Do You Have A Tax Question?
The typical taxpayer faces dozens of tax questions every year when they file their taxes. Is this trip deductible? Can I claim my 23 year old son as a dependent? Are my homeowner's dues partially deductible? If you answer these tax questions wrong, they can cost time and money, and trigger an audit from the IRS.
Six Steps to Good Tax Answers
When we look at a tax question, we take a six step approach to arrive at an answer. When you are audited, the ability to document these steps may be the difference between winning or losing you case. And this can add up to paying thousands in penalties.
Steps in Tax Research
- Establish the Facts - understand the situation, the parties involved, the nature of the transaction, motivations, current and future tax positions, rates and laws.
- Identify the Issues - look at areas that might be questionable. Experience, education and training are important in this step - it helps to know what might be questioned and to have seen it before.
- Research the Law - the Internal Revenue Code, Regulations, Revenue Rulings, legal cases and even academic papers are all important sources of guidance for you to review and assemble.
- Evaluate the Situation - this step involves looking at the information from Steps 2 and 3 and applying the law to the situation at hand. Understanding how the IRS and courts looked at similar cases is one of many assessments to use.
- Develop a Conclusion - at the end of the day, the question needs to be answered. The question and answer should be documented with supporting sources in the event of an audit - or to defend a prior position if part of audit defense.
- Communicate the Conclusion - the client or your tax file (this is the file the tax preparer maintains in the event of an audit) needs to receive a memo or other support as to what the recommended tax position is and why. This will be important in the event of audit defense.
Tax Planning Implications
Tax research is an iterative process and takes time. It takes an average of 8-12 hours to effectively research and document an uncertain tax position. However, doing your own research up front will likely cost you less than defending an aggressive or incorrect audit position. This is an effective tax planning strategy that pays off down the road in the event of an audit.