CAREFUL STEPS TO TAKE WHEN YOU HAVE AN EGGSHELL AUDIT. By Frank J. Rooney, Esquire Offices CO, DC, MD, & VA

Transcription

1 CAREFUL STEPS TO TAKE WHEN YOU HAVE AN EGGSHELL AUDIT By Frank J. Rooney, Esquire Offices CO, DC, MD, & VA

2 EGGSHELL AUDIT DEFINITION Understatement of Income Overstatement of Deductions Other Factors-Misclassification of Income or Employee Status

3 SOURCES THAT TRIGGER IRS EXAMS: Bad Luck Bad Decisions Angry Informants i.e. disgruntled spouse or employee Whistleblower Rewards 15 to 30 percent of Ultimate Under Section 7623

4 WHY BE CONCERNED WITH EGGSHELL AUDITS: Avoid Criminal Referral Greater than $10,000 Income in a Single Year Auto Referral to Technical Fraud Examiner Avoid 75 percent Civil Fraud Penalty

5 PRIVILEGES TO PROTECT THE CLIENT Accountant Client Attorney Client

6 FEDERAL ACCOUNTANT-CLIENT PRIVILEGE Statutory privilege for federal tax practitioners Any tax advice communication between a taxpayer and a federally authorized practitioner is privileged to the same extent that it would be privileged if the communication were between a lawyer and client. I.R.C Covers attorneys, CPAs, enrolled agents.

7 Subject to limitations: FEDERAL ACCOUNTANT-CLIENT PRIVILEGE Applies in federal tax contexts (before IRS and federal courts in actions by or against the United States). Does not cover criminal matters. Does not protect work product. Does not apply to written communications in connection with the promotion of a tax shelter. Privilege is waived if the communication is shared with any person outside the practitioner-client relationship.

8 ATTORNEY-CLIENT PRIVILEGE NOTE: NO PRIVILEGE IF ATTORNEY PREPARES THE TAX RETURN

9 KOVEL ACCOUNTANT TAX PREPARER NON-TAX PREPARER Know the Audit Facts- PREVIEW WHAT AGENT MAY SEE

10 Voluntary Disclosure PROVIDED NO IRS AUDIT OR POTENTIAL TRIGGER AUDIT EVENTS No Audit No Potential Audit Trigger Events Like Spouse or Business Associate Threat to Turn Taxpayer into IRS

11 TWO TYPES OF CLIENT- TAXPAYER WHO COMES IN WITH AUDIT LETTER AND RED EYES TAXPAYER WHO HIDES EVERYTHING FROM PREPARER OR ATTORNEY

12 RED EYE CLIENT

13 TAXPAYER WHO HIDES EVERYTHING

14 INTERVIEW PREPARER ASAP COPIES OF RETURNS HELD BY PREPARER WORKPAPERS, ORGANIZERS ETC ANY ISSUES PREPARER HAD WITH THE RETURN

15 INTERVIEW PREPARER ASAP CONT D. BANK RECORDS REVIEWED BY PREPARER CHECK PREPARER CREDENTIALS i.e. if CPA, ENROLLED AGENT, ATTORNEY (VERIFY GOOD STANDING) TAX PREP EXPERIENCE AND TRAINING AS A PREPARER

16 REVIEW IRS PROCEDURES: Internal Revenue Manual AUDIT TECHNIQUE GUIDES FOR A PARTICULAR INDUSTRY e.g. cash intensive business

17 CASH INTENSIVE BUSINESS There are three main ways to misappropriate cash from a business: It can be skimmed from receipts, for example, pocketed before it is recorded. If this happens it will not be discovered by auditing the books. It can be stolen after it has been recorded, for example, cash removed from the cash register or goods stolen from the shelf for future resale. A fraudulent disbursement can be created, for example, a payment to a vendor that is actually cashed by the owner s son.

