When an underlying issue(s) in a single or set of tax or information reporting returns exists that is caused by yet undiscovered taxpayer’s potentially criminal noncompliance, this gives rise to what is called an “eggshell tax audits” where such documents come under examination. The taxpayer’s original audit representative (often the preparer) can often be clueless as to the misconduct or may have been complacent or worse yet a participant in the misconduct. Consequently, once counsel is engaged to provide representation in an eggshell audit, damaging evidence may already be in the record. One of the first decisions is to decide whether to involve the original preparer in the representation or not. Sometimes it may be advantageous for criminal defense counsel to remain unknown to the examining agent and prop up the client’s preparer where the preparer is not him or herself potentially criminally culpable, is not viewed by defense counsel as being in a position to provide damaging testimony obtained in a non-privileged client relationship and the exposure is seen to be slight. Where the original preparer is potentially culpable for the noncompliance (client indicates preparer advised the culpable conduct at issue) it is ordinarily advantages to replace the original representative with an arm’s length CPA or criminal defense counsel themselves depending upon the circumstances and the clients financial pain tolerance. Defense counsel may decide to throw the original preparer under the proverbial bus where the preparer advised the culpable conduct but this is not without risks.
Where counsel choses to stay off the radar they will often closely follow the audit proceeding and secretly advise the client and their representative how to advantageously communicate with the civil auditor. Extreme diligence must be utilized when counsel decides to have a third party interact with IRS personnel. The third party must be counseled to avoid making misleading or intentionally incomplete statements or exponentially worse yet, flat out lying to the agent. This is hard to control from a distance especially with a professional whom you are unfamiliar with.
If this strategy is chosen, Defense Counsel’s covert participation should not be disclosed to the government agent unless obvious and unrecoverable badges or fraud surface, the agent or his or her manager communicates his or her intention to refer the case to for criminal investigation, it becomes obvious that a Fraud Technical Advisor (FTA) is being consulted and the case is being developed for criminal investigation, or there are obvious signs that a referral to CI has already been made.
Providing counsel in an Eggshell audit is vastly different that that provided in a civil examination. In civil tax audits representation, counsel is much freer to function as an advocate and openly engage the agent to clarify facts and make legal arguments in an adversarial manner where necessary. Eggshell audit representation dictates a non-adversarial strategy in an attempt to mitigate the chances of a criminal referral. The primary strategies are to shield the client away from direct interaction with the agent to the extent possible to avoid criminal admissions and damaging testimony, avoid the presentation of evidence as to the taxpayer’s willful behavior and knowledge, and dictate the amount and content of any cooperation offered, all while attempting to downplay any rising suspicions regarding the client’s underlying culpable conduct. All of these strategies are extremely challenging, as they are art and not science. It incredibly hard to properly, ethically and fully explain an unwillingness to provide damming documents or respond to damming questions without invoking the client’s Fifth Amendment privilege against self-incrimination or take other actions which would certainly send the agent’s suspicions through the roof and almost guarantee the involvement of a FTA or outright handoff to CI.
In an eggshell tax audits, additional strategies involve providing the absolute minimum documentary evidence possible and to avoid contesting audit adjustments in areas where undisclosed culpable conduct is at issue during the audit. The best-case scenario is to get to a position where the case can be expeditiously agreed to and closed civilly. If it is not financially advantageous to the client to close the case as agreed and the underlying culpable conduct is not of the variety 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 in order to reduce the likelihood, and associated exposure, of additional civil examination or of a referral to CI. After the 90-day letter is issued, the client should once again be counseled to weigh the advantages in timely paying the tax, interest and penalty asserted without filing a tax court petition in order to reduce further criminal exposure in the subsequent appeals and litigation process versus attempting to negotiate lower tax, penalties and interest liability via the appeals process.
An eggshell audit can materialize in a rare manner where a previously examined tax period is reopened. If the IRS opens a second examination, formal notification procedures are required before a taxpayer can be re-audited. This procedure also requires specific internal approval. A reopening may or may not involve CI in the background, but a reopening implies the government is in receipt of evidence that suggests fraud. Consequently, a reopened civil tax audit should usually be viewed as a condition highly likely to draw CI’s eventual potential involvement.