Orange Country, CA Income Tax Evasion Defense Lawyer & CPA

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Income tax regulation and enforcement in the United States is constantly shifting.  This state of flux can create uncertainty and land an otherwise honest, responsible taxpayer in hot water with the federal government.  However, by ensuring that you understand the implications of various income tax violations, you can help prevent audits, eggshell audits, reverse eggshell audits and criminal tax investigations from happening, even when you least expect them.

The IRS and Department of Justice often take extremely aggressive measures where income tax evasion is suspected. If you are being charged or investigated for attempting to defeat or evade your income tax payment or assessment, you could be facing a felony criminal tax conviction & record, tens or hundreds of thousands of dollars in fines & restitution, and years in prison.

With so much at stake, you need professional support and aggressive legal representation on your side. At The Tax Law Offices of David W. Klasing, have an Orange County income tax evasion lawyer represent you, and offer you the combined legal and financial acumen of tax attorneys and accountants. To schedule a confidential case evaluation, call our law offices at (800) 681-1295 today.

When Can You Be Charged with Tax Evasion?

In order to understand the grounds for tax evasion charges, you need to understand how the offense is defined. Also referred to as “attempt to evade or defeat tax,” income tax evasion essentially means that a defendant took deliberate actions to try and avoid paying his or her full tax obligations. However, in accordance with Section 7201 of the Internal Revenue Code, there are actually two subcategories of income tax evasion:

• Willful attempts to defeat or evade tax assessment. The IRS reports that in many cases, the taxpayer will file a false return containing inaccurate information or falsely claim deductions that are not actually applicable. This is not the same as an attempt to avoid paying the tax — it’s an attempt to prevent tax obligations from being accurately assessed in the first place.
• Willful attempts to defeat or evade tax payment. In contrast to evading assessment, evading tax payment means that while the taxpayer’s obligations have already been established, he or she avoids actually paying those obligations by concealing their assets or accounts.

While these two subcategories have subtle differences, you may have noticed that both contain the term “willful.” This is very important because, to prove that a defendant evaded or attempted to evade tax obligations, three critical components must be established. As the Criminal Tax Manual states, “To establish the offense of attempting to evade and defeat a tax, the government is required to prove beyond a reasonable doubt the following three elements.” These three elements are:

1. The defendant owed a “substantial income tax” in addition to that which was actually declared on his or her income tax return.
2. The defendant “made an affirmative attempt” to evade or defeat the assessment or payment of tax.
3. The defendant’s actions were “willful,” i.e. deliberate. The IRS states that any “voluntary, intentional violation of a known legal duty” is sufficient to fulfill the willfulness requirement.

Fortunately for defendants, the burden of proof falls upon the prosecution in these sorts of cases. Defendants are not required to call upon witnesses or to provide any evidence of their own.

What is the Crime of Tax Evasion?

Under federal law, tax evasion is also referred to as an “attempt to evade or defeat tax.” It involves deliberate attempts to cheat the system and pay lower taxes by underreporting income, claiming deductions for which you are not eligible, and other acts involving false or misleading information on your returns that would lead to a purposefully understated tax assessment. Generally speaking, there are two subcategories of tax evasion: willful attempts to defeat or evade tax assessment and deliberate efforts to defeat or evade tax payment. This occurs when a taxpayer evades collection of taxes that have been legally assessed.

Is Tax Fraud a Felony?

Tax fraud is the broad term that is used to apply to a litany of tax crimes.  Conversely, charges of tax evasion are always felonies.  You can typically separate whether a tax code charge will be felonious by determining whether the government is claiming that there was intent to violate the tax code.  Still, if you are charged with tax fraud, you should always consult a tax attorney to determine what specific charge you are facing.

Willful Attempts to Defeat or Evade Tax Assessment

This category refers to actions taken to purposely / willfully avoid or understating taxes being assessed against you in the first place, rather than not paying taxes already assessed. It can include actions like failing to disclose all sources of income on your returns, underreporting your income from a specific source, reporting inaccurate information on your tax returns, or claiming deductions or credits for which they are not eligible. For example, if you are mainly employed by a salon but also do haircuts outside of the salon as a side business, and you fail to report the income from your side business on your tax returns, you could face this type of evading charge.

Willful Attempts to Defeat or Evade Tax Payment

Unlike willful attempts to defeat or evade assessment, this type of evasion case stems from conduct after your taxes have already been assessed. If you try to conceal your assets, sources of income or financial accounts to avoid paying your obligations, that would qualify as this type of criminal tax behavior.

