IRS Audits Target Wealthier People and Companies
By WebCPA Staff, WebCPA.com
The Internal Revenue Service has increased its audit rates of the wealthiest individuals and corporations, according to testimony by IRS Commissioner Douglas Shulman.
Shulman told a hearing of the House Appropriations Committee’s Financial Services Subcommittee that, in fiscal year 2008, the IRS conducted nearly 1.4 million examinations of individual tax returns, an 8 percent increase over fiscal year 2006. The audit coverage rate also rose from 0.58 percent in fiscal year 2001 to 1.01 percent in fiscal year 2008.
“While the growth in examinations of individual returns is visible in all income categories, it is most apparent in examinations of individuals with incomes over $200,000,” said Shulman in his prepared testimony. “Audits of these individuals increased from 105,549 in FY 2007 to 130,751 during FY 2008, an increase of 24 percent. Their coverage rate has risen from 2.68 percent in FY 2007 to 2.94 percent in FY 2008.”
In the business arena, he added, audit coverage rates for small corporation returns (with assets under $10 million) increased slightly over fiscal year 2007 by 0.03 percent. However, coverage rates for three classes of large corporations with assets between $50 million and $250 million and higher all increased. Coverage rates for partnership returns stayed even as compared to fiscal 2007, while Subchapter S returns reflected a small 0.05 percent drop due largely to an increase in the number of S corporations. The coverage rate for tax-exempt organizations increased slightly.
Rep. Jose Serrano, D-N.Y., pointed out during the hearing that Shulman’s figures contradicted the findings of Syracuse University’s Transactional Records Access Clearinghouse, which showed that audit rates for wealthy individuals had declined steeply (see IRS Audit Rate for Millionaires Plummets). Shulman disputed those findings, saying, “We think some of it is wrong and some of it is looking at unfair comparisons,” according to Reuters. The IRS’s own Web site, however, shows that the agency audited about 5.6 percent of individuals making over $1 million in fiscal 2008, compared to 6.8 percent in 2007.
The IRS Criminal Investigation Division has also been vigorously attacking egregious tax avoidance, money laundering and other financial crimes, Shulman noted. The overall number of individuals charged in an information or indictment rose from 2,323 in fiscal 2007 to 2,547 in fiscal 2008. Over the same period of time, prosecution recommendations for employment tax evasion more than doubled. The incarceration rate in these investigations was 81 percent and the average sentence was 29 months.
In fiscal 2008, IRS-developed cases related to foreign and offshore issues also resulted in 61 criminal convictions, and the average term for those going to jail was 32 months. For the first four months of fiscal 2009, there were 20 convictions, and the average sentence was 84 months.
IRS collections from audits fall in 2008
“The number of reviews of returns filed by individuals increased slightly this year. Those earning less than $200,000 had about a 1 percent chance of being audited. Those with incomes of more than $200,000 had about a 3 percent chance of being examined.
Meanwhile, taxpayers with incomes of more than $1 million had a 5.6 percent chance of being audited, a drop from 6.8 percent the year before.”
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Your risk of getting a tax audit ‘is way up’
IRA takes tougher stance on returns
Based on the amount of income that Americans fail to report every year - $345 billion, according to one government report - millions of Americans have little fear of a government audit.
But tax pros and government reports suggest the Internal Revenue Service is gradually shedding its “kinder and gentler” attitude in favor of more and stricter audits. An audit could be like a truck in your side-view mirror: closer than it appears.
In January, the IRS said audits for the fiscal year ended Sept. 30 climbed 7 percent for individuals, 14 percent for taxpayers earning more than $100,000, and 30 percent for those making $200,000 or more. Millionaires had a 1 in 11 chance of losing audit roulette.
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IRS reports increase in audits and taxpayer services for 2007
AccountingWeb.com has recently posted the following:
During 2007 the IRS audited 84 percent more returns of individuals with incomes of $1 million or more than during 2006. Overall, enforcement revenue reached $59.2 billion, up from $48.7 billion in 2006 and nearly $34.1 billion in 2002.
Highlights of the enforcement and services numbers for fiscal year 2007, which ended on September 30, include:
Individuals
Audit rates increased in 2007, both for overall individual rates and for higher-income taxpayers.
