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A civil tax audit is a frightening prospect for any taxpayer in San Francisco. If the auditor discovers that you made accidental errors in calculating and paying your tax liabilities, the IRS may assess additional taxes, in addition to charging interest and applying civil penalties. But while these outcomes are daunting enough, the situation can get even worse. If, at any point during the audit process, the auditor finds indicators that you took intentional actions to avoid paying taxes, the case can be worked up by a fraud referral for a possible hand off to the IRS’ Criminal Investigation Division (IRS-CI). That means you could be criminally prosecuted by the U.S. Attorney’s Office, potentially resulting in prison time, costly fines, IRS restitution, and damage to your business or career. In fact, if CI opens an investigation, they have a 92% conviction rate.
If you are currently under audit, have been chosen for an audit, or have been contacted by the IRS to act as a witness or to provide information regarding an audit or criminal investigation of another taxpayer, you should contact a criminal tax audit defense lawyer right away. Only a tax defense lawyer affords you the protection of the attorney-client privilege, which does not exist between taxpayers and their accountants or tax preparers. Do not make the mistake of the very professional you turn to for help being forced to become a witness against you! At the Tax Law Office of David W. Klasing, we have more than 20 years of experience providing audit and criminal tax defense representation to both individuals and businesses, including more than a decade of experience conducting audits as a CPA, which gives us an invaluable insider perspective on how the IRS builds cases against California taxpayers. We are here to control the damage, defend your reputation, and vigorously uphold your constitutional rights.
Warning Signs a Civil Tax Audit is Becoming a Criminal Investigation
IRS audits, or “examinations,” are generally civil matters that are conducted by IRS auditors or “revenue agents.” Regardless of whether the auditor is conducting a field, office, or correspondence audit, his or her primary goal is to determine whether the information you reported to the government was truthful and accurate – and, where appropriate, to assess additional tax, interest, and penalties accordingly.
While audits are normally civil at the outset, they can become criminal tax matters if referred to IRS-CI. The question for taxpayers is, what sorts of issues could cause the case to be referred? And what are some of the warning signs that a “normal” audit is transforming into a criminal investigation?
During the IRS audit process, the auditor will review your financial records, such as bank statements, in addition to interviewing you and/or your representatives. Throughout this process, the auditor will be on high alert for “badges of fraud” that could indicate criminal activity, i.e. willful attempts to circumvent tax laws. There are dozens of badges of fraud that revenue agents are trained to detect, including:
- Attempting to bribe, avoid, or threaten the auditor
- Destroying financial records
- Failing to file tax returns
- Failing to report income
- Hiding assets by transferring them to other people or entities
- Improperly claiming or overstating deductions
- Keeping multiple sets of books
- Not being able to provide a feasible explanation for assets, purchases, or deposits that greatly exceed your reported income
For a full list of IRS badges of fraud, refer to Internal Revenue Manual 25.1.2 (Recognizing and Developing Fraud), particularly IRM 25.1.2.3 (Indicators of Fraud).
Even if your case is referred to IRS-CI for an IRS criminal investigation, you may not be aware of it until it is already too late, and you have already provided incriminating information. That is why it is so important to contact an IRS tax audit lawyer right away once you are notified of an upcoming examination.
The IRS will not necessarily provide you with explicit notification that your case is now subject to criminal investigation. However, there are several tell-tale signs that a criminal investigation may be developing, including the following:
- The audit abruptly ends, and you cannot seem to reach your auditor afterward.
- The auditor seems especially interested in specific transactions or records during the audit.
- The auditor wants to know about why you took certain actions, rather than how or when you took them. This indicates that the auditor is attempting to determine your intent.
- You are “ambushed” without notice by an agent of the IRS-CI, otherwise called a “special agent” (not to be confused with a revenue agent, or auditor), who arrives at your home looking for information. Unlike revenue agents, special agents wear badges and carry firearms.
- Your bank notifies you that financial documents have been subpoenaed or summoned.
Eggshell Tax Audits and Reverse Eggshell Audits
In discussions of types of tax audits, the focus often falls on field audits (audits at your home or business), office audits (audits at an IRS office), and correspondence audits (audits that take place via mail correspondence), as these are the three main categories of audits performed by the IRS. Less often discussed – but even more dangerous for taxpayers – is the subject of “eggshell audits” and “reverse eggshell audits.”
