What to Expect When the Internal Revenue Service is Auditing You
When the Internal Revenue Service (IRS) notifies you of questions or concerns regarding your tax return, an item on your tax return, or if you are questioned by a government agency, regardless of how benign the question may seem to be, remember that how you respond, if at all, is an extremely important decision that should be made only upon consultation with an experienced tax attorney.
Clearly, complying with all laws is of the upmost importance, but can be difficult to do so for many people without making the audit situation worse - expanding the audited issues, admitting to other crimes, confusing the issues, or causing you to pay more than is legally required of you.
Some of the ways responding to audits or continuing to gamble with the return may be construed by the government as a false or misleading statement. You can easily, even innocently fall into a trap because you may be nervous about answering a question (aka, making a statement). Further, IRS agents are trained and skilled in their line of questioning. Remember, their job is to maximize the amount of money that they can extract from you and possibly, use you as an example by bringing criminal charges against you. Therefore, an IRS agent has an incentive to illicit responses from you that can be used against you, if that means being able to utilize a statement for leverage later, for instance to uphold a tax audit deficiency, civil or criminal fraud penalty, or for putting pressure on you to concede the tax audit deficiency rather than dispute the findings when you may otherwise prevail by taking your case further.
False or misleading statements to the government, especially in the context of a tax audit, can have serious consequences. For instance, it was Martha Stewart’s statement to investigators that led her to serve five months in a federal prison and labeled her a felon for the rest of her life. Yet, some taxpayers are either tempted to do so, or are not represented by an experienced tax attorney, and fall into traps for the unwary. For instance, consider an early stage of an audit. Since the IRS agent may have not yet focused upon the particular facts, his or her questions will be unfocused - opening the door to civil or even criminal penalties such as:
False Statement / Misleading Statements
False Statements in Criminal Tax Cases
Audit leading to criminal charges -
An Estate Tax Return was audited by the IRS, the executor of the estate gave information to the IRS auditor. The audit was referred to the Criminal Investigation Division (“CID”) because of the executor’s statements to the IRS agent in light of the tax return that was filed. CID recommended prosecution; however, after our trip to Washington DC and a meeting with the Department of Justice (“DOJ”), we were able to present evidence that we believed would make proving to the jury certain elements of the crimes difficult. Unlike the Hirst case below (whom we did not represent), after our meeting, the DOJ declined to prosecute the case.
Statements made to Internal Revenue Service agents during a civil estate tax audit regarding the individual’s assets and value of the assets led to an indictment for violation of USC §1001. (United States v. Hirst, 2012 U.S. Dist. LEXIS 117364, 2012 WL 3583044 (N.D. Cal. Aug. 17, 2012)
False Statements and the Civil Fraud Penalty
The Civil Tax Penalty 26 USC § 6663
This penalty is seventy-five percent (75%) of any underpayment attributable to fraud. The penalty is measured by the additional tax owed. Civil tax fraud which may also lead to the additional charge of criminal tax fraud, generally is considered an intentional wrongdoing by a taxpayer with the specific purpose of evading a tax. Mere negligence is not in itself sufficient to establish fraud. But this is a highly subjective standard. That is, what you may see as a simple honest mistake, the IRS may see as criminal and civil tax fraud. The filing of an amended return does not bar assessment of the penalty.
Example of how a false statements were used to uphold a civil fraud penalty:
1. False statement to auditor regarding real estate investment:
The IRS must prove that some part of the underpayment resulted from the taxpayer’s intentional wrongdoing, deceit, and intent to evade tax. Therefore, a false statement is very useful to the government in assessing this penalty.
Here, the taxpayer went through the tax audit and was assessed a tax deficiency. Included in the assessment was the 75% penalty for civil tax fraud. The taxpayer believed that he had fully cooperated during the tax audit and that he should not be liable for the penalty; he elected to dispute the fraud penalty by filing a tax court petition.
The Judge’s analysis looks like this (note Moskowitz LLP has redacted and edited the opinion for brevity and identification of the party issues):
When the existence of the holding account was finally uncovered and (Ms. X, IRS auditor) was seeking additional information on [taxpayer’s business] purported loans to [taxpayer], [taxpayer] told her that [taxpayer’s business] was paying his personal mortgage because the corporation was investing in real estate. We believe [taxpayer’s] statement was simply intended to deceive [Ms. X, IRS auditor] and delay the investigation. In addition to making the false statement … We believe that [taxpayer’s] actions when dealing with [Ms. X, IRS agent] were intended to conceal information which eventually led her to discover understatements of income for both [taxpayer and taxpayer’s business]. We find the concealment of such information from [Ms. X, IRS Agent] and the false statements made in connection with that concealment to be badges of fraud.
The civil fraud penalty was upheld.
Example 2 - The attorney who made false statements (Grosshandler v. Commissioner, 75 T.C. 1, 19-20, 1980):
There are other indicia of fraud present in this case. First, the petitioner was aware of his obligation to file returns and that taxes were due for each of the years 1963 through 1969. He was an attorney and a well-educated person. He had filed Federal income tax returns for previous years. He earned substantial income which required him to file returns. He had prepared income tax returns for some of his clients and had communicated with the Internal Revenue Service on behalf of his clients. Second, the petitioner attempted to avoid payment of his tax liabilities for 1963 through 1969 by making false and inconsistent statements to respondent's agents during the course of their examinations. (emphasis added)