How Can a Tax Lawyer Assist Me with My Tax Evasion Case?

As stated above, the best time to contact a criminal tax defense lawyer for help is before you are facing criminal tax charges. First and foremost, we can help you reconstruct your records and file your tax returns accurately and entirely in the first place. If you have already filed inaccurate returns but the IRS has not yet opened an audit or criminal tax investigation, there are several voluntary disclosure programs with varying eligibility requirements that can keep you from facing the most severe criminal penalties. At the Tax Law Offices of David W. Klasing, our experienced voluntary disclosure attorneys can help you figure out which one of these programs, if any, is best for you.

If you have already been charged with evasion or any other tax crime, a skilled criminal tax defense lawyer can try to work out a deal with the prosecutor for your charges to be downgraded or dismissed in exchange for you paying what you owe, usually plus interests and fines. The burden of proof in this type of case is on the prosecution to prove beyond a reasonable doubt that you willfully made an affirmative attempt to evade or defeat the assessment or payment of taxes. There is no tax crime, including evasion, of which you can be convicted if the prosecution cannot prove that you acted willfully, meaning that your conduct was not just a careless mistake or error.

This high burden of proof can be helpful to our lawyers before trial, not just during a potential trial. We can use it as a bargaining chip, especially if their case is weak. Overall, to get a better deal for you, perhaps one where your criminal charges will be dismissed. If we cannot get a dismissal, we may be able to get a deal where you plea to a lesser charge or where you plead guilty in exchange for a lenient sentence recommendation from the prosecutor, which the judge will almost always follow. Of course, if you do not wish to take a deal, our skilled trial lawyers at the Tax Law Offices of David W. Klasing are ready to fight for a not guilty verdict at trial.

What About California-Specific Tax Agencies?

You can also be audited and referred for criminal prosecution for tax evasion by California state tax agencies. The three major ones are the California Franchise Tax Board, which handles state income taxes, the California Employment Development Department, which handles state payroll taxes, and the California Department of Tax and Fee Administration, which handles state sales taxes. Many agencies’ audits and criminal tax charges come from referrals they received from the IRS as a sort of piggy-back investigation. Sometimes, however, they can independently conduct their tax evasion investigations for California-specific crimes.  I have also seen multi tax agency task forces set up to after common issues like Zapper software.

Each of these agencies has similar definitions of tax evasion to that of the IRS. However, there are some critical differences in how these cases should be handled and the agencies’ processes. If you are concerned about tax evasion related to actions on your state sales, income and employment taxes, reach out to an experienced California tax lawyer like those at the Tax Law Offices of David. W. Klasing, and we can walk you through your potential options.

What Are the Penalties for Evading Tax Payment or Assessment?

It’s important to understand that income tax evasion charges are extremely serious and should absolutely never be ignored. If you are facing these charges, or if you have concerns about the results of an IRS tax audit or IRS criminal investigation, it is imperative that you consult with an experienced tax attorney right away.

Evading or attempting to evade tax obligations is a felony. Pursuant to 26 U.S. Code § 7201:

Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.

Keep in mind that the above penalties pertain only to criminal charges, and even the civil consequences can be very harsh. Civil consequences can include a massive 75% penalty on any assessed income tax, plus interest on the penalty.

What is the Statute of Limitations for Tax Evasion?

A “statute of limitations” is the legal time limit on when the government can bring charges against someone who they accuse of a crime.  Note that this is different than the IRS’ “10-year-rule,” which only pertains to enforcement and collection of tax liability.

In order to determine what the statute of limitations may be in a particular tax case, you will need to determine whether the charges levied are civil or criminal.  Civil tax crimes have no statute of limitations, meaning the government can bring the case whenever they want and go back to the dawn of time once they suspect fraud has occurred during an open tax year.

The statute of limitations clock will typically start when the noncompliance began.  However, depending on the crime and the nature of the noncompliance, there is much legal dispute about when the clock begins.  For instance, courts have decided in some cases where intentional deceptive acts were taken before the act of filing, such as falsifying tax documents, that the clock begins at filing rather than the creation of the documents.  Courts can determine that the statute of limitations may restart each time that a noncompliant act occurs. Beware of the concept of the last affirmative act.  If the last affirmative act of a tax crime occurs during an open tax year, the crime can be prosecuted if the statute of limitations has already run.   For example, lying to an IRS agent regarding a tax crime that occurred 10 years ago can bring that crime into the prosecution window as the lie covering up the crime is the last affirmative act of that crime.

