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Tax Audit Lawyer

Tax Audit Lawyer

Tax Audits: This Page at a Glance

You may feel like you are a brave person who has a handle on fear. Then you receive an official letter, notifying you of an IRS audit of your income taxes, and you have a new respect for fear.

An IRS tax audit can occur for a variety of reasons. Perhaps you made a simple error in entering data, or you may have omitted a key form with your return. This type of audit is simple and not all that frightening.

In other instances, though, the IRS may be seeking extensive information about your income and tax situation, leaving you in danger of owing a much higher tax bill with late payment penalties.

A tax attorney can help with this extremely scary situation. The attorney has the ability to negotiate with the IRS on your behalf, while helping you prepare a defense against the financial exposure and assist with any subsequent collection action.

If the audit does not go your way, a tax lawyer can help with an appeal of the judgment.

To schedule a 10-minute call with an experienced tax attorney to discuss a potential IRS audit, contact the Tax Law Offices of David W. Klasing.

Tax Audit Help from a Tax Attorney & CPA

For many taxpayers, there are few things as concerning and anxiety-inducing as being selected for a tax audit or taking some action that raises red flags and triggers an audit by the IRS. Many taxpayers will suffer through countless sleepless nights before reaching out to a tax attorney for guidance regarding the severity of the situation they face. In some instances, it is indeed an action by the taxpayer that increases their odds of being audited or triggers the audit. For instance, the individual may have forgotten to include one or more sources of income and was identified by the IRS from information matching procedures. The tax lawyers and tax professionals of the Tax Law Office of David W. Klasing can taxpayers tax audit help when navigating these difficult scenarios.

However, in other cases, certain characteristics of the taxpayer makes the individual an attractive target for an audit. For instance, the IRS is known to audit small business owners, businesses that deal extensively or exclusively in cash, and high-income individuals at higher rates than the general population. If you face audit due to certain characteristics, it is equally important to prepare and protect your assets and business from the IRS.

IRS Tax Audit Notices

If I Receive a Letter from the IRS, does it Mean I’m Under Audit?

Simply because you have received a letter or some correspondence from the IRS does not necessarily mean that you are under audit. The IRS sends letters and notices to taxpayers for an array of reasons. So, simply seeing a letter from the IRS in your mailbox does not necessarily mean that your worst fears are coming true. Some of the reasons the IRS may send correspondence to a taxpayer include:

  • You are the victim of identity theft (IRS Notice CP01, CP01S)
  • You or a spouse are engaged in active military service in a combat zone and may be eligible for a tax deferment (CP04)
  • You have no balance due with the IRS due to changes made to your taxes (CP21C)
  • You are receiving a reminder of the installment agreement in place with the IRS (CP521)

However, the IRS may also send letters requesting missing documents or stating that certain information provided to the IRS does not comport with their records. To assess your IRS letter or notice, please consult the IRS Notice look-up tool. Taxpayers who handle this limited request in a timely manner without raising additional red flags will typically avoid a full-scale IRS tax audit unless there are serious underlying problems. An experienced tax audit attorney can often facilitate this process and reduce the likelihood that the taxpayer makes a serious mistake or a damaging admission.

Unfortunately, some taxpayers do receive a notice of audit (CP06, CP75, CP75A, CP75D, etc.). Other taxpayers may botch a limited request for information and trigger a full-scale audit. Therefore, if you have received correspondence from the IRS about a problem with your taxes, it is prudent to seek the guidance of a tax lawyer.

How Far Back Can the IRS Audit?

If you are faced with a potential audit by the IRS, rest assured that your entire tax history is likely not under investigation unless they discover fraud in which the statute of limitations becomes open all the way back to the dawn of time. If there are specific issues being examined, your audit might only go back just far enough to when the issues are believed to have arisen. For example, if you are being audited in connection with your business but have only owned the business for the last 2 years, your audit might only go back 2 years. In fact, most audits tend to only go back about 2 years. However, according to the IRS, it is fairly normal for audits to include the last 3 years of your tax history.

If your situation is unique, like where the IRS proves a 25% of greater understatement of taxable income, the IRS is permitted to extend how far back your audit may go. Generally, audits do not go back farther than 6 years, although this is not a hard rule. If your audit is still not resolved after examining the last 6 years of your tax history, the IRS can request you to extend the statute of limitations for assessment of tax. Typically, the statute of limitations imposes a 3-year limit on how long the IRS has to assess any additional tax. The statute begins to run after your tax return is filed. You do not have to consent or agree to an extension of the statute of limitations. However, if you challenge the extension, the auditor will decide what to do based on the information you have already provided and quite often will assess based on known income often accompanied by a complete disallowance of all expenses claimed on the returns under audit.

Talk to our tax dual licensed California Audit Representation Attorneys & CPAs for help. We can review your situation and determine whether challenging the audit or the extension of the IRS’s time limit is in your best interests.

How many years of returns are at risk during an audit?

The IRS typically restricts the scope of a potential audit to three years from the due date or filing date of the most recent return, whichever is later. This restriction does not, however, apply if fraud is allegedly involved, if a return was not submitted, or if the taxpayer is accused of materially omitting or concealing items of gross income. Therefore, all can potentially lead to the examination of additional tax years and tax deductions that were not initially mentioned in the audit letter.

IRS Audit Triggers

Taxpayers are ordinarily selected for an audit based on statistical computerized analysis of their historical tax returns against a pool of similarly situated taxpayers. Every return analyzed by the IRS supercomputers receives a score. The worst score a return can receive is a 999, the next worse is a 998 etc. The more likely the return is to understate taxable income the higher the score the return receives. The IRS starts off an audit cycle by starting with all the 999’s then moves through the 998’s then the 997’s and so on as time permits until they run out of audit budget for a particular tax year that they are currently working.

It is not uncommon for people to believe they have been selected for an audit at random. The truth is these random audits are not at all as random as they seem to be. Essentially, when tax returns do not substantially line up with what is considered statistically “normal,” an audit will eventually follow. Remember, unusual tax events might get you flagged for an audit, but it does not mean you have automatically done anything wrong. You should, however, speak with our tax audit attorneys as soon as you know you are being audited, especially where you know you cheated on the returns that are under audit. Being represented will make all the difference between facing criminal tax prosecution, having to pay 75% fraud penalties, versus a civil resolution with at most, 20% negligence penalties that are statutorily required if you owe $5,000 or more in tax following your audit.

Facing a high-risk audit with criminal tax exposure will also result where your lifestyle appears excessive in comparison to your history of reported income compared to easily verifiable financial spending habits. For example, if a taxpayer is writing off proportionately large charitable donations as tax deductions, but they have relatively small income streams, this may be a red flag to the IRS, and that taxpayer will often be audited. Paying off very large debts with very low historical reporting of income is also a red flag which ordinarily leads to an IRS eggshell or reverse egg audit.

Many audits are the results of tax filing errors. Oftentimes, these errors are merely clerical. Transposing numbers when reporting taxable income could mess up your entire tax return and get you audited. Merely adding or omitting an extra zero where it does not belong could cause confusion and necessitate an audit from the IRS. All returns go through a computer matching process where all information received from third parties is reconciled to your return. W2, 1099 Int, 1099 Div, 1098, 1099-K, 1099-B etc… are matched to your return. Omitting one or more sources of taxable income will get you audited.

You could also trigger an audit if your business is suddenly and uncharacteristically not doing well. It is normal for businesses to experience varying degrees of success and failure. In some years, your business might do very well. Other years might not be so great. However, reports of business losses for more than a few years in a row might trigger an audit or the hobby loss rules.

Common reasons for the IRS to conduct a tax audit

An automated DIF score is used to select three-quarters of all returns for audit. The taxing authority’s automated rating system, or DIF, or Discriminate Function, generates a score (DIF). Each return is subjected to statistical analysis with the goal of rating the return’s likelihood for substantial misrepresentation. Underreporting of income or overreporting of deductions might lead a return to be underestimated.
Additionally, the tool flags returns that incorrectly state information the taxation authority has received from other parties regarding your taxable income, such as 1099, 1098, and W2 forms. The begins the audit selection process by choosing audit reports with the lowest DIF scores, or 999s, and then moves on to the 998s, 997s, and so forth until they reach their audit budget cap.
Based on data gathered from a third party or source that suggests a return could be understated, the opposite quarter’s results are chosen. Newspapers, open records, and informants are a few of these sources. In order to establish if a taxpayer’s lifestyle makes economic sense given their stated income level, taxing authorities are known to match an individual’s perceived quality of living from various sources of information against their reported income.

