How To Survive a Veterinary Practice Tax Audit

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Receiving notice that you’re being audited by the IRS or another state tax agency is daunting under any circumstances. However, the worry and concern can be overwhelming when you have knowingly made misrepresentations or intentionally under reported your taxable income on your federal or state income tax returns. This situation can become even more worrisome when you are in a career that requires you to act with the highest moral integrity, such as veterinary medicine, where any implication that you have engaged in federal or state tax crimes could result in you having to explain to a licensing board why you deserve to keep your license. If you find yourself in the circumstance where you cheated on the return that is now under audit, your top concern should be to avoid the inherent criminal tax exposure associated with an Egg Shell or Reverse Egg Shell Audit. An experienced dually licensed Criminal Tax Defense Attorney & CPA will be invaluable to you during this emotionally challenging time and relieve the overwhelming stress and sleepless nights this type of high risk audit can cause. To schedule a consultation with an experienced tax attorney to discuss a potential audit, contact David Klasing.

Common Veterinary Practice Business Models

To fully appreciate the inherent exposure an audit can cause you must understand that the IRS will be considering the tax and accounting reporting requirements associated with your practice’s chosen business structure.

Veterinary practices are prohibited from being organized as a limited liability companies (“LLCs”), however formation as a partnership, C or S corporation or sole proprietorship are common. In California, many veterinarians opt to organize their practice as a personal services corporation (“PSC”), which have distinctive characteristics, particularly when it comes to taxation. Importantly, with respect to the PSC business model, a 35% tax rate is applied. No matter what business model you use, it is essential that you keep your personal assets and business assets separate. Poor record keeping and converting business assets to personal use are key circumstances that are likely to result in civil and potential criminal tax liability.

A Veterinary Practice’s Unique Tax Challenges

One way that veterinarian’s contrast with other medical providers, such as physicians, is that veterinarians typically operate cash intensive businesses. IRS Auditors are well aware that most individuals don’t carry insurance on their pets, and consequently most veterinarians won’t be reimbursed on the services they’ve rendered through an insurance company. This cash-based structure presents some unique—and complicated— challenges when it comes to tax reporting procedures. However, you won’t be able to disguise your intentional misrepresentations as mindless mishaps due to the complicated tax structure your business must abide by. The IRS is on high alert that cashed-based business scheme could easily be abused.

One complicated matter when it comes to veterinary practices and taxation is the distinction between active and passive income with respect to property ownership. A veterinarian owning the real property on which their practice sits is quite commonplace, and likewise, a veterinarian leasing their premises to the business is equally commonplace. Although it may be tempting to consider the lease income as passive income, any involvement you have, as the property owner, in the business makes the income active rather than passive. This may seem like a minor mix up that isn’t likely to impute liability on you or your business. However, this distinction can result in improper deductions on “passive” losses, which will not go unnoticed.

To avoid an audit by the IRS, the income reported on your practice’s tax returns should not solely rely on bank deposits to represent gross receipts. This is a common mistake made by Veterinarians and their tax preparers that can result in enormous civil and criminal tax consequences. The IRS generally will reconcile reported revenue to point of sale systems, and conduct a thorough investigation into whether income is being diverted to other non-business accounts. Among other things, the IRS will likely want to review billing records, patient sign-in sheets, and other documentation that could reveal any unreported receipts that could resolve any discrepancies. For this reason, veterinarians must engage in accurate and thorough record keeping with respect to all transactions made to survive an audit.

To that end, be cognizant that providing inadequate documentation—or no documentation at all—to attempt to substantiate the numbers in your return will not help you avoid liability when the IRS believes that you’ve intentionally understated your income or overstated your deductions or diverted taxable income to a personal account. The IRS, BOE, or other tax agencies will simply assume that the necessary records don’t exist. When you have intentionally tampered with your numbers, it is a given that the documentation you provide will not meet the tax agency’s requirements, making it virtually impossible to avoid liability for, at a minimum, additional tax penalties and interest. In this case, it is prudent to contact an experienced dually licensed Tax Audit Defense Attorney and CPA to discuss what steps must be taken to mitigate your civil and potential criminal tax liability.

