Cautious On Tax Returns

[geekgirldany]

I have a new client and know I am being too cautious I suppose. This is an 07 return. They made around $35,000 in Adj. Income. But their mortgage interest is extremely high (live in a large home), property taxes are high, and there was a good bit of mileage from her being a salesperson. Itemized deductions showing $49,000.

I guess I just don't understand how people survive if they are paying out so much. Has anyone else come across this? Do they live on inheritance or family members take care of them? They seem to be from a well to do family and there has been alot of health problems.

I guess if it raises questions for me it would for the IRS. Just trying to understand about this.

Thank you
DAny

[erchess]

You are not too cautious

Your client is asking you to believe that he/she/they had more expenses than revenue. It's certainly not impossible to do that. For example I did it for tax year 2008 but I didn't choose to try to deduct the expenses paid by relatives without a legally enforcible obligation to repay.

All I am really saying is that you need to get a firm grip on where they got the money to pay their expenses and then consider whether expenses paid with those fund sources are truly deductible for tax purposes. You're only asking the questions the IRS will and if you elect not to ask them and document the answers you risk preparer penalties. I don't know about you but I give what I consider to be excellent customer service but it does not extend to paying penalties because of the taxpayer's lies.

[AZ-Tax]

Echo...you are not to cautious

I had a similiar client a couple years ago. I told the client, you are self employed, have no 1099's to support your gross income disclosed, your business lost quite a bit of money but yet you paid your mortgage, paid your utilities, bought groceries, etc. so do you have a bunch of money put away, rich relative or relatives, etc.? The client got the message and went back to recalculate his gross business income. My experience may or may not be similiar to yours but I had my client sign documents I created.. The scares the heck out of me when all I have to do in most cases is obtain a verbal answer from the client that potentially could lead to thousands of dollars of taxes owed if my client made a mistake or lied to me therefore I create all kinds of additional documents for my clients to sign. I dont believe in being overly cautious.

[JohnH]

Your instincts are the best guide in a situation like this. You've given enough info about the facts to make any reasonable person ask a lot of tough quesitons, but I'm guessing you sense something about the client that also makes you uneasy. Body language, eye movements, tone of voice, etc can all communicate unmistakable non-verbal messages. What's so funny to me is that most people who think they're really good at deceiving us are usually the easiest ones to read.

I've often run into situations in which I'd tell the prospective client that their situation will raise eyebrows at IRS and I'm not the one to deal with it for the client. (No further explanation needed, as far as I'm concerned). I'll suggest that they go to HRB, JH, or another chain because those companies have the deep pockets to absorb penalties better than I. The implication of what I'm saying is, of course, that I expect penalties for SOMEBODY down the road - I leave it to the client to figure out WHO.

On one or two occasions the client was able to provide enough info that I was comfortable going ahead. But in most cases I'm not interested in a do-over when the client clearly tried to use me at the outset to deceive the IRS about major items. If they'll put you in that situation upfront, they'll definitely try to throw you under the bus if there are problems you don't discover the second time around.

Follow your instincts in this situation - you won't have any regrets.

[dtlee]

In the few cases I have encountered this, I have queried the taxpayer what means they had to pay for their expenses and I have documented their responses as my own notes with the file copy of the return. One client had rung up huge overdrafts on their credit cards. Another had sold a recently purchased vehicle and was about to sell the house due to being unable to afford it.

One stymied me. It was a trusted client who was out of work and who I knew had no significant savings from prior years. I kept asking and he swore that he had no idea how they managed to pay the bills and he knew that they had severely cut back on other things. His wife handled all the bills. I got my answer a week later when her Mom and Dad came in and mentioned how awful it had been for Tom and Jane. Then they asked how much they can give to them each year without filing a gift tax return. I mentioned that they could each give no more than a total of $10,000 to Tom and each give $10,000 to Jane (the limit at the time) totaling $40,000. They asked if it would be $20,000 if they gave it only to Jane and I agreed. They said, "Good, because we gave her less than that amount. We don't want to give anything to Tom because we don't want him to know we're helping them out now that he lost his job."

[Snaggletoof]

Sometimes it's O.K.

This is ALWAYS cause for suspicion in a situation like this. But sometimes there is a logical explanation.

One key factor to look at is earnings from investments. Even with an AGI of $30K, if there are significant amounts of interest, dividends, proceeds from capital gains/losses, this tells you that your client has made significant money in the past but just had a bad year.
Keep in mind also that many CD's are paying only 1% these days, so a mere $1000 in interest income could mean that the client has $100,000 salted away in a CD.

A capital loss can disguise an influx of cash. Your client may have sold land for $300,000 after paying $350,000 for it. This means he is walking away with $300,000. But on his tax return, this may show up only as a $3000 loss becasue of the ceiling.

