Tax Preparer Ethics: Miscellaneous Deductions

secret-379428_1280Scenario: a taxpayer works as an employee somewhere. The taxpayer insists that their purchase of (insert something personal in nature that’s clearly not deductible) is deductible as a work-related expense.

If it was a legitimate work-related expense, it would be considered a “miscellaneous itemized deduction” and would only benefit the taxpayer if:

  1. They itemize deductions and
  2. The total of their miscellaneous deductions is greater than 2% of their income

In most cases with average taxpayers, their miscellaneous deductions are nowhere near 2% of their income.

Question: Let’s assume that the taxpayer gets crabby when you tell them that their purchase isn’t deductible.

Is it okay to show the purchase as a miscellaneous deduction if the amount is less than 2% of their income and thus isn’t deductible anyway?

That way, the taxpayer sees it on their tax return but technically the government hasn’t been harmed because the amount was too small to actually be deducted. Is this okay?

My Thoughts

First of all (since I know of at least one IRS representative who reads my blog!): I have never done this before (okay maybe I have once or twice with things that I think are in the gray area); I’m asking hypothetically!

My thought is: it might technically be “okay” in that there’s virtually no way the IRS would audit a return that shows a $0 deduction. But I wouldn’t do it. Here’s why:

  1. It trains the preparer that it’s okay for clients to boss you around (I struggle with this as it is)
  2. It trains the client that they can boss the preparer around and get what they want
  3. It trains the client and the preparer that it’s okay to fudge now and then … which could lead to the fudging happening more often and in much bigger ways
  4. What if the taxpayer’s situation changes in future years? Their income drops, or they suddenly start wanting to claim the same illegitimate expenses AND they now have legitimate expenses too, so they suddenly meet the 2% threshold. How will the preparer talk himself out of the box he’s put himself in with this client?

More Commentary About Year-Round Proactive Services to Clients

If you want to be respected, be a respectable person.

(A quote from my mother)

People treat us the way we teach them to treat us.

(Wayne Dyer)

On Friday I offered my own anecdotal experiences regarding giving clients the proactive advice they all say they want.

The problems I have encountered with this are 1) getting paid and 2) having people actually take my advice.

Certainly this doesn’t describe all clients. It actually describes only a minority of clients.

But it happens enough to be noticeable. And I’ve heard other accountants and tax professionals lament about the same problems.

The root cause of these problems lies with accountants and tax preparers. Many of us fail miserably at the first two quotes of wisdom above.

We as a community have allowed ourselves to become a commodity.

Most of us don’t tout our skills or our knowledge or our training. We don’t talk about the positives we bring to the table. We allow ourselves to be used and abused by clients — oftentimes unpaid or underpaid — and then complain that clients just don’t listen or just don’t value what we do. (I plead guilty to that last one a thousand times over.)

Instead, we advertise ourselves by using the generic “we can get you more deductions” or we simply say we “provide bookkeeping, accounting and tax preparation services.”

And when we talk to clients about what we’ve done for them, we always talk about rote tasks completed or hours spent.

Rarely do we talk about the value of the things we do.

Those of us who are good professionals rarely demand the respect we have earned. And then we wonder why clients seemingly don’t respect us, don’t value us, don’t listen to our advice, or jump ship the moment you breathe about a rate increase.

You reap what you sow.

And what irritates me the most about this is: I’m guilty of doing all these things. I can identify the problem and sometimes the solutions, but I have a hard time actually fixing the problem for myself.

This should be filed under Solo Practitioner Blues. (Hey … that sounds like a good title for an ongoing blog series. Hmm.)

And maybe I’m just projecting my own insecurities onto the entire industry.

So I ask — and this is open to clients and accountants alike — is my analysis sound, or am I way off-base here?

Bridging the Gap Between What Clients Want … And What They’ll Pay For

I’ve been following a discussion on LinkedIn regarding whether it’s better for an accountant to work with a business client once a emoticons-150528year at tax time, or throughout the year.

I have thoughts on this, and as I often do, I am using my blog as a soapbox to rant and rave a little.

What Clients Want

No two clients fit into the same box. Some of my business clients make six-figure income from their business but they only need to see me at tax time because their accounting needs are simple. Other business clients are side businesses or very small to where there’s not much to discuss or do during the year.

For many other business clients, their needs are such that a year-round relationship is best.

And we know that clients want a proactive approach, with year-round business advising and more out of their accountant than just punching numbers into a computer and spitting out financial statements and tax returns.

Two Observations

Everyone, from business owners to individuals who just need their personal tax return prepared at tax time, “wants” their accountant or tax preparer to be “proactive.” In my anecdotal experience, I can make two observations and one over-arching point about this.

OBSERVATION 1: Sure, people “want” a proactive approach. But it seems to me like few are actually willing to PAY for the service.

OBSERVATION 2: Sure, people “want” a proactive approach. But so many times it seems like I’m beating my head against the wall, giving advice that is not actually taken or acted on.