If You Are Facing Tax Evasion Charges, Call Our Skilled Orange County Attorneys Today

Whether you are facing tax evasion charges at the federal, state or local level, our experienced tax attorneys at the Tax Law Offices of David W. Klasing can help you mitigate the damage and bring your case to the most positive possible resolution. We will leave no stone unturned, serving as your fearless advocate and fighting to get the charges against you downgraded or dismissed. To schedule a consultation, call us at (800) 681-1295 today.

Orange County Tax Law Offices

For any of your tax planning compliance and controversy needs in Orange County, contact the Lawyers at The Tax Law Offices of David W. Klasing today. Our experienced Tax Lawyers offer a reduced-rate consultation on new cases or engagements. Call (949) 681-3502 or 800-681-1295 or contact us online today to schedule a reduce rate initial consultation at our Orange County tax law offices, or at one of our other convenient locations across Southern California.

How should High Risk Tax Audits be Handled by Criminal Tax Defense Counsel?

When undetected badges of fraud underly a taxpayer’s income tax, or domestic or foreign information reporting returns that are caused by a criminally motivated taxpayer’s willful noncompliance an “eggshell tax audit” is at issue. The initial audit representative for the taxpayer, who is frequently the preparer, frequently exhibits one of three extremely dangerous behaviors: complacency, ignorance, or even complicity in the improper conduct.

It ordinarily is extremely advantageous for the taxpayer to find new representation (i.e. criminal defense counsel) where the original preparer is possibly implicated in the taxpayer’s noncompliance.   See video below for more information:

If you cheated on your initial return and are now the subject of an audit, your original preparer may be your worst enemy. Because tax accounting and preparation account for most of the CPA, EA, or CTEC certified preparer’s income, they have a strong incentive to preserve their standing with the tax authorities at the expense of your reputation if need be. They will frequently be forced to serve as the government’s first witness to prove that you willfully filed a tax return using false or even worse, incomplete financial records. Additionally, there is no attorney-client privilege while dealing with the original preparer, so whatever you say to them could be used against you in a court of law in a subsequent criminal tax prosecution.

The taxpayer must not to give the agent purposefully false or misleading information, or tell lies especially where obvious badges or fraud surface, the agent or his or her manager communicates their intention to refer the case for criminal tax investigation, it becomes clear that a Fraud Technical Advisor (FTA) is being consulted and the case is being developed for criminal tax investigation, or there are obvious signs that a referral to CI has been made. In a civil tax audit, an advocate may have more room to engage in open discussion whereas in an eggshell audit, a non-adversarial Approach is taken in order to decrease the likelihood of a criminal tax referral. Some important strategies include:

• Shield the client from direct interaction with the agent to avoid criminal tax admissions and damaging testimony,

• Avoid the presentation of evidence as to the taxpayer’s willful behavior and knowledge,

• Dictate the amount and content of any cooperation offered,
• Attempting to downplay any rising suspicions regarding the client’s underlying culpable conduct. 

See video on the warning signs on when and audit has gone criminal here: 

 

It is very difficult to fully explain a refusal to provide incriminating documents or respond to incriminating questions without invoking the client’s Fifth Amendment privilege against self-incrimination or taking other actions that would undoubtedly raise the agents’ suspicions and ensure the involvement of an FTA or outright handoff to another party.

Additional tax audit methods include; offering the least amount of documentation evidence and refraining from opposing audit adjustments in instances when the audit involves undiscovered criminally culpable tax evasion activity. If it is not financially advantageous to the client to close the case as agreed and the culpable conduct is not the type that will potentially be discovered by the audit review, appeal, or litigation personnel, it is ordinarily preferable to move the case toward a timely notice-of-deficiency to reduce the chances of additional civil examination or of a referral to CI. After the 90-day letter is sent, the client should be advised once more to consider the benefits of timely paying the tax, interest, and penalty claimed, without submitting a tax court petition, to reduce further criminal exposure in the following appeals and litigation process, as opposed to attempting to negotiate lower tax, penalties, and interest liability via the appeals process.

An eggshell audit has the potential to reopen a closed tax period. If the IRS starts a second audit, formal notification procedures must be followed before a taxpayer can be re-examined. Additionally, this procedure requires specific internal consent, which must be obtained. Whether or not CI is active in the background, reopening indicates that the government has received evidence that fraud has occurred. As a result, it is generally recommended to assume that CI will eventually become engaged in a reopened civil tax audit.

How to survive audit when I cheated on return being audited?

