What to do when the Auditor Stops Contacting You

My auditor hasn’t contacted me in a couple of months, what should I do?

In this scenario, it’s best to do nothing at all. The IRS doesn’t have an unlimited amount of time to finish your audit, they have 28 months since the date you filed your return to complete the audit. If the auditor is no longer contacting you, there is no point in trying to reach out to them. Why help them if they’re running out of time?

There are a couple of different reasons that the auditor has stopped contacting you. Although not likely, the auditor in charge of your case could’ve been transferred or fired mid-audit. Your case may also be dormant in a pile of other cases awaiting processing. If you’re really lucky, the auditor may have missed the deadline to close your case. You don’t ever want to remind the IRS to finish your audit nor do you want to give them more information than they request, so if the auditor doesn’t contact you, don’t go out of your way to reconnect.

Only in one instance should you take action after not receiving word from your auditor over a long period of time. The auditor is required to cut off contact if the IRS finds sufficient evidence of tax fraud and refers your case to the IRS Criminal Investigation Division. Unless you intentionally commit fraudulent activities and until you’re contacted by an IRS special agent, you shouldn’t have anything to fear from the auditor ending correspondence. In the situation that a special agent does contact you, however, seek out professional representation from the Law Offices of Jef Henninger immediately.

What documents will the IRS want to see?

Don’t wait until the IRS audits your return to start collecting and organizing your financial records. Keeping track of documents such as receipts and payroll reports can mean the difference between sufficiently substantiating your claims and having to pay hefty fines.

The IRS is going to request different documents for different situations. For example, if you’re running a small business and you deduct your travel expenses claiming they’re business-related, the IRS is going to want to see a mileage log and receipts for gas and lodging. You will also have to provide some proof that the travel was business-related. If you vacation in Cancun and write it off as a business expense, that’s called fraud. If you have the documents to show that your trip was to meet with a client, however, this would be a legitimate deduction.

The Information Document Request

For any taxpayer unlucky enough to be audited, it will be impossible for them to know what documents the IRS wants to see until they receive an Information Document Request (IDR) in the mail. The IDR, also known as IRS Form 4565, usually arrives with an audit appointment letter that details what steps need to be taken.

The IDR itself is a list of specific documents the taxpayer must gather in order to substantiate questionable items on their tax return. The number of IDRs sent to the taxpayer depends on the type of audit and its complexity. Sometimes, the IRS only needs to verify one item and can settle the audit after one IDR. In more complex cases, you may have to gather a variety of documents from an initial IDR, meet with the IRS in person, then receive more IDRs to support what was discussed at the meeting.

The Information Document Request will list out all specific documents you must deliver to the IRS for examination. The documents vary on a case-to-case basis, but frequently requested items include:

  • General ledger
  • Copies of  loans, leases and material contracts
  • Cash disbursements journal
  • Accounts payable ledger
  • Trial balance
  • Financial statements
  • IRS Forms 940, 941 or 944, 945
  • Forms W-2
  • IRS Form 1099
  • Collective bargaining contracts with employees
  • Loan statements
  • Bank statements
  • Cancelled checks
  • Receipts
  • Listing and invoices for fixed asset purchases
  • Payroll reports

Once you finish reading your IDR, you should begin gathering the requested documents as soon as possible. Be sure to make copies and to never send in the original copy. If you can’t find a specific document, get in contact with whoever originally issued the document immediately and request a duplicate. The IRS doesn’t accept missing documents as an excuse. Do not ever send the IRS more information than they asked for, this will only come back to haunt you if the IRS finds another mistake.

If you are being audited, you don’t have to go at it alone. The Law Offices of Jef Henninger work aggressively to assure our clients the best possible outcome from their audits.

Appealing the Audit

The IRS has finally completed poking through your financial history and has concluded your audit. Upon completion, you will receive an IRS examination report in the mail that details all the proposed changes, penalties (with interest), taxes, and possibly even refunds you will receive.

If you agree with the findings of the IRS, all you have to do is sign and return your copy of the report. Pay your fines, and your audit problems are over.

If, however, you disagree with the findings, you have the right to appeal the IRS’s conclusions.

How to appeal an audit

The first step in appealing your audit is refusing to sign and return your copy of the examination report. Doing so results in the IRS sending you a 30-Day Letter that lists the steps of appealing the audit. You are given 30 days from the date listed on the letter (not the day you received it) to file your official protest, although extensions are usually given upon request. The IRS requires that your protest includes each of the following:

  1. Your name, address and a daytime telephone number
  2. A statement that you want to appeal the IRS findings to the Office of Appeals
  3. A copy of the letter you received that shows the proposed change(s)
  4. The tax period(s) or year(s) involved
  5. A list of each proposed item with which you disagree
  6. The reason(s) you disagree with each item
  7. The facts that support your position on each item
  8. The law or authority, if any, that supports your position on each item.\
  9. The penalties-of-perjury statement as follows: “Under the penalties of perjury, I declare that the facts stated in this protest and any accompanying documents are true, correct, and complete to the best of my knowledge and belief.”
  10. Your signature under the penalties of perjury statement

Accepting your request to appeal

Note that the IRS is not legally required to grant your request for appeal. Your chances of the IRS approving your appeal request are likely if you can prove any of the following:

  • You did not receive proper notice for the audit
  • The IRS ignored documents that would reduce any taxes or penalties you owe
  • You have new documentation to support your case
  • You filed an accurate tax return to replace the tax return filed by the IRS during a year in which you failed to file
  • The IRS made math errors regarding the amount of tax owed

Denying your request to appeal

Once you receive IRS Form 4549 that details the adjustments to your tax return, you must be certain that you do not want to appeal before you respond to the IRS. Your request to appeal can be denied if you’ve already made a payment or reached a closing agreement with the IRS. Your appeal can also be denied if a United States Tax Court issued a final determination of your owed taxes.

