Surviving a Tax Audit: A Comprehensive Guide
How to Survive a Tax Audit When You Fudged the Numbers
To some taxpayers, fudging the numbers on an income tax return probably seems as American as apple pie and hot dogs.
Trust us, though: The IRS does not agree.
If you have fudged the numbers on your taxes, the chances exponentially increase that the IRS will select your return for a tax audit. The IRS uses software that scans tax returns, income records, and spending habits of taxpayers for anomalies that could indicate tax fraud.
So, if you aggressively fudge the numbers on your return, your tax return may be flagged for a tax audit and whether you realize it or not you are at risk for prosecution for tax crimes.
When contacting you by mail regarding an audit, the IRS may request to come to your home or business for the meeting. You should not agree to this meeting. IRS agents often are hoping to look at your personal property, seeing if your belongings don’t match the income level you’ve reported. This helps them build a case of tax fraud.
Instead, you may want to hire a tax attorney and meet with the IRS at the attorney’s office as part of your defense strategy or better yet, have the attorney attempt to prevent you from being interviewed at all as you cannot make criminal tax admissions if you do not speak with them.
To schedule a 10-minute call with an experienced tax lawyer to discuss a tax audit you are facing, contact the Tax Law Offices of David W. Klasing.
What is a Tax Audit?
With over 230 million tax returns filed every year, the IRS has developed computerized statistical protocols to easily identify when a taxpayer has submitted a return with potentially incorrect information. Various types of software are used to catch reporting irregularities in tax returns versus information supplied by third parties including financial institutions, individuals, and businesses. When a taxpayer’s return is flagged by the IRS, they will then determine whether they should investigate the matter, which is the purpose of a tax audit.
Depending on the information you gave the IRS, you may receive notice that an IRS agent wants to further examine the records in question. For example, evidence of unreported revenue would immediately garner the attention of an IRS examiner.
Notification of any type of an IRS tax audit will almost always be sent through the mail whether the IRS wants to conduct a correspondence or an in-person field or office audit (which have both been temporarily curtailed because of Covid 19). In a correspondence audit, an IRS examiner will request specific documents to verify selective details in your tax returns be mailed to them. As a result, a person that claims to have donated $20,000 to charities may be asked to provide documentation substantiating those donations.
If you have the information on hand, you simply need to mail it to the IRS agent in question, and this would likely be enough to resolve the audit. However, if you do not have the records to substantiate the challenged transactions or made a series of significant errors or outright cheated when filing your tax return, it is important to hire representation to limit the years and additional issues that come under audit and to ensure that the audit stays solely about money and does not morph into criminal tax exposure / prosecution. Our skilled dually licensed California Tax Attorneys and CPAs will be able to help you with this.
Receiving notice of an on-site IRS audit is an extremely stressful communication to receive for the average taxpayer. The IRS agent handling your audit will almost certainly interview you extensively regarding the positions taken on your tax returns and your ability to substantiate them. Every deposit to any personal or business account you control will be considered taxable income unless you can prove it is not. Any claimed deduction will be considered a nondeductible personal expense unless you can prove otherwise. You will face civil penalties and even potential criminal tax exposure if you cannot prove that the tax return you filed was substantially correct or be able to convince the auditor any substantial mistakes you made were in good faith and not Badges of Fraud.
Fortunately, you have located the absolute right choice to hire for legal and accounting representation for an in-person audit. The Tax Law Offices of David W. Klasing have a proven track record of providing successful audit representation for many types of industries, entity types, estates, trusts, businesses, individuals in office audits all over the state of California, the Nation and worldwide for expats and could be indispensable in getting you safely through a civil, Eggshell or Reverse Eggshell, Office Audit. We can protect you from almost everything except the proper amount of tax liability you should have paid in the first place.
IRS field audits are the most expansive, in depth and consequently high-risk examination that the agency performs. For example, the IRS agent assigned to your case will often request to meet at and tour your business or home and then will proceed to question you about possibly every line item on your personal or business income tax returns. You would absolutely benefit by working with our dually licensed California Tax Attorneys and CPAs during a field audit to make sure that your net worth and very liberty are protected to the full extent possible.
