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Table of Contents

    The Steps IRS Takes When Auditing Attorneys

    Pre-Contact Analysis

    The IRS has published a detailed guide of the audit steps and techniques for examiners to carry out while auditing lawyers. An examiner will start with a Pre-Contact Analysis that will include thorough behind the scenes research and examination of the attorney in question. It will examine the attorneys’ licensing records using the relevant state bar association and internet-based searches of their assets and income stream. The software used by IRS examiners is called Accurint, which provides information on a person, their business, their professional standing, their assets, pending or resolved litigation cases, and other matters. The attorney’s legal area and magnitude of practice will be a determining factor for the examiner to generalize a discrepancy in the income generated. Some attorneys are less likely to receive cash payments than others. For example, attorneys that are compensated through third-party charges (e.g., insurance settlements) are less likely to obtain cash. Certain attorneys are more likely to be paid directly by the client, including criminal defense attorneys, estate and trust attorneys, real estate attorneys, and tax attorneys.

    Initial Interview

    Following the Pre-Contact Analysis, the IRS examiner will conduct an initial interview, which is an essential step of the audit process. Meticulous planning and preparation go into the planning of an interview by the IRS agent. The questions about how the practice started and areas of specialization will give insights to the examiner about the probable accounting systems, the size and scope of the lawyer’s practice, and what types of income and operating costs to expect. You should be aware that the interview will be the examiner’s best chance to have an in-depth understanding of your accounting system, your level of involvement, and whom to talk to about questions that may arise during the audit. In addition, the examiner will establish your credibility level by comparing the pre-audit analysis and information supplied during the interview.

    We know from our experience that the IRS is most certainly going to require you to produce an exhaustive list of documents for the initial interview, including but not limited to all books and records, bank statements of all related accounts, investment records, work papers to reconcile books with the tax returns, employee forms, records of travel and entertainment expenses. This is usually followed by an extensive bank document request list.

    At the Tax Law Office of David W. Klasing, we are California tax attorneys and CPAs with over 20 years of combined experience providing award-winning service to attorneys that are based or do business in California and national wide for federal tax audits. We understand that it can be incredibly overwhelming to produce such lists of documents and are here to provide on point advice and assistance in responding to the aforementioned requests by the IRS. We can provide valuable support and advice to a lawyer who is undergoing a tax audit. We can help to protect your rights, ensure that you are treated fairly, and minimize the potential civil and criminal tax consequences of any issues that may arise during the audit.

    Accounting and Fee Arrangement System of Attorneys and its Record and Bookkeeping

    The audit process and techniques used by the IRS examiner revolve around the attorneys’ accounting and fee arrangement system and its record and bookkeeping system. An examiner will first identify the type of work undertaken by the attorney. Attorneys get paid in a variety of ways depending on the legal work they do. For example, a personal injury attorney typically works on a contingency fee basis and is paid a percentage of the amount of damages recovered by the client. Hence, this percentage may vary depending on the outcome of the case. On the other hand, criminal and immigration attorneys are more likely to receive cash during business activities and be paid directly by the client rather than through third-party payments. While there are some attorneys, who are paid by the amount of hourly work irrespective of the outcome of a particular case.

    The various fee models described above can result in several fee arrangements and recordkeeping systems that attorneys use during their business. Most commonly, an attorney gets paid based on the time he spends on a particular case; hence, attorneys maintain detailed records of tracking the time spent. It may be done using traditional methods and documents, books, and client ledger cards, but it is now increasingly done using various time and billing software. This record is imperative to an IRS examiner. It is viewed comprehensively as part of the examination, along with the reconciliation of the output of the time and billing system to the appropriate accounts in the general ledger.

    Records maintained by attorneys include appointment books, cash registers, client card index, disbursement journals, case time records, time summary reports, individual client records, receipts journals, and daily logs. They may also maintain a petty cash journal. The examiner’s job is to review the documents comprehensively and test the validity of the reported income by comparing and reconciling the data provided by the client.

    Any discrepancy between the income generated, deductions, trust accounts, expenses, and employment taxes, intentionally or otherwise, can have fatal consequences on an audit’s outcome. The existence of inaccurate books is like the holy grail for an IRS examiner. At the Tax Law Office of David W. Klasing, we provide various accounting and bookkeeping services for lawyers in and around California. The accounting and bookkeeping services of our firm include:

    • Tracking and analysis of accounts payable and receivable;
    • Tax basis accounting (income statements, profit, and loss statements, balance sheets)
    • General journal maintenance;
    • Subsidiary ledger maintenance; and
    • Bank statement reconciliation.