Before you file for an appeal, you must also be sure that the reason you’re appealing is viable. Your appeal must be in accordance to tax laws and relate to a disagreement with the IRS’s conclusions. Cases cannot be appealed for moral, religious, political, or constitutional reasons.

Your letter of protest to the IRS should make it clear which changes you disagree with and why. It’s important to include as much documentation that supports your claim as possible. You can expect a response from the IRS in approximately 30 days, however you should be aware that any penalties and interest you owe from the audit will still accumulate during this process.

Depending on the amount of money you owe, the appeals process can proceed in one of three ways.

You owe less than $2,500

If the IRS claims that you owe less than $2,500 in taxes, you can take your appeal straight to the auditor. This will not go to the IRS Office of Appeals but will be handled by the agent that conducted your audit. A request by phone or in person should be enough, but it would be smart to write a protest letter anyway or fill out IRS Form 12203, the Request for Appeals Review.

You owe between $2,500 and $25,000 (Small Case Request)

If the IRS claims that you’re responsible for $2,500 to $25,000 in tax liability, you can request an informal appeal called a small case request. Although it is informal, it must still all be in writing. You can either fill out IRS Form 12203 or write a letter of protest that must include your contact information, tax ID numbers, a summary of the disputed items, and a statement of intent to appeal. IRS Form 12203 is a form that allows you to list out any objects on the IRS examination report that you disagree with and why. The form will ask for your Taxpayer Identification Number which is your Social Security Number if you’re filing as an individual or your Employer Identification Number if you’re filing as a business. Once you complete the form or the letter of protest, have it mailed to the office that conducted the audit.

You owe more than $25,000 (Large Case Request)

In any case in which you owe upwards of $25,000 to the IRS, known as a large case request, your only option to appeal is to write a formal letter of protest. The letter must contain:

  • Your name, contact information, and SSN
  • A statement of appeal of the IRS conclusions
  • A list of the findings you disagree with and explanations as to why they are incorrect
  • The tax periods involved
  • Documents supporting your explanation
  • A copy of your 30-Day Letter
  • A copy of your examination report
  • Your signature with a penalty under perjury clause

Send the letter to the local IRS office and an appeals officer should respond within 90 days. If you do not hear back within 90 days, follow up with the Office of Appeals to get an update on your appeal.

The IRS Office of Appeals

The IRS has an independent branch that conducts appeals called the IRS Office of Appeals. This office is made up of experienced employees, most of them previously auditors, who evaluate examination reports and assess the taxpayer’s arguments. The original auditor plays no part in this process. The goal of the Office of Appeals is to resolve tax disputes and to avoid court. Unlike the auditor, appeals officers have no interest in fining you or raising funds for the IRS. Appeals officers work to avoid litigation and to compromise with taxpayers, not to uphold whatever the original auditor concluded. Once they approve your appeal request, the Office of Appeals will schedule a conference with you.

The Appeals Conference

After submitting your request to appeal, you generally have 60 days to prepare for the appeals conference. The appeals agent will contact you and arrange a meeting in their office. In preparing to make your case, you should be sure to:

  • Solidify any arguments you plan to make
  • Acquire a copy of the auditor’s file from the local IRS office (this is done by mail and can take up to a month)
  • Prepare and organize all necessary documents, statements, receipts, and forms that support your argument
  • Get professional help from a tax professional permitted to practice before the IRS

Organization is an important component to winning over the appeals officer. If you go into the hearing unprepared with a mess of unorganized files, you probably won’t get your point across nor will the officer be willing to listen. The burden of proof is on you, so you must make your case as clear as possible. Organize your documents—receipts, bank statements, cancelled checks, etc.— according to each item you disagree with from the examination report. File them into folders and provide a brief explanation as to why the auditor was incorrect on each item. If organization isn’t your strong suit, hiring a bookkeeper is recommended.

The conference with the appeals officer is informal. There will be no testimony or procedures for evidence like in a trial, nor does the IRS record these meetings. You can record it yourself if you wish to as long as you notify the IRS several days in advance. This isn’t recommended, however, in that the officer will view you as difficult and be less willing to cooperate.

When negotiating with the appeals agent, keep in mind that the Office of Appeals settles disputes on what is known as the hazards of litigation. The hazards of litigation is the chance that the IRS would lose in tax court. If you can convince the officer that your case would win in court, they will lower your tax bill to avoid an unsuccessful case.