Use Tax Issues and the BOE

What makes California sales and use tax issues particularly tricky is that veterinarians are usually both retailers and consumers when it comes to certain products. As a veterinarian practicing in California, you likely know about, and have an ongoing relationship with, the California Department of Tax and Fee Administration, (CDTFA), which is charged will collecting sales and use taxes on products sold through your practice. Pursuant to California law, all retailers (including veterinarian’s who sell products to their clients) are required to obtain a seller’s permit in order to sell goods to consumers. Generally speaking, you are liable to pay sales taxes on the products that you purchase and intend to resale to consumers in your veterinary practice. Sales and use tax obligations also include nontaxable sales and charges made to render services, which must also be reported.

When goods are purchased using a valid sales certificate and are intended to be sold, the use tax is not applicable. However, products that are purchased with the purpose that they be resold but end up being used in your practice requires that a use tax be imposed. However, there are recognized exceptions to the use tax obligation.

One exception exists when these products are being used in the medical service being provided, such as administering medication to a pet during an appointment. Another exemption exists when the products are being used while providing boarding services (unless billed as separate items), and a sale made to other retailers with a valid resale certificate. Other common exemptions include items used as a demonstration or display (unless the item is later sold), business supplies and equipment, veterinary drugs used to assist ranchers or other agriculturalists (with a partial exemption imposed), and certain other drugs and medicines.

Accordingly, understanding how you are using certain products in your practice and the tax consequences the use can result in is necessary to comply with the CDTFA regulations. Keeping accurate and up-to-date records on the products you’ve sold, the products you’ve consumed in your practice, and the services you’ve rendered is pivotal. Should the CDTFA decide that an audit is necessary, they will expect to see that your numbers and receipts have been reconciled.

The Audit Process

It isn’t as easy to sneakily understate taxable income without getting caught as you may think. Any good auditor can find the telltale signs that the books have been cooked. Most auditors have a bachelor’s degree in accounting. Moreover, as fraud detection technology continues to advance, it will become increasingly harder to lie on your tax returns and avoid the civil and criminal tax exposure that will naturally result. It is important to realize that most tax returns aren’t reviewed by individual IRS agents. With nearly 230 million federal tax returns to review each year, the IRS uses technology that statistically recognizes when taxpayers most likely have submitted inaccurate income tax returns. This technology not only makes tax returns easier to review, but also eliminates at least some human error that would otherwise occur during the review process, making it less probable that you won’t be caught when you’ve made intentional misrepresentations on your returns.

These various computerized technologies catch reporting irregularities in tax returns by comparing the data you’ve provided with data supplied by various similarly situated third parties, such as other Veterinary practices. All returns receive a “score” that is based on the tax return you provided in statistical comparison to tax returns submitted by similarly situated persons and/or business entities. The higher the score, the more likely it is that there is taxable income that has been understated. Once a tax return has been tagged by the IRS as likely to contain inaccuracies, the IRS will determine whether it is necessary to audit or criminally investigate, which is the ultimate purpose in conducting a tax audit or criminal tax investigation. Not all inaccuracies will merit a thorough investigation into the records in question. However, the chances that any given taxpayer will face an eggshell or reverse egg shell audit or be criminally investigated dramatically increase based on any badges of fraud apparent in the fact pattern.

Veterinarians, in particular, are more likely to face an audit than the average taxpayer. In addition to the inherent suspicion surrounding a veterinarian’s inherently cash-based business, statistically speaking, higher-income individuals and businesses are more prone to drawing tax audits. As stated above, veterinary practices, particularly PSCs, must engage in complex reporting practices. The IRS is more likely to seek an audit on a business that could easily provide misleading numbers, whether it be intentionally or unintentionally. However, there is another serious circumstance that makes it more likely than not that a veterinary practice will be audited: the trust relationship that exists between medical providers, such as veterinarians, and their patients, which requires that a medical provider conduct themselves with the highest moral integrity.

Once the IRS has determined that an audit is necessary, the audit can be conducted by various means. The IRS can request that certain documentation be sent, an in-person meeting where an extensive interview is likely to take place concerning your businesses practices and ability to substantiate tax returns, or a meeting at your home or business where a high-risk examination will be conducted on every line item contained on your business and/or personal tax return(s). You should assume that the more involved the audit is, the more likely it is that you will bear civil or criminal tax liability, and the greater the need to seek a dually licensed Tax Attorney & CPAs assistance.

