public accounting firm with offices in Dayton, Ohio, Alpharetta, Georgia, Columbus, Ohio and Richmond, Indiana.
Mike Blake: [00:01:07] If you’d like to engage with me on social media with my Chart of the Day and other content, I’m on LinkedIn as myself and at #Unblakeable on Facebook, Twitter and Instagram. I also host a LinkedIn group called Unbreakable’s Group that doesn’t suck, so please join that as well if you would like to engage.
Mike Blake: [00:01:24] Today’s topic is, “Should I fight the IRS?” And I’m actually surprised at myself that we haven’t had this topic before because I think this is topical for everybody. It’s clearly an evergreen topic. I’m not sure that anybody is more feared in our government than the Internal Revenue Service.
Mike Blake: [00:01:47] You can make an argument that outside of the armed forces of the most powerful government agency. And, you know, the fact of the matter is that hundreds of thousands, if not millions of people have interactions or people and businesses have interactions with the Internal Revenue Service every year involving some dispute over the amount of taxes that they owe.
Mike Blake: [00:02:14] And I think for many of us, the goal if the IRS approaches us with any kind of controversy is we just, kind of, want to make them go away. Most of us don’t necessarily have an appetite to fight the IRS, but that calculus may change. You may not have the money to pay what the IRS wants you to pay, or it may be just an unreasonable demand, or it may be in effect if it goes in front of a court. It may wind up being an illegal demand.
Mike Blake: [00:02:50] But how do you know that? And I think that is difficult to know. And even CPAs will give you a nuanced answer here, because fighting the IRS is hard and fighting the IRS is scary and fighting the IRS has an uncertain outcome. Notice I didn’t say, should I beat the IRS? I said, “Should I fight the IRS”? There’s no guarantee of victory. And so, I think this will be a very interesting topic, even if you haven’t been the target of an IRS investigation or action or principle of an action.
Mike Blake: [00:03:25] You may be in the future and forewarned is, of course, forearmed. And so joining us today is my new colleague, actually, Bruce Wood, who is a principal at Brady Ware Arpeggio. He is a business appraiser whose practice focuses primarily on tax-specific areas, including tax controversy, which means executing business appraisals and litigation support in US tax court cases. As well as settlement offers between the IRS and taxpayer under the direction of tax and estate litigation attorneys from national and local law firms.
Mike Blake: [00:03:59] Bruce is also an expert in estate, gift, and trust, tax and business transactions, planning and compliance. He works with closely held businesses such as S-Corp, C-Corp analysis, family partners, and et cetera.
Mike Blake: [00:04:13] He brings over 30 years of experience to the marketplace. Spending the last 20 in business appraisal after 12 years as a CPA tax adviser. Often faced with decisions or situations impacting the value of a transaction or business, Bruce helps navigate the complexities of those situations. He has helped in industries such as meat processing, professional services, manufacturing, distribution, food service, mining technology, retail, and other business sectors. And I can’t tell you how delighted we are to have him join the team and I’m equally delighted to have him on the podcast. Bruce Wood welcome to the Decision Vision podcast.
Bruce Wood: [00:04:50] Thank you so much for having me, Mike. And I am equally thrilled, not only about being here, but about being with our company. It’s been a really good, really good match.
Mike Blake: [00:05:03] So, let’s start with the basics. The IRS doesn’t challenge every tax return that comes through. In your experience, what – why does the IRS challenge tax returns at all?
Bruce Wood: [00:05:17] Well, anything else out of estate and gift, as far as I know, they’re selected first by a computer scoring system that is set up to determine anomalies. And then managers go through those returns that are selected to see which ones are audit worthy. Then this – when it comes to estate tax returns, when somebody files one, it’s going to be looked at. And more automatically, it’s not random – if you have enough estate to file an estate tax return, they’ll look at it and they’ll either send a closing letter. Once you got the closing letter then that’s saying they’re going to leave you alone. Otherwise, if they think it’s audit worthy, you know, they’ll look at it more closely, may inquire, may do an audit.
Mike Blake: [00:06:24] Now, that’s interesting. I didn’t realize they sent the closing letter. So, no news is not necessarily good news. You either get an affirmative notification that your estate appraisal has been accepted or or there’s some sort of other action that will be taken.
Bruce Wood: [00:06:41] Right.
Mike Blake: [00:06:42] Interesting. Okay. And for purposes of this discussion, I think it’s important that our audience understand, and you and I have talked about this prior to the conversation, you know, you specialize in a specific area of tax controversy. You’re not necessarily challenging or working on income tax returns, that’s what more conventional CPAs do.