Any type of audit, including a correspondence, field, or office audit, can be an eggshell tax audit. The term broadly refers to any audit in which there appears to be a “material” overstatement or understatement, such as a material overstatement of deductions, or a material understatement of income. While there is no explicit dollar or percentage limit as to what exactly constitutes a “material” misstatement of information, the term generally refers to a significant or substantial error – possibly criminal, possibly attributable to mere negligence. That is what the audit aims to determine. Your attorney will take every possible measure to prevent the investigation from becoming criminal, fight to prevent the imposition of penalties, and work to hold penalties to a minimum if imposed.
The term “reverse eggshell audit” refers to a scenario in which a criminal investigation and civil audit are occurring simultaneously. In most cases, these investigations begin when an auditor forwards the case to a Fraud Referral Specialist, whose function is to assess and prepare information for special agents from IRS-CI. The auditor will not inform you that you are the subject of a criminal tax investigation, making it critical to work with a skilled tax evasion defense attorney who can endeavor to protect your legal rights and mitigate any potential harm throughout the process.
Criminal Penalties for Tax Evasion, Failure to File
When a person is charged with a non-tax offense, such as burglary or assault, the defendant is normally tried and penalized under the laws of the relevant state. By comparison, tax cases are generally based on federal statutes, namely the Internal Revenue Code (IRC). You may see tax statutes written out as, for example, “IRC § 7201” or “26 U.S. Code § 7201.”
That particular statute provides the definition of tax evasion – and sets forth the penalties. Tax evasion, or tax fraud, is legally defined as a willful attempt “in any manner to evade or defeat any tax,” be it state or federal income taxes, payroll (FICA) taxes, sales and use taxes, gift and estate taxes, or any other taxes for which the taxpayer was liable. The criminal penalties for tax evasion are up to $100,000 (or $500,000 for corporations) and up to five years in federal prison. Other common criminal tax charges that can arise from or during an audit include:
- 26 U.S. Code § 7202 – Willful failure to collect or pay over tax
- Fines – Up to $10,000
- Prison – Up to 5 years per count
- 26 U.S. Code § 7203 – Willful failure to file return, supply information, or pay tax
- Fines – Up to $25,000
- Prison – Up to 1 year (for misdemeanor violations), up to 5 years (for felony violations) per count
- 26 U.S. Code § 7205 – Fraudulent withholding exemption certificate or failure to supply information
- Fines – Up to $1,000
- Prison – Up to 1 year per count
- 26 U.S. Code § 7206 – Fraud and false statements
- Fines – Up to $100,000
- Prison – Up to 3 years per count
- 26 U.S. Code § 7207 – Fraudulent returns, statements, or other documents
- Fines – Up to $10,000
- Prison – Up to 1 year per account
For a more detailed overview, refer to the IRS Tax Crimes Handbook.
San Francisco Criminal Tax Defense Attorneys for IRS Eggshell Audit Defense
A criminal tax charge is a serious matter that could leave you both indebted and incarcerated and in certain circumstance can end your career as an act or moral turpitude. Criminal fines and restitution can cost you thousands or millions of dollars, while prison sentences often stretch on for years.
An egg shell audit is a civil audit in which the return(s) under examination contain a material understatement of income, material overstatement of deductions or credits were claimed that the taxpayer was not entitled to, the end result of which was that the taxpayer showed less tax liability than they would have owed had a true, complete and accurate return been filed. These errors can be caused by mere negligence, which may result in a 20% negligence penalty on any additional income tax found to be owed under audit, or via willful intent which would indicate underlying criminal issues with the tax filings under audit, which may result in 3 to 5 years in jail and or a 75% fraud penalty.
If you are under audit and are concerned about the potential for a criminal tax investigation to develop, you should immediately contact the Tax Law Office of David W. Klasing for assistance. For a confidential, reduced-rate consultation, contact us online today, call our San Francisco office at (415) 287-6568, or call our main office at (800) 681-1295. Please note that in-person meetings at our San Francisco office are by appointment only.