Businesses
In the business arena, the IRS continued efforts to review more returns of flow-through entities – partnerships and S Corporations. The agency’s business numbers reflect that they have placed more emphasis in the growing area of these flow-through returns. While large corporate audits are down slightly, they have increased their focus on mid-market corporations – those with assets between $10 million and $50 million dollars. The IRS enforcement budget in 2007 was similar to the budget in 2006, and in times of flat budgets, the agency states that it cannot increase activity across the board but must address the areas where there is growth and potential risk.
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Washington, IRS more likely to audit millionaires
Washington IRS more likely to audit millionaires
There’s at least one advantage to not being a millionaire — less chance of being audited by the Internal Revenue Service.
The tax agency said Thursday that in the 2007 budget year it audited one out of every 11 with incomes of $1 million or more. Among those with incomes of $100,000 or less, 99 out of every 100 escaped further IRS scrutiny…There were 31,382 audits of those with $1 million incomes, up 84 percent from the 17,015 audited in 2006.
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Unreported Income - Attorney Client Privilege
Filed under: IRS, irs tax audit, tax preparer, unreported income
Attorney Client Privilege - US v Kovel
If retained by an attorney, client accountants may receive the benefits of Attorney-Client privilege. In United States v. Kovel, 296 F.2d 918 (2d Cir. 1961), the Attorney-Client privilege was extended to accountants retained to assist the attorney in understanding taxpayer’s financial records.
The IRS Restructuring & Reform Act of 1998 extended Attorney-Client privilege to communications with federally authorized practitioners with respect to tax advice. (IRC § 7525)
IRC § 7525 applies to:
1. Any non-criminal matter before the IRS, or in Federal Court brought by or against the U.S.
2. IRC § 7525(b) provides the privilege will not apply to representation of a corporation involved in the promotion or the direct or indirect participation of any such corporation in any tax shelter.
3. The IRC § 7525 privilege does not extend to criminal tax investigations.
A federally authorized tax practitioner is any individual who is authorized under federal law to practice before the IRS. This includes attorneys, CPAs, and enrolled agents. IRC § 7525(a).
Tax advice is advice given by an individual on a matter for which he is authorized to practice before the IRS. IRC § 7525(a). In general, the privilege, like the common-law privilege, applies to the content of the advice, not the identity of the person seeking the advice.
For communications made on or after October 22, 2004, the privilege does not apply to written communications concerning tax shelters. Thus, the privilege does not apply to any written communication between a tax practitioner and any person, director, officer, employee, agent, or representative of a person, or any other person holding a capital or profits interest in a person, in connection with the promotion of the direct or indirect participation of the person in any tax shelter. IRC § 7525(b).
A tax shelter is a partnership or other entity, an investment plan or arrangement, or any other plan or arrangement, if a significant purpose of the partnership, entity, plan, or arrangement is the avoidance or evasion of federal income tax. IRC § 6662(d)(2)(C). (This exception was limited to communications concerning corporate tax shelters, IRC § 7525(b), prior to amendment by Pub. L. 108-357, American Jobs Creation Act of 2004, Section 813.)
The IRS’s position is that the Attorney-Client privilege also does not apply to tax accrual workpapers (tax accrual and other financial audit workpapers relating to the tax reserve for deferred tax liabilities and to footnotes disclosing contingent tax liabilities appearing on audited financial statements).
These workpapers are not generated in connection with seeking legal or tax advice, but are developed to evaluate a taxpayer’s deferred or contingent tax liabilities in connection with a taxpayer’s disclosure to third parties of the taxpayer’s financial condition. IRS Announcement 2002-63, 2002-2 C.B. 72.
The crime-fraud exception may be asserted to defeat the claim of tax practitioner privilege for communications that were made for the purpose of getting advice for the commission of crime or fraud. This prevents a party from seeking advice to commit a crime or fraud and then claiming that the communication is privileged.