Most audited taxpayer’s have been selected for audit through the IRS’s discriminant scoring function system. The Discriminant Function System (DIF) score rates the potential for change, based on past IRS experience with similar returns. The Unreported Income DIF (UIDIF) score rates the return for the potential of unreported taxable income. IRS personnel screen the highest-scoring returns, selecting some for audit and identifying the items on these returns that are most likely to need review.

The most commonly audited issues are: the total amount of gross income reported; the trade or business deductions taken; bad debts; net operating losses; capital loss carry forwards; depreciation; and capital expenditures.

If you are not entitled to certain deductions you took, or if you have understated your income, it is best to consult with a tax defense attorney at this point. From the initial IRS correspondence, your tax counsel should also be able to identify which type of audit it is, as it could be a correspondence audit, office audit, or field audit.

Be aware that “Anything you say can and will be used against you,” and not just by the IRS but also in a court of law.  When you are confronted with an audit in these circumstances, you do not want to “do it alone.” It is best to use a middleman, specifically a dual licensed Tax Defense Attorney & CPA. The second piece of advice is finding out what kind of audit you are working with. The three fundamental types of tax audits are correspondence, office, and field audits.

The IRS may conduct a correspondence audit if its computer system detects an error in your return and notifies you in writing. The computer might believe that you underreported your income (thus understating your tax liability). Did you mistakenly write $27,000 instead of $72,000 on your tax return? You might have listed too many dependents. The IRS is writing to let you know that you owe extra money in taxes, whatever it may be. The IRS may or may not be right regarding the points brought up. These reports are being automatically produced via occasionally flawed computer programming.

Most correspondence audits are automatically generated by IRS computers comparing data the IRS receives from third parties with the income and deductions you reported for a calendar year. For instance, the IRS receives 1099Ks that detail the amount of debit and credit card payments made to your business, K-1s from flow-through entities you have invested in (S-Corps, Partnerships, and LLCs), 1099-Misc income, and 1098 mortgage interest statements. A correspondence audit will generally occur where the IRS computer cannot establish that you have accurately disclosed these sources of income or deductions reported by third parties.

A correspondence audit is ordinarily far less serious than an office audit. This is due in part to the greater likelihood of an office audit giving rise to an interview, the six-year statute of limits for a 25% understatement of income, and the open-ended statute of limitations for fraud that the IRS discovers, or the taxpayer admits. The likelihood of being charged with a tax crime increases dramatically any time the IRS requests a meeting with you to address specific discrepancies in your tax return(s). The IRS may request that you bring a list of specific documents, books & records to an in-person meeting and be ready to discuss them. The IRS will try to verify how much of your reported gross & net income is accurate (the IRS often looks to see if you understated your gross income). They will question how you arrived at your gross receipts figures and whether they line up with your bank accounts, point of sales receipts, cash receipts journal and other sales records. They will inquire about cash payments made for costs or cash receipts for income, as well as regarding your payroll documentation for employees and 1099 reporting on independent contractors. You should be prepared to provide evidence for any of the more significant deductions you claimed.

The Field Audit is by far the most extensive and intrusive of the three types of audits. In order to find unreported income or inflated deductions, the IRS will visit your home or place of business, examine the premises, and interview the taxpayer and several employees of the taxpayer’s business. Your financial accounts and business records will be carefully examined by the agent. Most of the time, IRS officers are well-trained and can identify practically all “typical” tax fraud strategies and associated “badges of fraud.” The IRS will examine all deductions, audit capital gains or net operating loss carryforwards, and much more. The IRS field agent assigned to a field audit is frequently a CPA as well.

Understand that keeping inaccurate or unorganized documents is not in the best interests of taxpayers. Even though it might be challenging to “piece them together” to grasp the larger picture, if the IRS becomes unclear, realistically speaking, it will just assert a tax due by disallowing all claimed expenses and treating all deposits to any account you control as income, affectively shifting the burden of proof to you to establish otherwise requiring you to “piece together” the data yourself. Simply put, the strategy of keeping shoddy records to hide tax fraud will ordinarily work against a taxpayer. Even if your business deductions are legitimate, you must “prove them or lose them.”  Our firm will ordinarily recommend performing a reconstructive accounting in this scenario to get you through the audit. 

If you cheated on the initial, or worse still, revised, position being audited by the IRS, FTB, EDD, or BOE, you do not want to go through the audit process yourself. Our offices will strive to prevent the taxing authorities from securing criminal tax admissions rather than just proof of careless accounting and tax preparation, by placing a barrier between you and the auditing agency. 