18 Danger signs AGENTS WITH WHO AND WHY QUESTIONS?

19 AGENT QUESTIONS WHO HANDLED THE: Information to Complete the Return Approved and Classified Expenses Responsible for Bank Deposits Ultimate Determination of Gross Receipts of the Business

20 AGENT ASKS WHY QUESTIONS: Why are Business Deposits in Personal Accounts? Why are Expenses Paid from Personal Accounts? Did You Give All of Your Bank Account Statements to the Revenue Agent? Special Interest in Certain Transactions?

21 OTHER INDICATORS AUDIT IS GOING IN THE WRONG DIRECTION: Agent s Manager Shows up at the Audit Agent Contact s Third Parties for Information Why Questions to Establish State of Mind on Specific Income or Deduction Items Long Time Length with No Returned Calls from Agent

22 FRAUD INDICATORS-INCOME Omissions of Selected Items while Others Are Included Omissions of Entire Sources of Income Unexplained Failure to Report Substantial Amounts of Income Identified as Received

23 FRAUD INDICATORS-INCOME CONT D. #1 Substantial Increase in Net Worth especially over a Period of Years Substantial Personal Expenditures Exceeding Reported Available Resources Bank Deposits from Unexplained Sources Substantially Exceeding Reported Income

24 FRAUD INDICATORS-INCOME CONT D. #2 Concealment of Bank Accounts, Brokerage Accounts, and Other Property Inadequate Explanation for Dealing in Large Sums of Currency, or Unexplained Expenditure of Currency Consistent Concealment of Unexplained Currency, Especially in a Business Not Routinely Requiring Large Cash Transactions

25 FRAUD INDICATORS-INCOME CONT D. #3 Failure to deposit receipts in a business account contrary to established practices Failure to file a tax return, especially for a period of several years, despite substantial amounts of taxable income were received Cashing checks, representing income, at check cashing services and at banks where the taxpayer does not maintain an account Concealing sources of receipts by false description of the source(s) of disclosed income, and/or nontaxable receipts

26 FRAUD INDICATORS-EXPENSES OR DEDUCTION Substantial overstatement of deductions Substantial amounts of personal expenditures deducted as business expenses Claiming fictitious deductions Dependency exemption claimed for nonexistent, deceased or self-supporting persons.

27 FRAUD INDICATORS-EXPENSES OR DEDUCTION CONT D. #1 Providing false or altered documents, such as birth certificates, lease documents, school/medical records, for the purpose of claiming the education credit, additional child tax credit, earned income tax credit (EITC) or other refundable credits Trust fund loans disguised as expenses or deductions

28 FRAUD INDICATORS-BOOKS AND RECORDS Maintaining multiple sets of books or no records False entries, or alterations made on the books and records; back-dated or post-dated documents; false invoices, false applications, false statements or other false documents or applications Invoices are irregularly numbered, unnumbered or altered

29 FRAUD INDICATORS-BOOKS AND RECORDS CONT D. #1 Checks made payable to third parties that are endorsed back to the taxpayer; checks made payable to vendors and other business payees that are cashed by the taxpayer Failure to keep adequate records, concealment of records or refusal to make records available Variances between treatment of questionable items as reflected on the tax return, and representations within the books

30 FRAUD INDICATORS-BOOKS AND RECORDS CONT D. #2 Intentional under- or over-footing of columns in journal or ledger Amounts on tax return not in agreement with amounts in books Amounts posted to ledger accounts not in agreement with source books or records

31 FRAUD INDICATORS-BOOKS AND RECORDS CONT D. #3 Journalizing of questionable items out of correct account Recording income items in suspense or asset accounts False receipts to donors by exempt organizations

32 FRAUD INDICATORS-ALLOCATION OF INCOME Distribution of Profits to Fictitious Partners Inclusion of income or deductions in the tax return of a related taxpayer, when difference in tax rates is a factor