    Attorney-Client Privilege

    Attorney-client privilege is a legal doctrine that protects the confidentiality of communications between an attorney and their client. The purpose of this privilege is to encourage clients to communicate openly and honestly with their attorneys, knowing that their communications will be kept confidential.

    In the context of a tax audit of an attorney, the attorney-client privilege can be very relevant. Here are some ways that the privilege may come into play:

    • Protecting confidential communications: The attorney-client privilege can protect confidential communications between a lawyer and their clients, including discussions about the client’s income, expenses, and tax-related matters. This can be important in a tax audit because it allows the lawyer to provide candid advice to their client without fear that their communications will be disclosed to the tax authorities.
    • Asserting the privilege in response to requests for information: If the tax authorities request information or documents that are subject to the attorney-client privilege, the lawyer can assert the privilege and refuse to disclose the information. This can help to protect the confidentiality of the lawyer-client relationship.
    • Limiting the scope of the audit: The attorney-client privilege can also help to limit the scope of the audit. For example, the tax authorities may be prohibited from examining communications that are subject to the privilege, which can reduce the potential for the audit to uncover evidence of wrongdoing.

    It is important to note that the attorney-client privilege is not absolute, and there are some circumstances in which it may not apply. For example, if you and your client were engaged in criminal activity, the privilege may not apply. We can provide guidance on how to assert the privilege and protect the confidentiality of communications between a lawyer and their client during a tax audit. Here are some ways that we may employ:

    • Identifying privileged communications: We can help you identify which communications are privileged and which are not. This can help to ensure that you are not inadvertently disclosing privileged information during the audit.
    • Asserting the privilege: If the tax authorities request information or documents that are subject to the attorney-client privilege, you can assert the privilege and refuse to disclose the information. We can provide guidance on how to assert the privilege in a way that is both effective and legally defensible.
    • Negotiating with the tax authorities: We can negotiate with the tax authorities on your behalf of you to limit the scope of the audit and protect privileged communications. For example, we may negotiate to have a neutral third-party review privileged communications to determine which are relevant to the audit.
    • Challenging improper disclosure of privileged information: If the tax authorities improperly disclose privileged information during the audit, we can challenge the disclosure and seek to have the information suppressed or excluded from the audit.

    In sum, we can provide valuable guidance and advice to you during a tax audit to ensure that privileged communications are protected and that the attorney-client relationship is preserved.

    Why Should You Never Contact Your Original Preparer?

    It’s never a good idea to return to the original tax return preparer during a tax audit. It could create a conflict of interest and complicate the audit procedure. Following are a few reasons why:

    • The appearance of Bias: Return to the original tax return preparer following an audit would give the impression of bias or conspiracy, primarily if the preparer benefits from the audit’s outcome. It will compromise the integrity of the audit process and raise concerns among the auditors.
    • Lack of Independence: If the original tax return preparer is involved in the audit process, they may be less likely to raise issues or disputes with the IRS on behalf of the taxpayer. It could lead to the taxpayer missing out on potential deductions or credits that could have been claimed.
    • Risk of Noncompliance: In some cases, the original tax return preparer may have made errors or omissions on the tax return that could be uncovered during an audit. If the preparer is involved in the audit process, they may be less likely to disclose these mistakes, which could result in penalties or other consequences for the taxpayer.
    • Conflict of interest: There is a potential conflict of interest when the original tax return preparer is involved in a tax audit of a client’s return. It is because the preparer may feel a sense of loyalty to their client and could be hesitant to reveal any errors or omissions that they made on the original return leading to a less objective assessment of the taxpayer’s tax liability and could ultimately result in penalties or other consequences.
    • Loss of reputation: Professional tax preparer makes their living based on reputation. If potential clients hear that the preparer botched or otherwise made grave errors of judgment on a filing, few people will seek the preparer’s services. Thus, the preparer is likely to be more than willing to shift blame to the client and turn over the information provided to the client that resulted in the contents of the tax return. Since the accountant is likely to be significantly more knowledgeable about taxes, they are likely to deflect blame, perhaps aided by anything additional you have disclosed after the return comes under audit.