Complex tax and accounting issues are expertly handled by the IRS, FTB, EDD and BOE 24 hours a day, 7 days a week. Contrarily, most taxpayers are focused on maintaining or expanding their businesses and enjoying their personal lives. Working with an experienced tax defense lawyer who defends you while utilizing the attorney-client privilege, which shields your discussions, is the ideal option if you want to level the playing field. The chances are exponentially moved further in your favor if you are fortunate enough to hire a tax defense attorney who is also a CPA and has close to 30 years of expertise in tax controversy representation and has earned a master’s degree in taxation.

You should strongly consider hiring the Tax Law Offices of David W. Klasing to represent you if you ever come under audit by any California or Federal Taxing authority for any of the reasons listed above. Hiring our firm can mean the difference between successfully avoiding the worst case scenario of potentially having to serve jail time, face the loss of professional licensing, paying a $250,000 fine, and covering the cost of your prosecution if you are found guilty of a tax crime because you chose to represent yourself or hired the wrong tax defense representative, or the best case scenario, of having to pay the correct amount of income taxes in the year under audit that you were legally required to pay in the first place.

What is an eggshell audit? 

When the tax returns under audit contain substantial understatements of income, material overstatements of deductions, or credits were claimed that the taxpayer was not entitled to, an eggshell audit is at issue. Consequently, the taxpayer’s originally reported tax liability was substantially less than it would have been had they submitted a true accurate and complete tax return. These mistakes could be the result of carelessness, which would incur a 20% negligence penalty on any additional income tax discovered to be owed during an audit, or they could be the result of willful intent, which would suggest underlying criminal issues with the tax filings under review and incur a 3-to-5-year prison sentence and/or a 75% fraud penalty.

What is a reverse eggshell audit?

A reverse eggshell audit is an industry term that describes a clandestine criminal tax investigation disguised a civil audit. It is a criminal tax probe that effectively passes as a civil audit. Reverse eggshell audits typically start when a civil examiner or revenue agent refers a case to a fraud referral specialist, who’s sole job it is to evaluate and develop the case for potential transfers to an IRS special agent in the criminal investigation (CI) division. In some cases, the CI division may also request that a civil auditor be assigned to an ongoing clandestine criminal tax investigation. In a reverse egg audit, the taxpayer and maybe their representative are the ones who are uninformed of a taxpayer’s potential criminal tax liability at the commencement of the civil audit.

Why is a reverse eggshell audit extremely dangerous for a taxpayer?

Parallel investigations are increasingly common as a result of changes in IRS internal policy. Reverse egg shell audits provide several advantages for the government, including the ability to use the numerous investigative tools available to the civil auditor, such as third-party subpoenas to witnesses and banks, without the taxpayer having hired criminal tax defense counsel and invoking the due process clause, 4th amendment privilege against unreasonable searches and seizures, and utilizing the 5^th amendment right against self-incrimination, which are the most significant constitutional protections available to taxpayers.  In stark contrast, taxpayers that are directly approached by the IRS criminal tax division typically will hire criminal tax defense counsel rather than blindly and naively moving forward with their original tax preparer who is likely to be government witness number one against the taxpayer should the case ultimately get criminally prosecuted. 

An IRS Civil Revenue Agent’s primary concern is typically supposed to be determining the correct civil tax liability for the relevant tax years, as opposed to an IRS Special Agent from the Criminal Investigation Division, who is primarily concerned with gathering evidence to demonstrate criminal tax violations have occurred and to prove it at trial, if necessary. IRS CI Special Agents are required to advise taxpayers of their constitutional rights against self-incrimination and of the taxpayer’s right to have an attorney present during an interview. This is done through a non-custodial reading of the taxpayer’s rights, which states that anything they say may be used in a subsequent criminal prosecution for tax crimes. The initial special agent interview will often be delayed, by the enlightened taxpayer, while the criminal target obtains appropriate criminal tax defense counsel. 

While the civil examiner is still gathering data and conducting interviews, initial contact is typically made through a civil revenue agent to prevent alerting the investigated taxpayer that they are the subject of a criminal tax investigation. This stops the unsuspecting criminally investigated taxpayer from protecting themselves.

Therefore, reverse eggshell audits present a significant risk to less experienced taxpayers who frequently tragically choose to work with less experienced and frequently less expensive tax representatives (i.e., CPAs & E.A.s), who lack attorney client privilege and frequently have a conflict of interest with the client because they prepared the original returns at issue and thus need to protect their own reputation with the taxing authorities. CPAs and E.A.s will often sacrifice a client’s reputation to spare their own and are not trained nor qualified to counsel the client on invoking their constitutional rights that knowledgeable criminal tax defense attorneys would have raised if they had cause to believe their client was under criminal investigation for a tax crime. These less experienced and qualified tax professionals frequently lack the expertise necessary to determine whether an eggshell audit is underway, and they will often collaborate with the auditor without question since they believe the taxpayer is only complying with a civil audit.