IRS Auditing Procedures

The following variables increase a taxpayer’s audit risk:

  • Reported or omitted amounts that materially differ from information gathered by the 
taxing authorities from third parties on the return. (i.e. W2’s 1099’s 1098’s 1099R’s)
  • Complex and large dollar investment or business expenses on the tax return.
  • Previous audit that resulted in a tax deficiency.
  • Complex tax transactions that lack sufficient explanation on the tax return.
  • Itemized deductions on the tax return that is disproportionate to the income or that are outside the taxing authorities’ statistical parameters.
  • Taxpayer owns or works for a business that receives large amounts of cash in the ordinary course of business.
  • Taxpayer has claimed substantial cash contributions to charities that are disproportionate to their income.
  • Taxpayer is a shareholder or partner in a partnership or corporation that is currently under audit.
  • An informant or whistleblower has given information to the IRS.
  • Taxpayer has made extensive use of offshore credit cards, investment or bank accounts. or filed a high-income return.
  • Taxpayer is self-employed and thus viewed as more likely to under-report taxable income and overstate tax deductions. Additionally, self-employed individuals that report Schedule C losses are often selected for audit.
  • Taxpayer’s engagement in employment tax schemes, such as employee leasing, paying in cash and or filing false payroll tax returns.
  • Taxpayer’s that underreported alimony. (The IRS matches alimony deducted by one ex-spouse to the income reported by the other ex-spouse)
  • Non-filers. Each taxing authority has its own strategy to identify non-filers. Most non-filers are discovered via computers that attempt to match the taxable income obtained from documents provided by third parties.

IRS Auditing Procedures

An audit might occur in a couple of different ways. Auditing procedures in your case will depend on the complexity of your tax situation and the issue being examined in your audit. Generally, an audit will begin by correspondence through the mail. You should receive a letter from the IRS informing you of the audit and what your next step must be.
Note:

A criminal tax investigation by the criminal investigation division of the IRS will often begin in complete secrecy and two or more years normally goes by before they surprise you in person while you are half asleep and walking to your car in the morning to go to the office or work site. If this happens to you the most important thing to remember is that they are going to ask you a bunch of questions that they already know the answer too hoping that you will lie to them. It is human nature to try and talk your way out of trouble and CI will often try and encourage you to do so claiming that they are there to help you clear up a misunderstanding. Don’t fall for it!!! Politely tell them that you are happy to speak to them but not without your tax counsel being present and then pick up the phone and call our office. If you do happen to fall for their trickery, write down everything you can remember you were asked and truthfully write down what your answers were to aid your criminal tax defense attorney in defending you and perform damage control.

Sometimes, especially with the surges of covid, the audit will happen entirely by mail. In such cases, you might be instructed to provide certain documentation or records to the IRS through the mail for review. These records could include but are not limited to bills, receipts, legal documents, loan agreements, financial logs, and insurance documents. Our dual licensed California Audit Representation Tax Attorneys and CPAs can help you if you are unsure how to provide certain documents or need time to gather the appropriate documents or simply have no substantiation (especially where you fudged numbers).

In nearly all audits, the IRS may wish to conduct an in-person interview as part of your audit. IRS agents are often required to do this to aid them in identifying which areas of your tax returns are more likely than not to contain misstatements and to help them gain an understanding of your business. The interview process is high risk because lying to a federal agent is a felony by itself. Interviews are more critical in cases where your audit deals with complicated tax issues or if the documentation required is so voluminous it cannot practically be sent by mail. For example, if the IRS wants to conduct a full audit of your business records, it might make more sense for someone from the IRS to meet with you and your accountant to go over the extensive records at your place of business or your home if that is where you keep the records. We generally try and prevent our client’s from being interviewed where possible and where it is not, we thoroughly prepare our client’s in how to successfully cooperate with the auditor while not creating additional exposure by providing a poor interview or one that is interpreted by the auditor as fraudulent.

Once the audit is complete, the IRS will reach a determination about what happens next. This could include assessing additional taxes, penalties, and interest, refunding overpaid taxes, or simply issuing the ever allusive no change audit. You will be given a chance to agree or disagree with the findings of the audit. If you disagree with the audit, speak to our dual California licensed Tax Litigation & Appeal Attorneys and CPAs for assistance.

Types of IRS Audits

Audits may be conducted for any number of reasons. As stated above, audits may be triggered by suspicious financial activity, or a routine computer screening could flag you. However, there are generally three types of audits. These types of audits were discussed above as part of audit procedures, but there are a few important distinctions to make between them.

The first type of audit is an audit by correspondence. This type of audit happens entirely through the mail. You are sent a letter from the IRS notifying you of the audit and what kind of documentation, if any, is required of you. Once you send any necessary documents or records to the IRS, the audit will commence, and you will be notified again when it is completed. This is more common for less complex audits.

Field audits occur when someone working for the IRS comes to you for a face-to-face interview as part of your audit. A field audit might be necessary for a few different reasons. Field audits are often conducted because the records required for the audit cannot be sent by mail.

An office audit is like a field audit because you are meeting with an IRS employee face-to-face in a local IRS office. However, you will go to them in a local IRS office instead of the IRS employee coming to you. The reasons for each type of audit will vary from case to case. Speak with our dual California tax audit representation lawyers and CPAs for more information.

What is an IRS civil examination?

Civil tax audits may take many different shapes, and it usually varies on the audited individual and how complicated their tax return is. One common audit method is the IRS or FTB correspondence examination, which is usually just a phone conversation or written contact with the IRS or FTB addressing very simple issues, such as how the person supported a certain deduction. The IRS or FTB will want documentation in support of any queries they raise on a tax return. The IRS or FTB will predictively simply refuse to grant the appropriate deduction if the audited taxpayer is unable to provide the requested supporting documentation, but a pattern of unsupported deductions can lead to an inference that tax fraud has occurred.
A filed audit takes place at a taxpayer’s place of business or home, the revenue agent conducts a “field inspection” to go through the taxpayer’s books and records. The IRS and FTB field agents often conduct a more comprehensive examination than an “office / campus auditor” because of their higher level of training.

What to Do If You Get Audited

If you get audited, you should begin by speaking with a lawyer as soon as possible, especially where you know for a fact you cheated on the returns under audit. Many taxpayers do not realize the full extent of their rights when it comes to being audited. The IRS can be intimidating, and many people believe you have no rights in an audit. However, you can challenge the results of an audit if you believe they are incorrect or unfair.

You must also begin preparing to provide any necessary documents, records, or other information to the IRS. Not everyone is good at keeping organized, thorough records, and you might need some extra time to get everything together. Our dual licensed Tax Audit Representation Attorneys & CPAs can help you communicate with the IRS and arrange for any necessary extensions of time while cooperating with any information document requests (IDR).

Is it your right to know why you were selected for examination?

The IRS Restructuring and Reform Act of 1998 (RRA 98) Section 3503 stipulates that the general criteria and procedures for choosing which taxpayers to examine must be published. The IRS examiner must give the taxpayer an answer that is as accurate as possible without disclosing restricted information if the taxpayer is under examination or his attorney asks why the taxpayer was chosen for examination.

Top Reasons for Tax Investigations and Audits

Speaking generally, there are two main reasons why taxpayers are selected for an IRS audit. The first reason is that the taxpayer holds certain characteristics that the IRS finds intriguing. The second reason is that the IRS found red flags in the form discrepancy in the information you submitted due to your failure to file or other problems with your taxes.

In some instances, taxpayer characteristics may mean that the taxpayer’s risk of committing fraud is greater than average. In other cases, taxpayer characteristics are targeted as part of IRS attempts to maximize the potential return on its audit dollar. That is, the IRS selects a high-income taxpayer since that is where the money is. For instance, taxpayers who reported $10 million or more in income for the 2014 tax year faced an audit rate of greater than 16 percent. By contrast, a filer reporting between $50,000 and $74,999 in income had only a 0.53 percent audit rate. Individuals with income in the single-digit millions also face an elevated risk of an audit with those taxpayers reporting between $5 million and $10 million in income facing an audit rate of 10.53 percent.
Similarly, taxpayers who are the owners of a small business, who are involved with a business dealing mostly in cash, or taxpayers who see big changes in their finances are also more likely to face an audit. Finally, in light of the IRS and DOJ push to stamp out offshore tax evasion, holders of foreign assets and accounts along with people who file international tax returns also face an elevated audit risk.

The second common reason why people face an audit is because the IRS identifies a problem with their taxes. All tax returns are scored according to a “Discriminant Function System” or DIF. According to the IRS, DIF functions by:

… rat[ing] the potential for change, based on past IRS experience with similar returns. The Unreported Income DIF (UIDIF) score rates the return for the potential of unreported income. IRS personnel screen the highest-scoring returns, selecting some for audit and identifying the items on these returns that are most likely to need review.

Thus, DIF and UIDIF act as a screening and identification mechanism such that IRS can allocate its audit resources to address taxpayers with a high likelihood of tax problems.

People who report zero income or fail to file taxes at all are much more likely to be audited. In fact, the audit rate for individuals reporting zero income is only surpassed by the rate of high-income taxpayers reporting income of more than $1 million. Other mistakes that IRS computer systems are adept at identifying include failures to include all or some sources of income, deductions or tax credits out of step with those of similarly situated taxpayers, and failures to disclose foreign accounts.

Top Reasons Why You May Have Been Chosen for an IRS Tax Audit

Many taxpayers want to know why they were selected for a tax audit. Thankfully, it is part of a taxpayer’s rights to know why he or she was selected for an audit. In fact, Section 3503 of the IRS Restructuring and Reform Act of 1998 (RRA 98) mandates that the general criteria and procedures for selecting taxpayers for examination are published.