Bruce Wood: [00:07:03] That’s right.
Mike Blake: [00:07:03] But rather a fairly specialized area where wealth is being transferred from one party to another, whether it’s a gift or an estate or charitable contribution, things of that nature.
Bruce Wood: [00:07:15] That’s right.
Mike Blake: [00:07:17] So, you know, when the IRS decides they’re going to raise an issue. And then they send – they say, you owe us X number of dollars. What usually goes into that? How are those numbers of dollars calculated from the IRS perspective?
Bruce Wood: [00:07:40] What they’ll do is what’s called an adjustment or first will be a proposed adjustment. And so, for example, they may disallow a discount – well, you go to a background. In business appraisals, for non-controlling interests, especially there are control in marketability discounts because people wouldn’t pay for as much for us. A block of stock that’s non-controlling.
Bruce Wood: [00:08:09] And the IRS has a serious issue with that. It’s very common that they’ll make an adjustment to the discount. So, it may – we make a proposed adjustment. So, say it’s $10 million. So, that means you owe tax in their mind on an additional $10 million-plus interest and penalties for underpayment. It may be $40 million. But they may make several adjustments in one return so it can get expensive pretty quickly.
Mike Blake: [00:08:41] And how does the IRS decide on interest and penalties to those formulas? Do they get to make up what those things are? How do those work?
Bruce Wood: [00:08:50] No, those are in the – either in the code or statutory. They’re – I mean, I’m not using the right word but they’re predetermined. They don’t get to decide.
Mike Blake: [00:09:01] Okay. So, they’re rules-based. They’re not just —
Bruce Wood: [00:09:03] That’s right, rules-based
Mike Blake: [00:09:04] Not just the IRS says, well, we think you’re a jerk. So, you have to pay more dollars. That’s —
Bruce Wood: [00:09:09] Yes, you can pay credit card interest. It’s the same.
Mike Blake: [00:09:09] There’s a rule that has to be followed.
Bruce Wood: [00:09:11] That’s right.
Mike Blake: [00:09:12] Okay. So, if you’re in the unlucky group, for lack of a better term, that does not get that all-clear notification. Instead, they’re going to challenge and propose an adjustment. What does that look like procedurally? And then, how long does that – can that process takes in trying to resolve an IRS challenge?
Bruce Wood: [00:09:39] I’m not sure there’s a limit on how long it can take. They have – a there’s generally a three-year statute for them to make changes. But litigation can go on for years. I’m dealing with a 2018 case right now. So, it’s hard to put a cap on either the time or the professional fees that would be spent.
Mike Blake: [00:10:11] So, years of litigation, that sounds expensive.
Bruce Wood: [00:10:15] Very much so.
Mike Blake: [00:10:17] So, it’s safe to say that you’re probably looking at the hundreds of thousands of dollars. And if the matter is large enough, like, say, the Michael Jackson case that recently resolved maybe millions of dollars.
Bruce Wood: [00:10:30] Exactly.
Mike Blake: [00:10:33] So –.
Bruce Wood: [00:10:34] And there are —
Mike Blake: [00:10:34] Go ahead.
Bruce Wood: [00:10:35] There are situations where it’s the best thing to do but you really – but making the decision of what we’re talking about. Analyzing and making the decision is key. Are you going to fight this or not? What’s it worth in terms of losing sleep, stress, distracting you from other things you need to do whether it’s work or play. You know, what’s that worth to you?
Mike Blake: [00:11:08] Yeah. So, you know, in a way, I mean, the IRS does that cost of prosecuting or challenging does give the IRS a particular element of leverage, doesn’t it? And that, you know, if the IRS is asking you to pay another $10,000, for example, they probably wouldn’t do that, but just for an example. They’re making an adjustment of 10,000 on an estate. Probably, most of the time, you’re going to say, you know what, just write the check and move on.
Bruce Wood: [00:11:41] I would think so.
Mike Blake: [00:11:43] A boss of mine once said, you know, you cheated me fair and square.
Bruce Wood: [00:11:48] Right. Is it worth – right. In a situation like that, typically – maybe negotiate with the agents and see what you can get. But I wouldn’t go – get heavy into litigation hiring professionals for $10,000, no.
Mike Blake: [00:12:06] So, let’s talk about the negotiating with the agent, because I’d like our audience to understand, and candidly, I don’t fully understand kind of how it works. So, you know, from a day-to-day or practical perspective, when the IRS proposes an adjustment, you decide that, as a taxpayer, you want to challenge that adjustment. What happens then?
