How to Survive a Tax Audit as an Aerospace Entity When You Blatantly Cheated on your Federal (IRS) or California (FTB) Income Taxes, Payroll Tax (IRS/EDD) or Sales Taxes (CDTFA)

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The aerospace industry is one of the most regulated in the world, so it should come as no surprise to you that it is frequently a target of tax audits by the IRS and California taxing authorities. In order to ensure that you or your enterprise does not fall on the wrong side of the law, it is crucial that you are aware of all of the intricate issues involved in audits of the aerospace industry.

If you failed to file tax returns for one or more years or stated something in your returns without a valid basis, we advise you to seek legal guidance from a dually California licensed Tax Attorney and CPA immediately. At the Tax Law Office of David W. Klasing, we are California tax attorneys and CPAs with over 20 years of combined experience providing award-winning service to aerospace companies that are based or do business in California. The tax services that we offer include IRS audit defence, California state audit defence, criminal tax defence, and audit appeals representation. We can also assist you or your business with tax compliance, tax planning and, personal or business tax preparation, and bookkeeping and accounting services tailored to the aerospace industry. In addition to being a dually licensed California Tax Attorney and CPA, David Klasing is a private pilot with an instrument rating with deep connections in the California General Aviation Community.

Potential IRS Audit Issues

The IRS’s focus on the aerospace industry can be gauged by the fact that the IRS had included the aerospace industry in its Industry Specialization Program. The IRS National Office’s Industry Specialization Program was designed to increase the effectiveness of IRS examinations involving specialized industries by improving the identification and development of issues and by ensuring the consistent treatment of issues nationwide. For the aerospace industry, there was a nationwide industry coordinator and a specialist within both the examination and appeals functions of the IRS. Therefore, you can rest assured that the IRS and California taxing authorities know all the tricks of the trade, and it would be a mistake for you to assume that you can hoodwink them in any way.

If you took a position on a tax return that could not be supported upon an IRS or state tax authority audit, eggshell audit, reverse eggshell audit, or criminal tax investigation, there are several agencies that may select you or your business for an audit. These agencies are the Franchise Tax Board (FTB), which is authorized to conduct California personal and corporate, partnership, and LLC income tax audits; the California Department of Tax and Fee Administration (CDTFA), which audits aerospace businesses with sales and use tax or special tax compliance issues (such as jet fuel taxes); and finally, the Employment Development Department (EDD), which, as its name suggests, is responsible for California employment and payroll tax audits.

If you have undertaken any of the actions listed below, you run the risk of alerting the examining agent that something is not right and triggering a federal of California criminal tax investigation:

keeping a double set of books;

making false entries or alterations;

making false invoices or documents;

destruction of books or records;

concealment of assets or covering up sources of income;

handling of one’s affairs to avoid making the records usual in transactions of the kind; and

any conduct, the likely effect of which would be to mislead or to conceal.

Please be aware that where one wilfully fails to file and also engages in affirmative acts of evasion, the government may upgrade the failure to file, a misdemeanor charge, to felony tax evasion.

The “Eggshell” Civil Tax Audit

You should be aware that eggshell audits carry within them the potential for a criminal referral. An eggshell audit arises if you have filed one or more false returns in previous years and are subsequently selected for an audit. Although the exam is a civil one, it can potentially lead to criminal tax charges. We pride ourselves on our ability to know what needs to be done when a taxpayer is going through an eggshell audit.

During the audit, we will monitor the audit proceeding and advise you on how to properly interact with the examining agent. Extreme care must be taken when you are interacting with the agent. We ensure that you do not make incomplete statements or misrepresentations of fact to the agent, even if you believe them to be true.

Please be aware that representation in the eggshell audit is unlike the routine civil examination where your representative might function freely, engaging the agent to offer facts, legal argument, and precedent. In the eggshell audit, we will implement a less adversarial strategy, seeking to diminish the chance of a referral to a criminal investigation. The principal techniques we employ are to keep you away from the agent, avoid discussion of your knowledge and intent, and control the extent of cooperation without arousing the agent’s suspicions. As you can imagine, little of that is easy because it is difficult to properly and fully explain a refusal to provide some documents or respond to some questions without invoking the Fifth Amendment privilege. However, that is where our decades of experience comes in. Having represented thousands of clients, we have nailed down the strategy and are able to walk this fine line without any issues.