To assert the crime-fraud exception, (1) there must be a prima facie showing of a crime or fraud, and (2) the communications in question must be in furtherance of the misconduct. U.S. v. BDO Seidman, 368 F.Supp. 2d 858 (N.D. Ill. 2005). If the IRS shows sufficient evidence that the communication was made in furtherance of a crime or fraud, then the taxpayer may respond by providing an explanation that would rebut the IRS’s evidence. The crime-fraud exception will apply only if the court finds the taxpayer’s explanation unsatisfactory. U.S. v. BDO Seidman, No. 02 C 4822 (N.D. Ill. May 17, 2005), aff’d on this issue and vacated and remanded on other grounds, No. 05-3260 & 05-3518 (7th Cir. July 2, 2007).
Unreported Income: Tax Preparer (CPA) Civil & Criminal Penalties (Summary)
Filed under: irs tax audit, tax preparer, unreported income
Taxpayers who have unreported income, may subject their tax preparer (CPA) to up to 9 years imprisonment, with the following penalties:
Tax Preparer Penalties
1. Penalty for causing an understatement of tax on a return (IRC § 6694), either: greater of ($1,000/or 50% of Income Derived), or if willful: ($5,000/50% of Income Derived)
2. Penalty for aiding and abetting an understatement of tax (IRC § 6701) either: $1,000 per violation (individual taxpayer), $10,000 per violation (corporate taxpayer)
3. Tax Preparer/Criminal Penalties
a. Felony Tax Evasion (IRC § 7201) (i.e., assist Taxpayer in evading tax)
Fines: $100,000 (per person)/ $300,000 (per corporation). Up to 5 years imprisonment (or both) plus: costs of prosecution
Misdemeanor Additional Tax Evasion (IRC § 7203)
Failure to file Taxpayer’s tax returns, keep records, supply information
Fines: $25,000 per person/ $100,000 per corporation. Up to 1 year imprisonment (or both) plus: costs of prosecution (This penalty is in addition to other penalties)
b. Willfully aiding the preparation of a false tax return (IRC § 7206)
Felony: Fines: $100,000 per person, $500,000 per corporation. Up to 3 years imprisonment (or both) and costs of prosecution.
Misdemeanor: (Additional) IRC §7210: Failure to comply with Summons for testimony or produce books and records. Fine: $1,000. Up to 1 year imprisonment.
Unreported Income: Fraudulent Failure to File Tax Returns
Filed under: IRS, irs tax audit, tax preparer, unreported income
In order to avoid the 75% penalty for fraudulent failure to file tax returns the tax payer must establish:
1) The delinquent filing is due to reasonable cause.
2) The delinquent filing is not due to willful neglect.
If both elements are established the failure to file penalty does not apply.
Penalty: Failure to file tax return
To establish that the penalty does not apply, the taxpayer must furnish the IRS a written statement setting out the grounds of the claim. The statement must contain a declaration that it is signed under penalty of perjury. Treas. Reg. Section 301.6651-1(c)(1). The written statement must be filed with the IRS office where the late return is filed.
If the IRS determines that the delinquency was due to reasonable cause and not due to willful neglect, the penalty is not assessed.
If a taxpayer exercised ordinary business care and prudence and was nevertheless unable to file a return, the delay is due to reasonable cause. Treas. Reg. Section 301.6651-1(c)(1).
The Internal Revenue Manual lists the following circumstances under which reasonable cause may exist:
(1) the delinquency was due to the death or serious illness of the taxpayer or a member of the taxpayer’s immediate family (for a corporation, estate, trust, etc., the delinquency was due to the death of the individual responsible for filing or a death in the immediate family of such individual);
(2) the taxpayer is unable to obtain records;
(3) reliance on erroneous advice from the IRS;
(4) reliance on a tax adviser; and
(5) failure to file resulting from a fire, casualty, natural disaster, or other disturbance.
Penalty: Failure to pay tax shown on return
Treas Reg Section 6652(a)(2) penalizes the failure to pay the amount shown as tax on the taxpayer’s return unless the delinquency in payment is due to reasonable cause and not due to willful neglect.
The penalty period starts with the date prescribed for payment (generally the due date of the related return, but determined with regard to extensions) and ends with payment of the tax. The penalty is one-half percent for each month (or part of a month) up to a maximum of 25 percent. However, the one-half percent rate is increased to 1 percent if the taxpayer fails to pay after the IRS notifies the taxpayer.