Reverse Egg Shell Audits and Parallel Investigations occasionally involve collaborating federal organizations (such as the SEC, FBI, DEA, ABC, and the DOJ) as well as the IRS’s civil and criminal investigation divisions. The IRS’s eggshell or reverse eggshell audit could potentially support a criminal case of the cooperating federal agency.

Revenue officers frequently conduct their own personal reverse eggshell audits, in violation of IRS internal guidelines, and continue to collect data even when they have discovered obvious indications of tax fraud. The revenue agent’s continued criminal tax investigation without giving the taxpayer and their representative the proper notice that any additional statements made, and information provided will likely be used in a subsequent criminal tax investigation and prosecution violates the taxpayer’s constitutional rights which would most likely be invoked by criminal tax defense counsel if the taxpayer was approached by the CI division directly and given a reading of their rights.

Warning signs there has been a criminal referral from an IRS civil audit

A criminal referral is likely to occur during a civil audit if the civil auditor develops strong suspicions of fraud. Common fraud indicators are known as “badges of fraud, “and include:

• Failure to disclose revenue,
• Fraudulent accounting understanding income and overstating deductions
  • A technical fraud advisor will be contacted automatically if more than $10,000 in income is omitted in a single year to develop the case before passing it on to the criminal investigation division.
• The use of two sets of books,
• Fabrication of records
• Signs before a criminal referral takes place include:
  • A civil audit may be suspended before completion and referred to CI for criminal investigation without the knowledge of the taxpayer.
  • If the Revenue Agent becomes unreachable
  • If the Revenue Agent focuses heavily on the “intent” of the client in taking positions on a return or mentions a pattern of non-compliance on several tax returns.
  • If the Revenue Agent prepares a net worth analysis or subpoena’s bank records
  • If the Revenue Agent gathers an excessive amount of documentation or makes excessive copy requests
  • If the Revenue Agent makes undisclosed contact with third parties
  • If you receive a summons for records or for an appearance
  • If more than one revenue agent, or an attorney from chief counsel’s office and a court reporter attend a client interview
  • When an appointment is canceled or the civil auditor fails to return taxpayer calls.
  • If An officer of the IRS wearing a gun and a badge approaches you and reads you something similar to a Miranda warning (this is likely an IRS special agent from the criminal investigation division of the IRS). If you are ever faced with one, demand that counsel be present for your questioning and remain silent until they arrive.

What are effective tax defense counsel’s goals in an eggshell audit?

Criminal tax defense attorneys will strive to keep the client from making any criminal admissions during an eggshell audit to attempt to prevent the initiation of a criminal tax probe. In a reverse eggshell audit, they seek to uncover any ongoing criminal tax investigation and possibly limit the taxpayer’s cooperation to shield the taxpayer from criminal tax prosecution by upholding their rights under the constitution against unreasonable searches and seizures and self-incrimination. Criminal tax defense lawyers who represent a client in an eggshell audit frequently aim to accomplish four objectives:

1. To try to handle a civil investigation in a manner aimed at avoiding the start  of a criminal tax investigation.
2. Avoid being subject to civil fraud penalties under IRC 6663, which carries a 75% fine on any percentage of an underpayment attributable to fraud.
3. Reduce additional tax, fines, and interest to a minimum.
4. Reduce the amount of tax years that are audited.

How are the 4 goals and outcomes 1 and 2 best obtained?

Only experienced criminal defense counsel or CPA’s should be representing you in an egg shell audit. Specifically, such CPA’s or counsel that perform via a Kovel agreement (United states v kovel,296 F.2d 918 (2nd Cir. 1961). This will render the client and the CPA communication as attorney client privilege. Because the IRS’s criminal investigation unit’s main goal is to deter the general public from committing tax crimes by criminally prosecuting a sample of taxpayers caught cheating, the criminal tax defense attorney’s main concern in an eggshell audit is to persuade the examining agent not to refer the case to the CI unit of the IRS.