    DO NOT contact the original preparer if you are an attorney, have received an audit notice, and

    know that you cheated on the return under audit. They are likely to be government witness

    number one against you if the government figures out the truth and chooses to prosecute. In

    addition, anything you say to them can be compelled from them when they are forced to take

    the witness stand against you under the government’s contempt of court powers.

    David W. Klasing is a dually credentialed Tax Attorney and CPA with a Master’s degree in taxation. He is also a former public accounting auditor who managed a staff of 15 while dealing with sophisticated audits, including private placements, IPOs, employee benefit plans, non-profits, and for-profit entities. We understand the auditing methodology and process utilized by the IRS, anticipating the auditor’s strategy and dealing with it accordingly. Using his education, training, knowledge, and experience, David stays several steps ahead in the audit process in order to mitigate the risk of civil and criminal consequences you may face.

    How to Survive an Audit When You Cheated on Your Taxes?

    The chances of a lawyer getting audited increase exponentially if numbers have been altered. With the advent of modern software, the IRS uses several methods to detect discrepancies in the lawyers’ income records, tax returns, expense disbursements, and other anomalies leading to potential tax fraud. So, don’t be surprised if the IRS comes knocking on your door. Lawyers have been known to be susceptible to thinking that they will get away with fudging the numbers. However, nothing could be further from the truth. Attorneys have a horrible compliance record and are prone to get audited more frequently than other professionals. With incredibly high stakes and potential career-ending situations such as disbarment and prison time, attorneys are in the position of losing far more than other professionals if prosecuted following an audit.

    If you are selected for an IRS audit and know that you may have cheated, remember that anything you say can and will be used against you. The worst thing you can do is try and face the audit process alone. It is a highly stressful process, and you need an experienced tax attorney to guide you.

    The IRS’s agents are well-trained and can spot almost all of the “common” tax fraud tactics and associated “badges of fraud.” Badges of fraud are a set of circumstances or factors that can indicate the presence of fraud or an intent to defraud. The deliberate concealment of assets or income from the tax authorities can be a badge of fraud. Making false statements or omissions on a tax return or in other communications with the tax authorities can be a badge of fraud. Keeping incomplete or false records can be a badge of fraud because it can be an indication of an intent to deceive the tax authorities. Overall, badges of fraud are an important consideration in tax law and can be used by tax authorities to identify potential instances of fraud or other improper conduct.

    The best step you can take in recovery if you know that you have cheated on your tax return is to call an experienced and competent tax lawyer. You want to avoid going through an IRS audit alone, especially where you cheated on the original or amended position that is being audited. Adding a buffer between you and the IRS can be hugely beneficial in preventing the IRS from obtaining criminal admissions rather than just evidence of negligent accounting and tax preparation.

    Eggshell Audit of an Attorney

    An eggshell audit is a term used to describe an audit in which the auditor is particularly cautious and delicate in their approach because the audited party is particularly sensitive or fragile. The term “eggshell” is used because the auditor must tread carefully, as if walking on eggshells, to avoid causing any damage or harm to the audited party.

    An example of an eggshell audit of an attorney might be a situation where an attorney is being audited by the tax authorities due to a potential issue with their tax returns. Let us illustrate by way of an example.

    Suppose that you have claimed a large number of deductions for business expenses, and the tax authorities want to review the supporting documentation to ensure that the deductions are legitimate. In this scenario, the audit is considered “eggshell” because you are particularly sensitive to any potential negative consequences that might arise from the audit. For example, if the audit uncovers evidence of tax fraud, your professional reputation and career could be seriously damaged, and you may even face criminal tax charges!

    On December 5th, 2022, The United States Attorney’s Office for the Central District of California issued the following press release:

    Lawyer Michael Avenatti Sentenced to 14 Years in Federal Prison for Stealing Millions of Dollars from Clients and Tax Fraud

    Michael Avenatti became a national celebrity when he represented Stormy Daniels in her lawsuit against former president Donald Trump. The fame was short-lived as the United States Attorney’s Office for the Central District of California found Avenatti guilty of stealing millions of dollars from clients, including a paraplegic man, and committing tax fraud. In addition to the 14-year sentence, Avenatti was ordered to pay $10,810,709 in restitution to four clients and the IRS.