Once you prove your case, you should request that the officer waive or reduce the tax penalties placed on you by the auditor. The officer will be more lenient if you speak in terms of percentages as opposed to flat dollar amounts. Do not demand anything. This is a compromise, so you should be willing to pay at least part of the proposed adjustments. Your willingness to compromise will influence the officer’s willingness to compromise. Once you reach a settlement, the hearing is over.

You can then expect IRS Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Over-assessment, within your mailbox within the next couple of months. Before you sign and return the form, read it and reread it again. Signing the form prevents you from taking the IRS to tax court or take any further actions regarding your audit. Be sure that the numbers and reductions on the form match the compromise you made during the hearing.

If you still do not agree with the IRS’s findings even after the appeal, your only option is to take your case to the U.S. Tax Court.

Advantages of appealing an audit

The pros to appealing an audit are obvious. You can reduce and in some situations completely eliminate any extra taxes or penalties you owe to the IRS. The process is completely free, too, unless you hire professional help. Chances of a favorable outcome are also high. IRS statistics show that approximately 70% of cases are settled and lead to a 40% reduction in penalties originally assessed by the auditor.

The appeals process can also delay the due date of your assessed tax bill for months at a time, giving you more time to raise money or consider payment plans.

Disadvantages of appealing an audit

There are a few situations in which appealing an audit can potentially be harmful to you. Although it is rare, the appeals officer may find suspicious items on your return that the auditor had missed. The last thing you want to happen is to be criminally investigated on suspicion of tax fraud. If you are afraid of this happening, it would be smarter to just pay your tax bill or take your case directly to U.S. Tax Court. It’s also important to know that any penalties and interest placed on you during the original audit will continue to accumulate during the audit process. In the event that you lose the appeal you will have to pay even more than you originally owed.

Audits are generally frustrating, dragging processes that usually result in increased tax liability. Appeals, however, are not as complex and usually put money back in the taxpayer’s pocket. If you are undergoing an audit or need assistance in appealing the findings of the IRS, contact the Law Offices of Jef Henninger to assure the best possible outcome.

How do I avoid an audit?

There are many different reasons that you can be audited, but more times than not you will receive that dreadful letter in the mail from the IRS because there was a mistake on your tax return. There’s nothing you can do to prevent yourself from being randomly selected, however there are a number of precautions you can take to reduce the likelihood of being audited.

Make sure your information is correct

The most common reason people are audited is for inconsistent information on their tax return. If you file your return with one income on your return but your W-2 says otherwise, you will most likely be audited.

It is important to double check everything you write on your return. Make sure all of your math is correct, nothing is omitted, and everything is signed. Make sure you sign your return! Many people are guilty of this simple mistake that gives the IRS reason to take a closer look at your return.

Always double check your math. Math errors raise eyebrows, so be certain that your calculations are correct.

It is crucial that the income you claim matches the income reported on documents such as the W-2, 1099, and 1098. Underreporting income is a serious matter that can get you in a lot of trouble. Mistakes happen, just make sure this mistake doesn’t!

To verify that your information is correct, wait until you have all the necessary documents before filing your tax return. Gathering bank statements, income reports, and other financial documents make filing your return a whole lot easier. You’ll have a reference to work from to ensure your information is correct and it will be hard to forget any income with your financial records right in front of you.

Although the IRS has human auditors, most returns are examined by computers that analyze your tax return and search for errors and inconsistencies. It is crucial to double check everything you write on your return. If there is an error, the computer will catch it.

Maintain your records

Keeping financial records for both business and personal expenses can help you prevent an audit. Maintaining accurate books and records assures that your return will be accurate, preventing suspicion from the IRS. In the event that you are audited, keeping meticulous records can also be used as substantiation for any questions the IRS has. Financial records you should track include:

  • At least three years worth of tax returns
  • Checkbook stubs
  • Receipts from all purchases throughout the year
  • Property and taxable investment costs
  • Bills
  • Records of deductible items
  • Receipts and appraisals for any charitable contributions
  • Records of work-related expenses.

Small Businesses

Small business owners and self-employed individuals are some of the most at-risk for audits because they have the most opportunity to under-report income. If you’re a small business owner, it’s crucial that you don’t try to “push the envelope” and see how much income you can get away without reporting. If you really want to avoid the nightmare of an audit, it’s best just to be honest.

Businesses that deal primarily in cash are under more scrutiny from the IRS. Restaurants, bars, salons, taxi services, and other cash/tip based businesses are very likely to be audited because it is much easier to under report income when dealing in only cash. That being said, it is important to be consistent in your accounting method. Switching back and forth between cash and accrual accounting is a red flag to the IRS and will most likely trigger an audit.

One thing that the IRS loves to nail small business owners for is writing off personal expenses as business expenses. While ordering new business cards justifies a business expense, a vacation to Disney World does not. Be smart about what you write off as a business expense, because the IRS will come knocking if you decide that your personal expenses can be deducted. An easy way to keep your business and personal expenses separate is by having a separate account and card for each. It’s recommended to keep a journal of everything you purchase for your business and your reasoning why. Both these methods reduce the likelihood of the IRS auditing your business and will help you in the event of an audit.

Deductions

A simple way to avoid an audit is to make sure your deductions are in check. If you claim an usually high deduction given your income, the IRS will be suspicious. It’s important to know what constitutes a deduction. Gas money for your daily commute to the office does not justify a deduction, whereas a special trip to meet with a client in the next state over would.