Once a revenue agent has indicated fraud during a civil audit, after consulting privately with his manager and receiving approval, the revenue agent will secretly consult with a “fraud referral specialist” who works closely with the auditor to develop a “fraud development plan” in order to document the affirmative acts and firm indicators of fraud in order to refer the case to the criminal investigation team. The criminal tax attorney must know when to continue working with the civil revenue agent and when to advise their client to stay silent as the client could be admitting to tax fraud or by making statements that the auditor later reveals to be false, which would amount to a felony in and of itself because it is illegal to lie to a federal agent. The tax attorney’s priority is then to work closely with the civil revenue agent and advise the client to refrain from over-sharing information in order to further prevent incrimination. 

In an eggshell vs a reverse eggshell audit, differing goals are achieved by asking the auditor if there is an ongoing criminal tax investigation, grand jury inquiry, related technical fraud advisor, or associated special agent of the IRS criminal investigation division. This line of inquiry may be required in an eggshell audit to safeguard the taxpayer, but it must be asked in a way that won’t make the auditor suspect that the client’s fact pattern contains evidence of tax evasion. This line of questioning can assist in protecting the taxpayer if a reverse eggshell audit is ongoing because it will notify counsel of the existence of a covert criminal tax investigation or if the revenue agent provides more information than a tacit denial of the existence of a parallel criminal tax investigation.

To protect the taxpayer in an eggshell audit, inquiring about any ongoing criminal tax investigation, Grand jury inquiry, related technical fraud advisor, C.I.D agent working clandestinely with the civil auditor can actually protect taxpayer against a future reverse eggshell audit by exposing an ongoing covert criminal tax investigation. 

United States v. Tweel, 550 F.2d 297 (5th Cir. 1977) which determined that any auditor fraud in a reverse eggshell audit must be tacit rather than affirmative in order for subsequently acquired material to be suppressible, is one of the best safeguards for criminal tax defense attorneys. Therefore, any later-obtained documents and statements are suppressible in a subsequent criminal tax prosecution if a revenue agent lied when he or she claimed there was no concurrent criminal tax investigation ongoing, no technical fraud advisor was involved with the audit, or they continued their civil investigation after detecting enough signs of fraud to be legally required to stop the civil examination and refer the case to IRS law enforcement.

The United States v. Tweel determined, that the IRS could not knowingly continue to extract implicating evidence and build a clandestine criminal tax case against an unsuspecting taxpayer in an ongoing civil audit. Thus, rendering later collected taxpayer information inadmissible. 

It is also possible to argue that Toussaint, (United States v. Toussaint, 456 F. Supp. 1069 (S.D. Tex. 1978) makes all subsequent information and taxpayer comments inadmissible and thus suppressible after the revenue agent’s initial identification of signs of fraud. Contrary to case law, the evidence gathered by the auditor will not be deemed inadmissible in a subsequent criminal tax prosecution under Caceres (United States v. Caceres, 440 U.S. 741 (1979)) and will not be suppressed if the auditor’s conduct is merely a deception that violates IRS procedure but does not violate the U.S. Constitution or applicable federal statutes. Due to the division in federal case law, a range of auditor conduct has been created that necessitates quantifying acts made by auditors, which are frequently covert and difficult to ascertain. 

A taxpayer’s constitutional rights and privileges may be permanently lost if a taxpayer’s representative fails to raise the appropriate issues at the stage between an eggshell audit and its culmination into a reverse eggshell audit. The future prospects of the taxpayer can be determined by examining the issues brought to light by the representative during the transition of an egg-shell audit and ultimately into a reverse eggshell audit. 

The following steps should be taken to reduce the dangers of an eggshell audit:

• Prevent the taxpayer from making any criminal tax admissions by limiting their involvement in the audit,  or closely observing a client interview, only having first thoroughly prepared the client for the expected questioning they will receive. 
• Attempt to relocate any taxpayer interview originally scheduled to take place in the personal residence or the business establishment of the taxpayer to prevent the potential for an economic lifestyle analysis in their home and avoid hard to control auditor access to the client’s business records and employees at their business premises. Do not have the client or his or her employees present at any required business tour.
• Create thorough records (or portfolio) of any damaging positions taken by the agent. Create a thorough record that affectively highlights the position taken by agent assigned. Subsequent to the examination, a FOIA request (Freedom of Information Act) may be submitted to obtain a copy of the record created by the agent including his or her notes.
• Clients must be thoroughly advised of the importance of not making false statements, as they can lead to obstruction charges in a criminal tax investigation and can constitute a felony even during a civil audit.
• Have the client plead the fifth under the proper conditions. Failing to use the taxpayer’s Fifth Amendment rights, when necessary, can be much more detrimental to a taxpayer in the event of a Criminal investigation because the auditor’s evidence of fraud will be used against them. Moreover, the 4th and 5th Amendment safeguards may be waived in whole or part if an auditor gives incriminating remarks or facts.

