Articles Posted in Audits

When a client has a tax problem, that may also be a criminal tax problem since they crossed the line of mere negligence to civil fraud, extra steps are needed to protect the clients interests. As in all cases, there is not a bright line between civil and criminal tax cases, and many tax cases with the potential for criminal prosecution are resolved through civil proceedings.

a9-300x300A criminal tax case involved when the taxpayer willfully violated the tax laws. The most common examples of this is tax evasion or failing to file a tax return. Typically, the government must institute criminal charges within six years of the due date of the tax return. Criminal tax cases are typically investigated within the IRS by special agents. Many cases start of civil audits, and as information is uncovered that leans toward potentially criminal conduct, the audit can shift to the criminal investigation group within the IRS. Therefore, it is important to recognize the warning signs  that the person handling the civil audit, whether it is a compliance officer of revenue agent, is going to suspend the audit and refer the case to the criminal investigation unit. Since the IRS will not tell the taxpayer about the potential criminal investigation, the clearest indicator that the case was referred is it is difficult to reach the civil auditor after many attempts.   However, before that happens there are warning signs to look for that the case is headed in the direction of a criminal issue when during the course of the audit the auditor asks for many details related to omitted income, the audit is taking longer than normal, the auditor is issuing summons to third parties, or is making copies of all the relevant documents. Most seasoned tax professionals can spot this issue fairly easy.

The next issue therefore, is how to handle the case at that moment you suspect a criminal issue. A IRS special agent will normally want to visit the taxpayer at their home, as a surprise tactic to gather information. The  taxpayer should not let the agent into the home, and should tell the agent they are retaining council to assist with the matter.  Since this initial interview may be the most important event during the case, it has to handled with care. Many honest taxpayers believe that they can talk their way out of trouble, but then they start making admissions and factual misstatements that criminally hamper their case. In most cases, a tax attorney should be the person explaining to the IRS why certain items are missing from the tax returns, and the taxpayer should remain quiet.

There is no denying that a sales tax audit is not a pleasant encounter with the New York State Tax Department. I guess any interaction with the tax authorities is likely to produce an uncomfortable experience but going through a detailed sales tax audit is like going to the dentist. As a tax attorney who assists clients with providing guidance through all phases of the sales tax audit process the goal is to have the audit produce minimal pain and little financial loss.

a8-300x301-299x300Through many tax audits, I have gained an original perspective on the motivations on the State Tax Department to improve their taxing abilities by being aggressive with imposing taxes. As troubling as this may appear, it must be remembered that the best offense is a great defense. In many cases, a typical client does not spend the time to compile the necessary and sufficient documents to meet the needs of the auditors. This is a huge mistake, but you may ask why do we care about the tax auditors, and if they review the right records?  In a few words, they will make your life hell if your records are poor. Often, most taxpayers do not have the correct records, so the first step is to organize their records which will make the audit go much better, and reduce the cost of crazy wild guesses by the tax department in their quest to create a tax bill. Any time a client does not have ample tax records, the tax laws and regulations allow the state to start calculating the taxable sales, and they never come out on the low side.

Seeing that having good records can be so critical to a successful sales tax audit, I spend a lot of time with my clients to organize and improve their sales tax records before the audit begins. They are often shocked at the level of detail we make their records. When the actual audit starts, we (my client and I) sit along with the auditors and be available to answer questions and try to manage the process. Trying to influence the auditor is key, and honey works better than vinegar, if you know what I mean. Most clients are uncomfortable at first being at the sales tax exam, but after a while they understand the value in being there to help reduce their tax bill. Also, by showing our real human side and showing that we will not be bullied around, in all times in a friendly nonetheless productive manner, a positive difference can be had. If the sales tax auditor is being debilitating to constructive progress, then we can ask to speak to the persons supervisor and division group manager if we decide that would be productive. If all else fails, and where the client’s records have no value we try to reach a low tax settlement. In the conciliation conference, a mediation comes about between the taxpayer and tax department to come to a settlement. Often the results of this process are very good, and a reasonable result can be obtained to lower the tax bill to amount that can be paid all at once, or a reasonable payment plan can be established.