However, a taxpayer must specifically request the reason why they were selected for audit. Once the taxpayer or his or her tax attorney makes this request, the IRS is required to provide a reason for the audit that is as accurate as possible in light of nondisclosure of protected use information. Thus, information gleaned from this request should be taken in context and with a grain of salt. Once again, an experienced tax attorney can assist in assessing the IRS’s response and avoid the possibility of making admissions or other mistakes that may result in the case being referred for criminal prosecution.

How the IRS decides which tax returns are audited

The IRS in a Fact Sheet from 2006 outlines how several criteria are used to choose returns:

  1. “Potential participants in abusive tax avoidance transactions“.
    Because the IRS receives information when it audits other taxpayers who are involved in abusive tax avoidance transactions, some taxpayers’ returns are chosen.
  2. “Computer Scoring.”
    Each tax return is given a “score” based on the Service’s previous statistical experience with returns of a similar nature. The IRS assesses each return for the possibility of a taxable income discrepancy using its “discriminate function system,” whereas it rates returns for the possibility of unreported taxable income using its “unreported income function.” The highest of these scored returns are then chosen by the IRS for an audit.
  3. “Large Corporations”
    Large corporate filings are frequently examined by the IRS each year.
  4. “Information Matching”
    The IRS will frequently reconcile a taxpayer’s tax return with related information returns from third parties and check for errors. If errors are discovered, the return can be chosen for audit or automatically adjusted via a CP 2000 notice.
  5. “Related Examinations”
    Some tax returns are chosen for audit solely because they engaged in transactions or business with someone else who was audited. This is an instance of the IRS tracing a transaction’s “breadcrumbs.”
  6. “Other Methods”
    Finally, when returns are a part of a “local compliance initiative,” the IRS designates them for examination. For instance, the IRS occasionally chooses particular tax return preparers or tax preparation companies suspected of aiding and abetting income tax evasion or simply for incompetence for audits or criminal tax investigation and checks the clientele of such preparers. Additionally, it will occasionally focus on certain markets or market segments.

What Triggers a Tax Audit?

Pinpointing all the potential triggers of a tax audit is practically impossible. However, there are indeed some tax audit triggers that are more prevalent than others. If you received a notice from the IRS or a state taxing authority that you will be the subject of an audit, it may be for one of the following reasons.

Discriminant Information Function
The IRS and many states use various types of software to enforce the many provisions of the tax code. The IRS’s Discriminant Information Function (DIF) is one such program that is used to identify statistical anomalies in a taxpayer’s annual return. The DIF system additionally looks for several types of questionable and or conflicting data, such as a taxpayer claiming a home office deduction and at the same time deducting rent on an office outside the home.

Any red flags that are raised by the DIF will be further analyzed by IRS examiners should your return be selected for audit.

Taxpayer’s Income Level

The IRS primarily performs tax audits on those who have an income level of over $500,000 per year. Alternatively, those that earn between $20,000 and $200,000 were rarely under the audit microscope.

Additionally, if you earn more than $500,000 and you attempted to wipe out a large portion of your taxable income through deductions, this may be used as an anomaly to support a tax audit.

Depositing Large Sums of Money

Another red flag that could trigger a tax audit is when a taxpayer frequently makes deposits of at least $10,000 into their accounts. If a taxpayer does not have a reasonable explanation for why they could make cash deposits of over $10,000, the IRS may use this as evidence the taxpayer is engaged in illegal activity.

Additionally, if a person tries to evade triggering an audit by purposely depositing funds less than $10,000, such as $9,999, this will also trigger bank and IRS reporting regulations and possibly a criminal tax prosecution for structuring.

Self-Employed Workers

Schedule C Self-employed businesses are also typical targets of tax audits. One reason for this is that self-employed workers are known to often incorrectly claim deductions to lower their taxable income. For instance, if a taxpayer frequently uses their vehicle to travel for business, they cannot claim that they only used the vehicle for business purposes to get a larger deduction.

Operating a Cash Business

For taxpayers who operate businesses that accept payment primarily in cash, there is a universal taxing authority concern that the taxpayer will not completely report all the income they earned. For example, if a taxpayer operates a barbershop as their only source of income and their reported expenses do not proportionally match their income, this may trigger a tax audit and possibly a criminal tax investigation and prosecution. The IRS and state taxing authorities want to ensure that a business owner is not pocketing cash payments to evade taxes on their income.

Utilizing or Having Signature Authority Over Foreign Financial Accounts

The United States is on a very short list of countries that tax its citizens on worldwide income which includes income that is earned in foreign countries. If you own or control one or multiple foreign financial accounts, the IRS wants to know that you are reporting investment, retirement and business income earned offshore and deposited offshore. They are also interested in funds inherited or received by gift and kept offshore. Taxpayers that have over $10,000 in all their combined foreign financial accounts must report this to the IRS on an FBAR.

If the IRS believes that a person is evading offshore taxable income and hiding that fact by not disclosing foreign financial accounts and failing to supply other required foreign information reporting like those that are required for foreign business entities, they may open an offshore financial account and evaded taxable offshore income focused eggshell or reverse eggshell audit.

The IRS may decide to begin a civil or potentially criminal tax audit for a myriad of other reasons. As a result, you should be sure to have a dually licensed California Tax Attorney and CPA by your side if you are facing a tax audit to protect your liberty and possibly your very liberty. Moreover, federal and state taxing authorities often view the facts and the law in a manner that benefits the taxing authority to your detriment. There is no better qualified set of credentials to take on the taxing authorities in the appeals process and potentially in litigation than a dually licensed Tax Attorney and CPA.

IRS and State Tax Audit Notices

When the IRS or state taxing authority has determined that a taxpayer should be audited, they will typically send notice of the audit through the mail and not through a surprise in-person interview or telephone call. IRS guidelines state that a tax audit will never be initiated through a phone call. As a result, be wary of any parties that may pose as an IRS or State agent and request to go over sensitive tax information over the phone or in person.

Depending on your unique circumstances, the interview with an IRS or state examiner may occur at IRS or state taxing authority headquarters or within your home or place of business.

When initiating an audit, the IRS or state taxing authority may request additional information regarding you or your businesses finances. For instance, the representative may want to know more about your personal expenses or the reasons you claimed a certain business deduction.

It is imperative that you respond timely to a federal or state tax audit notice. If you ignore all correspondence from the IRS or state taxing authorities, you could quickly find yourself in serious legal trouble. You could be assessed penalties for your failure to respond, and the IRS or state taxing authorities may seek more extreme options like referring your case to the Justice Department for DA for criminal tax prosecution.

Call a dually licensed California Tax Attorney and CPA that could easily guide you through the various steps of a tax audit including an appeal or litigation if necessary.

Factors That Trigger an IRS Audit

 

IRS Audit Trigger #1. Undisclosed Foreign Account Holdings
IRS Audit Trigger #2. Discovery of Unreported Income


IRS Audit Trigger #3. Undisclosed Cryptocurrency Transactions
IRS Audit Trigger #4. Cash Intensive Business

IRS Audit Trigger #5. Payroll Tax Errors
IRS Audit Trigger #6. Difficulty of Tax Compliance


IRS Audit Trigger #7. Using a Tax Prep Service That Guarantees Big Refunds

IRS Audit Trigger #8. Making Use of a Captive Insurance Company


IRS Audit Trigger #9. Failure to File Taxes.
IRS Audit Trigger #10. Being a High Net Worth Individual

How Many Tax Years Does an IRS Tax Audit Cover?

An audit will generally and typically look back at your past three years of tax returns. While three years seems like a large window for the IRS, the audit window can only expand. For instance, if a substantial understatement or other substantial error is detected, then the audit window can expand to up to six years. When the taxpayer has failed to file or fraud allegations are included or the auditor discovers signs of fraud, the length of the audit period is, theoretically, indefinite. That is, the auditor can lookback and assess tax for any tax year.

What Type of Tax Audit Will I Face?

There are three basic forms of an audit that the IRS can launch against a taxpayer. Determining the type of audit you face can often provide insight into the potential severity of the situation you face. The types of IRS audits a taxpayer can face are:

  • Field audit – A field audit is the most serious type of audit that can be faced by a taxpayer or taxpayer’s business. During a field audit, an IRS investigator will come into your home, business or both to get a sense of your operations, assets, and facilities. This type of audit is highly intrusive and presents the potential for trained IRS agents to detect an array of “badges of fraud” that may result in a criminal tax referral.
  • Office audit – An office audit is typically less serious than a field audit but significantly more troubling than an audit by correspondence. Like in a field audit, an office audit does open the door to increased risks and increased exposure to interview. Furthermore, when an office audit is justified, a six-year statute of limitations typically exists and there is greater likelihood that fraud will be discovered. If fraud is discovered or admitted, the IRS may have an open-ended statute of limitations and may levy a 25 percent understatement penalty.
  • Correspondence audit – A correspondence audit is typically conducted after a taxpayer is flagged by the IRS’s DIF or UIDIF computer system. While the computers are generally reasonably adept at flagging issues, the systems are not perfect. Thus, the IRS may request additional documentation from the taxpayer to verify his or her claims. While many correspondence audits are handled relatively painlessly, the potential for serious mistakes that result in a full-scale audit exists.