The Mistake of Using Your Accountant/Original Preparer

If you know you cheated on your tax returns, the biggest mistake you can make is to consult the original preparer regarding the audit or criminal tax investigation. Your original preparer can be your worst enemy in the situation where you cheated on your original return and now find yourself under audit. The CPA, EA, or CTEC certified preparer often makes the bulk of their income from tax accounting and preparation, and thus they have a strong motivation to protect their reputation with the taxing authorities at the expense of your reputation. They will often be government witness number one to establish your wilful tax evasion where you provided them incomplete or, worse yet, a cooked set of books that they relied on the prepare your return.

Please note that there is no evidentiary privilege for communications between an accountant and his or her client. However, we know exactly how to circumvent this problem. An accountant retained by us is not expected to testify. Such an accountant is commonly referred to as a Kovel accountant, referring to the case that established an early precedent that an accountant working adjunct to a lawyer’s representation can operate within the attorney-client privilege and/or work-product protection.

Your historic accountant or return preparer should never be retained as the Kovel accountant because of potential conflict with the accountant’s role as a fact witness. The way we operate, it is almost impossible to distinguish between knowledge gained as a return preparer from that learned as the Kovel accountant.

What if I Know I Cheated on My Taxes and the IRS or California CDTFA FTB or EDD Wants to Speak with Me?

In our experience, the first symptom alerting the examiner to the possibility of fraud is frequently provided by the taxpayer himself. Your conduct during the examination and method of doing business may be indicative of the filing of improper returns. If you undertake any of the actions mentioned below, commonly called badges of fraud in the criminal tax defence industry, you run the risk of alerting the agent that something is amiss:

(a) repeated procrastination on your part in making and keeping appointments for the examination;

(b) uncooperative attitude displayed by not complying with requests for records and not furnishing adequate explanations for discrepancies of questionable items;

(d) disregard for books and records;

(e) destroying books and records without a plausible explanation;

(f) making false, misleading, and inconsistent statements;

(g) submitting false documents or affidavits to substantiate items on the return;

(h) altering records;

(i) using currency instead of bank accounts;

(j) engaging in illegal activities; and

(k) failing to deposit all receipts.

Generally speaking, when a taxpayer is being examined civilly for taxes, and there is no criminal tax violation exposure, the general rule is to be cooperative and give the examining agent most, if not all, of what he wants. This is due, in part, to the fact that the taxpayer has the burden of proof.

However, if we are aware that you have willfully violated the law, we may shift the tone of cooperation 180 degrees. This is particularly true when we get the sense that the agent is already on the scent of wrongdoing. As stated above, this situation is referred to as an eggshell audit since the practitioner who knows of his client’s wrongdoing proceeds through the audit very carefully, as if walking on eggshells. How to play the game of cooperation/non-cooperation requires exceptional skill and knowledge, and we vary it in each case. In so doing, we balance protecting you from prosecution “by your own hand” with the fact that your non-cooperation could alert the agent to something being amiss.

Why do You Need Us?

While representing you, our objectives in dealing with the examining agent are:

(1) to attempt to limit the scope of the inquiry;

(2) to limit the information provided to avoid both waiver of the Fifth Amendment and incrimination;

(3) to avoid tying you to an explanation you cannot support;

(4) to prevent the presentation of false or misleading information that could lead to the allegation that you are engaged in a scheme to cover up the fraud; and

(5) to avoid claiming the Fifth Amendment or otherwise alerting the revenue agent to the fraudulent aspects of the returns.

There is a world of difference between an ordinary audit and a fraud investigation. The objective in most civil audits is to present as much evidence as possible to convince the agent or conferee that an adjustment is not appropriate. However, our goal in a fraud investigation is to withhold all possible incriminating information to the extent possible in an effort to reduce the scope of the criminal tax investigation.

Please be aware that you should never attempt to bluff or explain an item or transaction. Anything you say can and will be used against you. There are no informal conversations with agents. If the explanation is false, it is evidence of fraud and when dealing with a federal agent, a felony in itself.

We truly understand how the IRS and California Tax authorities function and run their civil audits and criminal tax investigations. We are well conversant with the background information that IRS, CDTFA, FTB, and EDD have on the aerospace industry and how it familiarizes and trains its examiners with the issues they need to understand when civilly auditing or criminally investigating/prosecuting you.

Mr. Klasing is a dual licensed Tax Attorney and CPA who has decades of experience as a former auditor himself from working for various public accounting firms. As such, he can often anticipate the approach auditors will take and can craft a strategy to meet these challenges. To schedule a confidential, reduced-rate initial consultation, call our Irvine or Los Angeles law firm at 800-681-1295 or schedule online today HERE.

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