This is another installment in a series of articles meant to keep members from making the same mistakes that have proven costly to their competitors. This article will deal primarily with Title 31 AML exams and everything they entail.
So, you got your letter from the IRS. It is either a form letter #4479 (precious metals BSA exam) or a form letter #4313 (MSB BSA exam). Either way, you will be going through a Title 31 exam, the purpose of which is to determine your level of awareness of, and compliance with, the BSA and the laws that regulate your type of business. There are two types of exams here, the first of which is correct for you if you are strictly a precious metals dealer and you do NOT perform any Money Service Business (MSB) services like money order sales, wiring of funds, currency exchange etc. If this is you, and you got the other letter, you need to notify the examiner and explain you are not an MSB. This won’t stop the audit, but it will minimize the scope.
The letter will have an attachment known as a 4564 which is a document request. If you got the MSB letter in error, then you will need to get clarification from your examiner as to what documents you will now need to produce since the list is substantially shorter for non-MSB’s. You will be asked to produce copies of your AML program, your business risk assessment, training materials, independent audit reports, and lots of internal paper (bank statements, sales receipts, purchase records, supplier lists, invoices etc. for a 6-month period they will identify. Remember the first installment where we discussed the requirements of an AML program? All those items are on the top of the document request list. This is why you need an AML program at least 6 months prior to receiving the exam notification.
The day of the exam, you will be greeted by the examiner and asked to provide several answers to very simple questions as they start the process. Lots of “how do you do this”, and “how long have you” or “have you ever” etc. and then the fun begins. You will be asked to provide a piece from your showcase and then provide the source for it. The examiner may pick the piece, or they may ask you to go grab one. It is critical here that you pass this part of the exam or your Title 31 exam may morph quickly into a Title 26 Tax audit.
Sourcing means being able to identify the source of the item. Where did it come from or who brought it into the store? Was it a default? A buy? Did you purchase the piece from Stuller? Where exactly did the item come from? Any vague answers here will not pass muster and they will keep digging. If you use any type of bin or bucket method with your scrap, then you have exposure to a very thorough IRS exam. For example, if the majority of your jewelry inventory has “inventory” tags that do NOT correlate with how the item came into your possession you are at risk. If you can’t identify the person or company that sold you the item, you are at risk. Why? Because you can’t then prove where it came from or how much you paid for it. This is the IRS after all folks. Do you see how this can escalate quickly? It is highly recommended that all precious metals items in showcases are tagged with inventory numbers that allow you to fully source the items.
If the IRS agent thinks for half a second that you are hiding anything, whether through naivete or blatant actions, then be prepared for a long visit indeed. The additional time it will take to change how you price your inventory and enter it into your system is minimal compared to that tax audit I can guarantee you. This goes back to the whole illusion piece I always talk about. If in very short order the illusion is presented to the IRS agent that you can source every single piece, then they will move on. If, on the other hand they get the feeling that you can only source a few pieces, then they will react accordingly.
Now, once you get past the scary part, the next piece can be done off site, either in the CPA’s office or a meeting room somewhere. This is where all the documents from the request letter will be examined. In reality the process goes the same here as it did back at the store. They will ask for a few documents and will observe your ability to answer how your paperwork is done. How do buys make it onto the paperwork? How does that get to the IRS eventually? While many owners want to hide from the IRS and let others handle their exams, this could be a huge mistake. The person who can provide the fastest and clearest responses with regards to the paperwork should be in the room. It is also highly recommended that you have a professional in the room as well to help with the question and answer process as it relates to the AML components. Your CPA will NOT be the best person for this function unless they have training in AML processes. On the other hand, the AML professional is of no help if the audit becomes a Title 26 audit.
The exam covers a 6-month period, but really the examiner will start with the first 3 months and will only go further if they feel the need to do so. If you are good at answering questions quickly and thoroughly, the chances are good that you will be asked to forward a week or two of records to the examiners office for them to use in writing their report and they will head off to their next appointment. It will take up to a couple of months to get your results back, and a short notice with the words “no findings” printed on it is your best possible outcome.
Bottom line here is that you deal in precious metals and cash. The combination of these two items is a quick path to money laundering and also tax evasion. Regulators assume neither but are looking for both. What illusion are you sending them? When you get the letter do you start stalling right away and postponing the exam date? How do you think that looks to the examiner? Do you immediately get the copies requested by the examiner sent to their attention in the time frame they have set forth in the document request letter? What does that tell them about your program? What impression are you sending to them about your compliance with your responses? How will that impact the attitude they enter your business with?
A normal exam should not take more than 2-3 hours. The examiners that I have dealt with are all very personable and are indeed helpful. They are also thorough. They do not ask yes or no questions. They are pros at what they do just like you are. Treat them well and they will respond well. Patronize them and you are in trouble. Nobody likes to be patronized. Do NOT try to sit through one of these audits without representation. Much like taking a trusted friend or family member to difficult doctor appointments, it is important to have good representation at an exam. You will miss critical elements due to your nervousness which is perfectly normal. It is why you need someone there to help you answer correctly and to listen for things you don’t know you should be listening for. If you are prepared, you will do just fine. You are either proactive here or reactive. Proactive wins the day. Every. Single. Time.