Again, do not write off personal expenses as business expenses. If you work from a home office, don’t try to write off the new dishwasher as a business-related deduction.

A general rule of thumb is if you have to spend money on something to help you make money, it can count as a deduction. Don’t get carried away, though. The IRS won’t appreciate it, and you’ll pay for it regardless in the end.

Report your income accurately

Are you currently a small business owner who also does some consulting on the side? If so, be sure to accurately report all of the money you are bringing in across your different income streams.

As tempting as it may seem, never exclude a portion of your income from your tax return. When you do this on accident, it’s called negligence and can have minor but unfavorable penalties in the form of fines plus interest. When you do this on purpose, it’s called tax fraud and there will be harsh consequences such as a $250,000 fine and up to 5 years in prison.

The IRS compares your reported income to information collected from banks and employers to look for any discrepancies. Always make sure that what you report is accurate. Any error, whether by mistake or intention, can have you face fines that should’ve easily been avoided.

Dependents

If you or your spouse can claim dependents, make sure the dependents are only claimed on one tax return. This is a common mistake that can trigger an audit.

File your return electronically

The IRS says that the chances of you making a mistake on your return are dramatically reduced if you file it electronically. The IRS reports that the rate of errors on paper returns is 21%. The error rate for electronically filed returns, however, is only 0.5%. If you’re still filing on paper, it is highly recommended that you make the switch over. Less chances of an error means less chances of an audit.
The most effective thing you can do to avoid an audit is be honest. Lying on your return will never work out for you. As long as you file your tax return accurately, honestly, and on time, you don’t have much to worry about. Should you find yourself under audit regardless, contact the Law Offices of Jef Henninger, Esq., for professional assistance. You don’t have to face the IRS alone, we’re here to assure the best possible outcome for our clients.

IRS Criminal Investigation Process

The most frightening thing the IRS can do to you is open up a criminal investigation. The Internal Revenue Service Criminal Investigation Division (CID) conducts criminal investigations of individuals and firms under suspicion of committing tax fraud or other serious financial crimes. The CID looks for violations of the Internal Revenue Code, the Bank Secrecy Act, or for significant discrepancies in tax returns that constitute tax fraud. Examples such as deliberately under reporting income or intentionally failing to file a tax return can spark an IRS investigation.

Although only a handful of the millions of taxpayers undergo investigation, those who do are usually convicted and face devastating consequences. According to the IRS website, 3,853 criminal investigations were initiated in 2015 with 2,879 convictions and 80.8% of those investigated sent to prison. Alongside incarceration, a criminal investigation can result in huge fines, the loss of licenses, and the closure of businesses.

It’s important to understand that an investigation by the CID is very different and much more dangerous than an audit. Whereas the IRS during an audit seeks to find errors in a return in order to collect funds for the agency, the CID seeks not to collect money but only to prosecute you.

Warning Signs

More often than not, you will not be notified immediately when the investigation begins. If you are being audited, warning signs that the audit has turned into a criminal investigation include:

  • The IRS auditor who has been conducting your audit suddenly stops contacting you and will not return your calls for days or weeks at a time. This is not luck and no, they did not decide to just let you off easy. Your case may have been referred to a Special Agent in the CID. The auditor reviewing your return is no longer is in control of your case and ceases contact with you in order to prevent any obstruction to prosecution.
  • Your bank informs you that the CID using a summons or the local U.S Attorney’s Office using a grand jury subpoena are collecting copies of your bank records. Hiring representation will allow you to follow the IRS investigation and acquire the same records the IRS collects.
  • Your accountant is contacted by the CID or is subpoenaed to appear before a grand jury and hand over your tax records. Unfortunately, you are not given the same confidentiality guarantees with your accountant that you are with your lawyer. Not only does the accountant have to bring forward your records but they may also be called to testify, using any conversations you’ve had with them against you. While there is such a thing as accountant-client privilege, it does not apply in criminal investigations.
  • You are in the middle of an audit and the IRS informs you that a different year’s return has also been selected for examination.

How it’s Initiated

Criminal investigations usually begin when the auditor finds suspicious or significant errors in your tax return and refer your case to the CID. Investigations can also be based off of information given by other law enforcement agencies such as the FBI or the United States Attorney’s office. It is important to note that if the auditor finds indications of fraud, they are required to suspend your audit without telling you. It is illegal for the IRS to conduct a criminal investigation while you think it is an audit, but they will not tell you that your case has been given to the Criminal Investigation Division.

When your case is referred to the CID, it is given to a Special Agent. Like other agencies, IRS Special Agents are highly trained and armed  federal law enforcement officers conducting the investigation. The investigation begins with what is called the “primary investigation” which is a preliminary evaluation of your financial records, tax return, etc. The special agent analyzes your information to determine if fraud or other financial crimes are present. The agent has to acquire approvals before he can contact your bank/employer and needs special authorization before they can ask the grand jury to use its subpoena power to collect certain documentation. Once the special agent concludes his preliminary examination, they hand it to their front line supervisor who will then determine if there is significant evidence to approve investigation. Upon approval, the special agent is given permission to conduct a “subject criminal investigation.”

