Hans Kasper, MS-CPA, PS
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From 1973 to 1976, I was an IRS agent in the Chicago District. During that time, I audited a wide range of companies in type and size. The question is: Why would someone want to become an IRS agent? In my case, I wanted to own my own business, and the best way to learn tax law is from the inside, so I went to work on the inside.
From the following stories, you will see that the experience that I gained was invaluable. Because of these and many more audit cases, I am able to see where the IRS is going with an audit before other accountants can. I also have worthwhile insights about how to prepare a return that will help prevent an unnecessary audit.
Let me tell you about the structure of the IRS and then go on to some stories. Generally, there are four classes of employees at the IRS. The office auditor is the person who audits personal income tax returns which can include the small Schedule Cs-the sole proprietor. This person usually does not have a degree in accounting. These audits are performed at the IRS office.
The revenue agent will have a degree in accounting and is the person who audits large Schedule Cs and corporate income tax returns. I was a revenue agent. These audits are performed at the company's business location.
The revenue officer is the person who collects past due tax accounts. These are the people who will give you a bad time, and they can have the worst attitudes. When they wanted to make the IRS kinder and gentler, these are the people they wanted to tame down. However, there are cases that involve some real big crooks, and the actions that the revenue officer takes are justifiable.
Then, there are the investigation agents (ID) who handle the fraud and criminal cases. These are the people who pack the heaters (guns, shotguns, and rifles). These are the kind, sympathetic, and understanding people that you will meet in the event that you are ever found to be significantly cheating on your taxes. You see, by going after you, making a public case out of you (newspapers, radio and TV), and by putting you in jail, they can assist in the government's goal of voluntary compliance with the tax laws.
The following are a few stories of my experience inside the IRS.
Based on these stories, you will think that everyone in the world is a crook, but that is not true. I met many wonderful, honest business owners, accountants, and attorneys that I had to contend with as an auditor with the IRS. They treated me very well, and I learned a great deal from all of them about business and how they handled themselves. At first, as a rookie auditor, these guys killed me. They threw stuff at me that I was unprepared for, but I learned from them. As time went on, I began beating them. They asked me how I had learned these techniques, and I reminded them that I had learned it from them. They had stimulated me to rise to a higher level, and to this day, I am able to use what they taught me in my business.
Remember that there is a right way to run your life. If you focus on cheating, then you are not focusing on making money. My experience tells me that making a lot of money and finding out how to do that far out weighs any taxes you will have to pay. Do you think that Bill Gates worries about taxes? He plans for them, but he does not worry about them. Instead, he worries about making money.
I was assigned a case where a company that was manufacturing truck parts was turned in by one of its competitors. The competitor suspected that the company was not paying the excise tax that is due on truck parts since this company was winning most of the government bids to supply the military. The excise tax on the parts, tires and fuel is used to maintain the Federal roads.
I pulled copies of the returns from the service center and sure enough, no tax was being reported or paid. I called the company and set an appointment for the audit. I started going through the books and records and found that the truck parts were for government contracts and in the contract it specifically stated that the excise tax was due on these parts. So I took a trip out to O'Hare airport where the government contracting agency was located to review more of the contracts and talk with the management staff there. Here is the problem: just because it says so in the contract, that doesn't make it so. I had to prove that the excise tax law, the facts and circumstances of the case, and the language of the contract were all correct.
I went back to the company to continue my audit. While there, I noticed that one of the owners had a picture of an airplane on his wall. Since there is also an annual excise tax on small airplanes, which at that time was only $25 per year, I thought that I would test this guy. So I got him into a conversation about how much he loved his airplane and then I asked him for copies of the excise tax returns for the plane. He acted dumb, like he didn't know anything about it. So I gave him blank forms to fill out for the last three years. After he filled them out, he, yes this is correct, threw them at me. After they hit my chest and fell to the floor, I thought, I'll bet he feels the same way about the excise tax on truck parts.