Bruce Wood: [00:12:31] Well, first thing to do is talk to the IRS agent on your case. And get him to explain why – or get him or her to explain why the adjustment. They’ll usually – they’ll document that usually. And then, make sure they have all the facts. They may be missing facts. Well, did you know this, this, and this?
Bruce Wood: [00:12:59] So, it’s good to talk with him. A good IRS agent will talk to you about the adjustment before they make it. And that way, if there’s a – if it’s based on a misunderstanding or something, you can catch it early. But if they do propose an adjustment, one thing to keep in mind is their manager has given them this case and say, go out to this taxpayer. You’ve got to make it easy for the IRS agent to take into account what you’re saying, whether it’s you personally or through your professional. Knowledge is power.
Bruce Wood: [00:13:43] A professional should be advising the taxpayer on what to do, giving the agent the relevant law. Keep in mind these agents are – the IRS is understaffed, according to them. And there are so many things they can’t get to. So, they’re going to go for the low-hanging fruit. Don’t give them low-hanging fruit to the extent possible.
Mike Blake: [00:14:10] And then, you know, there’s an – so, there’s an agent involved, right? And I think it’s important for the – for audience to know this. It’s not like you disagree with the IRS and bang, you’re in tax court. There’s likely going to be a lot of things that need to happen before appearing in tax court is even a realistic possibility. And that’s before we even entertain the discussion as to whether or not that’s even a desirable outcome, right?
Bruce Wood: [00:14:38] Right.
Mike Blake: [00:14:39] So, Where does that conversation with the agent go? If you’re not able to get a resolution with the agent, what happens then? Is there an escalation to a manager or something or how does that work?
Bruce Wood: [00:14:55] Yes, she can request to talk to the agent’s manager next. And if you exhaust it, if you exhaust that kind of option, there’s IRS appeals. And it takes at least several months to get on their calendar, but this is just what I’ve heard in several places, but appeals will give away about half of the cases or half of the issues, I should say. Because if the IRS agent hasn’t documented it property, the agent thinks they are or that appeals agent thinks the agent is wrong, they don’t have the bandwidths to redo it for them. They’ll just, typically, I think, decide right there. Okay, we’re going to throw this issue out. We’re going to fight for the IRS for this issue.
Bruce Wood: [00:15:53] And then even if – and then lawyers talk back and forth. And it is – and then, of course, getting it heard in tax court it takes, God only knows how long. So, you would be basically held hostage. If you were – if that was a big issue to you, waiting to go to tax court, they may or may not hear your case. It may take years. There’s a lot involved.
Mike Blake: [00:16:24] So, and it’s important to understand, I think in that process, the meter’s still running to an extent, right? You’re still accruing interest and potentially additional penalties while that process is playing out, right?
Bruce Wood: [00:16:40] It depends. There are cases where you – I don’t know, I’m right offhand, but there – this would be an attorney question. But there are cases where you have to pay the tax upfront and then seek a refund.
Mike Blake: [00:16:55] Interesting.
Bruce Wood: [00:16:55] Depending on the retort you’re going to. And so, that would stop the interest and penalties from accruing.
Mike Blake: [00:17:00] Right, but of course, the downside is the IRS already has your money.
Bruce Wood: [00:17:04] Right, and you may or may not get it back.
Mike Blake: [00:17:06] Right. I mean, this may or may not apply, but they say the possession is 9/10 of the law, right? It’s —
Bruce Wood: [00:17:14] Exactly.
Mike Blake: [00:17:14] You know, I don’t know if this is true with IRS matters, but it certainly feels like I have less leverage if I’ve already written the check.
Bruce Wood: [00:17:21] It does, that never helps.
Mike Blake: [00:17:22] I don’t know if it’s actually true. But it certainly feels uncomfortable. So —
Bruce Wood: [00:17:26] Sure.
Mike Blake: [00:17:28] So, in this conversation – and let’s kind of go back to the agent level. How does having a CPA and a business appraiser, like you, and specialized tax legal counsel, how does having a team like that impact the likelihood of getting the matter resolved in a way that’s positive for the taxpayer?
Bruce Wood: [00:17:52] Well, they have – these professionals know the law. They can – you know, when the agent proposes an adjustment, they can assess the validity of the adjustment. Check out the law and provide the agent more information. There may be something the agent missed. And they can say – they can communicate if they disagree with the agent on the issue.