The special agent may appear at your home unannounced. If you didn’t know you were under criminal investigation by now, this is your wake up call. The agent is required to identify themselves and give a warning. The purpose of this visit is to catch you off guard without representation in order to interrogate you. Without counsel, it is very likely you will incriminate yourself in attempt to explain your mistake. Absolutely do not speak with the Special Agent without representation. You are not required to and it is in your best interest that you wait until you have professional help.

Once the criminal investigation has officially begun, the special agent will begin collecting evidence against you through a variety of means such as conducting surveillance, acquiring search warrants, collecting bank records and other financial documentation, and interviewing third parties such as employers, coworkers, and landlords.

The Investigation Process

To summarize, the IRS criminal investigation proceeds as follows:

  1. The IRS agent auditing your return finds evidence of fraud and refers your case to the Criminal Investigation Division.
  2. The special agent in the CID reviews your case and begins the primary investigation, reviewing your case for potential fraud.
  3. The special agent obtains authorization to collect information, issue a summons for records, ask the grand jury to subpoena documents, and to interview third parties.
  4. Once the special agent has collected sufficient evidence to bring the criminal case to court, they will document their findings in a Special Agent Report (SAR). This report features the agent’s conclusions of the criminal investigation and possible federal charges you can face. The agent then refers this report to the Department of Justice in order to prosecute and indict you. The referral, prosecution, and indictment must first be approved by a higher-up in the IRS.
  5. Once the IRS collectively approves the special agent’s referral, the IRS must seek approval from the local United States Attorney and from the Tax Division of the Department of Justice. You have the right to meet with anyone involved in the approval process to potentially stop the prosecution before it even begins.
  6. Once the IRS, United States Attorney, and the Tax Division of the Department of Justice all approve the referral, they must finally seek authorization from the grand jury to indict you.
  7. When the grand jury decides to indict you, your case has officially been brought to court. You must appear in court for a bail hearing and an arraignment where you will either plea guilty or not guilty. It is absolutely crucial that you have legal counsel by this time.
  8. It is your right to meet with your district federal judge and convince them to have the indictment dismissed before it goes to court. If they do not dismiss it, your case will appear before a jury.
  9. The jury will then determine whether you are guilty and not guilty. You have the right to appeal, but if your appeal does not succeed, jail time and other harsh penalties will follow.

Conviction

The goal of the CID is not to collect money owed to the federal government but to put tax evaders behind bars. Penalties can be severe, generally resulting in fines up to $250,000 for individuals, $500,000 for businesses, and up to 5 years in prison. If you find that you are being criminally investigated by the IRS, contact an attorney immediately. Alone, you won’t stand a chance against the IRS. With professional help from the experienced attorneys at the Law Offices of Jef Henninger, we’ll keep you out of jail and assure you the best possible outcome from a criminal investigation.

Tax Fraud

What is tax fraud?

Tax fraud is a general term for when a person or firm intentionally defrauds the government in order to avoid paying taxes. Major examples of fraud include failure to file a tax return, intentional failure to pay taxes, intentional under-reporting of income, preparation of false files, filing a false tax return, and using a fake Social Security number. Tax fraud is a serious offense with brutal consequences. Along with jail time, individuals convicted of tax fraud can be fined up to $250,000 and businesses can be fined up to $500,000.

The key component to fraud is that the taxpayer’s actions are intentional. Taxpayers are legally bound to accurately report income and expenses on their tax return. Withholding or falsifying information on a return is illegal and can result in either civil or criminal charges. If the auditor reviewing your return finds evidence or sufficient suspicion of tax fraud, your return may end up in the hands of the IRS Criminal Investigation Unit.

It is important to note that, while the IRS usually has 3 years to conduct an audit, there is no statute of limitations if they find evidence of fraud in your tax return. The IRS can investigate a fraudulent return for however long they require and can open up returns from previous years, so don’t try to wait them out.

If you intentionally commit tax fraud, the IRS will find out. The IRS combines both trained auditors and computer systems to detect discrepancies within your return. The auditors are trained to find fraud within a return, however most of the errors they find are honest mistakes. So what distinguishes fraud and mistake to the IRS?

Fraud or Negligence?

The IRS can tell the difference between honest mistakes and fraudulent actions. If you did not intentionally falsify your tax return, you don’t have anything to worry about. Honest mistakes do happen, though. The IRS knows that the tax code is complicated and most people are unaware of how it works. When errors are found in a return, the IRS generally gives the taxpayer the benefit of the doubt and assumes the mistake was out of negligence. Intent is the key difference between fraud and negligence. Common intentional actions that serve as red flags to the IRS include:

  • Overstatement of deductions and exemptions
  • Falsification of documents
  • Concealing income
  • Keeping two sets of books
  • Falsifying personal expenses as business expenses
  • Using a false Social Security number
  • Claiming an exemption for a nonexistent dependent, such as a child

A 20% penalty can be placed on you for negligent actions such as failing to keep adequate records. This means that if you owe $10,000 in taxes and are given a 20% penalty, the penalty will amount to $2,000 for a total of $12,000 plus interest. This is an honest mistake and is much better for you than the 75% penalty placed on you for civil fraud. Negligence isn’t illegal, but you can still pay for it. Be careful to keep records and to file your return accurately. The IRS is trained to tell the difference between fraud and negligence, but you don’t want to give them any reason to take a closer look at your finances.