Time and again, I will give the advice people say they want. And then they go off and do the opposite of what I advised them to do.

I just recently had to fire a business client, in part, for this very reason. Wanting my advice (the client did pay for it, at least!) but then never acting on that advice. All the while, the owner would complain that no one was helping solve the problems he was having with his business.

There were other issues with that particular client. But when the time came for me to make a decision about our relationship, the client had dug a deep hole because I had given detailed advice multiple times that was never acted on.

OVER-ARCHING POINT: First of all, this doesn’t really apply to ALL clients. It doesn’t even apply to “most” or a “majority” of clients. But it happens often enough that I notice it and feel compelled to go all “dear diary” here on my blog.

And it might seem like I’m blaming or lashing out at clients in this blog post. But I’m not.

The fault mostly lies with accountants. We have sowed our own seeds here.

More on that in part 2.

Image from PixaayBay by OpenClips

S-Corporation Compensation Revisted

In May I wrote about a friend of mine who owns an S-corporation and who received bad advice from his CPA regarding the salary rules for S-corps.

My friend’s corporation took in about $25,000 of gross income and netted about $10,000 after expenses. He drew out nearly all of that $10,000 profit for himself.

Despite what his CPA said, the IRS’s position and case law are quite clear that since he drew money out of the corporation and he provided services to the corporation he needs to pay himself a salary.

But what should the salary be? And what if the year has ended and the W-2 deadlines have passed, but the corporate tax return still needs filed?

Here are some options:

ONE: Find legitimate expenses the owner incurred, and call the draws expense reimbursements.

My friend could legitimately document his cell phone usage for business (paid out of personal funds) as well as mileage.  As long as there’s a written reimbursement policy in place, (which — shockingly — my friend DID have), he could legitimately argue that some or all of his draws were reimbursements rather than salary.

Another thing he had going for him: in his articles of incorporation, a resolution was created that specifically said that he would pay the startup costs out of his own funds and the corporation would reimburse him.

In his case, between the startup costs and other reimbursements, he was probably close to the $10,000 mark and could reasonably say his salary that first year was $0.

TWO: File the payroll forms late.

What if there were no reimbursements (or no documentation in place to justify reimbursements)? You could classify some or all of the draws as salary and file the payroll forms late and pay whatever penalties might be assessed. While this is the least desirable, it’s probably the most “right and proper” fix.

THREE: The 1099 route.

One thing I’ve done before – and it’s admittedly not “right and proper” – is to have the owner issue himself a 1099 for some or all of his draws for the year in question, and then get real payroll set up for the current year and going forward. Doing this results in the FICA taxes being paid on the owner’s personal return (in the form of self-employment tax) rather than on the corporate side. Again, not right and proper, but it’s a quick and dirty fix in a pinch.

Why an LPA?

Why did I pursue an Iowa “Licensed Public Accountant” designation? LPAs are an obscure lot, in that we only really exist in 3 states (Iowa, Delaware and Minnesota).

I was told anecdotally by another LPA in Iowa that my achieving the LPA designation makes me the 126th active LPA in Iowa. I haven’t verified exactly how many LPAs there are in Iowa but I have no reason to doubt what this person said to me.

I don’t expect the LPA designation to set my world on fire with new clients.

If the Enrolled Agent designation is the equivalent of Liechtenstein, then the LPA designation is Luxembourg.

But it does allow me to practice as a public accountant in Iowa. Indeed, I can do anything a CPA can do except for audits.

Changing World

Obtaining the LPA designation is the first step in me trying to open up more revenue streams for my firm. I don’t want to get pigeon-holed as “just” a tax preparer. While I don’t foresee major tax reform anytime soon, the fact is that Congress could always pull the rug out from the tax prep industry.

If all I do is prepare tax returns, my business is at the whim of whatever Congress does with tax law.

So I’m trying to open up two other revenue streams:

  1. Accounting services: even if income taxes were to completely go away, there’s always going to be a need for accounting services. That’s why I pursued the LPA designation and converted my tax prep business to a public accounting firm.
  2. IRS representation: there’s a lot of rhetoric from politicians about how a nationwide sales tax would make the IRS go away. But let’s be realistic — there will always be an IRS in some form because there will always be a tax system in some form. That means there will always be conflicts between taxpayers and the IRS, and there will always need to be professionals to help deal with the IRS. I am planning, in the next few years, to attend the three-year “National Tax Practice Institute” program offered by the National Association of Enrolled Agents. NTPI is an intensive program that teaches EAs the ins and outs of IRS representation.

Doing this will ensure that I have multiple revenue streams. If the tax prep stream ever goes away, I have other sources of revenue.

I don’t think tax prep will ever go away, but I do think the days of high-volume tax prep are going away. If I ran a business that depended on preparing hundreds or thousands of simple tax returns in order to survive, I’d be worried about the future. But that’s another post for another day.