So I went down to the IRS information division to retrieve microfilm copies of the processing records of the corporate and the owners' income tax returns. These records show if returns have been filed and if any penalties and interest were assessed. And guess what I found? The other owner had never filed personal income tax returns for the last five years. You see, a fraud case just doesn't jump out at you. You build it little-by-little and in this case all of the parts were starting to add up. It is called an intentional disregard for the law.
This case was eventually taken over by another agent when I left the IRS. It did go to a criminal trial and I lost touch with the results. However, as concerns the guy who didn't file his five years of tax returns, his wife divorced him and he lost total custody of his kids. Let's presume that he did not go to jail. He and his partner still owed $250,000 in taxes plus significant penalties and interest, and they had to pay a huge sum for criminal defense attorneys.
Some companies like to spend large amounts on travel and entertainment and, in some industries, it is necessary. I was assigned a case where, for the size of the company, the T&E expense seemed a little high. As I got into the audit, I realized that there was only one salesman-the owner-and his T&E expenses per year amounted to $250,000 in 1975 dollars. Now let me tell you that is some real money.
As I started going through the receipts for the expenses, I noticed some interesting things. I noticed receipts for mink coats, wash machines, TVs and etc. I asked the outside CPA about these items and he said that they were for corporate gifts to clients. In the IRS code at that time the gift limit per person, per year was $25 and these were a little higher than that. I asked the accountant what the purpose of these gifts were and he said that this was the only way that the company could get the buyers' in the retail chains to purchase the company's products. Let's put this in English-these were corporate bribes and payoffs to purchasing agents. These retail chain purchasing agents were on the take. The items were for their wives and their own homes.
To complete the audit, I disallowed 50% of the company's T&E expenses due to a lack of documentation and excessive gifts, and I went back three years.
Sometimes you go out to a company and on the surface of the tax return and financial statements everything looks just normal, and most of the time it is. But, on occasion, the unusual just jumps out at you.
There I was, going through my normal, boring audit procedures when, in 1974 dollars, I came across an entry in the books for about $10,000 that looked a little unusual, so I checked it off and asked for the documentation.
When I returned to complete the audit, the CPA sat down with me to go over the list of items that I had requested. When he came down to the $10k item, he explained to me that it was for the owner's daughter's wedding and that since he HAD TO invite his customers to the wedding that some or all of it was a business expense. Now some people will try to justify anything; however, the average Joe out there can't take a tax deduction for inviting fellow employees to his daughter's wedding.
Needless to say, he didn't get the deduction, but if there hadn't been an audit, you, the taxpaying public, would have paid for this man's daughter's wedding.
Again, sometimes when things look normal, they aren't. Here I was, just trying to get an audit done, and I stumbled across it, right there hidden in the cost of goods sold. The COGS is where material, labor and related product costs are supposed to be recorded. So what is the total cost of a 45 foot yacht doing there?
The explanation given to me was: "Oh, no! We didn't mean for that to happen. Alice the bookkeeper entered that to the wrong account, and it slipped by us." So I suppose that she should have buried it in another account. That's right, nail the bookkeeper with the wrap. This was the same guy whose dog ate his homework!
While there is a provision in the law for the use of a boat as a travel and entertainment expense, expensing a whole boat in one year just doesn't work.
Again, needless to say, he didn't get the deduction, but if there hadn't been an audit, you, the taxpaying public, would have paid for his boat.
When you least expect it, things jump out at you. A car comes around a curve, a person walks around the corner of a building, or a dog barks and startles you when you least expect it.
Sometimes during an audit, the same thing happens. In the old days before computers, books were kept in ledgers and journals and were handwritten. Adding machines weighed 20 pounds and were not digital-in fact, they did not multiply or divide. One of the audit procedures that I used was to take a column of numbers from a ledger page to see if they added up. They always added up, and it was a good procedure to keep your fingers nimble.
So here I am in this company, and the columns are already added up for me with the adding machine tapes Scotch-taped right onto the page. Well, so much for finger exercises. So how do I kill my time now? Hey, how about tracing large amounts from the bank statements back into the journals? And what do I find? Numerous large amounts on the banks statements that do not appear in the check register, both deposits and checks of equal amounts.