The chances of you being charged criminally for fraud are extremely low. The IRS Criminal Investigation Unit only investigates about 2% of taxpayers, only 20% of that actually face charges. When an auditor spots an error in a return, they usually just place civil penalties to avoid extra paperwork. The IRS unofficially only conducts criminal investigations on cases with at least $70,000 in unpaid taxes. Considering most people don’t even make that in a year, the average American shouldn’t worry about being accused of tax fraud.

How the IRS Proves Fraud

The IRS relies on four indirect methods for determining fraud. They examine specific items, bank deposits, expenditures, and net worth to determine if you have committed tax fraud.

Specific items, such as checks given in payment to a company that are pocketed by the company owner, are useful in an investigation but there must be enough specific items to prove fraud. Unless a single check is pocketed for a significant amount of money, anywhere between 15 to 20 specific items are needed to prove fraud.

Bank deposits are the easiest way for the IRS to prove fraud because the auditor only has to find the sum of all of your deposits and compare it to your reported income. If your deposits exceed your reported income, you will be accused of fraud.

As with bank deposits, the IRS will calculate the sum of all your expenditures such as written checks, living expenses, and estimated cash expenses. The auditor can even use statistics on the cost of living in your area. If the sum of all of your expenditures exceeds your reported income, the IRS will be suspicious of tax fraud. The auditor will want you to fill out IRS Form 4822 which lists your living expenses. Do not do this. There is no punishment for refusing to fill it out and it only makes it easier for them to incriminate you.

Net worth is calculated by the IRS by finding the sum of all your liabilities and subtracts it from the sum of all of your assets from the start and end of the year under audit. If there is an increase of net worth without an increase of income from the previous year, the IRS will suspect you of tax fraud.

The IRS has additionally compiled a list of “badges of fraud” which are specific indicators that fraud is present. The badges are various but generally fall under the categories of understated income, insufficient books and records, failure to file tax returns, inconsistent or unlikely financial behavior, concealing assets, and failure to cooperate with the IRS.

No one of these badges are enough to prove fraud on their own. Multiple indicators are necessary for the IRS to conduct a criminal investigation.

A Clear Example of Tax Fraud

It is fairly easy for a self-employed person to fall into fraudulent habits. Since they keep track of their own books and records, it is easy for them to write off personal or fictitious expenses as business related. This would give them tax benefits they are not actually entitled to.

Say you own a restaurant and you decide to write off personal expenses such as vacations, personal travel expenses, or your phone and internet bill as business you can amount large illegal deductions that hide the actual amount of money you owe the IRS. This is an example of intentionally fraudulent behavior that can result in criminal consequences.

It is the IRS’s responsibility to prove that you intentionally committed fraudulent actions. Regardless, it is vital that you cease contact with the IRS and get legal representation such as the Law Offices of Jef Henninger as soon as you discover you are being investigated for fraud.

What kind of penalties can an audit result in?

How likely am I to go through an audit without owing any money to the IRS?

The IRS doesn’t audit someone if they don’t think there’s money to be made. Other than to ensure that taxpayers are abiding to the U.S. tax code, the main purpose of an audit is to provide funds to the IRS through penalties and interest. That being said, your chances of getting away scot-free or even receiving a refund are slim. Less than 25% of taxpayers audited by the IRS end up owing nothing to the IRS. There are a variety of reasons why you can be audited, but whatever reason it may be you will likely have to fork over a large sum of cash to the IRS.

It’s important to file your taxes accurately on and time. The penalties the IRS can place on you plus interest rates pile up quickly and can lead to you owing substantial amounts of money.

There are a variety of penalties you can face depending on the nature and severity of the error on the tax return.

Accuracy Related Penalties

If your tax return is inaccurate, the IRS can impose a penalty of 20% on the total tax understatement. If your taxes are severely understated, this penalty can double to a massive 40%. The following are the types of inaccuracies that can result in penalties.

  • Negligence or Disregard of Regulations: You can face penalty if you do not conform to the Internal Revenue Code, such as not submitting a tax return or not keeping records.
  • Substantially Understating Your Taxes: If you under-reported your income by more than 10% or $5,000, whichever is greater, you will face penalties.
  • Substantially Misstating the Value of Property: Penalties are placed on you if you substantially overvalue property donated or you substantially undervalue property that is depreciating.
  • Substantially Overstating Pension Liabilities: You will face penalty if you overstate pension liabilities by 200% or more.
  • Substantially Understating a Gift or Estate:  You will be fined if you undervalue property claimed on an estate or gift tax return by 65% or less resulting in an understatement of tax of $5,000 or more.
  • Understatements Related to Reportable Transactions: If you understate tax liabilities due to a reportable or listed transaction you can be fined.

Failure to Pay Penalty

If you file your tax return on time but you do not pay all the taxes due, you will have to pay a penalty for late payment. This penalty is 0.5% for each month that increases each month up to a maximum of 25%. This penalty covers all unpaid tax from the date the return was due until the penalty is fully paid.