Usually, the most panicked and upset clients call me and when they have not filed their tax returns in many many years, and are extremely worried that by this inaction they will be arrested, or worse thrown in prison. Occasionally, clients are audited for non-tax problems ( for example workman’s payment insurance, highway permits) by the IRS or State of New York, and the auditor makes the discovery that the taxpayer has not filed their income tax returns in a long time. This “great” discovery causes a lot of angst to the taxpayer, but usually the IRS and the States are not quick to press charges if the tax returns are filed quickly (see list below of action steps needed). Typically, you only have a criminal tax problem is you intentionally do not pay the right amount of taxes, so usually they issue is manageable. Therefore, non filing typically does not cause the same level of problems are actively avoiding paying taxes, and your almost never going to jail.  Please keep in mind, in New York State it is actually a felony to not file your income tax returns for at least three years in a row where you owe taxes for each of those years. It is not often that NYS Tax uses this law to charge a taxpayer with a crime, but I have seen it applied in hundreds of cases, so it is not overly rare that they do.

a7-300x300The IRS and NYS tax auditors normally take the approach of creating their own estimated version of the income tax return you failed to file (called a substitute tax return), and charging the taxes owed based upon their computation based on limited information. Please keep in mind they have no incentive to lower your tax bill, so their work is suspect. The crucial point is that the substitute tax returns tends to overstate the tax debt amount, since they give you no deductions and use  the highest possible tax rate. As they say, you never get something good for nothing.

The very long standing IRS’s voluntary disclosure policy applies to a taxpayer who: 1) Informs the IRS or NYS that they failed to file a tax return, 2) You make the disclosure prior to being notified by the tax authorities, or before you are under criminal investigation for failing to pay the right amount of taxes, 3) File the correct income tax come returns, and cooperate with the tax authorities (NYS and IRS) in ascertaining their correct income tax liability, and 4) Make full payment of the amount of the sales or income taxes due, or if are unable to make payment in full, to create a monthly tax payment plan for the tax balance owed.

If a taxpayer does not file an income tax return (IRS calls them non-filers), and the IRS deems that a tax return is due to be filed, the IRS will use the information it receives from third parties (employers, brokerage firms, mortgage lenders) and filed W/2 forms, Form 1099, Form 1098, and other similar income reporting forms, to prepare the missing tax return. The tax return is prepared by the substitute return group at the IRS, which is connected to the audit group. The tax return is called by the IRS a Substitute For Return (SFR).

tax-planning-300x263When the IRS prepares your tax return, they use the highest tax rate and do not include any tax credits you are entitled to. Therefore, the tax computed is higher than what it would have been if you prepared the tax return in most cases. They also treat married people as married filing separately, which also causes the tax rates to increase. They also exclude dependents, which causes a higher tax bill. 

When you don’t file an income tax return, there is no statute of limitations of when you or the IRS can file a tax return, or audit you. The typical rule is that the IRS can audit you for the last three years once you file a tax return, unless they find your income was materially under reported on a filed tax return and they can go back for the last six years. The IRS however, under the Internal Revenue Manual sections 412.1.3, says in general they will only prepare substitute income tax returns for the last six years. The six-year rule also agrees with the IRS policy for non-criminal cases of only looking for taxpayers to file for the last six years if they did not file for a longer period of time.

The IRS appeals function has the mission of attempting to resolve tax disputes between taxpayers and the IRS by negotiated settlement discussions rather than litigation. Since tax litigation is very expensive, the IRS appeals process is a very useful tool to help resolve tax disputes. Today, in our society, using means other than litigation has caught on in the form of mediation and arbitration.