At the conclusion of any of the above audits, the IRS will come to one of three decisions:
- The taxpayer owes additional tax, civil and or civil fraud penalties, and interest to the IRS.
- All information on the tax return was correct, and the taxpayer does not owe money or is owed money by the IRS which is incredibly rare.
- Sufficient badges of fraud were identified in the audit so that the civil auditor is procedurally required to hand off the case to the criminal investigation division of the IRS for potential development of the case for criminal tax prosecution.
How to Avoid an IRS Tax Audit in California, the United States and Offshore
No taxpayer wants to be on the receiving end of an IRS tax audit. Statistics have shown that higher-income individuals are more prone to being audited by the IRS because of the complexity of their returns and likely additional tax penalties and interest to be assessed. However, limiting the amount of money you earn is probably not the solution that you want to use to avoid a tax audit. Luckily, there are some quick tips that could save you from an IRS audit in the future.
Report All Income
Reporting all your income from all sources is incredibly important. All it takes is for an IRS auditor to identify $10,000 of unreported income during an audit and they may be required to associate a civil fraud advisor into your case. This highly trained and specialized agent’s sole job is to assist the auditor in developing the audit for potential hand off to the criminal investigation division of the IRS for potential development of the case for criminal tax prosecution. If you have utilized a check cashing outfit to hide cash receipts, had checks cut to a nominee entity, failed to deposit all cash receipts /skimmed cash, did not report the revenue deposited in all of your bank accounts, reported less income than the sum of your 1099’s indicate you should have, have unreported cryptocurrency revenue of investment gains, deposited unreported revenue in undeclared foreign accounts or failed to report all of your revenue in any way you are at very high risk of facing criminal tax charges if you do not hire a properly trained Criminal Tax Defense attorney to get you through your eggshell, reverse eggshell audit without facing criminal tax and foreign reporting fraud prosecution or a civil fraud penalty.
Do Not Claim Deductions You Cannot Fully Substantiate or That Are Personal in Nature
Every deduction will be considered nondeductible personal by the auditor unless you can prove it was business related. For that reason, you must be able to prove how you paid for an expense, (by check or credit creates the best trail) exactly what was paid for via valid receipts and how what was paid for was an ordinary and necessary expense for your business. Fraudulently inflating deductions or claiming a personal expenses as business expenses, utilizing fictitious payees, and simply not being able to substantiate the expenses you claim will be viewed as badges of fraud in your audit and can lead to criminal tax prosecution. An egregious pattern of claiming deductions is a common way to raise a red flag to the IRS that there may be severe problems with your return. Getting caught attempting to support bogus deductions with forged substantiation is a sure-fire way to get criminally prosecuted for tax fraud.
Do Not Claim Tax Credits You Are Not Entitled Too
A credit is a dollar-for-dollar reduction in the tax you would otherwise owe. Fraudulently or mistakenly claiming dependents, earned income credits, business credits, education credits, energy credits etc. is another sure-fire way of drawing an audit or in egregious cases, facing criminal tax exposure.
Incorrect Employee Versus Independent Contractor Classification Issues or Failure to Remit Employment Taxes
Making a mistake or fraudulently classifying employees as independent contractors and failing to remit required employment taxes and federal and state income tax withholding are sure-fire issue that could bring a federal of state employment tax audit or criminal tax investigation your front door. When utilizing employees, make sure that you collect and remit the proper employment taxes and federal and state withholding from their paychecks. Extreme caution, especially in California following the passage of AB5, when classifying a worker as an independent contractor.
Surviving a Tax Audit
Seeking professional help from a dually licensed California Tax Attorney and CPA would certainly ease your stress about the possibility of being audited if your returns were properly filed in the first place and the documentation to support them if they happen to be audited were kept in order. Very few of our ongoing compliance clients have ever been audited because we file returns that make sense to begin with.
If you do happen to receive an audit notice and you know for a fact you cheated on the return under audit do not contact the original preparer. They are likely to be government witness number one against you if the government figures out the truth and chooses to prosecute. In addition, any you say to them can be compelled from them when they are forced to take the witness stand against you under the government’s contempt of court powers. Hire our firm to get you through the audit and make sure the audit is just about money and not criminal tax prosecution.