    In the indictment, it was alleged that:

    • Avenatti failed to file individual tax returns or pay any personal income taxes from 2011 through 2017, even though he had a substantial income and lived lavishly.
    • He also failed to file partnership returns or pay taxes – including payroll taxes – for his now-defunct Newport Beach-based law firm Eagan Avenatti LLP, of which he was the managing partner, from 2013 through 2017, even though the law firm received many millions of dollars during those years.
    • Furthermore, Avenatti failed to file corporate tax returns or pay taxes for Avenatti & Associates, of which he was president, from 2011 through 2017, even though this entity also received substantial funds.

    The case of Michael Avenatti serves as a reminder that, for attorneys, liabilities resulting from taxes can be severe, including prison time and significant fines. The IRS takes tax fraud very seriously and has various tools and resources to investigate and prosecute individuals attempting to evade their tax obligations. We are here to tell you how you can avoid following in the footsteps of Mr. Avenatti.

    You should be aware that because attorneys as a group have a terrible compliance record, the IRS has generated a comprehensive Attorneys Audit Technique Guide (ATG) to enable auditors to effectively audit issues pertaining to attorneys. It contains detailed information about attorneys’ recordkeeping and bank account systems, including general and segregated trust accounts, client-related expenses, web currency and bank retrieval systems, and gross income types. However, rest assured that, using our in-depth understanding of these resources, we can identify areas of audit scrutiny for you and help you adjust your practices and recordkeeping to avoid or minimize potential problems.

    Why is a Criminal Tax Defense Counsel Needed In an Egg Shell Audit?

    Given the potential stakes, we know from our experience that the auditor conducting the eggshell audit will be particularly careful in his approach. They will review the documentation thoroughly and ask you probing questions to elicit incriminating responses. They will be aware of your professional and personal circumstances.

    You would likely benefit from working with a criminal defense tax attorney who has experience representing lawyers in tax audits. The attorney could provide guidance on how to respond to the audit, assert any relevant legal privileges (such as attorney-client privilege), and negotiate with the tax authorities on behalf of you to minimize the potential consequences of the audit. Overall, an eggshell audit of a lawyer can be a delicate and challenging situation, and it requires you to proceed with caution and care.

    Taxpayers facing an eggshell audit require the expertise of a seasoned criminal tax defense attorney who can advise them on how to fulfill the auditor’s data requests, questioning, and summonsing of records without inadvertently providing false information or waiving their constitutional privileges against self-incrimination and unreasonable searches. The primary concern of the attorney in this type of audit is to prevent the auditor from referring the case to the IRS’s criminal investigation unit. This is because the criminal investigation unit’s main goal is to prosecute tax crimes to deter the general public and they have a 90% conviction ratio.

    If a revenue agent uncovers indications of fraud during the audit, they will privately consult with their manager and a “fraud referral specialist” to develop a “fraud development plan” to document the affirmative acts and firm indicators of fraud. This plan is for the sole purpose of referring the case to the criminal investigation function of the IRS. In such cases, the criminal tax defense attorney must assess the benefits of continued cooperation with the revenue agent to dispel their suspicions or advise their client to remain silent to avoid self-incrimination, as it is a felony to lie to a federal agent after a referral has been made.

    Why do You Need Us?

    As your representative, our goals include the following:

    • Attempting to narrow the scope of the inquiry;
    • Limiting the information provided to avoid self-incrimination;
    • Avoiding providing an explanation that cannot be supported;
    • Preventing the presentation of false or misleading information that could imply an effort to cover up fraud;
    • Avoiding any actions that could alert the agent to fraudulent aspects of the returns, such as claiming the Fifth Amendment against self-incrimination unless absolutely necessary.

    In an ordinary audit, the objective is to provide evidence to support adjustments, but in a fraud investigation, our goal is to withhold incriminating information (where possible) to minimize the scope of the investigation. Please keep in mind that attempting to bluff or explain an item or transaction can be used as evidence of fraud. There are no informal conversations with agents, and providing false information to a federal agent is a felony.

    We have a thorough understanding of the IRS and California Tax authorities’ procedures for civil audits and criminal tax investigations, including their knowledge of the legal industry and its examination issues.

    If you have failed to file a tax return for one or more years or have taken a position on a tax return that could not be supported upon an IRS or state tax authority audit, eggshell audit, reverse eggshell audit or criminal tax investigation, it is in your best interest to contact an experienced tax defense attorney to determine your best route back into federal or state tax compliance without facing criminal prosecution.

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

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

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

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


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