Saturday, December 12, 2009

More thoughts on Rachel Porcaro

Ms. Porcaro, the Seattle hairdresser and single parent of two boys who spent a lot of money contesting an IRS audit, has been much on my mind.

By coming forward to share her story, Rachel Porcaro has put a face on the faceless millions of low-income taxpayers who have been audited in the past decade. As I noted before, the IRS feels obligated to audit so many low-income taxpayers with refundable credits because there are very high error rates on their returns, some due to deliberate fraud, and some due to honest errors caused by the complexity of the tax code (all those bed buffaloes in the tax code!)

Of course, when the IRS chooses a return for audit, they can't know for sure, in advance of the audit, whether there are errors on that particular tax return, so inevitably some perfectly compliant, innocent, honest taxpayers are going to be caught up in the audit process, which can cost a lot of time, trouble, anxiety, and money to straighten out.

According to National Taxpayer Advocate Nina Olson, many honest compliant taxpayers just give up and don't even try to defend their position.

Rachel Porcaro provides a glimpse into the burdens that low-income taxpayers determined to prove their compliance may face.

She hired a CPA/attorney tax pro, Dante Driver, to help her with the IRS audit. According to the press coverage, the IRS was initially demanding $16,000 in additional taxes, interest, and penalties for her 2006 and 2007 tax returns. After spending $8,000 in legal/accounting expenses, she managed to get the IRS to agree to a lesser figure of $1,600.

That's a lot of legal fees for a low-income single mom to be spending. Her attorney, Dante Driver, has stated that even the final $1,600 was contestable, but the legal cost of fighting any longer was just not worth it.

Did she have any alternatives?

I've been thinking a lot about the alternatives that face low-income taxpayers like Rachel Porcaro, who are audited at rates much higher than the general public. Her story makes a good case study.

What can a low-income taxpayer in her situation do when faced with an IRS audit and a demand to pay back a very large sum of money, almost as much as she makes in an entire year?

Alternative #1: Get help from her original tax preparer
The Seattle Times reported that H&R Block prepared Ms. Porcaro's original tax returns. The H&R Block website states that it will provide a substantial amount of free assistance and support to any of its customers who are audited. They will also pay for any penalties and interest that resulted from errors made by their preparers. Customers who pay the optional $30 "Peace of Mind" fee are entitled to even more support. An IRS-credentialed Enrolled Agent employed by Block will represent Peace of Mind taxpayers at their audits, and Block will also pay up to $5,000 of additional tax liability assessed by the IRS at such audits.

Hindsight is 20-20, as they say, but in retrospect, it seems that Rachel Porcaro might actually have been at least a little bit better off if she'd opted for the $30 Block "Peace of Mind" plan in 2006 and 2007. (Of course, there is a good deal of fine print on those Block guarantees, and in order to collect the penalties and interest and $5,000 per year in additional tax liability reimbursement, she would have needed to establish that it was Block's errors that created the problem, not her own errors. Arguing with a tax pro about whose error was actually responsible for the additional tax liability could be a tough challenge for typical taxpayers. Also, it should be noted that any amounts reimbursed by Block under their Peace of Mind guarantees would constitute taxable income on her next year's tax return! So, the bottom line for the Peace of Mind guarantee isn't so clear after all.)

In any case, it's understandable that Rachel Porcaro didn't pay the $30 for the Block Peace of Mind program. Back at the time she filed her 2006 and 2007 tax returns, she probably did not realize that low-income taxpayers are audited at rates much higher than the general population.

Alternative #2: Get free help from a Low Income Tax Clinic As a low-income taxpayer, Rachel Porcaro was also entitled to contact a Low Income Tax Clinic (LITC). There are 168 LITC programs located around the country, mostly at law schools. These are private non-profit programs that receive funding from the IRS to assist taxpayers in audits and other IRS legal matters. Taxpayers with incomes up to 250% of the poverty level are eligible for assistance, so Rachel Porcaro would certainly have qualified.

Fortunately, because Rachel Porcaro lives in Seattle, she is close to one of the largest LITC programs in the country, the University of Washington Low Income Tax Clinic. The clinic received a $91,000 IRS grant this year, the largest such grant awarded in the country. The University of Washington Low Income Tax Clinic has also benefited from the generosity of the Gates family as it is located in a modern and well-equipped building named after Bill Gates' father, William H. Gates II, someone who clearly cares a great deal about tax equity.