Generally, taxpayers should endeavor to avoid field and office audits. They should consider the form of audit they face along with the potential reason for the audit when they begin to work with a tax lawyer to prepare.

How to Handle Errors When Facing an Audit

If you have a suspicion that your audit was triggered by a mistake or some potential wrongdoing on your part, the most important thing you can do is to seek the representation of a tax attorney as soon as possible. This is essential because if you believe that you made an accidental or intentional error, a chance exists that the agent may interpret the surrounding facts and circumstances as wilful tax fraud or tax evasion.

Consider this scenario: You enter the audit with knowledge that certain “mistakes” exist in your taxes. You know that there is a reasonable likelihood that the examining agent will detect these potential improprieties. An experienced tax lawyer may be able to present the information to the agent in such a way that the agent is satisfied that fraud has not occurred. For instance, additional documentation or proof of mitigating circumstances may suffice. However, if the agent discovers the errors without an accompanying explanation or mitigating factors, he or she may determine that additional inquiry into related tax documents and additional tax years is necessary. Related tax documents may include an audit of your company’s taxes, your personal income taxes, and your California state tax returns. Needless to say, taxpayers who are aware of tax “mistakes” and errors should immediately contact a tax lawyer and begin preparation to meet the challenge of an “eggshell” audit. Remember, if you cheated on your taxes and face an audit, it only takes one “crack” in the veneer of propriety for the entire potential fraud to come to light.

IRS Audits Due to Failure to File Taxes

If you have failed to file taxes for all or some years, you face a similar situation to the one described above. The extent of the consequences you can face are based on several factors. First, taxpayers who have failed to file and pay taxes are likely to have unpaid tax obligations. These tax debts are generally inflated by penalties for non-filing and non-payment along with interest on the unpaid balance. Taxpayers who have not filed taxes also run the risk of having the IRS complete taxes on their behalf. While this may sound like an appealing labor-saving approach, the IRS will typically take positions that are extremely unfavorable to the taxpayer and results in an inflated tax liability.

While the financial penalties are concerning, if your failure to file taxes is accompanied by signs of fraud then you face the potential for even more severe tax consequences. Acts that may be interpreted as signs of fraud are identified in the Internal Revenue Manual 25.1.2.3 Indicators of Fraud and include concealing income, dealing only in cash, using check cashing services, making inconsistent statements, keeping multiple sets of books, claiming inflated deductions, and keeping secret accounts. If these indicators of fraud are present, your audit is likely to expand in scope and you may even be referred to IRS Criminal Investigations.

Can Foreign Assets, Trusts, and Accounts Trigger an Audit?

Few taxpayers should be surprised at the fact that the IRS, Department of Justice, and the entirety of the U.S. government is focused on identifying and halting offshore tax evasion. That is, starting just after the Great Recession the U.S. Congress became increasingly interested in closing the “tax gap.” Wealthy Americans who used offshore accounts and trusts to conceal income were identified as a main cause of the difference between expected and actual tax revenues. Therefore, while the Report of Foreign Bank Account (FBAR) obligation has existed since the 1970s, stringent enforcement only began circa 2008. Furthermore, Foreign Account Tax Compliance Act (FATCA) was passed in 2010 and more than 100 nations have agreed to provide the IRS with their foreign financial data.

If you have undisclosed foreign accounts or assets, the risk of an audit is extremely high. In fact, it is likely more of a matter of when the audit will be conducted rather than if the IRS will audit. Offshore penalties are particularly harsh even when conduct is non-wilful and present the potential for felony tax evasion charges.

How Should I Prepare for an IRS Audit?

It is essential for taxpayers to prepare for an audit. While some taxpayers seem to believe that disorganized books and records will cause the IRS, California FTB, Employment Development Division or other tax agency to throw up their hands and give up on the audit, nothing could be further from the truth. IRS and other auditors are highly trained and familiar with methods to make life difficult for taxpayers who do not comply. Generally, insufficient or non-existent records open the door to potentially catastrophic determinations by the IRS.

For individual filers with insufficient or unreliable records, it is not uncommon for the IRS to draw unfavorable conclusions against the taxpayer and simply assert a large tax liability. This shifts the burden of proof onto the taxpayer. Now, the taxpayer must piece together documents and records to disprove the IRS’s claims. Needless to say, this is labor intensive and frequently requires the services of a consulting forensic accountant.

Businesses can also face catastrophic consequences when books and records are insufficient. For instance, the IRS agent may determine that he or she needs to audit on a sample basis. If the business owner fails to establish ground rules for the sample audit, there is a chance that the sample will not be representative of the company’s actual volume of business. As such, the company may be placed on the hook for taxes on income that was never actually received. Like the first scenario, the burden of proof is shifted and the business must then endeavor to disprove the IRS’s determinations.

Therefore, it is essential to seek out a tax audit help from a tax professional as soon as possible to begin preparing for an audit.

What can I do to prepare for an audit?

Audits tend to focus on credibility, so be as organized as possible and be prepared to substantiate any receipts, invoices, sales records, canceled cheques, credit card statements, bank statements or other documents. Failure to prove to an auditor that a deposit was non-taxable can lead to your taxable income going up as well. If you have any missing records, immediately arrange duplicates. In order to be more credible, take original business documents with you which can be copied and returned to you. Do not discuss tax returns not currently being audited.

How to survive audit if you have cheated on your return being audited

If you get a letter from the IRS stating you have been selected for audit, ordinarily it is because you have been selected through the IRS’s discriminant scoring function system. The Discriminant Function System (DIF) score rates the potential for change, based on past IRS experience with similar returns. The Unreported Income DIF (UIDIF) score rates the return for the potential of unreported income. IRS personnel screen the highest-scoring returns, selecting some for audit and identifying the items on these returns that are most likely to need review.”
The most commonly audited issues are: the total amount of gross income reported; the trade or business deductions taken; bad debts; net operating losses; capital loss carryforwards; depreciation; and capital expenditures.
If you are not entitled to certain deductions you took, or if you have intentionally understated your taxable income, it is best to consult with a tax attorney prior to having any contact with the IRS. A Tax Attorney should also be able to positively identify which type of audit it is, as it could be a correspondence audit, office audit, or field audit.
A correspondence audit is often caused by the IRS’s computerized system flagging your return. One reason could be that the system thinks you have underreported income. However, whatever the reason may be, if the IRS thinks a discrepancy exists, an audit will result.
An office audit is a much more serious type of audit, because of the increased chance of an interview or 6-year statute of limitations being opened, if it is found that your taxable income is understated by 25% or greater. An open-ended statute of limitations can open if fraud is discovered or admitted by the taxpayer in question. At the interview, the IRS will require you to provide information on your reported net income, as well as how you obtained the figures reported. They will further cross check your accounting to your banking records, as well as ask you about your payroll substantiation and 1099 reporting on independent contractors. You must be able to substantiate both your reported income and claimed deductions.
A field audit is by far the most intrusive audit that exists. Such an audit will often involve a business and or home visit by the IRS or FTB in order to interview both the taxpayer and members of the business at random. All business records and financial statements will be thoroughly reviewed. Often the IRS or FTB agent will be a licensed CPA.
You must keep and present your tax records in an organized fashion as the IRS or FTB will shift the burden on to you to help them make sense of the records, forcing you to have to sort them out ahead of time. The most important thing to remember is to call your tax attorney to avoid making any criminal admission apart from other evidence they may have if you find yourself under audit after having intentionally misstated your taxable income.
A tax attorney is also important because he/she can help avoid a situation where additional tax years are audited and attempt to limit the number of your businesses that become audited due to findings related to the initial audit target.
If you cheated on your original return and are now being audited, then your original preparer is likely to become a witness for the government in the case where you had provided them with altered tax or accounting figures. You will also not have attorney client privilege in such a situation, and any communication between you two can be used against you in court regardless of any promises to the contrary by your accountant.

Warning signs of a criminal referral from an IRS audit

If the civil auditor has strong suspicions of fraud, a criminal referral is likely to occur after the civil audit. Common fraud indicators are sometimes known as “badges of fraud, “and may include:

  • Failure to disclose revenue,
  • Inability to substantiate significant amounts of claimed deductions,
  • Material overstatement,
  • The use of two sets of books,
  • Fabrication of records & substantiation
  • A technical fraud advisor will be contacted automatically if more than $10,000 in income is omitted in a single tax year in order to potentially develop the case before passing it on to the criminal investigation division.