This fellow was taking money in and not recording it on the books and then writing checks out to himself that were being recorded on the books as void checks. The amounts are equal, everything balances, and he rides off into the sunset without paying the taxes.
But, hold on, how did the adding machine tapes add up when they were used for the bank reconciliations? Those old adding machines allowed the tapes to be rolled forward and backward. A person could roll the tape forward, clear the tape, roll the tape backward and input the missing numbers and tear off that part of the tape, roll the tape forward to the cleared point, and start adding. The missing numbers would not appear on the tape but they would be added into the totals. This is how the totals worked for the bank reconciliation, but excluded the money that was being pocketed.
This was the most unusual case that I ever worked on. One in ten thousand revenue agents ever get to work on such a case. This case hit the radios, TVs, and newspapers in Chicago, and since there was going to be a criminal trial, I couldn't say a word about it to anyone.
In the fall of 1974, I passed the CPA exam and, by doing so, it came to the attention of the District Director of the IRS in the Chicago District. So he looked at my notice, and he looked at a special enforcement case he had on his desk, and he said, "Let's let Mikey try it."
The investigation division called me in (remember these are the guys with the heaters) and said, "Have we got a case for you!" The audit was already in progress, and the agent on the case had, in one day, up and quit the IRS. These guys felt there was something fishy out there and wanted me to take a look.
It didn't take me more than half a day to find it. Company A (the company under audit) would provide Company B (a friend of theirs) with a service. However, instead of sending B one invoice for the service, A would send B two invoices. The first invoice, A would record on their books as income. The second invoice would be recorded in a second set of books. B would take an expense for both invoices and would pay both with separate checks. A would receive both checks. A would record one against the first invoice and the second as a loan from B. Then, A would write checks (here was their mistake) payable to cash which were then deposited into savings accounts for A's two owners. These men would then split the money with the owner of B.
Here is the rule on fraud: There is no statute of limitations. That means the IRS can go back forever, and you have to produce the books and records. Double invoicing a customer, recording only one invoice, and taking the money out of the company without paying taxes on it is fraud. Especially if the amount is large enough that ID will want to take the case. But hold it-wasn't ID already involved in this case from the start?
This is why they were involved. They thought that the previous IRS agent doing the audit had been offered a bribe and that is why he had quit.
So when I went in and started asking questions, they offered me a bribe of $50,000 and a new car to process the audit as a "no change". It had been previously cleared with the US Attorney General's office in Chicago what I was supposed to say in the event of a bribe offer, and this had never been done before in legal history.
The standard procedure prior to this period of time was a three-step process: one, say that you will have to think about it; two, contact the ID division; and, three, go back all wired up (I will explain this later) and wait to see if they offer you the bribe again. The change was in step three. The legal history of bribe cases and where they would fail in criminal prosecution is in step three which follows the legal precedence of offer and acceptance of a contract. If I were to go back in and say, "I have found out that you were cooking the books, and I want $50,000 to keep my mouth shut", then that would blow the fraud case because I was the one who would be making the offer, and they would get off. This is called entrapment. If I waited for them to make the offer again, they most likely wouldn't, unless they were stupid, because they knew I might be wired, and they would surely go down. Thus, a stalemate where no one would bring up the bribe offer, and the ID people wanted this one to hit the headlines on the evening news.
Thus, this is where the US Attorney's office got involved. They came up with the statement that I was to say when I went back and had it approved by a judge. The statement was, "I have been thinking about your offer, and I would like to go forward with it! Your offer was $50,000 and a new car for me to give you a 'no change' audit result. To give you the 'no change' audit result today, I will have to have payment." Notice that I was referencing their prior offer, stating that I was willing to go forward with it, and requesting them to complete the contract between us. However, this is where the ID people almost blew the bribe.
