Word AUDIT composed of wooden letters. Money, papers, pen in the background. Closeup
If you are facing a tax audit or other enforcement proceeding motivated by alleged non-compliance with FBAR, FBATCA, cash or other reporting laws or other foreign transactions, you probably already know that you face a difficult situation. The IRS and Department of Justice are focusing on all forms of offshore tax evasion and will not hesitate to launch an audit or tax enforcement action when signs of fraud are present. IRS agents and attorneys from the DOJ’s Tax Division are often extremely aggressive in their inquiries.
If you simply go back to your accountant or attempt to face the challenge alone, there are an array of legal pitfalls that can impact your ability to mitigate the consequences you face. For one, many taxpayers do not realize that different discovery and production rules can apply when foreign financial documents are at issue.
Every Tax Audit Begins with a Request for the Taxpayer’s Tax and Financial Documents
Many taxpayers aren’t necessarily aware that every audit begins with the IRS agent or investigator seeking relevant documents and information from the taxpayer. Generally, these requests for information from the taxpayer will proceed under the rules set forth for Information Document Request (IDR). One exception to this general procedure is that when requests for documents are for foreign financial documents, then Formal Document Request (FDR) procedures outlined in Code Section 982 can apply. Under Code Section 982, the IRS is permitted and authorized to request “the production of foreign-based documentation.”
When Do Formal Document Request (FDR) Procedures Apply in the Context of Offshore Tax Fraud?
IRC Section 982(c)(1) authorizes the IRS to issue a formal document request (FDR) to any taxpayer to request “the production of foreign-based documentation.” Rather than thinking about the FDR procedures as replacing IDR procedures, it is more useful to think of FDR as a broadening of the powers the IRS already has under normal circumstances. However, the keys as to when FDR procedures apply is when foreign documents are involved and normal procedures have already been utilized and have failed to produce the requested materials.
That is, formal document request procedures only become available after the normal procedures have failed. Taxpayers can expect for their audit matter to begin with a standard request for documents. If this procedure fails, the taxpayer will receive a formal request for documents. Under IRC Section 982(a)(1) the FDR must contain:
- Guidance regarding the time and place where production of relevant documents is required.
- Guidance setting forth why previous attempts at production were insufficient.
- The materials requested under the formal procedures.
- What will happen to the taxpayer if he or she fails to respond and produce the materials.
As to the last point, many taxpayers do not realize that the failure to comply with a formal request for documents can materially affect their likelihood of success.
What Happens if I Fail to Respond to a FDR before a Tax Audit?
If you have failed to respond to an FDR, there are consequences intended to discourage delay and obstruction by taxpayers. Perhaps the most serious consequence a taxpayer can face for failure to comply with an FDR is the exclusionary rule.
The exclusionary rule is set forth in IRC Section 982. Under the rule, taxpayers who have failed to “substantially comply” with the requests can be barred from later introducing these materials as evidence. Some courts have interpreted this mean that the taxpayer must show that he or she has engaged in reasonable, good faith efforts to produce the documents. In other words, merely claiming that you were unable to produce the documents without providing justification is unlikely to provide protection from the exclusionary consequences. However, taxpayers are understandably and justifiably hesitant to turn over documents that can be used as evidence to support a criminal tax conviction.
Facing an Offshore Tax Audit?
If you are facing a tax audit or criminal tax proceeding, it is therefore essential to proceed strategically. Whether it is prudent to resist or comply with early informal requests for documents is a determination can only be made on a case-by-case basis after a careful review of the facts and circumstances. To discuss your tax situation, call the Tax Law Office of David W. Klasing today. Mr. Klasing is a dually certified attorney and CPA with more than two decades of experience. To schedule a reduced-rate initial consultation with a member of our team of tax professionals, call (800) 681-1295 today.