Signs a criminal referral has already takes place include:

  • A civil audit may be suspended before completion and referred to CI for criminal investigation without the knowledge of the taxpayer.
  • If the Revenue Agent becomes unreachable
  • If the Revenue Agent focuses heavily on the “intent” of the client in taking positions on a return or mentions a pattern of non-compliance on several tax returns.
  • If the Revenue Agent prepares a net worth analysis or subpoena’s bank records
  • If the Revenue Agent gathers an excessive amount of documentation or makes excessive copy requests
  • If the Revenue Agent makes undisclosed contact with third parties
  • If you receive a summons for records or for an appearance
  • If more than one revenue agent, or an attorney from chief counsel’s office and a court reporter attend a client interview
  • When an appointment is canceled or when the civil auditor fails to return taxpayers calls.
  • If An officer of the IRS wearing a gun and a badge approaches you and reads you something similar to a Miranda warning (this is likely an IRS special agent from the criminal investigation division of the IRS). If you are ever faced with one, demand that counsel be present for your questioning and remain silent.

Should I Consult My Original Tax Preparer Prior to an Audit?

While it may seem tempting for a taxpayer to ask the person who “broke it” to “fix” their taxes, this is not typically a prudent approach. The fact is that anything you disclose to an accountant or tax preparer is not protected. That is, if the tax preparer or CPA is subpoenaed in a subsequent criminal tax proceeding, they will be compelled to reveal any wrongdoing you admitted. Furthermore, accountants and tax preparers who come under scrutiny often blame their clients to protect their license, reputation and livelihood.

Instead, taxpayers should seek out tax audit help from a criminal tax defense lawyer as soon as possible. Only the attorney-client privilege and the attorney work-product rule can protect the disclosures you may make in the course of seeking legal advice. Furthermore, a tax attorney can bring in consulting accountants while providing them with derivative attorney-client privilege through a legal device known as a Kovel letter. Last, the focus of an attorney is advocacy while the focus of an accountant is accuracy. Once matters have moved into questions of tax law and tax controversies, the skill set of a lawyer is more appropriate and likely to be effective.

Can California FTB, EDD, or BOE Audit Me After the IRS Is Completed?

Yet another reason why it is so important to work with a tax lawyer from the outset is the fact that the IRS and State tax agencies like the California Franchise Tax Board, Board of Equalization, and Employment Development Division are all known to share information. If an IRS or California state agency audit discovers problems or other improprieties, it is highly likely that they will share this information with the sister agency. Thus, it is not uncommon for taxpayers to face a federal and subsequent state tax audit and vice-versa.

If the party under audit is a business and the IRS audit turns up issues relating to understated income or payroll tax issues, it is reasonably common for the California Employment Development Division to audit. It will typically assert employment tax obligation problems and will require the business to produce, at minimum, the records required by California state law under Sections 1085 and 1092 of the CUIC. IF the business has not kept these records or is not prepared to provide them and other requested documents, EDD is likely to dig deeper into the company finances.

Can I Appeal the Results of an Audit?

Following the close of the audit, you are likely to receive a number of documents from the IRS. You will receive a 30-day letter setting forth your right to appeal along with the audit determination and other accompanying documents. The 30-day letter is named as such because it sets forth the taxpayer’s right to accept the changes or to appeal the audit determination within 30 days. If the taxpayer fails to respond to this letter, a 90-day Notice of Deficiency will be sent.

In any case, a taxpayer does have multiple appeal options. If the taxpayer’s appeal concerns the application of tax law, he or she may request an appeal through a small case review or via a formal written protest. A small case review request can be filed when the total amount for any one tax period is $25,000 or less. This type of appeal can be filed via IRS Form 12203. Taxpayers can also file a formal appeal in which they must set forth:

  • A statement evincing your intent to appeal the audit decision.
  • All changes to your tax return that you do not agree with.
  • All tax periods or tax years involved.
  • Citation of all facts supporting your position.
  • Citation of all relevant law supporting your tax position.
  • Authentication of the appeal documents under penalty of perjury.

If your appeal is premised on mistakes made during the IRS collection process, a number of collection-specific appeals options exist. These options include the Collection Appeals Program (CAP) and Collection Due Process (CDP) programs. While the CAP program covers a broader array of collection appeal issues, your right to further appeal in a federal court is limited. By contrast, CDP is more narrowly focused but preserves a taxpayer’s rights to further appeal. A tax lawyer can help a taxpayer determine if appeal is appropriate and, if so, the form of appeal that is reasonably likely to result in a successful appeal.

Right to disagree with IRS tax auditor’s findings

You will receive a report outlining the proposed adjustments as well as any penalties and interest that may be associated with the proposed changes after the audit is complete. The Internal Revenue Code and other important sources of authority may also be cited in the report.
You shouldn’t sign anything that you either do not understand, do not think is fair, or think is incorrect, even if you feel coerced into doing so. It’s a good idea to ask the auditor for enough time so that you may discuss the suggested adjustments with your accountant or lawyer before deciding whether or not to accept them. In order to decide whether to accept the proposed adjustments, file an appeal, or even bring legal action against them, your Tax Council will be able to assist you.

What is involved with appealing disagreements?

If you disagree with an IRS examiner’s findings, you are allowed to speak with the examiner’s manager. If, after doing so, you are still unable to come to a compromise, the Service will give you documentation outlining your right to ask for a meeting with an Appeals Officer. Appeals conferences can be held in one of three ways: over the phone, in person, or through correspondence.
You have the option of choosing to represent yourself or to hire a Certified Public Accountant. If you choose not to file an appeal with the IRS or you are unable to reach an agreement with the Appeals or Settlement Officer, you may appeal certain decisions in court.

What are your appeal options if you disagree with the IRS?

Three options exist for the taxpayer after an audit,

  • Appeal before an IRS supervisory conference with the auditor’s manager,
  • Appeal within the IRS administrative system, or
  • Appeal using the court system, where the taxpayer can bring his case to the U.S. Tax Court, the U.S. Claims Court, or the local U.S. District Court.

Taxpayers can employ a mix of strategies. They could first meet with the examiner or the manager of the examiner. He will then have 30 days to decide what to do given no agreement has been reached at the closing meeting. The taxpayer should give the IRS’s proposed revisions to the audit within that 30-day interval.
If the taxpayer does not respond to IRS’s suggested adjustments after 30 days, the IRS will issue a “statutory deficiency notice,” which will start the clock on the taxpayer’s 90-day window to file a petition with the Tax Court. Tax Court, unlike the Claims Court and the District Court, does not mandate that the taxpayer pay the tax arrears first before filing an appeal with a refund action following the IRS’s denial of an administrative refund claim.
A taxpayer is not required to pay their deficiency before filing an administrative appeal with the IRS. The U.S. Court of Appeals or the Supreme Court may consider matters after Tax Court, but only if those courts choose to do so.

Payment Options After Being Audited

If you can’t pay the taxes the IRS says you owe but do not disagree with the determination, there still may be relief available. If your tax audit was preceded by a recent divorce or separation, innocent spouse relief may be relevant to your circumstances. Relief may be available in circumstances where one spouse was responsible for the misstatements that gave rise to an unsatisfied tax liability and the innocent spouse did not have reason to know about the improprieties. Other potential options to manage a large tax bill as the result of an appeal include:

  • IRS Installment agreement – The IRS makes a number of payment agreements and arrangements possible. While the programs a taxpayer qualifies vary on the basis of the amount of the debt and whether the taxpayer is a business, an installment agreement approach can make a tax debt more manageable.
  • Reasonable cause for compliance failure – In some circumstances, a taxpayer may be able to mitigate or eliminate penalties by showing evidence for reasonable cause for the delay or compliance failure. To be clear, reasonable cause requires more than a simple “I forgot.” Rather, the taxpayer must generally experience a major, life-altering event to qualify for relief of this type.
  • IRS Fresh Start Program – Is the name of a number of IRS policies and procedures that are intended to encourage taxpayers to come forward and settle tax debts. IRS policies and procedures offer the opportunity for taxpayers to reap the benefits of penalty abatement and procedures to stop a lien against a taxpayer’s property.
  • Offer-in-compromise – While offers-in-compromise are not granted liberally, a taxpayer who files this type of request that contemplates their “reasonable collection potential” is perhaps more likely than average to be granted this form of relief. Essentially, an offer-in-compromise can permit a taxpayer to settle their tax debt for less than the full amount of the obligation.

Every tax situation is different and an experienced attorney can provide tax audit help that will determine if relief is likely to be available in your matter.

Facing a Tax Audit? Work with a California and IRS Tax Audit Defense Attorney

If you are facing a tax audit, it is prudent to seek the profession and experienced guidance of a tax lawyer. IRS, California FTB, and other revenue agents are highly trained, experienced, and aggressive in their tactics. Don’t you deserve a level playing field when tens of thousands of dollars or more or your business in on the line? If you have underlying tax problems or tax mistakes that may be discovered during the audit, your need for strategic guidance is even more pressing.

The tax attorneys and tax professionals of The Tax Law Office of David W. Klasing may be able to fight for you and mitigate the consequences you face. Mr. Klasing is a former public auditor who can put his more than 20 years of experience to work for you. He can often anticipate audit strategies and techniques that will be utilized by the examining agent and develop approaches to meet these challenges. To discuss how an experienced tax lawyer can provide you or your business tax audit help through an IRS or California tax audit, call 800-681-1295 today. We offer reduced-rate, confidential tax audit initial consultations at both our Los Angeles and Orange County tax law firm offices.