The appropriate penalty rate is applied to the amount of tax shown on the return, which is the net amount of tax due. The net amount due is the total amount shown as tax reduced by the sum of (1) any part of the tax that is paid on or before the beginning of the month and (2) the amount of any credit against the tax that may be claimed on the return. If the amount of tax required to be shown on the return is less than the amount shown on the return, the lesser amount is used for computing the penalty. Treas. Reg. Section 6651(c)(2).
Unreported Income: Criminal Penalties: Tax Preparers
Filed under: IRS, irs tax audit, tax preparer, unreported income
Clients, with unreported income, may subject tax preparers to criminal penalties, fines, costs of prosecution and up to 10 years imprisonment (2 felonies, 2 misdemeanors):
1. Any person who willfully attempts in any manner to evade or defeat any tax or payment of any tax imposed by the Code is guilty of a felony.
A person convicted of tax evasion may be fined up to $100,000 ($500,000 for a corporation) or imprisoned not more than five years or both, together with the costs of prosecution. This penalty is in addition to any other penalties provided by law. (IRS § 7201.)
2. Any person required by the Code or regulations to file a return, keep any records or supply any information who willfully fails to file the return, keep the records or supply the information is guilty of a misdemeanor.
A person convicted of this offense may be fined up to $25,000 ($100,000 for a corporation) or imprisoned not more than one year or both, together with the costs of prosecution. This penalty is in addition to any other penalties provided by law. (IRC § 7203.)
3. Any person who willfully aids or assists in, or procures, counsels, or advises the preparation or presentation of a return, affidavit, claim, or other document under the tax laws that is fraudulent or false as to any material matter is guilty of a felony. This provision applies regardless of whether or not the taxpayer knows or consents to the falsity or fraud.
A person convicted of this offense may be fined up to $100,000 ($500,000 for a corporation) or imprisoned not more than three years or both, together with the costs of prosecution. (IRC § 7206.)
4. Any person who fails to comply with a summons issued under the Code that calls for testimony or for the production of books or documents and neglects to appear or to produce the books or documents has committed a crime.
A person convicted of this offense may be fined not more than $1,000 or imprisoned not more than one year or both, together with costs of prosecution. (IRC § 7210.)
Unreported Income (IRS): CPA Liability
Filed under: IRS, irs tax audit, tax preparer, unreported income
The IRS has a new method for identifying returns with a high probability for unreported income (i.e., Unreported Income Discriminate Index Function (UI DIF)). Unreported income is both civil tax fraud and criminal tax evasion.
Taxpayers who have unreported income may be subject to up to 6 years in prison, 100% penalties and fines, and expose their accountants to civil and criminal liability.
1. Statutes of Limitations
a. Civil Tax Fraud: No statute of limitations on assessment (tax can be assessed at any time)
b. Criminal Tax Evasion: For crimes, the statute of limitations is either 3, 5 or 6 years, only on the prosecution of the crime (i.e., tax evasion, not the assessment of tax owed)
2. Burdens of Proof
a. Civil Tax Fraud: “Clear and Convincing Evidence”
b. Criminal Tax Evasion: “Beyond a Reasonable Doubt”
3. Penalties/Fines
a. Civil Tax Fraud
i. Fraudulent Failure to File Tax Return: (IRC §6651(f))
ii. Fraudulent Tax Return Filed: (IRC §6663(a))
Maximum Penalty: 75% of tax due
iii. Failure to Pay Tax:
Shown on Return (IRC §6651(a)(2)),
Not Shown on Return (IRC §6651(a)(3))
Maximum Penalty: 25% of tax due
b. Criminal Tax Evasion
i. IRC §7201: Evade Tax
Fine: $100,000 (individual) $500,000 (corporate)
Imprisonment: not more than 5 years (or both fine and imprisonment)
ii. IRC §7203: Failure to File or Pay Tax
Fine: $25,000 (individual) $100,000 (corporate)
Imprisonment: up to one year (or both fine and imprisonment)
As a tax preparer, if a client has unreported income:
1. What is your liability re: IRC §6694 preparer penalties?
2. If you advise the client to report the income, do you prepare the tax return, or advise the client to engage an attorney to hire a CPA to prepare the tax return (for attorney-client privilege)?
3. If you advise your client to file or amend a tax return, is it a voluntary disclosure with no criminal liability? Is there any criminal liability for you?
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