Veterinary Practice Bookkeeping and Accounting

Your profession as a veterinarian will not give you an advantage when it comes to your burden in proving your innocence. As with the average taxpayer, the phrase “innocent until proven guilty” isn’t the standard when it comes to federal or state income tax audits. Rather, you’re guilty until you prove you’re innocent. For example, all deposits placed in your personal or business accounts will be deemed taxable unless you can prove that they aren’t. To that end, be cognizant that providing inadequate documentation—or no documentation at all—to substantiate your return will not help you avoid liability when the IRS believes that you’ve overstated your income or diverted taxable income to a personal account or overstated your deductions. Do not be deceived into thinking that messy and lackadaisical bookkeeping that prevents the tax agency in question from effectively conducting the audit will help you. The IRS, BOE, or other tax agencies will simply assume that your records don’t exist. With no way to reconstruct your tax records, the tax agency will likely assess you based on all income that has been deposited into your business and personal accounts and will disallow any expenses that can’t be proved to their satisfaction. As a result, you will often be facing an exponentially larger tax bill, including penalties and interest, if not criminal tax exposure, when the audit is complete.

When you have intentionally tampered with your numbers, it is impossible to unlikely, that you’ll be able to back up your transactions unless the bookkeeping and records have been manipulated to match your stated income. For this reason, it is necessary to obtain a dually licensed Tax Audit Attorney & CPA immediately to try and get your bookkeeping and records in compliance to mitigate your civil and criminal tax liability. While the financial damage may have already been done and you will likely be pinned with some civil liability, a Tax Attorney dually licensed as a CPA can help you get you and your business in compliance with the tax regulations at issue and can help limited continued exposure.

Intentional Misrepresentations

Should you have a long history of misstatements on you or your business’s tax returns or purposely engaged in inaccurate tax accounting and reporting methods, there is still redemption, especially where you have not currently under audit or criminal tax investigation.

Note: As long as a taxpayer that has willfully committed tax crimes (potentially including non-filed foreign information returns coupled with affirmative evasion of U.S. income tax on offshore income) self-reports the tax fraud (including a pattern of non-filed returns) through a domestic or offshore voluntary disclosure before the IRS has started an audit or criminal tax investigation / prosecution, the taxpayer can ordinarily be successfully brought back into tax compliance and receive a nearly guaranteed pass on criminal tax prosecution and simultaneously often receive a break on the civil penalties that would otherwise apply.

It is imperative that you hire an experienced and reputable criminal tax defense attorney to take you through the voluntary disclosure process. Only an Attorney has the Attorney Client Privilege and Work Product Privileges that will prevent the very professional that you hire from being potentially being forced to become a witness against you, especially where they prepared the returns that need to be amended, in a subsequent criminal tax audit, investigation or prosecution.

Moreover, only an Attorney can enter you into a voluntary disclosure without engaging in the unauthorized practice of law (a crime in itself). Only an Attorney trained in Criminal Tax Defense fully understands the risks and rewards involved in voluntary disclosures and how to protect you if you do not qualify for a voluntary disclosure.

As uniquely qualified and extensively experienced Criminal Tax Defense Tax Attorneys, Kovel CPAs and EAs, our firm provides a one stop shop to efficiently achieve the optimal and predictable results that simultaneously protect your liberty and your net worth. See our Testimonials to see what our clients have to say about us!

While you may think that you can handle the IRS, CDTFA, FTB, BOE, EDD or any other tax agency on your own, you are taking on an extreme risk that can result in life changing exposure if you are wrong. Given the inherent presumption that you are guilty until you prove you’re innocent, intentionally underreporting your income makes the chances that you can outsmart the taxing authorities slim to none.

To avoid the risk of an inadvertent criminal tax admission, it is best to create some distance between you and the auditing agent. You should contact a dually licensed Tax Attorney & CPA immediately and avoid voluntarily engaging in communications with the IRS absent an attorney’s presence or consent. This does not mean that you should become MIA. Rather, it is best to seek representation and obtain a representative who can act as an intermediary between you and the auditor or investigator. An attorney can help you avoid making any inadvertent admissions that could prove that you intended to engage in tax evasion.

Because intent is the hardest element to prove when it comes to imposing criminal tax penalties, an attorney’s assistance is imperative throughout the audit process. By letting an experienced tax attorney guide, you through the audit, you to take a step back and avoid engaging in conduct that IRS and other tax agents could view as guilty acts. In this sense, an attorney can help you avoid providing direct evidence garnered by your own conduct that can be used against you should the IRS decide to prosecute. Because anything you say can and will be used against, you are likely your own worst enemy when it comes to an audit.