Common Tax Audit Questions

What Is a Tax Audit?

A tax audit is a notice from the IRS that it is going to examine your tax return to ensure information on it is accurate. Tax audits occur in different levels of complexity, but if you’re ever confused about information the IRS is requesting, you may want to contact a tax attorney to help you.

A basic tax audit may simply ask you for a bit more documentation, such as to verify your deductions for charitable giving. This simple audit usually can be done via mail and does not require meeting with an IRS agent. More complex audits may require you to verify your income levels and the various deductions you’ve claimed in a face-to-face meeting with agents.

You’ll receive notice of a tax audit from the IRS by mail, rather than through other means of communication.

When Is a Tax Audit Conducted?

The IRS may choose to conduct a tax audit on any taxpayer return within a reasonable time period, which could extend as far as six years in the past. However, auditing returns so far back is rare. There are a few guidelines the IRS follows regarding auditing timeliness.

Most audits occur within a few months after you submit a return. However, the IRS requires that you keep tax records and documents for at least three years after submitting your return. Any of your tax returns within that three-year window could be selected for an audit. Should the IRS find a significant error that has been repeated on multiple returns, it could go back as far as six years’ worth of returns.

Understand that not every tax return the IRS selects for an audit has an error or problem. The IRS could simply be seeking to verify information you’ve entered.

How Is a Tax Audit Conducted?

If the IRS selects your tax return for an audit, you’ll receive notification through the postal mail. Any other means of initial notification could be a signal of someone trying to defraud you.

After receiving notification from the IRS, you’ll either be asked to submit the requested information by mail or through an in-person interview. At this point, you may want to hire a tax attorney to help you prepare your documents and to ensure the IRS treats you fairly.

Pay close attention to the exact documentation the IRS requests from you, because you don’t have to provide other types of information during the audit. It’s possible that the IRS could request additional documentation later as part of the same audit process, but you’re only required to provide the documents the IRS formally requests.

How Long Does a Tax Audit Take?

Providing the documentation to satisfy a tax audit could take as little as a few minutes, or the audit process could drag out for months or years.

When the IRS initially contacts you about an audit, it will include a deadline for you to respond to the document request. You sometimes can submit this information by mail in just a few minutes. Other times, you will have to meet with IRS agents in person, and you could end up having multiple meetings that may stretch over months.

Ultimately, the length of the audit depends on things like the complexity of the return, the type of information requested, and the availability of the taxpayer to attend meetings. Many times, hiring a tax attorney to help with the audit can expedite the process, because the tax attorney can handle the complexities that cause the process to take a long time.

What Triggers a Tax Audit?

Although the IRS may select any tax return for an audit, there are a few circumstances that may cause the IRS to flag a return for an audit. For example, if your tax return numbers fall far outside the statistical norms – such as if you have abnormal deductions – you’re more likely to be audited.

Should someone with whom you have a business relationship have his or her return selected for an audit, this could trigger an audit of your return as well. If you make a mathematical mistake on your return, or if the income data you enter on your return doesn’t match what your employer sent to the IRS, you could be subject to an audit.

Additionally, the IRS will select returns for audits randomly. However, this is a rare occurrence. More commonly, the IRS picks a return for a specific reason.

Are all audits the same?

A federal or state taxing authority will conduct an audit as a way to gather relevant data about your tax return and assess the accuracy of the information you provided. The taxing authorities will ask for whatever documentation it deems essential to support the claims made in your return. The two primary types of audit methods are employed by the taxing authorities. They have the option of administering the examination by mail or by in-person interview at and IRS or FTB office or at your home or business.
The location of your audit is frequently a reliable indicator of its seriousness. Because the IRS Auditor is a Revenue Agent, a field audit (in-person audit) should be treated with greater seriousness. Revenue Agents are trained in auditing methods to a greater extent than a correspondence on office tax examiner.
Correspondence audits are audits that are carried out over the mail. Usually, the taxation authorities will inform you that they want more information from you, and the letter could state that they think a revision to your tax return may be necessary.
A home or office audit takes longer as opposed to a correspondence audit. The auditor may inquire about other matters that were not initially included in the audit communication. The branch office of the taxing authority nearest to your home or place of business will often host the office audit. The audit will often be scheduled by the taxing authority for a time and location that are fair and advantageous to both parties.

What should you do if the IRS is investigating you?

Do not speak openly with any taxing authority representative if you believe you are the subject of a criminal tax investigation without first seeking legal counsel. Incorrectly reported data discovered during a civil audit may be used as proof in a future criminal tax investigation. A criminal investigation may start with or without the taxpayer being informed.

Can you stop the IRS from repeatedly auditing you?

Repeat examinations of the same taxpayer are typically avoided by the IRS, although they can occasionally occur, particularly when the Service effectively assesses more income tax with each inspection. Certain mechanisms are in place that can be used to attempt to try and stop a further review if your tax return was checked for the same things in either of the two prior years and lead to no change audits.

What if you don’t respond to a taxing authority audit notice?

Failure to reply to an audit notification will ordinarily result in further fines and penalties being added to the overall payable amount. If an audit notification is disregarded, collection actions such as wage garnishment, liens, levies, and the seizure of your real and personal property may follow. Disobeying the audit notice may lead to criminal tax penalties if it is determined that your silence was wilful.

What are your basic taxpayer rights if the IRS audits you?

The taxpayer is given some privileges when the IRS interacts with them during an audit. For instance:

  • Taxpayer retains the right to receive professional and courteous treatment by the IRS;
  • Has the right to privacy and confidentiality for his or her tax matters;
  • Has the right to know why the IRS requests information, how it plans to use, and what consequences would ensue if he or she does not comply with the information request;
  • Right to be represented by counsel; and
  • Right to appeal the IRS’s decision, either before an IRS administrative hearing or before the courts. The taxpayer can appeal the auditor’s conclusions with an IRS supervisory conference with the auditor’s manager or administratively within the IRS. In addition, he or she can appeal an audit using the court system, and bring his case to the U.S. Tax Court, the U.S. Claims Court, or the local U.S. District Court.

The following is a list of some of the typical taxpayer rights during an audit:

  • Right to request certain information pertaining to your audit from the IRS
  • Right to set appointments related to the audit at a reasonable time and place
  • Right to professional tax representation
  • Right to privacy and confidentiality
  • Right to be treated with professionally and with courtesy
  • Right to be treated fairly with respect to your civil rights
  • Right to be notified of any third-party summons and to contest the summons
  • Right to record any IRS interview
  • Right to be free from potential repetitive audits regarding the same issue
  • Right to independent administrative and judicial review of the audit findings.

Having legal representation during the audit process is one of your most crucial rights as a taxpayer. An experienced tax lawyer can assist in limiting the scope of your audit, preparing you for the interview, guarding against unintentionally disclosing sensitive information, spotting potential criminal tax investigations, pointing out instances of IRS auditor misconduct, developing a general strategy for minimizing your civil and criminal liabilities, and, most importantly, protecting you when the IRS incorrectly applies the law to the facts of your case.

Can you have the examination transferred to another area?

Typically, the location where you live will be where your return is examined. You can ask to have the case relocated if it can be argued that your return might be investigated more quickly and conveniently in another location such as where your records are.

Can you record your IRS interview and is it a good idea?

You are allowed to videotape an IRS interview. If you decide to do so, a written request must be submitted 10 days prior to the interview. Additionally, you must provide your own audio equipment. An interview may be recorded by the IRS itself, in such a case, you must also be informed ten days in advance and will then have the option to purchase a copy of the tape by paying them the sum of money required.
However, asking to film an interview is not a good idea, as it negatively alters the auditor’s impression of you. The IRS’s decision to record a meeting could also be a sign that a criminal tax investigation is ongoing or may be opened at some point in the future.

How do you avoid negative consequences from an IRS interview?

Keep your responses short, avoid expanding on any response. Avoid responding to inquiries that you weren’t asked and refrain from attempting to predict an auditor’s next query. Avoid talking during the audit unless it is absolutely required to answer an auditor’s inquiries, and do not provide the auditor with more information than requested.
Do not give the auditor copies of your tax returns from the previous or following tax years, unless your attorney advises you to do so. Furthermore, refrain from presenting any material from any prior year that is not presently being audited or that is not expressly included in the taxing authority’s information document request list.
If your tax counsel believes the auditor is treating you unjustly or disrespectfully, it is their duty to step in. If tax fraud is brought up during an audit, your attorney may urge you to invoke your privilege under the Fifth Amendment against self-incrimination. In this situation, you should keep silent and only talk as your attorney directs.

Do you have to agree to being interviewed by taxing authority directly?

