The IRS is not the enemy

Who doesn’t live in fear of a letter from the IRS? You grab the mail, chuck the junk in the garbage, and sitting there in a white envelope is some mystery communique marked “IRS.” You have that pit-of-your-stomach feeling where you can’t tell if you want to rip it open immediately to read the bad news or if you never want to open it at all. 

Well what if I told you that the IRS is nothing to be afraid of? What if I made the outrageous claim that the IRS is not your enemy, in the same way that if you’re not an international drug smuggler the DEA isn’t your enemy either? We all file tax returns, and we all do our best to make sure we follow the law, while keeping our fair share of the money we earn, right? The fear comes from the idea that we might make a simple mistake that, after years of accrued penalties and interest, will cost us our homes and our retirement accounts in one instant, sort of like finding out you’ve gone through an expensive divorce and you didn’t even know you were married. 

Let’s talk realistically about the IRS. Yes, they audit people. Yes, in those audits they try to determine if the person has followed the law and has been honest about how they have reported income and expenses. And yes, sometimes they disagree with people about what is fair and what is legal, but the truth is, the IRS doesn’t have the final say in any of these things. 

Tax laws are written and passed by Congress, not by the IRS. In its role of tax enforcement, the IRS interprets those laws and writes guidelines to aid the general public when preparing tax returns and to aid its officers when reviewing those same tax returns. These guidelines are necessary because what comes out of Congress can be pretty ambiguous and unclear (big surprise, right?). Here’s an example that pertains to S-Corporations, which is a business entity that could potentially benefit a lot of people reading this article. As far as we can tell there is no single law passed by congress that describes how S-Corp officers should be paid. Instead, there are a bunch of revenue rulings and tax court cases that have given us information we have to interpret and apply on a case-by-case basis. The IRS has done the work of collecting and collating all of these rulings and tax court outcomes and provided guidance that we use to determine what’s fair. However, the reason these rulings keep piling up is that often people disagree with the IRS, and sometimes the court says the IRS is right, and sometimes they say the taxpayer is right. Thus, even if the IRS has a guideline, that doesn’t mean it’s the gospel. We tend to stick with the IRS guidelines just to be safe, but if you strongly believe you are right, you can always challenge the IRS in tax court, and you just might win.

So the IRS interprets the law and all of the court cases and provides guidance for taxpayers, but of course the main thing they’re known for is enforcing those laws. Enforcement is surely where the scary part comes in, right? Well, we would argue that if you a) have a good tax professional on your side, and b) are fair and honest with how you provide your information to that tax professional, and c) run your business in a professional manner, then you have very little to worry about. Here’s the best part: A lot of the laws and guidelines on the books can greatly benefit you if you know about them. For political reasons congress is constantly passing tax laws to goose the economy or provide relief for certain types of taxpayers, and you can take advantage of those laws. 

Congress may have an idea of a certain type of taxpayer they want to help, and if we’re being cynical we might presume that it is a taxpayer who just made a huge campaign contribution. Let’s call him Carl. But here’s the thing - they can’t simply write a law that says, “If you are the certain Carl who just gave us all that money you get to take advantage of these deductions.” Instead they have to describe Carl in loose terms, and that leads us to the good part: If you can be described in the same terms as Carl, or if you can make yourself more like Carl, you can take advantage of the same deductions as Carl. Your tax professional’s job is to help you figure out all the ways you can strategize to benefit from the “work” Carl has done, and the IRS’s job is not to shout, “Hey, you’re not Carl!” Instead, the IRS’s job is to simply verify that you do, in fact, look enough like Carl. 

Why are we talking about this? We want to drive home an important point about your business: You should be eager to report income to the IRS. Reporting income from your business is what allows you to strategize your taxes to save even more money by morphing your business to look like the specific “Carl” that is most advantageous, and you also get closer to those amazing safe harbors. We all know that guy who is paranoid about the IRS finding out about income, and you don’t have to be that guy. Instead, if you do things the right way you can sleep well at night and get a bunch of great (and perfectly legal) tax deductions. 

Just remember this: The IRS is not your enemy, they simply interpret and enforce the laws passed by congress. Because those laws are often confusing and ambiguous the IRS has issued guidelines and provided “safe harbors.” If a tax break is available to some people it’s available to all people, and thus you should be eager to report income because it opens up additional tax strategies. Finally, if you follow your tax professional’s advice you will never have to live in fear of getting an IRS letter again.