Failure to File Penalty

If you do not file your tax return on time, the IRS places a penalty of 5% of the tax owed for each month that your return is late, up until a maximum of 25%. If you file your tax return over 60 days late, there is an additional penalty of $205 or 100% of the tax owed, whichever is less. This can be avoided if you can prove that you had reasonable cause for filing late.

Civil Fraud Penalty

If during the audit the IRS determines that any part of the underpayment is fraudulent, the entire underpayment will be treated as fraudulent and a 75% penalty will be imposed. It is the burden of the taxpayer to prove the return is not fraudulent.

Fraudulently Failing To File a Federal Tax Return

If the IRS determines that you intentionally filed your tax return late in order to evade taxes, you will be subject to a penalty of 75%.

Criminal Penalties

If the IRS finds that you intentionally commit tax evasion, tax fraud, fail to pay your taxes in general, and/or not keep records for your business, you can be charged criminally. Depending on the severity of the crime, punishments range from misdemeanors to felonies. You can face fines up to $100,000 and up to 5 years in prison for tax fraud according to the Internal Revenue Code. If you are being investigated by the IRS, it is absolutely crucial that you contact an attorney immediately.  Here at the Law Offices of Jef Henninger, Esq., we combine professional experience with unwavering determination to produce the best possible outcome for our clients.

How long can the IRS audit me for?

Fortunately for taxpayers, audits don’t last forever and the IRS cannot audit a tax return from any year they want.

In most circumstances, the IRS generally audits tax returns within the past 2 years. The Internal Revenue Code, however, provides a statute of limitations that allows the IRS to audit any return within the past 3 years. For example, if you received a notice of audit in 2016, the IRS can audit a return filed in 2013, 2014, and 2015.

There are a few situations in which the IRS can audit tax returns older than 3 years.

Omission of Income

If the IRS finds that a significant amount of gross income, 25% or more to be exact, is missing from a return, then the statute of limitations is extended. The IRS will then have 6 years to audit that return.

Return Not Filed

If you do not file a tax return for a given year, the IRS does not have a time limit to audit or tax you for that year.

Fraudulent Return

If the IRS finds evidence of fraud or intent to evade taxation within a tax return, they do not have a time limit to audit or tax you for that year.

The Taxpayer Agrees to Extend Statute of Limitations

If an audit is not resolved in time, you may be asked to extend the statute of limitations in order for the IRS to assess additional tax. Agreeing to extend the statute will allow you more time to gather more documentation to substantiate your claim, appeal if you do not agree with the audit results, or to claim a tax refund. You should think carefully before you agree, however. Extending the statute of limitations also gives the IRS more time to complete the audit and find something potentially damaging to you

You can extend the statute of limitations by filling out an IRS Form 872 which extends the audit to a specific date or a Form 872-A that extends the audit indefinitely (this can be revoked by submitting a Form 872-T).

The amount of time each audit takes varies and is dependent on the complexity of the case, the availability of documents, scheduling, and whether or not the taxpayer decides to appeal. Auditors are advised to complete audits within 28 months of the date you filed your tax return or the date it was due, whichever was later. The IRS is legally allowed 36 months from the date filed to close an audit, but the additional 8 months are to spare time for the appeals process.

Types of Audits: What should I expect during an audit?

Nobody wants to go through an audit, but everyone wants to know what to expect. What many people are unaware of, though, is that there are different ways the IRS will audit you. Your expectations will be dependent on the type of audit. Each type of audit has varying means of correspondence between the taxpayer and IRS, has different levels of participation for the taxpayer, and requires different documents from the taxpayer. To figure out what you should expect during an audit, you must first determine what type of audit you’re experiencing.

All audits begin with a letter that states what parts of your tax return are in question. It additionally specifies when, where, and how you are to respond to the IRS. The taxpayer will also receive an Information Document Request (IDR) that specifies which documents must be gathered by the taxpayer.

Correspondence Audits:

Correspondence audits are the most common type of audit, making up approximately 70% of all audits, and are done entirely through mail. These audits are fairly simple and do not require in-person meetings or extensive investigation. Correspondence audits are primarily for verification issues on a tax return such as justifying income or deductions.

The IRS uses computer systems to examine your tax return and to detect mathematical errors, missing documents, or inconsistencies. The IRS compares the information on your return to information already on record provided by third parties such as banks and employers. Items typically requested by the IRS for verification purposes usually include W-2’s, 1099 income items, itemized deductions, and Schedule C receipts.

If the information from the return conflicts with what is on record or the return is missing significant documents, then the taxpayer will be sent a Letter 566 or a CP 2000.

Letter 566 informs the taxpayer that their return has been selected for audit and will list required documents to be sent back to the IRS. This letter is mostly sent out to substantiate specific claims on a tax return such as itemized deductions as opposed to a broad examination.

A CP 2000 is not a bill, but it can result in an increase, decrease, or no change in your taxes. The CP 2000 is a notification of the mismatched information and a request for additional information. Taxpayers are given 30 days from the date of the CP 2000 (not the day you received it) to respond to the IRS or they will face added penalties.

Although the correspondence audit is the most simplistic type of audit, it is not unusual for a taxpayer to consult an attorney for assistance. The IRS tends to request more than they’re entitled to, so proper representation will be helpful in protecting the taxpayer.