What are the odds that the University of Washington Low Income Tax Clinic will be able to help a taxpayer like Rachel Porcaro?

Not very good.

According to the Brookings Institution EITC database of IRS statistics, Rachel was just one of out of 154,000 low-income taxpayers in the greater Seattle-Tacoma-Bellingham area served by the clinic who filed a tax return claiming EITC in 2006. Using figures from Nina Olson's 2007 Congressional testimony, we can estimate that 2.5% of those EITC tax returns were selected for audit.

That means that there were 4,000 other low-income working taxpayers like Rachel Porcaro whose returns were audited in the Seattle area last year.

The University of Washington runs the only low-income tax clinic in the greater Seattle area (Seattle-Tacoma-Bellingham metropolitan area). According to their website, "During 2008, the clinic handled 132 cases through the IRS administrative process and 67 cases in the United States Tax Court."

So the University of Washington assisted less than 200 taxpayers in 2008, and surely not all were EITC taxpayers. The clinic director mentions, for example, assisting senior citizens, who also need tax help but who typically would not be included in the EITC statistics since they rarely claim it.

Even if all 200 University of Washington cases had been EITC cases, that means that about 5% of the low-income EITC taxpayers like Rachel Porcaro whose returns were selected for audit last year got free help from the only LITC in greater Seattle.

So where does that leave Rachel Porcaro and the overwhelming majority of the EITC audited taxpayers that the clinic can't serve? Unfortunately, their remaining options are not very good. According to a recent study published National Taxpayer Advocate Nina Olson, the vast majority of low-income taxpayers go to their audits without any legal representation.

Alternative #3: Do-it-yourself approachRachel Porcaro could have tried contesting the audit on her own, but she's a hairdresser, not a tax expert. A hairdresser going into an IRS audit probably feels very much like she's in a David vs. Goliath situation.

Even TaxGirl Kelly Erb, an experienced tax lawyer who used to work for the IRS as an auditor herself, felt "that it was a "completely different feeling"" when she was preparing for her own audit recently.

It is, I must say, a completely different feeling.

For those of you who have never been audited, let me advise that the experience isn’t fun. The requests for information can be somewhat overwhelming – especially for a small business. Our bookkeeper has spent days and days putting together charts and reports. We’ve been printing out ledgers and bank account statements and desperately looking for supporting documentation. It’s all part of the examination process.

If an experienced tax lawyer like Kelly was daunted by her audit, how do you think a hairdresser like Rachel Porcaro would feel? Especially if the IRS is demanding $16,000 in taxes and penalties from someone making $10 per hour cutting hair.

National Taxpayer Advocate Nina Olson recently published a study showing that low-income taxpayers who go to an audit without representation are twice as likely to come out of the audit with negative results (i.e., losing their EITC and/or owing additional tax) as those who have legal assistance.

As noted above, Rachel Porcaro wound up hiring a very expensive CPA/attorney and spending $8,000 in fees to contest the IRS audit.

Such professionals are very expensive--and few of them specialize in the kind of tax law that applies to low-income working taxpayers like Rachel Porcaro.

Billing rates for attorney/CPAs can run hundreds of dollars per hour.

According to the press coverage, Rachel Porcaro made $10 per hour cutting hair at SuperCuts.

At that rate, it would take her 800 hours of cutting hair to pay off the legal bills run up during her audit.


  1. Rachel tried to get help from Block first, but they refused to help. Anyone relying on Block's "Peace of Mind" product should read the contract very carefully. IMO it protects Block as much as or more than the taxpayer.

    Rachel was going to go the DIY route, but her father strongly advised her not to go to her audit alone. IMO that was very good advice.

    The reasons the fees were so high is the IRS applied the "support test" under Section 152(c)(1)(D) to the EIC in two of the three Notices of Deficiency. Although Code Section 32(c)(3)(A) specifically excludes the support test for purposes of the EIC, it took two separate written Requests for Appeal, many telephone calls, emails and letters and five months to get the IRS to change their position. Since the IRS position was not substantially justified, we also prepared a written request for costs under Code Section 7430.

    Most taxpayers and many tax "professionals" would not have recognized the IRS's error. I believe most low income taxpayers would have (1) paid, (2) gone bankrupt, or (3) been driven permanently out of compliance. However, if Rachel or another tax pro had recognized the IRS's error, they might be able to get the required help from the Taxpayer Advocate or a low income tax assistance program.

    If we can't recover fees from the IRS undere Section 7430, we will have to write off the vast majority of our fees.

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