The ability to utilize the IRS appeals function, as demonstrated by Facebook’s failed attempt to gain access to the appeals group and ended up going to court just to have the right to go to IRS appeals, can sometimes be a tricky process. I have used the IRS appeals process many times to try to avoid tax liens, for collection and exam issues, and penalty abatement cases. If you desire, the appeal can be heard in person, or over the phone.

a8-300x301-299x300Fast Track Mediation is geared mostly to the small business and self employed taxpayers that are disputing tax assessments as a result of an income tax audit, the imposition of a trust fund recovery penalty (for unpaid payroll taxes), offers in compromise settlements, or IRS collection actions where a Revenue Officer is involved. The trained mediator (who does not force either party to accept his or her decision), listens to both sides to understand the tax issues involved and try’s to formulate a solution that both parties can accept. This process is usually complete in about 30 to 40 days. The mediation process is started when the IRS and the taxpayer both sign a Form 13369, for the case to transferred to the mediation group. With the form, you also provide a written explanation of your position, with legal support (tax law, court cases), that supports your position. The mediator reviews all the evidence, speaks to each party, and then renders a decision.

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If you disagree with how much the IRS says you owe as a result of an tax audit, there is a process to correct the problem. The procedure is known as an audit reconsideration and is allowed when:

  1. You or your representative did not appear at the audit to provide your information that would support the items on your income tax return. This could be the result of you moving, and you did not get notice that an income tax audit was occurring. This is also the case, if you simply decided that you would not attend the audit (for instance, you were scared or intimidated)
  2. You have additional documentation that was not available when the “original” audit was conducted. This often happens since gathering the items needed for an audit (bank records, receipts, etc), takes time to gather and organize, and perhaps that was not done in time for the audit meeting

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Many new clients call us in a panic when they receive a letter from the IRS that their income tax return has been selected for an audit. In most cases the client knows that they overstated their tax deductions, or less likely did not report all of their income. In either case,  being caught is not a pleasant result. When the IRS audits an income tax return for deductions, it focuses on whether you have a receipt. From the basic perspective, the IRS is looking for a stack of receipts that add up to the tax deduction taken on the income tax return.

A lot of clients think that a bank statement or credit card statement is a receipt. This is not correct, since a bank statement or credit card bill only shows that the expense was paid, but not the details of the item purchased in order to verify it is a business deduction. Therefore, its important to save the actual receipts to get the tax deduction you are entitled to.

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We are all human and therefore prone to making the occasional mistake or two. This includes financial errors concerning one’s personal or business expenditures as well as tax-related faux pas. This is something that even the Internal Revenue Service acknowledges and seems to understand. However, depending on the type of mistake, the agency’s response may not seem very forgiving.

The IRS lists the following tax-related mistakes as being among the most commonly made by taxpayers.

  • Failing to provide or making errors when entering Social Security numbers

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Each year, countless Americans are duped by so-called tax preparers who commit identity theft or fraud, or at the very least, file incomplete or inaccurate returns. Possibly contributing to this problem is the fact that the IRS lost the ability to regulate the licensing of tax preparers who are not attorneys or CPAs last year following a Supreme Court ruling.

However, a new bipartisan bill that has been proposed in Congress would give the Department of the Treasury and the IRS the authority to regulate tax preparers once more. As a recent Forbes article reported, the bill would allow the two agencies to oversee “all aspects of Federal tax practice, including paid tax return preparers.”

Ultimately, this would mean people who prepare taxes for profit will once again have to pass exams, fulfill continuing legal education requirements and maintain a valid preparer tax identification number in order to be licensed to prepare taxes.

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For many who reside in the state of New York, one of their biggest fears is to be audited by the Internal Revenue Service. People who are concerned about this occurring probably believe that three years after a return is filed, they are in the clear. While it is true the statute of limitations for tax returns is generally three years, under certain circumstances it is possible that period could extend to six years. In some cases it could go even longer.

The audit period could extend from three to six years in situations where in completing the tax return, the tax player substantially understated his or her income. But just what does that mean? This situation arises when the taxpayer fails to account for more than a quarter of his or her income. The statute of limitations will start to run on either the date the filing is due or the date in which it is filed—whichever is later.

The IRS could also extend the audit period to six years in situations where the taxpayer has omitted more than $5,000 in foreign income. This might arise in situations where the taxpayer has accrued this income as a result of interest on an account that is overseas.

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