Now that the tax filing deadline for 2017 (to file 2016 tax returns) has passed, taxpayers throughout the nation have already had the pleasure of tracking down W-2s, 1099s, and various documents showing income and other financial transactions. But what if a taxpayer decided that he or she would simply skip reporting 1099 income from one or more sources because when he or she put the numbers into his or her preferred tax program, it generated a huge tax bill?
The reason a 1099 may generate a seemingly huge tax burden is two-fold. First, recipients of 1099s are typically independent contractors meaning that they are also responsible for self-employment taxes typically paid by the employer. Second, their failure to withhold taxes throughout the year means that the full amount of tax is now due. To make matters even worse, the taxpayer or taxpaying entity may even have had a quarterly reporting obligation and additional penalties and interest have been included in calculations.
Omitting a 1099 is almost a sure way of drawing an audit because the IRS will compare the total revenue reported on the taxpayer’s schedule C to the total of the 1099’s issued on the taxpayer’s social security number or the business’s EIN number. This process is also carried out where 1099’s are issued to an entity a taxpayer owns an interest in. If the net income reported is less than the sum of the 1099’s at least a correspondence audit is almost guaranteed as this process is automated and the audits are computer generated. If a large amount of unreported income is detected a criminal investigation could be sparked as any underreporting of income of at least $10,000 will require the auditor to consult with a technical fraud specialist whose sole job it is to work up civil audits for potential referral to the IRS criminal investigation division. The mission of the criminal investigation division is to investigate and criminally prosecute tax cheats.
An audit by the IRS can take a number of forms. It may be conducted by mail which is known as a correspondence audit. Typically, correspondence audits are ordered for matters where there was a relatively minor mistake or error. However, correspondence audits can reveal much more concerning issues. Audits may also be conducted in-person in the field at the taxpayer’s home or office. In general, audits conducted at a taxpayer’s home or business can mean that agents are looking for assets and other signs of fraud. Clearly, this is not a good sign and in-person audits typically suggest a major tax problem.
When you face an audit and know or strongly suspect that you evaded taxes, intentionally filed a false return, or engaged in any array of fraudulent behavior you face a scenario that is known as an “eggshell audit.” The general concept of an eggshell audit is a taxpayer is selected for an audit when he or she knows that there are major improprieties or tax crimes in his or her files. The taxpayer thus faces a situation where he or she does not wish to unnecessarily disclose or tip the agent off regarding underlying fraud. However, the taxpayer must simultaneously worry about making false or misleading statements in furtherance of the fraud.
In certain scenarios, such conduct may create new grounds for obstructing the administration of the U.S. Tax Code. However, the worst-case scenario a taxpayer could face is that false statements made to an auditor are viewed as a “last affirmative act of fraud.” The presence of a last affirmative act of fraud could give rise to felony tax evasion charges under a Spies’ evasion theory. Tax evasion can be punished by a federal prison sentence, fines, restitution, and interest.
If you merely made a tax error, you still face the potential for tax consequences. While it is significantly less likely that you will face criminal tax proceeding, there is always the possibility that agents will misinterpret statements, transactions, and behavior. In other circumstances, mistakes of law can produce harsh, inequitable outcomes.
Thus, even if you think your matter is a routine audit, it is important to have a representative who can set ground rules to prevent the audit from going off the rails. Similarly, it is important to proceed professionally and tactically to reduce the odds or confusion or inadvertent disclosures of damaging information. Furthermore, working with a tax attorney from the outset means that you will be well positioned for tax litigation or a tax appeal if it is required.
If you are worried about a tax crime, do not return to your original preparer regardless of whether it was an accountant, a CPA, or a company that produces tax software. Their interests in protecting their professional reputation are now in conflict with your desire to mitigate any potential criminal prosecution. Some accountants may even provide evidence to an auditor that their client provided inaccurate, incomplete, or misleading information that caused the tax understatement to protect their reputation.
Furthermore, the accountant-client privilege is not widely recognized. Even where it is recognized, it is unlikely to protect criminal disclosures to the client original preparer from discovery or subpoena. Rather, when you have concerns about potential tax crimes, work with a criminal defense tax lawyer. The attorney-client privilege is robust and can protect the disclosures you make in seeking legal advice.
The Tax Attorneys, CPAs and EAs of the Tax Law Offices of David W. Klasing may be able to help you strategically navigate a high-risk tax audit or when you are being investigated for criminal tax charges. To schedule a reduced rate initial consultation, please call 800-681-1295 or schedule online today.