Bruce Wood: [00:18:22] And another – and they’re not emotionally wrapped up in the case like a taxpayer is. That’s another key element. It’s – a lot of times it’s best for the taxpayer not to talk unless he’s directed to and let the professionals do the talking.
Mike Blake: [00:18:44] And that brings up, I think, a very important point in that. You know, not speaking at all to the dedication or professionalism of the IRS agent or individuals involved. But the fact of the matter is, it’s not their money they’re playing with –.
Bruce Wood: [00:19:02] Right.
Mike Blake: [00:19:03] — on any level, right? And so —
Bruce Wood: [00:19:04] That’s right.
Mike Blake: [00:19:06] You know, I do think that there’s an inherent negotiating advantage with the IRS that is in favor of the IRS because, you know, at the end of the day, the entire exercise is depersonalized, right?
Bruce Wood: [00:19:20] Right.
Mike Blake: [00:19:20] It’s not like an IRS agent gets a bonus if they collect more tax.
Bruce Wood: [00:19:25] They’re not on commission, you’re right.
Mike Blake: [00:19:27] They’re not on commission, exactly. And so, you know, just like in my practice and transactions, we do have clients say, you know, we’re we’re too close because we don’t want to negotiate our own sale and we’ll, sort of, be that buffer. It sounds like there actually is a parallel with an IRS negotiation.
Bruce Wood: [00:19:47] There is. And another value of having the professionals there is this is not unique to IRS agents. Lawyers do this. And gaining somebody’s trust, getting them to talk. The IRS agent may go, wow, this is a really cool business. How did you do this and how did you do that? Get the guy talking. Some people love to hear themselves talk, love to talk about themselves, and they can get all kinds of information that way. And they don’t even realize, you know, what’s happened until it’s too late.
Mike Blake: [00:20:27] Well – and you know, that’s negotiating 101, too, right?
Bruce Wood: [00:20:30] Right.
Mike Blake: [00:20:30] If you can build some sort of relationship with the other party, some way of connecting and make the relationship somewhat less adversarial.
Bruce Wood: [00:20:40] Right.
Mike Blake: [00:20:40] It’s more likely you’re going to achieve some kind of resolution.
Bruce Wood: [00:20:44] Right, I agree that people skills are important. And good professionals know how to do that because IRS agents are people, too. You know, they go home. They don’t want to be screamed at or told they’re idiots, you know, anymore than anybody else does. And they have families. They go home to their families or, you know, they – after a rough day, they get upset, that kind of thing. So, they want they want respect just like the rest of us. That doesn’t mean you have to agree with them.
Mike Blake: [00:21:27] So – you touch on a point that I want to actually ask is the next question, which is, I think some people are tempted to stereotype IRS agents, or really any government employee as as somebody that may or may not necessarily be competent because they’re working for the government, right? We hear about, I’m from the government, I’m here to help, et cetera, et cetera. You know, is that true or do you find a lot of IRS agents, in fact, are very competent professionals?
Bruce Wood: [00:22:05] Sometimes, what you’re saying is true. But other times, I’ve known some that left big for CPA firms to go to work there because they wanted the work life balance. And my guess would be that they love to be underestimated, you know, they probably have fun with that.
Mike Blake: [00:22:28] Interesting.
Bruce Wood: [00:22:31] So, it – and the agent may act like they’re from a sticks. They don’t know anything. But that’s always dangerous. Underestimating people is dangerous, including IRS agents.
Mike Blake: [00:22:48] Yeah, I think that’s right. Years ago, I used to be a fairly serious chess player, decades ago now. But one of the hardest things to do is to play somebody who is new to the tournament scene because you had to make sure to not underestimate them. And because they were new, you couldn’t exactly predict what they were going to do
Bruce Wood: [00:23:11] Hustlers, perhaps.
Mike Blake: [00:23:12] Yeah, yeah. Kind of, hustlers or just, you know, they weren’t indoctrinated with conventional thinking necessarily. So, you weren’t exactly sure, kind of, what the move sequence is going to be, even if you kind of thought that you had that all figured out. And, you know, I can see that. I can see people, sort of, liking the position of being underestimated and being the underdog because if, you know, from the other side of the table, if your counterparty is overconfident, right, maybe they’re going to make a mistake, right?
Bruce Wood: [00:23:49] Right.
Mike Blake: [00:23:49] And maybe they’re going to say something dumb or damaging or compromising that if I’m the agent, that’s going to make my life a little easier.