If you have stopped sleeping at night because you are worried that you could face criminal tax prosecution over a pattern of fraudulent returns you have filed in the past, call our office to discuss the possibility of making a domestic or offshore voluntary disclosure. We can get you a guaranteed pass on criminal prosecution in exchange for you accepting the program terms which also limit your potential civil liability.
How to Survive a Tax Audit
For years you thought that “fudging” or “playing” with the numbers to reduce your income tax obligations was a victimless crime. After all, you may have assumed that in light of the billions — or the more than $1 trillion in fiscal year 2015 – of dollars in tax revenues collected by the IRS, they wouldn’t miss a portion of your income tax contribution. Unfortunately, your assumption proved incorrect and you are now facing an audit. While most taxpayers are concerned about audits because it could result in owing significantly more in taxes, you may be particularly worried about the potential for a federal prison sentence due to tax evasion. If you cheated in multiple, subsequent years this risk only increases because it can show a pattern of noncompliance that triggers red flags for tax evasion.
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Why Was I Audited?
There are an array of reasons as to why a taxpayer gets audited. However the bulk of audits are due to automatic DIF scoring. If you fall outside of the acceptable statistical range, you will be scored according to how severe your differential is from the norm. The IRS will proceed to audit those taxpayers falling outside of acceptable ranges starting with the worst and working towards those with lesser DIF scores until the yearly audit budget is exhausted.
There are an array of other reasons why a business or an individual might raise red flags for an audit. One such reason is due to a 1099-K audit. The 1099-K shows electronic transactions processed by credit card companies, banks, and debit card processors. The IRS can compare the total income you report versus the amount they calculate from the sum of all your third-party 1099-Ks. Consider for instance a restaurant that reports $1.2 million in income but has 1099-Ks indicating just over $1 million in electronic receipts. This ratio is highly unlikely for a cash intensive businesses like a restaurant and gives rise to a potential inference that the restaurant is skimming cash or otherwise underreporting. Since a mere $10,000 of unreported income can result in referral to a fraud analyst who may decide to pass your matter to IRS criminal investigations, a scenario of this type is particularly frightening for a tax payer or a business owner.
What if The IRS Wants to Come to My Home or Business?
An IRS auditor who wants to come to your home or business often signifies a very significant problem. If they are asking to come into your home or workplace it is most likely to take a visual inventory of your assets and belongings. They may be looking for expensive art work, luxury furniture, fancy cars, expensive technical or computing equipment, or anything that would significantly inflate your net worth beyond what can reasonably be expected for your historical reported income. They may provide a cover story of “wanting to measure your home office” if you took home office deductions, but do not believe their claims. There are other means you can use to prove the information they are seeking without opening your doors to a wholesale audit of your belongings.
What if My Books and Records Are a Mess?
If the IRS agent decides that your books and records are in such a state that it is impossible for the audit to proceed, some tax payers might mistakenly consider this a good thing. Unfortunately a situation like this is only likely to create significant problems for the taxpayer and set up an uphill battle. Rather than reconstructing your records, the agent will simply assess you on any and all income that was deposited into your bank account. Next, they will disallow all expense that you claimed as non-provable. In any case, this will significantly increase the amount of taxable income you have and result in a much larger tax bill. If you wish to overturn this determination, the taxpayer must prove that stated expenses are allowable and present a set of books that can withstand significant audit scrutiny.
If the taxpayer wishes to fight the determination, reconstructive accounting by a financial professional is typically necessary. An amended tax return filing may even be necessary if the difference between the original and new return is significant. In any case, the burden of proof is always on the taxpayer. In many cases, only a reputable and experienced team of tax professionals can satisfy an auditor that whatever mess existed with the original accounting that caused the original return to be misstated, has been corrected in the revised accounting, and that ultimately the revised return position is the correct position.
What if I Know I Cheated on My Taxes and the IRS Wants to Speak With Me?