The taxing authorities use interviews to learn about a taxpayer’s financial background, standard of living, typical business operations, principles of revenue and expense recognition, and other relevant accounting policies. Interviews are also used to assess the accuracy of the taxpayer’s books and records and make educated decisions about the likelihood of misstatements in the taxpayer’s returns.
Interviews are also used to prepare for further litigation and to weigh the evidence gahtered from a business workers, third party witnesses, and to elicit an accused tax violators’ confessions or admissions.
An auditor’s physical documentation may not always reveal data that may be obtained through oral testimony. Furthermore, 70% of communication is verbal body language. During an audit, we counsel and prepare our clients to attempt to ensure that their words and observed body language is consistent.
The taxing authorities have the power to issue a subpoena to compel you to appear for a face-to-face interview even though we will often attempt to get through an audit without our client being interviewed where possible.

What is an eggshell audit?

An eggshell audit is a civil audit which occurs when the returns being examined contain an as yet undiscovered material understatement of income, a material overstatement of deductions, or where tax credits were claimed that the taxpayer was not entitled to. As a result, the taxpayer showed a lower tax liability than they would have had they filed an accurate return. These errors may be the result of simple negligence, which could result in a 20% negligence penalty on any additional income tax discovered to be owed during an audit, or they may be the result of willful intent, which would indicate underlying criminal tax issues with the tax filings under review, which could result in 3 to 5 years in prison per felony and/or a 75% fraud penalty being assessed on any additional income tax owed.

What is a reverse eggshell audit?

In a reverse eggshell audit, a criminal tax investigation is effectively disguised as a civil audit but in reality, the audit is a clandestine parallel and simultaneous civil and criminal tax inquiry. Reverse eggshell audits typically begin when a civil examiner or revenue agent refers a case to a Fraud Referral Specialist who then prepares the audit for potential transfer to a special agent in the criminal investigation (CI) division. They also occur where CI requests that a civil auditor be assigned to an ongoing criminal tax investigation. Normally, the civil auditor is unaware of a taxpayer’s potentially criminal tax culpability at the beginning of a civil audit; however, in a reverse egg audit, it is the taxpayer and possibly their representative who are unaware of the clandestine criminal tax issues that are being investigated during the seemingly civil audit.

Why is a reverse eggshell audit dangerous for a taxpayer?

Due to fairly recent changes in IRS internal policy, clandestine parallel criminal tax investigations disguised as civil audits (reverse eggshell audits) are becoming increasingly common. The benefits of using reverse eggshell audits for the government include the ability to use the many investigative tools available to the civil auditor, such as third-party subpoenas to witnesses and banks while effectively preventing the taxpayer from being alerted as to the possible need to hire a criminal tax defense attorney who will ordinarily utilize the full extent of the constitutional protections embodied in the due process clause, 4th amendment privileges against unreasonable searches and seizures, and 5th amendment rights against self-incrimination to protect the taxpayer. In essence utilizing a reverse eggshell audit prevents an investigated taxpayer from legally availing themselves of the most important and powerful constitutional protections available to protect them.
While an IRS Special Agent from the Criminal Investigation Division is primarily concerned with gathering evidence to prove criminal tax violations have occurred and to prove it at trial, if necessary, an IRS civil revenue agent’s primary concern is typically supposed to be determining the correct civil tax liability for the tax years in question. Through a non-custodial reading of the taxpayer’s rights, which states that anything they say may be used in a subsequent criminal prosecution for tax crimes, CI Special Agents are required to inform taxpayers of their constitutional rights against self-incrimination and of the taxpayer’s right to have an attorney present during an interview. In a reverse eggshell audit the initial, and as of yet undisclosed, special agent interview will frequently be postponed preventing the investigated taxpayer from “lawyering up”.
Initial contact is frequently made through a civil revenue agent to avoid alerting the investigated taxpayer that they are under criminal tax investigation while the civil examiner continues to gather information and conduct interviews. This prevents the investigated taxpayer from gaining any constitutional tactical defensive advantage.
Therefore, reverse eggshell audits pose a serious risk to less knowledgeable taxpayers who frequently tragically hire less knowledgeable and frequently less expensive tax representatives (i.e., CPAs & E.A.), who lack attorney client privilege and typically have a conflict of interest with the client because they prepared the original returns at issue and thus need to protect their own reputation with the taxing authorities. Inadvertently waiving the constitutional protections that skilled criminal tax defense counsel would have invoked if they had reason to believe their client was the subject of a criminal tax investigation. These less knowledgeable representatives will frequently be unable to ascertain whether an eggshell audit is taking place, and blindly cooperate with the auditor under the impression that the taxpayer is merely complying with a civil audit.
Additionally, Reverse Egg Shell Audits and Parallel Investigations sometimes include working with undisclosed yet cooperating federal agencies (including the SEC, FBI, DEA, ABC, and the DOJ) as well as the IRS’s civil and criminal investigation divisions. This type of eggshell audit also bears the extra possibility that the IRS’s inquiry could help the cooperating federal agency’s criminal case.
Revenue agents frequently continue to gather data even after there are clear signs of fraud, breaking the rules by conducting their own personal reverse eggshell audit. The taxpayer’s constitutional rights, which would exist if they were approached by the CI division directly and given a reading of their rights, are violated by the revenue agent’s continued criminal tax investigation without giving the taxpayer and their representative the proper notice that any further statements made and information provided will likely be used in a subsequent criminal tax investigation and prosecution.

What are effective tax defense counsel’s goals in an eggshell audit?

Criminal tax defense attorneys typically endeavor to keep the client from making any criminal admissions during an eggshell audit, or reverse eggshell audit, in order to prevent the initiation of a criminal tax probe. In a reverse eggshell audit, they seek to uncover any ongoing covert criminal tax investigation and possibly limit the taxpayer’s cooperation in order to shield the taxpayer from criminal tax prosecution by upholding their rights under the constitution against unreasonable searches and seizures and self-incrimination. Criminal tax defense lawyers who represent a client in an eggshell audit frequently aim to accomplish three objectives;

1. To try to cooperate with a civil tax investigation in a manner that is designed to avoid the start of a criminal tax investigation where possible.
2. Prevent, if possible, their represented taxpayer from being subjected to civil fraud penalties under IRC 6663, which carries a 75% fine on any percentage of an underpayment attributable to fraud.
3. Reduce additional tax, fines, and interest to a minimum.
4. Reduce the amount of tax years or additional businesses owned by a taxpayer that are audited to a minimum.

What are possible outcomes of an eggshell audit?

Eggshell audits often have three possible outcomes:

1. The Revenue Agent does not find criminal tax issues since they do not believe the tax return modifications and misstatements discovered the audit were prompted by fraud;
2. The Revenue Agent finds inaccuracies that they believe may have been the result of fraud, but due to strong legal representation, the Agent is inclined to keep the matter confined to a civil investigation;
3. In order to transfer the case for a referral to the Criminal Investigation unit of the IRS (CI), the Revenue Agent refers the matter to a technical fraud specialist.

How are the 4 goals and outcomes 1 and 2 best obtained?