Another factor is whether there is self-employment income. Many owner-operator truck drivers lost money in 2008 because of the high gas prices, but have made significant money in the past.

The above post tells of how a parent was bankrolling their child's lifestyle when hubby lost his job.

If the same situation shows up again in successive years, then it becomes more suspicious. "Bad years" cannot continue to happen year-after-year with huge itemized deductions.

[FEDUKE404]

And the answer is...

The two most logical answers to your inquiry are: 1) they are living on credit, far beyond their means, etc or 2) there are other income sources not being revealed in whole or in part.

There could be a simple honest reason, such as a doting parent, helpful relatives, or recent inheritance, but with today's rules on tax preparer penalties it never hurts to ask at least a few more questions.

Better the client gets skewered by the IRS than me!!

BTW: Just getting around to filing a 2007 return for a new client?? There are some serious large red flags waving around that aspect of your question!

(And reread the post by JohnH who has a good approach to the problem.)

FE

[Uncle Sam]

Caution on Tax Returns

I have had the exact same experience with a relative.
Except I KNOW what the reason is for the crazy looking return, and that's why this will be the third year I will not be preparing the return much to the dissapointment of the other family members.
Let the headache fall on some innocent unbeknowing preparer.

[geekgirldany]

I want to thank you all for taking the time to respond. Extremely helpful.

I got my answer today. He said that his father helped them out for that year because of illness. Both of them are still sick.

I always feel a like I am meddling when I ask questions like this. Even this client acted like I should not have asked because he said it had nothing to do with the tax return. I told him that if I question it then the IRS will question it.

So I know I have to get use to asking these types of questions.

[JohnH]

You are meddling. Sometimes we have to meddle in order to do the best job for our clients. But they have to understand that we're professionals, not financial busybodies.

It can be uncomfortable for everybody, but the client needs to accept something very important. He NEEDS someone who has his best interests at heart (that would be YOU) asking these questions rather than someone whose only interest may be to try and trip him up (that would be our benevolent government). If giving you honest answers makes him feel uncomfortable, ask him to think about how uncomfortable he would feel if someone flashed him a Federal ID card and started demanding answers. He might get nervous, say the wrong thing, and open up a who-knows-what sort of can of worms.

One more thing. This isn't just about his pride or ego. He should be thankful that he has a father able & willing to help him out - maybe even proud enough of his father's generosity to tell you about it since you may be the only person he can freely share this information with. Time to give dad some well-deserved credit. OK, I'll get off my soapbox.

[tilt53]

I really have to agree with John's last reply. Especially for those clients who have been with us for years, we should never hesitate to ask the meddling questions. I mean, after all, they tell us about their prostate or breast cancer surgeries and the problems they have, Aunt Mildred's drinking problem. But when it comes to finances, they want to keep it close to the chest. They feel that it's embarrassing not to be able to manage. We are the ones who have to care for them at that time.

[JohnH]

Sometimes a little humor helps if it's possible to work it in when asking something really intrusive. I remember back when I had to start asking for birthdates when preparing the returns. (For those of you too young to know, there was a time when the only thing with respect to age that mattered on any return was "Over 65")

Depending on the client's temperament, I'd ask for the wife's birthday and if she gave me a funny look I'd say something to the effect that "I'll type it in but I promise not to look". I know, it's corny and a little sexist, but under the right circumstances it worked just fine.

[erchess]

Initial Interview

When I first interview a client I say that I will be asking them all kinds of nosy questions that are basically none of my business except that some possible answer could affect the tax return and assure them that what they tell me is privileged and they will never come home from work and find me gossiping to their neighbor about them. I also like to point out that I need to know about every dollar that came in and how it came in because it's probably taxable and I need to know about all the money they spent because some spending gives them deductions and credits. I enjoy the process of digging into their lives because it's fun to find tax savings they didn't know they had. It has been as simple as the family had a kid with braces and their Sch A had deductible medical expenses but I noticed they had left out the expenses for the braces. I was rewarded with pie and ice cream for that one.

[taxxcpa]

Expenses exceeding income

I had a client once that had about $ 50,000 mortgage interest with an income of less than the interest on the mortgage. However, she had won a big lawsuit for severe injuries by a drunken truck driver. She got over $ 1 million up front and about $ 10,000 per month in non-taxable settlements from the injuries.
I attached the interest statement to the tax return since I thought it might be questioned. But the IRS never made any inquiry.

[JohnH]

Too much information. Maybe you shouldn't have attached anything to the return. The time IRS spent on verifying that slam dunk info would have been time they couldn't spend annoying some other basically honest taxpayer whose documentation was a little shaky.