If you know that you made misstatements or engaged in inaccurate reporting methods on your taxes and have been contacted by any agency including the IRS, California Board of Equalization (BOE), California Franchise Tax Board (FTB), or the California Employment Development Department do not face the audit alone. All too often taxpayers think that they can fix their tax problems by making additional inaccurate or implausible statements to the examining agency. Other taxpayers may think that they can talk their way out of a situation. Unfortunately the taxpayer forgets that the auditor does this for a living and implausible statements made on the basis of charisma or confidence simply won’t carry the day. Rather, the taxpayer is more likely to compound their liability and trigger a criminal investigation due to the presence of one or more badges of fraud.
If the taxpayer knows that there are tax filing errors and potential improprieties on their tax form, the most prudent thing they can do is to establish a layer of separation between themselves and the auditing agent. A tax attorney can serve as a buffer and prevent the examining agent from obtaining criminal admissions from your conduct and statements. Since the most difficult element regarding criminal tax penalties for the IRS to prove is intent, taking the taxpayer out of the equation eliminates the possibility that you may provide the evidence their audit is designed to find. Aside from circumstantial evidence of intent, the only direct evidence they can obtain that you intentionally cheated will come from your own mouth.
Circumstantial evidence is the only other way the IRS and other agencies can prove criminal intent regarding taxes. Circumstantial evidence includes the information contained in your tax records and books, things your employees may say, and evidence that may arise from a third-party. Luckily, circumstantial evidence is typically seen as less persuasive than direct evidence. While you cannot control the circumstantial evidence the IRS may find, you can prevent providing direct evidence to agents and auditors. Remember, no matter how smart you are, you are outgunned and fighting against the resources of an entire agency.
What Can I Do if I am Facing an IRS Tax Audit?
First of all, if you are facing or suspect an IRS audit, you should not discuss your behavior with anyone. Do not tell your neighbor, best friend, or even your priest that you think you may have cheated on your taxes. These individuals have a financial incentive to report you and serve as a government witness through the whistleblower bounty program.
Furthermore, if you are facing an IRS tax audit, the type of tax professional you seek assistance from is extremely important. Some taxpayers and businesses owners are tempted to go back to their original accountant. Others may consider speaking to a CPA. However, this decision is fraught with consequences that can exacerbate your situation further should the IRS or state tax agency decide to subpoena your accountant or CPA and compel them to testify under the threatened penalty of contempt of court. In other words, what you tell an accountant or a CPA is generally unprivileged and subject to discovery in court. That means anything you disclose to these individuals regarding possible criminal intent can come out in court. Since you do not want to create government witness #1 against you in a criminal tax matter, you must take a different approach.
In contrast to the weak and unevenly recognized accountant-client privilege, attorney-client privilege is robust and recognized in all state and federal courts. Nearly anything that you disclose to a tax lawyer is protected and confidential and cannot be used against you provided that the attorney-client privilege is maintained and protected. The attorney-client privilege permits a taxpayer to speak frankly regarding mistakes, error, and other acts so that the tax attorney can prepare a defense to the audit techniques and other tactics you are likely to face. Furthermore, if you work through a tax attorney, consulting accountants can receive derivative attorney-client privilege and confidentiality through what is known as a Kovel letter.
When Do I Need an Experienced Tax Lawyer and CPA?
David W. Klasing is a dual credentialed attorney and CPA with Master’s degree in taxation. David is also a former public accounting auditor who managed a staff of 15 while dealing with sophisticated audits including private placements, IPOs, employee benefit plans, non-profits and for profit entities. David understands the auditing methodology and process utilized by the IRS. Often times, he can anticipate and prepare for where the auditor is attempting to take the investigation before the auditor actually takes it there. Using his educations, training, knowledge and experience he can stay several steps ahead in the audit process and mitigate the civil and criminal consequences you may face.
If you are facing an IRS, FTB, BOE, or EDD audit going it alone is simply not a prudent course of action. You may compound your liability and furthermore, these agencies share information and may trigger a subsequent audit by a different agency. Contact the Tax Law Offices of David W. Klasing by calling 800-681-1295 or contact us online.