But now, let me tell you about being wired. It was a hot Chicago day in the 90's, and they are taping to my body two tape recorders and wireless microphones. I mean I had adhesive tape all over me. I felt like an Egyptian mummy. Since Company A was at street level in a single story building, the ID guys, about six of them, decided to stay in the cars that were parked on the street where their tape recorders were running, and they could hide their shotguns on the floors of their cars. It was getting to about noon, and I was talking to the business owner when one of the small tape machines that was buried in the small of my back began to make a noise that sounded as if the tape was rubbing against the tape reel. (Note: Three to four tape machines were running at once so that if one failed, then it was likely that the others wouldn't.) When the owner left the room, I talked out loud so the guys in the car could hear me and I said, "Hey guys, this tape machine is making a lot of noise. You better get me out of here at lunch and fix this machine, and I can come back." So they called the business and acted as if my supervisor wanted to meet me for lunch. I left, and the ID guys followed me to a restaurant where we went into a bathroom to fix the tape machine. I had my shirt off with all the adhesive tape showing, the ID guys were in there with their shoulder holsters in full display, and in walks some guy who must have thought that I was in the midst of a holdup. After showing him their badges, the ID guys assured him that we were with a federal enforcement agency.
I proceeded to return to the company, and here is where the ID guys almost blew it. And, I still, to this day, cannot believe that no one thought of this before I went in--it was Wednesday. At that time, all banks in Chicago were closed on Wednesdays, and we were asking this guy to come up with cold, hard cash on a Wednesday. Now, I had to insist that he come up with the cash or the deal is off. He called the banker at home to open up the bank so he could get into his safety deposit box to remove all the cash. He came back with $5,000 in $100 bills and handed it to me. Before I went into the company, the ID guys searched me head to toe, removed everything from my wallet, and had me signoff on an affidavit. This way, no one could claim that I had walked in with the money to set these guys up. Therefore, as directed, I opened the envelope and started to count the money in front of the guy to make sure that all of the money was there, and he said, much to our delight, "Don't worry about it, all $5,000 is there." I told him that I would give him the "no change" papers when he delivered the full amount and the car. I left the company, drove around the corner, stopped the car, exited the car, was searched again, handed over the $5,000, and signed another affidavit.
But wait, there's more to the story! What they had in mind was to get this guy on film. A week later, we met at my apartment (my wife was 8-1/2 months pregnant and found herself sitting there with these guys with loaded shoulder holsters) where I called the guy from my phone (taped, of course, with a listening device) and set up an on-the-street pickup of some more money.
Prior to the appointed time of the pickup, a large van with one-way windows was stationed at the corner with a film crew. Again, the ID guys were stationed in cars around the corner. The guy drove up (yes, I was wired again and had been searched again), he hands me the money, and I asked him when I was going to get the rest of the money and the car. He said, for his fifteen minutes of fame, "I'll get it to you a little at a time, and the car will come shortly." Then he drove off. I was searched, and the affidavits were completed.
Can you imagine working for this Company A or B when the day came for the arrests? First, all three owners were arrested at their homes before they could go to work in the morning. Then, let's use Company A as an example, a moving truck drove up to the curb in front of the company's entrance. The ID guys walked in the front door (this was a large room where everyone worked; yes, they are also watching the back door from the outside of the building), flashed their badges, asked everyone to stay seated, told the employees that one-by-one they would be able to collect their personal belongings, and that this would be their last day of work at the company. Whole desks were loaded onto the truck, and the contents of the entire company--all books, records, and equipment--were gone by noon.
They brought the owner who offered me a bribe to the federal offices where, after having read him his rights, he called his attorney. With the attorney present, the questioning began. He denied everything. Then, they began to play the tape recordings, and he denied that it was him on the tapes. After he was done speaking, the lights were brought down, and a film projector was turned on presenting the on-the-street delivery of the money. The next words spoken were by his attorney who said, "_____ is that you?"
The two owners of Company A went to jail for one year and had to pay back $5,000,000 in taxes, penalties, and interest in 1974 dollars (in 2001 dollars that amount would be $19,000,000). They had been taking $1,000,000 per year from the business, and the fraud case went back five years.