What are possible outcomes of an eggshell audit?

Eggshell audits often have three possible outcomes:

1. The Revenue Agent does not find criminal tax issues since they do not believe the modifications and misstatements made during the audit were prompted by fraud.

2. The Revenue Agent finds inaccuracies that they believe may have been the result of fraud, but due to strong legal representation, the Agent is inclined to keep the matter within a civil investigation.

3. The Revenue Agent refers the matter to a technical fraud specialist to develop the case for transfer to the Criminal Investigation unit of the IRS (CI) for further investigation and potentially for criminal tax prosecution. 

Is it your right to know why you were selected for examination?

 Section 3503 of the IRS Restructuring and Reform Act of 1998 (RRA 98) mandates publication of the standard criteria and methods for selecting which taxpayers to examine. If the taxpayer is being examined or his attorney inquires as to why the taxpayer was selected for examination, the IRS examiner must respond with as much accuracy as feasible without divulging prohibited information.

What can I do to prepare for an audit?

Audits tend to focus on credibility, so be as organized as possible and be prepared to substantiate any receipts, invoices, sales records, canceled cheques, credit card statements, bank statements or other documents. If you have any missing records, immediately arrange duplicates. To be more credible, take original business documents with you which can be copied and returned to you. Do not discuss tax returns not currently being audited.

From the first encounter, gaining the auditor’s trust is critical. Be punctual. Dress professionally, just as you would for a courtroom appearance. Make good eye contact and be aware of your body language. Try to convey the idea that “you have nothing to hide” while being at ease and attentive. Even when you’re angry or disappointed with the auditor, show them respect and remain polite at all times. Be civil and agreeable if you disagree with the auditor. Avoid having a discussion or, worse still, a disagreement with the auditor. Keep your speech concise and give yourself enough time to consider before you speak. Use fewer words and avoid talking about tax returns that are not currently in question. Always remember that providing more details than requested could widen the scope of the current investigation. 

Earning the trust and respect of an auditor could be the determining factor in how your audit resolves. Treating the meeting as a courtroom appearance best represents the attitude that needs to be in place to best represent oneself. Being punctual, dressing professionally and an overall attitude conveying confidence can facilitate a good result. 

IRS TAX AUDIT CHECKLIST:

• Gather all relevant and necessary business records
• Be organized
• Be courteous and professional
• Establish credibility
• Be prepared to substantiate
• Limit the scope of the audit
• Avoid inadvertent disclosures
• Know your rights

What is an IRS civil examination?

These audits can take a variety of forms, depending on the individual or business entity and how intricate their tax return is. The correspondence audits usually only entail written correspondence with the IRS and ordinarily only addresses very basic concerns including how the taxpayer supported a specific deduction(s). The IRS may disallow the relevant deduction if the person does not submit the necessary documentation.

Another, typical audit more commonly used for individuals and business entities are “regional office exams” Where a taxpayer, or business entity’s representative is questioned in person at a local IRS filed office along with a comprehensive review of the books, records and supporting substantiation for the return in question.  

Field audits typically take place at the taxpayer’s home or place of business. The Revenue Agent will typically conduct an interview and then thoroughly go through the taxpayer’s books and records. The IRS field auditor typically conducts a much more comprehensive examination than an “office auditor” because of their higher level of training and experience and a higher level of perceived compliance risk including a higher likelihood that the IRS suspect fraud may have occurred. 

 How does the IRS decide which tax returns are audited?

 The IRS in a Fact Sheet from 2006 outlines how several criteria are used to choose returns:

1. “Potential participants in abusive tax avoidance transactions”.
   Because the IRS receives information when it audits other taxpayers who are involved in abusive tax avoidance transactions, related taxpayers’ returns are also chosen.
2. “Computer Scoring.”
   Every tax return is statistically given a “score” based on the Service’s previous audit experience with returns of a similar nature. The IRS statistically assesses each return for the possibility of a reportable income deficiency using its “automated discriminate function system,” via sophisticated software for the possibility of unreported income. The highest scores of these returns, (the higher the score the more likely the return is to understate taxable net income) are then automatically chosen by the IRS for an audit. The software will flag the three areas of the return most likely to contain misstatement.  The auditor will examine those areas first and if indeed misstatement is detected, will expand the scop of the audit to the entire return at issue and often will examine additional tax years.