Bruce Wood: [00:23:59] Right, that’s exactly right.
Mike Blake: [00:24:00] And you know also, I’m curious, I have – I don’t have that much experience with the government, but I’ve read enough about, in particular, SEC actions. And one thing that strikes me about the SEC anyway, is that, for the most part, they really – for the most part, they’re going to give you a lot of ways out. They’re going to give you a lot of off-ramps. But if you’re a jerk and if you’re condescending and if you’re sort of deliberately confrontational and not listening to any kind of reason, the SEC will then turn around and make an example of you.
Bruce Wood: [00:24:46] Sure.
Mike Blake: [00:24:47] There’s a point at which the door to a resolution, sort of a peaceful solution sort of closes. And now you’re going – not only you’re going to court, but you’re probably going to jail if you lose. In your experience, is that the way with the IRS, too, that you can sort of, you know, sort of, get in the ref’s face for a little bit. But at a certain point, there’s a technical foul and you’re thrown out of the game.
Bruce Wood: [00:25:14] Right. And you – well, it’s a little different. You probably won’t go to jail, but it’s – it can make your financial life hell. So, it’s not a good idea.
Mike Blake: [00:25:29] So, you know, we talked about the agent level, the manager level, and then the appeals level, and then presumably after that, there’s tax court level. In your mind, where is the optimal stage to settle a tax controversy?
Bruce Wood: [00:25:45] Well, the IRS is under pressure. Some kind of pressure to settle things at the lowest possible level. So, and to the extent, you can best get advice to follow. Because every time you decide to go over the next step, it’s more time, more stress, or more meetings with your professionals, more strategizing, work produced, and less attention to other things in your life.
Bruce Wood: [00:26:27] So, if you can get something reasonable agreement with the actual agent, that’s certainly the easiest appeals, you have a 50/50 shot. So, if you think, you know, in certain cases where it’s a lot of money, the IRS agent is being unreasonable, you don’t think they did their homework or really have a leg to stand on, that might be a good option.
Mike Blake: [00:27:03] So, in your experience, how often do challenges on – and I’m just saying limit this to your world because I know that’s the place you know. How often do challenges happen on gift and estate tax returns? What would you estimate as a percentage of, you know, given, say, 100 or 1,000 gift or estate tax returns that are filed? What number of those are likely to face a challenge?
Bruce Wood: [00:27:31] We probably – I don’t know a number but it would probably – I can tell you the start where I think the starting point would be though. The larger estates would likely be able to be looked at more closely. And they’re looking for low-hanging fruit. They don’t have – I’ve heard IRS appraisers talk. They came to the TSCPA one time and gave us a presentation. They don’t have time to look at every report. They’re overwhelmed. We have fundamental disagreements about whether control and marketability discounts even apply at all, much less the amount. But they’re going to go after the low-hanging fruit.
Bruce Wood: [00:28:20] The reports that aren’t documented that take leaps of faith that say, based at marketability discount on an average of interest studies instead of what’s going on with that company. When there’s – in time their analysis where they have an analysis when they have a conclusion and they don’t tell you how they got from one to the other, when they leave holes like that, my goal is – in my report, is always to make it easy for the user to go through and duplicate my work.
Bruce Wood: [00:29:03] They could take the same information I had, you know, access to the same databases that I have referenced in the report. So, even if the IRS doesn’t agree with it, they can duplicate my report and see how I got my answers. When they can do that, when there’s not a leap of faith somewhere, well, there’s no patrol here. So, we think it should be 20% or something like that. So, document, document, document. Make it – you’d make their job easier by making the report easier to read. And give them less gray area to jump on.
Mike Blake: [00:29:47] And you know, I’m a big fan of that approach. It’s one of the reasons I think, you know, you and I worked so well together and that we’re of the same cloth there. You know, we don’t like those holes. And in fact, one thing I regret about our profession, you know, I’m sure you know this, but not everybody does. We used to have another credentialing body, the Institute of Business Appraisers.
Mike Blake: [00:30:13] And one thing that stood out in their series of professional standards, that I think was unique, and has not been adopted since. But under IBA professional standards that, you know, a business appraisal report should be replicable by a competent professional given the same information set, basically. And again, it doesn’t mean that they agree with it, but it should be able to be replicated.
Mike Blake: [00:30:43] And, you know, we can and I truly wish the Appraisal Foundation and the National Association of Certified Valuation Analysts. I truly wish they would both – and the NACPA, the third one, would adopt that into their set of professional standards because it really should not be exceptional that we do that. But unfortunately, it is. But it’s really high class, I think, to put a report that an IRS agent or one of their valuation analysts or called engineers, still to this day, you know, that they can actually reverse engineer the report. And I think that’s really important.