Office Audits:

Not nearly as common as correspondence audits, office audits are more comprehensive looks at an individual’s financial history. These are conducted through interviews with an auditor in person at the local IRS office.

A letter is sent to the taxpayer that lists specific items on their tax return that are in question. The IRS requests that you bring in substantiation or any documents that can justify the questionable items in to the IRS office.

Office audits are far more troublesome for the taxpayer in that during the interview the IRS examiner may pursue information, such as financial and employment history, in an attempt to find issues outside the specifics of the audit. IRS agents are trained to scrutinize every word you say and every substantiation you claim. Depending on how you respond, you could potentially expand the scope of the audit to issues and tax returns from other years. This can result in what should have been avoidable fines or even criminal charges for the taxpayer.

It is highly recommended to bring an experienced tax attorney to the interview. Proper representation can protect the taxpayer from the IRS overstepping their bounds and can prevent further investigation.

Field Audits:

Field audits are the most thorough investigations conducted by the IRS with the purpose of uncovering major violations. These audits are done by highly trained revenue agents who review the entirety of an individual’s or firm’s financial/tax history. It is the agent’s goal to uncover issues with the taxpayer’s reported income and deductions.

They’re called field audits because the revenue agent will interview the taxpayer in their own home or place of business. Most businesses are audited this way so the agent can review all records related to the return and to interview the owners. If you hire professional representation, however, the first meeting will more than likely take place in your attorney’s office.

The agent will examine a tax return to discover any flaws or inconsistencies such as unreported income or improper deductions. After examining one year’s return, the agent can open other years’ tax returns if issues are found. The agent is not limited to tax returns but may also examine records such as credit databases and property records.

The investigation will go as far where the agent will examine the taxpayer’s general expenditures. If the agent finds that the expenditures surpass the reported income, the agent will assume there is unreported income and the burden lies with the taxpayer to prove otherwise.

It is crucial to contact an attorney or accountant as soon as a field audit has begun. Similar to the office audit, the agent will take advantage of the taxpayer’s lack of knowledge and will attempt to probe damaging information out of them. Any information you give to the agent can be used against you, no matter how innocent it may seem. This can result in substantial penalties and even a criminal investigation regardless of intent. By using IRS Form 2848, you authorize power of attorney which grants an experiences representative the power to settle tax matters on your part. Here at the Law Offices of Jef Henninger, Esq., we have the means and experience to shield you from the potential dangers of a field audit.

Why am I being audited?

You’ve received a letter from the IRS notifying you that your tax return from last year is undergoing an audit and the first question that comes to mind is, “Why me?” Unless you’re intentionally committing a tax crime such as tax evasion or under-reporting your income, you probably won’t know beforehand why you were chosen to be audited. After your tax return has been reviewed by the IRS, there are a variety of different reason the return will be audited.

Auditor Examination

When a return is reviewed individually by an auditor, they may either accept it as filed or pass it on to an examining group if anything on the return raises suspicion. If the manager of the examining group also does not accept the return as filed, the return is given to an auditor for one final examination. At this point either the return will be accepted or the taxpayer will be audited.

Computer Analysis

The majority of audits are chosen by computers that conduct a statistical analysis of tax returns to determine the likelihood of the information on the return to be correct. The IRS uses a couple different computer systems such as the:

  • Discriminant Function System (DIF): This system analyzes a tax return and gives it a score, called the DIF score, based on how accurate it appears to be. The higher the DIF score, the more likely the return is to be audited. The IRS does not disclose the specifics on how this system works, but it is believed that many factors are considered with deductions and exemptions being of most importance.
  • Unreported Income Discriminant Function (UIDIF): This program determines the likelihood for a return to have unreported income based on an expense to income ratio. If the program finds that an individual or firm is spending significantly more money than it makes, unreported income is probably occurring, triggering an audit.
  • Information Returns Processing System (IRP): The third program the IRS uses information gained from third parties that are required to report taxpayer income to the IRS such as employers and banks. If the income listed on your tax return is inconsistent with the data given by the employer, you are likely to be audited.

Related Audits

If the IRS audits a tax return involving transactions with other taxpayers or businesses and that return had questionable items, it is likely that individuals and businesses associated with the suspicious return will be audited.

Random Selection

While this method is not used very often, the IRS does use computer screening and random selection to determine which returns will be audited.

High Income

Your income can determine the likelihood of the IRS auditing you. The more income you make, the more likely you will be audited. IRS statistics state that over half the audits conducted are for taxpayers making over $1 million per year. In fact, even if you make $100,000 per year your chances for being audited are much higher than average. High-income taxpayers claim more deductions and contribute more to charity, leaving more room for error on a return and more reason for the IRS to take a closer look.

Document Matching

The IRS will audit a tax return if the information provided on the return does not match other records. For example, if the income listed on a tax return does not match the income listed on a Form W-2, the return will be audited.
Whether you’ve been audited for inconsistent records, missing documents, or even randomly selected, you shouldn’t try to handle an audit all on your own. The Law Offices of Jef Henninger, Esq. provide professional representation during audits, taking the burden off your shoulders and ensuring the audit settles in your favor.