Absent direct evidence that you have engaged in tax evasion, circumstantial evidence can be procured to prove your guilt. However, circumstantial evidence is not given the same weight as direct evidence, making it much harder to prove the tax agency’s case against you. Generally, circumstantial evidence may include your tax records and books, admissions and statements made by employees, and evidence provided by any other additional third-party with knowledge. While there is ultimately no avenue to avoid a tax agent procuring circumstantial evidence against you, it is much easier to overcome circumstantial evidence than direct evidence.

The Consequences

Severe consequences can result when a veterinary practice’s tax return contains blatant purposeful inconsistencies. Even innocent mistakes that may seem minor can lead to an extensive investigation into your business practices. Once the audit is complete, there are three possible outcomes: it will be determined that the taxpayer does not owe money to the IRS, which is rare (particularly when intentional misrepresentations have been made), the taxpayer owes additional money and interest to the IRS and civil and/or criminal penalties should be imposed, or the case should be passed on to the IRS’s criminal division so that the case can be developed and prosecuted, should it be necessary. The chances that you’ll be criminally prosecuted and potentially serve time in prison skyrockets once the audit is handed to the IRS’ criminal investigation division, which has a 90% conviction rate.

However, enormous monetary penalties and a potentially lengthy prison sentence aren’t the only consequences that can result you can lose your license to practice veterinary medicine, too. As discussed above, any indication that you engaged in tax evasion will make a licensing or ethics board question whether you can be trusted to continue on in your practice. Tax evasion and other related crimes involving lying and deceit directly bears on your character and moral turpitude. A determination made by the IRS establishing that you engaged in tax evasion—or even worse, a criminal conviction on this basis—would negatively impact others’ perspective on your morality and would make a licensing board think twice about whether you are trustworthy enough to work with a client base that relies on your authenticity and reliability.

Surviving the Veterinary Practice Tax Audit

Due to the heavy personal and career-altering consequences an audit can result in, it is best to engage in accurate bookkeeping practices and strictly comply with all relevant tax regulations. However, once the damage is done and irretractable and unexplainable misrepresentations have been made, it is prudent to call an dually licensed and experienced attorney to help you survive the audit process.

When you have received notice that you will be audited, it is necessary that you do not engage in conversations concerning your tax activities or the pending audit with acquaintances such as neighbors, co-workers, or employees. The IRS or other tax agencies, should they prosecute you, will seek out those you know to provide testimony against you (usually against their will). Importantly, it is also necessary that you do not communicate with the person that prepared your return. Although you might be tempted to engage in communications that could impute liability on your preparer rather than you, the preparer will be the prosecution’s star witness on the stand and would gladly save their reputation by ruining yours.

When seeking assistance through the audit process, you may be inclined to believe that an accountant will be better equipped to assist you. This is a misconception. While an accountant likely has extensive knowledge about tax procedures, they do not have adequate knowledge on how to best protect your constitutional rights to unreasonable searches and seizures or against self-incrimination when proper civil and criminal tax audit and investigation procedures are not complied with. In other words, once the damage has been done and you’ve not complied with required tax reporting procedures, an accountant’s help is a little value. In addition, no communication privileges exists between accountants and their clients where a criminal tax issue is at stake and the CPA can be forced to testify against you even if they did not prepare the original tax return. It is best to contact an attorney who has built-in tax consultants, as the discussions that take place between you an attorney-retained CPA are privileged and cannot be used against you at a later date.

While it is recommended that you retain an attorney any time an audit will be conducted—or is threatened—when you have knowingly lied on you or your businesses tax return, it is necessary to seek an experienced tax attorney to assist you in the audit process. An attorney is uniquely equipped to assist you in the audit process, as the attorney-client privilege guarantees that your admissions and discussions with your attorney regarding your tax matters will remain private and your attorney can’t be used as a witness against you should you be prosecuted.

A Tax Attorney to Assist You

If you have failed to file a tax return for one or more years or have taken 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, it is in your best interest to contact an experienced tax defense attorney to determine your best route back into federal or state tax compliance without facing criminal prosecution.

David Klasing has dual credentials as both a Tax Attorney and a CPA with a master’s degree in taxation. David has an expansive understanding on the auditing process and the methodology used by the IRS. Based on his extensive experience working with the IRS, FTB, and BOE, he is uniquely equipped to assist you as he anticipates the steps the tax agency will take prior to those steps being taken, leaving you less likely to be exposed to monetary penalties and/or criminal prosecution. To schedule a consultation and see how David Klasing can assist you during this critical time, contact David Klasing by calling 800-681-1295 or contact us online.

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