Bruce Wood: [00:31:26] It is. And there is no – in our recourse, there’s no ball to hide. So, why wouldn’t we be transparent about how we did it?
Mike Blake: [00:31:37] Yeah, well, and you and I could go down a different rabbit hole. Maybe we will, but not on this particular podcast. But yes, it does sometimes – I see some reports that sometimes make me think that the appraisers are intentionally trying to ensure that their report is just unreadable and taking their chances in the chaos.
Bruce Wood: [00:31:58] Some people fall asleep, you know. I’ve seen than.
Mike Blake: [00:31:59] But, you know, actually, you touched on the next question already. So, why don’t I just go ahead and slide into it which is, you know, when the IRS looks at a return. And the return basically is going to be based on a report like somebody would – you would do. What are the most common flags in your experience that the IRS looks for?
Bruce Wood: [00:32:25] Well, they want – if a report is not logical. If it contradicts yourself, make contradictory statements, for example. The company only pays distributions to cover tax liabilities and then you see something contrary to that. If the report looks, like it was – you know, if sections of the report, kind of, looked like they were copied and pasted from different sources. If it doesn’t flow. If it’s not logical. If there are holes in the analysis, there’s no segue from the analysis to the conclusion or there’s no analysis at all. The conclusions need to be based on something to show that the appraiser did his or her due diligence and follow through and came up with a reasonable conclusion.
Mike Blake: [00:33:31] So, you know, to me, the IRS seems like a different animal. Of course, we have lots of regulatory bodies the Securities Exchange Commission, Environmental Protection Agency, OSHA, Department of Justice, you name it, we’ve got it. But the IRS seems like a different animal to me. In particular in that I think I think more than any other agency, there is a, sort of, a presumption of guilt. You have to, kind of, prove to the IRS why you’ve paid the appropriate amount. Not to the IRS, what they’re suggesting you pay is inappropriate. Is that a fair observation or do you disagree with that?
Bruce Wood: [00:34:23] Well, yes and no. The IRS has to prove income. And you have to create your expenses. So if they think your income was –.
Mike Blake: [00:34:36] Interesting.
Bruce Wood: [00:34:36] Right, if they think your income was more than you reported, they’re obligated to prove that. And any expenses, you know, you’re obligated to show documentation of those.
Mike Blake: [00:34:48] But in your world where an appraisal for the estate or for the gift or has been filed, to me, it seems, again, like the burden of proof is actually on the estate of the gift or not the IRS.
Bruce Wood: [00:35:06] Right, and that’s why documentation, explanation is so key. And at the end of the day, they still have certain mandates, like, for one thing is tax affecting earnings and evaluation. Which means accruing, you know, pass through entity accruing taxes that will be paid at the shareholder level. Because the earnings that are capitalized or discounted should be what you keep, not what you make and they disallow tax affecting.
Bruce Wood: [00:35:47] There are several cases that came up and Michael Jackson, as you mentioned. And the IRS has a national mandate to disallow tax affecting. Regardless of all these court cases now. But most of them say, the tax code is not against tax affecting. But you’ve got to do a good job of it. You’ve got to do a reasonable analysis because they’re not there to recreate it. They’re going to throw it out if your analysis was not reasonable or you made assumptions that weren’t true.
Bruce Wood: [00:36:33] Like, for example, an assumption that the buyer would be a C corporation. Hanging your head on things like that will get it disallowed. But the IRS is starting to position, that’s a huge issue for them is that no tax affecting is allowed.
Bruce Wood: [00:36:51] And so, they probably have other mandates, too. Oh, and one of the IRS appraisers told me that to the IRS all discount evaluations, family and partnerships, LLCs, et cetera, all of them are abusive tax avoidance transactions. That’s their starting gate position. So, they prefer to start at zero. And discounts, generally speaking, unless you prove every percent.
Mike Blake: [00:37:20] So, that’s a very adversarial position to take. And just for our audience, when we say tax affecting, we mean that when you’re, in particular, appraising a business that you’re determining the value of the company on an after-tax basis in terms of profits rather than pre-tax basis. And there are technical reasons why that’s important when you get into things like pass-through entities. It can become very complex.
