Executive Education

Hiring an Attorney vs. Paying IRS Additional Taxes & Penalties: Which is More Expensive?

When you are contacted by IRS or State of California tax agencies for a tax audit, you have a choice: you can choose to pay additional taxes and penalties to IRS or state of California or you can hire a skilled tax attorney to review the government’s position and legitimacy of demanding additional taxes.

Hiring a legal representative can save you money in the long run where multiple years are involved and the government is changing an item on your tax return that will affect how you operate your business in the future.

Attorneys usually charge an hourly rate; some attorneys, however, may charge a flat fee where the audit has ended and the only issue is resolving the balance owed.

The decision to pay or hire a tax attorney may require an analysis of the costs versus the benefits of their services. If you’re facing a government tax audit, or feeling anxious about the potential liability of owing more taxes, it’s important to understand the value of the services an attorney can offer to make an informed decision.

Read on to get the information you need to assess your own situation.

What Do Tax Attorneys Do?

Tax attorneys act as your legal representative, which alleviates the need for you to speak directly to the government.  Tax attorneys analyze legal issues that allow the government to collect more taxes as well as the underlying business transactions that are in question. While CPAs and other tax professionals can also represent you before the IRS and State of California tax agencies, only tax attorneys maintain an attorney-client privilege that protects information and conversations you have with your attorney. This becomes helpful when your tax return is prepared by the same CPA who ultimately is questioned by the government as to the legitimacy of the reported transactions.

As a preventative measure a tax attorney can also:

  • Review a tax return prior to filing to ensure you are in compliance — minimizing your risk of any unwanted correspondence from the IRS in the future;
  • Help you minimize the costs of an audit from a state or federal tax agency;
  • Research legal issues to determine the legitimacy of transactions you intend to report on your tax return;
  • Resolve a tax balance you may owe.

Perhaps one of the most important services offered by a tax attorney is the legal assistance in reducing your tax balance through an offer in compromise (OIC). The OIC program is offered by the IRS to taxpayers who owe taxes but either are financially unable to pay the entire debt or can legally challenge the legitimacy of the debt.

According to IRS, the eligibility requirements for an OIC require a thorough analysis of your current and future financial ability to pay. This includes your monthly income from wages or from your business, if you are a business owner. The analysis also requires a review of the equity you have in your assets to determine if you are able to pay your taxes in full within the statutory period the government legal has to collect the tax balance you owe.

Additionally, you must be in current compliance which requires filing all tax returns and paying all current year and future taxes owed after your offer is submitted to IRS.  This includes making all required estimated tax payments for the year in which the OIC is submitted and not owing additional taxes when you file your tax return.

For 2015, the OIC success rate was just over 42%, according to the IRS Data Book. In other words, about three out of every five OICs submitted to the IRS were rejected, though the success rate has steadily been increasing since 2010.  Understanding the OIC process is vital to your decision process, because not every case is eligible to submit an OIC.

The Costs Involved with a Tax Matter

Tax attorneys normally split their fees into either a flat fees or hourly billing arrangement.

Flat Fees

Flat fees are single fixed costs for legal matters, regardless of hours spent on the case. While this might be preferential, if you want to cap your financial obligation upfront, it is a high-risk strategy for tax attorneys who may end up spending many more hours on your case then they had anticipated.  Thus, cases involving an audit and other legal issues will generally not be on a flat fee basis due to the uncertainty of the amount of time required to work on this case.

Retainer (Hourly Billing)

The most common and preferred payment method for attorneys is with hourly billing. As a client, you will pay an upfront “retainer” amount, which is kept in a attorney’s client trust account. Attorneys will bill that account according to the number of hours they spend working on your case.

The hourly cost will vary with each individual attorney. It’s up to you to analyze the strengths and weaknesses of your case (after speaking with a tax attorney) to estimate the benefit, or if you’re better off paying the IRS or State of California tax agencies. The cost of defending an audit can and do vary depending upon several factors:

1)    number of issues the government is examining;

2)    type of audit – business or personal tax return;

3)    number of years under audit.

According to the IRS Data Book, 1.2 million tax returns were audited in 2014, with the IRS collecting approximately $18 billion in assessed taxes. This brings the average tax bill per audit to approximately $15,000. That amount can fluctuate significantly by hundreds of thousands to even millions, depending on the tax years involved, the items reported on your return, whether the IRS or state of California is examining your personal business return, and the number of years under review.

At the end of the day, the question you need to assess is: will it cost me less overall to hire a tax attorney (and win the case), or to pay the government?

Tax Attorney or Tax Penalty?

At this point, you may be thinking: Are my only two options to pay an attorney, or pay the government? What if I represent myself against the IRS, and win the case without paying anyone?

Before considering the financial implications of hiring a tax attorney, consider the ramifications of trying to take on the IRS without any representation and legal experience. A study from the Cincinnati Enquirer reviewed nine legal groups from Ohio and Kentucky, and concluded that not having legal representation often led to inappropriate questioning and procedures from the IRS. So yes, you can represent yourself, but the IRS may take advantage of your inexperience in tax law, and knowledge of your legal rights, to unfairly gain an advantage in your audit.

Tax attorneys have undergone a rigorous educational process, legal training, and clearly understanding tax policy, which drives negotiations with IRS and State of California.  Additionally, tax attorneys offer the benefit of attorney-client privilege that cannot be offered by other tax professionals.

A tax attorney will fight diligently to minimize your tax liability, but remember the success rate varies case by case, given the information available to both the attorney and the IRS.

Contributed By: John Milikowsky.

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John Milikowsky
John Milikowsky represents U.S. and foreign businesses and individuals in sophisticated business transactions involving U.S. tax matters. Mr. Milikowsky relentlessly defends each client in federal and state audits and criminal investigations to protect their civil rights and provide financial security. Mr. Milikowsky is recognized in the legal and business community for his experience and knowledge in the area of taxation and financial analysis.