33 FRAUD INDICATORS-CONDUCT OF TAXPAYER False statement about a material fact pertaining to the examination Attempts to hinder or obstruct the examination; e.g., failure to answer questions; repeated cancelled or rescheduled appointments; refusal to provide records; threatening potential witnesses, including the examiner; or assaulting the examiner Failure to follow the advice of accountant, attorney or return preparer

34 FRAUD INDICATORS-CONDUCT OF TAXPAYER CONT D. #1 The taxpayer s knowledge of taxes and business practices where numerous questionable items appear on the tax returns Testimony of employees concerning irregular business practices by the taxpayer Destruction of books and records, especially if just after examination was started Transfer of assets for purposes of concealment, or diversion of funds and/or assets by officials or trustees

35 FRAUD INDICATORS-CONDUCT OF TAXPAYER CONT D. #2 Patterns of consistent failure over several years to report income fully Proof that the tax return was incorrect to such an extent and in respect to items of such magnitude and character as to compel the conclusion that the falsity was known and deliberate Payment of improper expenses by or for officials or trustees

36 FRAUD INDICATORS-CONDUCT OF TAXPAYER CONT D. #3 Willful and intentional failure to execute pension plan amendments Backdating applications and related documents Making false statements on Tax Exempt/Government Entity (TE/GE) determination letter Use of false Social Security numbers

37 FRAUD INDICATORS-CONDUCT OF TAXPAYER CONT D. #4 Submission of false Form W 4 Submitting a false affidavit Attempts to bribe the examiner

38 FRAUD INDICATORS-CONDUCT OF TAXPAYER CONT D. #5

39 FRAUD INDICATORS-CONCEALMENT Inadequacy of consideration Insolvency of transferor Asset ownership placed in other names

40 FRAUD INDICATORS-CONCEALMENT CONT D. #1 Transfer of all or nearly all of debtor s property Close relationship between parties to the transfer Transfer made in anticipation of a tax assessment or while the investigation of a deficiency is pending Reservation of any interest in the property transferred

41 FRAUD INDICATORS-CONCEALMENT CONT D. #2 Transaction not in the usual course of business Retention of possession or continued use of asset Transactions surrounded by secrecy False entries in books of transferor or transferee

42 FRAUD INDICATORS-CONCEALMENT CONT D. #3 Unusual disposition of the consideration received for the property Use of secret bank accounts for income Deposits into bank accounts under nominee names Conduct of business transactions in false names

43 EMPLOYMENT TAX FRAUD-MISCLASSIFICATION

44 REVIEW BANKRUPTCY DOCUMENTS Bankruptcy Statements Bankruptcy Schedules

45 BANKRUPTCY FRAUD ISSUES: Failure to Disclose Assets or Income Transfer of Assets for Little or No Consideration within 2 Years of Filing Lifestyles that Do Not Match Income

46 BANKRUPTCY FRAUD ISSUES CONT D: Accounts in Other s Names Failure to File Personal or Business Tax Returns Trusts Holding Assets Previously Owned or Purchased by Debtor/Taxpayer.

47 IF REPRESENTATIVE SUSPECTS AGENT HAS FOUND SENSITIVE MATTER: Ask Agent if Fraud Technical Advisor Contact Downside if Not Contacted It May Trigger a Referral

48 WHAT TO DO IF IRS AGENT FINDS SENSITIVE POTENTIAL REFERRAL MATTER Do Not Misrepresent Facts Do Not Plead 5 th Amendment on Behalf of Client Do Not Confess to Errors on Behalf of Client

49 ALLOW IRS TO INTERVIEW THE TAXPAYER Short Answer is NO, NO, and NO. Agent May Threaten Summons Be Prompt with Your Answers (assuming you can answer) Fight IRS Summons in Federal Court if Agent Tries to Enforce Summons

50 ALLOW IRS TO EXTEND THE STATUTE OF LIMITATIONS Short Answer is NO, NO, and NO. Agent May threaten Audit Adjustments and Statutory Notice i.e. 90 Day Letter

51 QUESTIONS