Mike Blake: [00:37:47] But it’s interesting that – I’m sort of vaguely aware of this. Again, you know, you do a lot more of this than I do. But I am vaguely aware of the fact the IRS, at least they’ve been trying to take this position of starting with zero discounts. They’ve been trying to take the position of assuming that no tax is paid by the company. That everything is a pass through entity.
Mike Blake: [00:37:47] How much have you actually seen that in practice? Because I have to say, knock on wood, I haven’t seen it a lot in my practice. But again, you do more of this and you do it deeper than I do. So, I’m curious how much the reputation is matching the practice on the road, in your experience.
Bruce Wood: [00:38:35] I just had a meeting this week where the agent actually said that. He said that it was a national mandate. They would not allow tax-affecting. And after you said that, I thought back to some other conversations in the past with IRS agents. It seems like sometimes they’re reluctant to say that if they’ve been told, they just can’t do it. And sometimes that comes out as, you know, I’m going to disallow that. And they won’t really explain. So, this is a theory, that maybe that’s why. That they’re uncomfortable saying they’ve been told not to.
Mike Blake: [00:39:17] Yeah. And I mean, it’d be interesting. If those actually get to tax court, I think the IRS is in trouble because when you take that position, you’re actually violating professional standards. You’re basically pre-determining to a large extent, in some cases, you’re actually pre-determining the appraisal outcome.
Bruce Wood: [00:39:40] That’s a good point.
Mike Blake: [00:39:40] And that may be why. Maybe there’s a national mandate, but they’re probably going to play soft with that because, you know, tax judges, generally speaking, know what they’re doing. I’ve actually been very impressed with their reasoning and how they articulate how they got to where they got. And they seem to understand complex financial discussions with actually a fair amount of fluency. Tax judges are going to pick up on that pretty quickly.
Bruce Wood: [00:40:10] Oh, sure. They don’t buy the smoke and mirrors, that’s for sure. They’ve seen enough of it.
Mike Blake: [00:40:20] And they understand, I mean, they get the professional standards. Of course, in every place there are good judges and bad judges. And every profession, there are good appraisers and bad appraisers. But there are enough good judges that, you know, they take the time to understand professional standards and amazing to see how that goes. But anyway, I can tell you about that stuff all day.
Bruce Wood: [00:40:45] Right, and they do. The tax court has disallowed tax-affecting but they make a point of saying but it’s not because they think tax-affecting is wrong, it’s because it wasn’t done correctly. And, you know, they think it’s not their job to recompute it for you.
Mike Blake: [00:41:04] Yes, that’s right. And I’ve seen the same thing that there’ve been a, you know, they’ll do what you’re supposed to do, which is rule and/or make a valued judgment based on the prevailing facts and circumstances. Not a blanket ideological statement, which is what you’re describing.
Bruce Wood: [00:41:27] Right.
Mike Blake: [00:41:28] A question I want to make sure we get to here is, there’s been a fair amount of press to this and you’ve indicated it yourself that the IRS is understaffed, or at least they say they are. I think they’re in the midst of a big hiring push right now. Good luck. But, you know, when the IRS is understaffed, how does that impact their reaction to tax controversies? Does that mean that taxpayer might be able to get away with more or they’re simply going to be a longer queue towards resolution or are there other ways in which understaffing by the IRS, kind of, impacts the the tax controversy conversation?
Bruce Wood: [00:42:14] Well, I think they certainly do have to pick and choose. You know, the IRS certainly has to pick their battles. Because of it – another theory I have is that taxpayers hear that news that the IRS is understaffed and that sometimes they get emboldened. Certain taxpayers will get emboldened to do to push the envelope and they might end up being the ones who stick out and get audited. I don’t have data to quantify that. It’s just a theory.
Mike Blake: [00:42:47] Yeah, and I suspect that is the case, right? A key distinction here that you’ve pointed out. I just want to come back to because I think it is critical, is that with income tax returns, there’s at least a semi-random element as to whether or not your return will be flagged for some sort of closer examination. But in terms of gift or estate, if you’re a taxable estate, i.e., roughly $11 to $12 million, I think the number range for a married couple. If you’re much more than that, it’s really a case-by-case basis where somebody actually is taking the time to carefully read your documentation.
Mike Blake: [00:43:28] And then if your documentation is dubious, then you’re probably going to get that call you don’t want. And if your documentation is solid, then they’re going to move on to that low-hanging fruit, as you said.
Bruce Wood: [00:43:38] Exactly.