Only experienced criminal tax defense attorneys and the Kovel CPA’s they exclusively contract with should be representing you in an eggshell audit. CPA’s assisting your criminal tax defense counsel must either perform via a Kovel agreement (United states v kovel,296 F.2d 918 (2nd Cir. 1961) or alternatively, be employed directly by your tax counsel to assist them in providing a legal service. This will render the communication between the client and the Kovel CPA subject to the attorney client privilege. Because the IRS’s criminal investigation unit’s main goal is to deter the public from committing tax crimes by criminally prosecuting a sample of taxpayers caught cheating, the criminal tax defense attorney’s main concern in an eggshell audit is to persuade the examining agent not to refer the case to the CI unit of the IRS.
Once a revenue agent has discovered badges of fraud during a civil audit, after consulting privately with his manager and receiving approval, the revenue agent will secretly consult with a “fraud referral specialist” who works closely and clandestinely with the auditor to develop a “fraud development plan” in order to develop and document any affirmative acts and firm indicators of fraud that they identify in order to refer the case to the IRS Criminal Investigation team. The criminal tax defense attorney must know when to continue working with the civil revenue agent and when to advise their client to stay silent as the client could be admitting to tax fraud or by making statements that the auditor later reveals to be false, which would amount to a felony in and of itself because it is illegal to lie to a federal agent.
In an eggshell vs a reverse eggshell audit, differing goals are achieved by asking the auditor if there is an ongoing criminal tax investigation, grand jury inquiry, related technical fraud advisor, or associated special agent of the criminal investigation division. This line of inquiry may be required in an eggshell audit to safeguard the taxpayer, but it must be asked in a way that won’t make the auditor suspect that the client’s fact pattern contains evidence of tax evasion. This line of questioning can assist in protecting the taxpayer if a reverse eggshell audit is ongoing because it will notify counsel of the existence of a covert criminal tax investigation or, if the revenue agent provides more information than a tacit denial of the existence of a parallel criminal tax investigation.
Tweel, which determined that any auditor deception regarding any underlying criminal tax issues in a reverse eggshell audit must be tacit rather than affirmative in order for subsequently acquired material to be suppressible, is one of the best safeguards for criminal tax defense attorneys. Therefore, any later-obtained documents and statements are suppressible in a subsequent criminal tax prosecution if a revenue agent lied when he or she claimed there was no concurrent criminal tax investigation ongoing, no technical fraud advisor was involved with the audit, or they continued their civil investigation after detecting enough signs of fraud to stop the civil examination and refer the case to law enforcement.
It is also possible to argue that Tousaint makes all subsequent information and taxpayer comments inadmissible and so suppressible after the revenue agent’s initial identification of signs of fraud. Contrary to case law, the evidence gathered by the auditor will not be deemed inadmissible in a subsequent criminal tax prosecution under Caceres and will not be suppressed if the auditor’s conduct is merely a deception that violates IRS procedure but does not violate the U.S. Constitution or applicable federal statutes. Due to the division in federal case law, a range of auditor conduct has been created that necessitates quantifying acts made by auditors, which are frequently covert and difficult to ascertain.
A taxpayer’s constitutional rights and privileges may be permanently lost if a taxpayer’s representative fails to raise the appropriate issues at the stage between an eggshell audit and its culmination into a reverse eggshell audit.
The following steps should be taken to reduce the dangers of an eggshell audit:
To prevent the taxpayer from making any criminal tax admissions by limiting their involvement in the audit, preventing or closely controlling a client interview, only having first thoroughly prepared the client for the expected questioning they will receive.
Attempt to relocate any interview originally scheduled to take place in the personal residence or the business establishment of the taxpayer because of the potential for an economic lifestyle analysis in their home and hard to control auditor access to the client’s business records and employees at their business premises. Do not have the client or his or her employees present at any required business tour.
Create thorough records of any damaging positions taken by the agent. Subsequent to the examination, a FOIA request (Freedom of Information Act) may be submitted to obtain a copy of the record created by the agent including his or her notes.
Clients must be thoroughly advised of the importance of not making false statements, as they can lead to obstruction charges in a criminal tax investigation and can constitute a felony in their own right even in a civil audit.
Have the client take the fifth under the proper conditions. Failing to use the taxpayer’s Fifth Amendment rights when necessary, can be much more detrimental to a taxpayer in the event of a Criminal investigation because the auditor’s evidence of fraud will be used against them. Moreover, the 4th and 5th Amendment safeguards may be waived in whole or in part if an auditor is given incriminating remarks or facts.

How should tax audits be handled by criminal tax counsel?

When an eggshell audit takes place, the taxpayer’s original preparer (audit representative) can either be unaware or complicit in the misconduct. It is pertinent at this point to decide whether the original preparer should be hired in the representation or not. When the client’s preparer is not potentially criminally culpable, and is not perceived by defense counsel as being in a position to provide damaging testimony obtained in a non-privileged client relationship, as well as if the exposure is deemed to be minimal, it may in fact be advantageous for criminal defense counsel to remain unknown to the examining agent and support the client. However, if the preparer is potentially complicit in the non-compliance, it may be better to find new representation (i.e. criminal defense counsel).
When counsel chooses to operate covertly, they frequently closely monitor the audit and give the client and their representative advice on how to interact with the civil auditor. When counsel chooses to have a third party communicate with IRS agents, extreme care must be exercised. The third party needs to be advised not to give the agent purposefully false or misleading information, especially lies. If this course of action is taken, Defense Counsel’s covert involvement should not be disclosed to the government agent unless obvious and irrecoverable badges or fraud surface, the agent or his or her manager communicates their intention to refer the case for criminal tax investigation, it becomes clear that a Fraud Technical Advisor (FTA) is being consulted and the case is being developed for criminal tax investigation, or there are obvious signs that a referral to CI has been made. In a civil tax audit, an advocate may have more room to engage in open discussion whereas in an eggshell audit, a non-adversarial Approach is taken in order to decrease the likelihood of a criminal referral. Some important strategies include:

  • Shield the client from direct interaction with the agent to avoid criminal tax admissions and damaging testimony,
  • Avoid the presentation of evidence as to the taxpayer’s willful behavior and knowledge
  • Dictate the amount and content of any cooperation offered,
  • Attempting to downplay any rising suspicions regarding the client’s underlying culpable conduct.

Without invoking the client’s Fifth Amendment privilege against self-incrimination or taking other steps that would undoubtedly raise the agent’s suspicions and ensure the involvement of an FTA or outright handoff to CI, it is extremely difficult to fully explain a refusal to provide incriminating documents or answer incriminating questions.

Additional tax audit methods include; offering the least amount of documentation evidence and refraining from opposing audit adjustments in instances when the audit involves unreported culpable activity. If it is not financially advantageous to the client to close the case as agreed and the culpable conduct is not the type 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 chances of additional civil examination or of a referral to CI. After the 90-day letter is sent, the client should be advised once more to consider the benefits of timely paying the tax, interest, and penalty claimed, without submitting a tax court petition, in order to reduce further criminal tax exposure in the following appeals and litigation process, as opposed to attempting to negotiate lower tax, penalties, and interest liability via the appeals process.

A tax period may be reopened by an eggshell audit. Before a taxpayer may be re-audited, official notification processes must be followed if the IRS initiates a second examination.

Furthermore, unique internal consent must be obtained for this process. Reopening means the government has received evidence that shows fraud, whether or not CI is involved in the background. As a result, a reopened civil tax audit should generally be considered a circumstance that will eventually lead to CI being involved.

What are the risks of attending an IRS audit without a tax lawyer?

Auditors will try to take advantage of your lack of understanding of the audit process. One of the main reasons you require representation during an audit is “Communication Risk.” It is your word versus the word of the taxing authority if the examiner incorrectly interprets or misrepresents your statements as a criminal tax admission. A skilled tax attorney can assist you in avoiding problems or helping you after one arises.

Most common audit technique used by taxing authorities

Every government auditor is instructed to “take it to cash.” It is customary for auditors to start an audit by verifying that they have identified all business, personal, checking, savings, and investment accounts used by a person or a firm and its owners. The deposits into your business and personal accounts will then be added up. They assess every deposit as taxable income until you can provide proof to the contrary.
You will therefore need to provide documentation for any non-taxable deposits, including those made with your personal savings, through interbank transfers, with borrowed money, or from other sources that do not result in taxable business income. Unless you can provide evidence to the contrary, the auditor will ordinarily classify every withdrawal from each of these accounts as non-deductible personal costs.

Why should you not go into an IRS audit without representation?

Without legal counsel, audited persons might say something that the tax examiner might mistakenly perceive as an admission of guilt.
Furthermore, tax examiners might make a decision that is contradictory with the relevant facts and circumstances of your case, or it might be founded on incorrect legal reasoning. An experienced tax lawyer will be able to cope with the technical difficulties that come up during an audit, counteract the aggressiveness of the examiner, and intervene where any factual or legal issues have come up during the examination.
A number of important advantages that attorneys offer include:

  • In-depth knowledge of the law, legal research and procedure,
  • Specialized training in the art of persuasion and negotiation,
  • Three or more years of post-graduate, formal education,
  • Attorney-Client Privilege,
  • Only attorneys can represent you in a court of law should litigation become necessary,
  • Licensure by the California State Bar, which maintains strict minimum competency standards.

Attorneys can help you settle your case if necessary

The IRS and other taxing authorities will see that you are serious about challenging the merits of your case by hiring an attorney rather than an accountant or enrolled agent. If they do not believe they have a good chance of winning in court, they may want to make a settlement.
Avoidance of excessive civil and criminal tax liability.
Due to their specialized legal training, attorneys can identify IRS irregularities or legal misinterpretations that other tax specialists might overlook, potentially lowering your civil liability and criminal tax exposure. Additionally, lawyers are better equipped to determine whether the IRS has launched a criminal tax investigation, and in very rare circumstances, they may even be able to assert equitable or other non-tax related defenses on your behalf.

Why hire David Klasing to represent you in an audit?

David W. Klasing holds a Master’s degree in taxation and is a licensed tax attorney and CPA in California. He has nearly 30 years of expertise assisting different kinds of companies and individual taxpayers to manage the audit process before the IRS, Franchise Tax Board, Employment Development Department and California Department of Tax and Fee Administration. He has guided countless businesses and their owners through the audit process, and he has a track record of helping his clients get the best civil and criminal tax outcomes possible based on their unique facts and circumstances.
David chaired the California State Bar, Tax Procedure and Litigation Committee due to his drive to assist clients with their tax disputes. He has also served as chair of the tax section of the Orange County Bar Association.
David regularly attends continuing professional education as a CPA and as Tax Attorney. He consistently completes considerably more education than what is required by basic professional standards. By taking part in online tax list serves sponsored by the California Society of CPAs, the American Association of Attorney CPAs, the American Bar Association’s Tax Section, the Orange County Bar Association’s Tax Section, and the American Association of Attorney CPAs, he also stays up to date and on the cutting edge of the tax profession.
You would struggle to find a more knowledgeable, skilled, or experienced representative to assist you in getting the best outcomes for your audit, criminal tax investigation, appeal, or tax litigation.

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