How did it all start you ask? The owner of Company B had gone to Las Vegas and had run up a substantial gambling bill. He went to the owners of Company A and convinced them to begin the over-billing scheme so that he could pay back the Las Vegas casinos.
The owner of Company B never did go to jail. He died of cancer before he could get there.
I was asked to audit a large company south of the Chicago area. The company was owned by a father and five sons. It was run by their in-house accountant who was a very good businessman and an all-around nice guy. The company was doing very well. They had national distribution of their product and were making several million dollars of profit per year.
Before going out to perform an audit, I would go to two different locations in the IRS. The first was the microfilm room, where I would obtain a record of tax filings and payments. This listing would show me if returns had been filed on time and any penalty assessments. Penalties are a non-deductible expense. If penalties do not appear on Schedule M-1 of the corporate tax return, then I had an automatic adjustment. This company had $5,000 in penalties that had not been adjusted on Schedule M-1.
The second location was the prior audit adjustments file. If the company had been previously audited and adjustments had been made, then I would know about those adjustments and look for the same ones. Sure enough, they had a disabled son or brother for whom private nursing services were being provided. Private nursing services are a personal expense and are not an allowable tax deduction to the corporation.
These adjustments with some other technical ones over the prior three years allowed me to walk out of the company in two weeks with a check for additional taxes in the amount of $250,000. Not bad for two weeks work.
Now I am going to show you how stupid the IRS management can be sometimes!!!!! I returned to the office, wrote up my report, and turned in the file and the check. The next day the supervisor called me into his office and said, "Kasper, I want you to go back out to this company and put more time into this audit. I'm not saying that you didn't do a good job, but the review people will kick this back saying that you didn't put enough time into it." So what did I do? Well I wasn't going to go back out to that place and re-audit what I just audited because they couldn't comprehend that someone could do a good job in two weeks. So I went to the IRS library for two weeks, booked the time to the job, turned it back in and everyone was happy. Now you know why the government is so screwed up. They're telling their employees to slow up and not be so effective.
This is exactly why I quit. These people were driving me nuts.
I had an opportunity to audit a company on the near south side of the city. Before an audit, the company's accountant will coach the owner what to say and what not to say. The owner was a wonderful fellow with a very fine product that he produced. As the audit proceeded, I would ask him questions about his business. In the tax law at that time, there were certain items that had to be perfectly timed and recorded in the corporate minute books to be able to achieve a tax deduction.
Very casually, I asked the fellow, "I can never understand how this amount is recorded in the minute books in the prior year when the calculation for the amount is made after the year ends?" He said, "Oh that is easy, we backdate the minutes and stick in the amount."
I said nothing further about it until the closing meeting when the accountant was present. When I brought it up, the accountant said to the owner, "Gee Harry, I told you not to talk to this guy, didn't I? Didn't I? Now look what you've gone and done."
Need I say more to make my point to you?
When an auditor starts work at the IRS, they go through six months of training in tax law and audit techniques. The first phase is individual income tax law after which you perform some individual income tax audits. The second phase is business tax law after which you perform some small business tax audits.
It was during this last stage that I was assigned to audit a small retail store. Upon going through the books and records, I could not get the deposits on the books to balance to the tax return and neither could the accountant.
I asked the accountant to prepare a cost of living analysis for the owner and the business. Congress has given the IRS the authority to prove the income of the taxpayer. This is a simple task. All deposits to your bank accounts are income unless you can prove otherwise. However, if all of the income does not get deposited, then the second method of proving income is a cost of living analysis. In that case, your income is equal to your cost of living unless you can prove otherwise.
Well, the cost of living analysis showed $30,000 more per year of income than what had been reported on the tax return. Boy, was the accountant nervous! Yes, I did send it up for a fraud review, but it was rejected. I assessed the additional tax and a negligence penalty.
The only reason that I asked for a cost of living analysis was that the books and records were not properly kept. Need I say more?
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This page was last updated on 05/13/2010
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