Mike Blake: [00:43:41] Let me ask, in your experience, the other side of that coin is, one, picking sort of the lucky few of the returns that will ultimately be audited or more closely examined. But then the other part is, once you’re in that phase, what is the motivation to negotiate, right? We’ve talked about the motivation on the part of the taxpayer, cost time, distraction, lost sleep, et cetera. In your experience, has a short-staffed IRS made the IRS more motivated to dispense with matters?
Bruce Wood: [00:44:24] I would think they would be. Since they are overwhelmed, the agent will be getting more cases from their manager or the manager – again, I’m theorizing. The manager says, Have you finished the Smith case yet? No, I have these stacks worth of filing with me, no. And I would think that the manager would be under pressure from even above them to say, settle it. Give them more. See if you can work it out.
Bruce Wood: [00:44:53] So, I think the IRS is so overwhelmed that I would think that. And They do have some pressure from the top, at least to settle at the lowest level possible. Because at some point, if they litigate too much and ask for too much more money from Congress, the taxpayers are going to start to get irritated. I think that’s how it would play out.
Mike Blake: [00:45:18] OK. Now, when we think about the IRS, we’re most of us anyway. you’re different because you’re so close to it. But most of us think of the IRS. we think of it as a pretty powerful agency. And that means that there can be concerns as to whether or not there could be an abuse of that power.
Mike Blake: [00:45:42] And what I’m getting at is there a recourse? Does a taxpayer have any recourse? If they feel like, for whatever reason, the person they’re talking to at the IRS is biased or is being unreasonable as being is not negotiating effect, not bargaining in good faith. Do taxpayers have recourse or are they kind of just stuck, they get who they get?
Bruce Wood: [00:46:11] Well, there are – the taxpayer advocate is another arm of the Treasury. And I think that’s more on the individual side. Honestly, I’ve never seen them get involved in what I do or whether business. And there are three arms of the Treasury. There is the IRS, the Taxpayer Advocates Office, and there’s TIGTA, the Treasury Inspector General for Tax Administration.
Bruce Wood: [00:46:45] And what TIGTA does is they protect the others from each other. So, nothing strikes fear in the heart of an IRS agent like TIGTA. The IRS agents fear them, kind of, like other people fear IRS agents. Because if there is some kind of abuse, if an IRS agent does an offer – engages in unauthorized access to taxpayer information, one they weren’t assigned or unauthorized disclosure. Those are examples where they can get into a tigta investigation pretty quickly if they’re not careful.
Bruce Wood: [00:47:36] And on the other hand, if a taxpayer harasses an IRS agent, like, shows them their weapons collection or something like that, TIGTA will show up very quickly to defend the IRS agent. So.
Mike Blake: [00:47:59] Okay. I’m talking with Bruce Wood and the topic is, “Should I fight the IRS?” We’re running out of time, but there are a couple more questions I do want to make sure I get in. And one of them is, can you countersue the IRS? You know, in conventional civil litigation, you can countersue for damages or at least you can seek compensation for the cost of litigating a lawsuit that might have been improper, frivolous, or whatever. Does any kind of mechanism like that exist with respect to a controversy with the IRS?
Bruce Wood: [00:48:44] Yes, I’ve heard the tax attorneys I work with that they call those administrative expenses. They can add those on as additional damages and they can be professional fees and any other direct costs of the litigation or the dealing with the IRS.
Mike Blake: [00:49:10] OK. So, Bruce, as we sort of wrap up here, there may be questions that some of our listeners would wish that I would have asked, or maybe we might have spent more time on. If somebody wants to contact you about a potential IRS controversy, just want some advice. can they do so? And if so, what’s the best way to contact you?
Bruce Wood: [00:49:33] Absolutely, they can. My cellphone is 770-310-5347. And my e-mail address is email@example.com.
Mike Blake: [00:49:54] And that’s going to wrap it up for today’s program. I’d like to thank Bruce Wood so much for sharing his expertise with us. We’ll be exploring any topic each week. So, please tune in so that when you’re faced with your next business decision, you have clear vision when making it.
Mike Blake: [00:50:08] If you enjoy this podcast, please consider leaving a review with your favorite podcast aggregator. It helps people find us that we can help them. If you would like to engage with me on social media with my “Chart of the Day” and other content, I’m on LinkedIn is myself and at Unbreakable on Facebook, Twitter, Clubhouse and Instagram.
Mike Blake: [00:50:26] Also, check out my LinkedIn group called Unbreakable Group that doesn’t suck. Once again, this is Mike Blake. Our sponsor is Brady Ware & Company and this has been the Decision Vision podcast.