One commonly misunderstood aspect of an audit team
is that attorneys are always vested with attorney-client
privilege and work-product privileges regarding their client's
documents; whereas, in most states CPA's/Accountants
are not vested with such privilege. In order to perfect this
privilege our approach is to assign either one of our internal
CPA's or an outside CPA firm to monitor and prepare
responses to the document requests issued by the auditor,
but we designate one or more of our licensed tax-attorneys
to serve as the supervising point of contact with the auditor in order to establish attorney-client and work product privileges. Our goal is to produce the proper documents that legally respond to the auditor's request, but protect our client's civil and constitutional rights against self incrimination, illegal search & seizure, and due process.
If we are working with an outside CPA firm, this often involves McGee Tax Law formally engaging the CPA firm even though the CPA firm may have originated the client. Our goal is not to take over the role of the outside CPA firm, but to ensure that all document productions and communication are made within the boundaries of attorney-client privilege; and to make sure that all legal rights afforded to the taxpayer are adhered to by the auditor.
Obviously the accounting portion of an audit involves the determination of whether material errors and/or omissions exists within the subject tax returns. In a tax audit, however, this basic focus can take on additional attributes within the context of certain tax code provisions. For example, some business expense categories fall under "strict substantiation" requirements while others fall under "general substantiation" requirements. Within this example, a tax return could contain zero errors and/or omissions from a mathematical or accounting reporting standpoint, but the taxpayer may still receive a large assessment if the proper substantiation requirements are not met.
In working the "accounting" portion of an audit, our CPA (internal or external) will respond to any accounting related issues and will remain in communication with the auditor about any issues that could result in a proposed adjustment (i.e. additional tax assessment). Our goal here is to eliminate any mathematical, reporting, classification, or substantiation issues. Any unresolved issues remain that we believe should be resolved in favor of our client will be addressed with the attorney(s) supervising the audit and decisions will be made regarding whether to appeal to issues administratively or judicially.
I never ceased to be amazed, in this era of advanced computer technology, at how often taxpayers are hit with tax assessments for which the statutory period that the assessment can be entered has lapsed. This is just one example of the role we play in defending an audit. While the taxpayer is given an arduous set of rules to follow by the government, the government has also set out a number of rules (statutes, regulations, rulings, etc.) which govern the manner that an auditor must conduct the audit and the manner (amount, time, penalties, reasons, etc.) in which assessments can be made against a taxpayer.
A factor that should also be considered, relating to compliance, involves pre and post audit treatment of transactions that may require certain legal disclosures and/or legal position arguments/opinions. This is often encountered if alternative methods of substantiation are needed; if the taxpayer experiences a change in accounting method; timing issues are experienced; hybrid methods of accounting/reporting are utilized; and other non-routine accounting transactions directly impacting the tax returns.
An interesting legal nuance that often lies beneath the surface of an audit involves the "adequacy" of records. Certain tax laws give the auditor the legal authority to use alternative methods of accounting in order to essentially reconstruct the taxpayer's books and records if the auditor believes the taxpayer's records are "inadequate." The problem for many small to medium sized taxpayers is that there is often no standard for what is considered legally "adequate". Consequently, the auditor will often go in and create figures that may be grossly inappropriate, unsubstantiated, or even seemingly fictitious; and, the taxpayer is essentially stuck with the results because the auditor deemed the taxpayer's records "inadequate". This archaic statute is still very common in many state jurisdictions and is referred to as the prima facie correct standard.
In addition to asserting the obvious due process of law violations associated with such a system, we also have skilled tax analysts on our team who are able to take otherwise "unsophisticated" books and records and transition them into books and records that would provide a more defensible position against the prima facie correct standard. Out tax analysts are also skilled at reviewing more "sophisticated" books and records and utilizing technology to extract the best forensic, accounting, and substantiating evidence in support of our client's audit defense and legal assertions.
From seeing that the auditor follows the government's own rules to arguing the proper accounting methodology associated with a value reported on a taxable transaction, the legal aspects of an audit simply cannot be overlooked. Out team members interact on a perpetual basis throughout the audit process in order to ensure that our client's defenses and claims are properly asserted throughout the audit, and, to ensure that all avenues for future administrative and judicial appeals are properly maintained throughout the audit process. Too often, taxpayers without legal representation will sign something during the audit process that can be devastating to future appeals. Our goal is to guide our clients through this process and obtain results that matter.
What Are My Legal Rights?
IRS Examiners (aka "Auditors") have the ongoing responsibility to ensure that all taxpayer rights are protected and observed, whether these rights are mandated by statute or provided as a matter of policy. Examiners should be aware of all the rights provided by the IRC, Taxpayer Bill of Rights I & II, the IRS Restructuring and Reform Act of 1998 (RRA 98) and IRS policies. The rights listed below are not all inclusive, but rather are mentioned here to provide special emphasis or to highlight some of the new rights provided in RRA 98. The taxpayer rights most commonly at issue include:
* Representation/Power-of-Attorney Requirements
* Confidentiality Privileges—Accountant/Client Privilege
* Notification of Appeal Rights
* Innocent Spouse Relief
* Interest Abatement
* Consideration of Collectibility
* Early Referrals to Appeals
* Separate Notices for Joint Filers
* Providing Taxpayers with Employee Contact Information
* Confidentiality of Taxpayer Information/Privacy
* Unauthorized Access Requirements
* Third Party Contacts
Effective Audit Defense Requires a Team
Having served as the Chief Financial Officer for an insurance company, I am personally aware of the stress and anxiety associated with going through an audit. Whether its a business or individual audit, or whether you or your company/employer is being audited, it is generally not a pleasant experience. To add to the intrusive feeling associated with being audited, IRS and State audits are usually structured to involve not just accounting issues, but also legal, compliance, and technology issues.
Given this reality, we structure each audit defense plan based on these four fundamental factors. Although we prefer to navigate through the audit process in an amicable matter, the fact remains that the auditor/examiner is not your friend and is looking for any opportunity to assess additional tax, penalties, and interest against you.
Therefore, we employ not only sound accounting, compliance, and technological methodologies in representing our clients, but we also utilize a host of legal defenses, including appeals and litigation, in order to best represent our clients. We are not afraid to go to court or to appeal an auditor's determination. In fact, we frequently give unreasonable auditors the opportunity to explain their, often very arbitrary and capricious, positions to a judge of appropriate jurisdiction. Our goal is to prevent our clients from having to pay 1 cent more than they are legally obligated to pay under the law.
Selecting a return for audit does not always suggest that an error has been made. Returns are selected using a variety of methods, including:
Random selection and computer screening - sometimes returns are selected based solely on a statistical formula.
Document matching - when payor records, such as Forms W-2 or Form 1099, don't match the information reported.
Related examinations - returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.
We Represent Taxpayers in the Following Types of Audits:
Auditing includes the accumulation of evidence for evaluating the accuracy of the taxpayer’s tax return(s). Evidence takes many forms, including the taxpayer’s testimony, the taxpayer’s books and records, the examiner’s own observations and documents from third parties. It is important to obtain sufficient competent evidence to determine the accuracy of the taxpayer’s return. Every examiner must determine the appropriate amount of evidence to accumulate and establish the proper depth of the examination. This decision is a matter of judgment and important because of the prohibitive cost of examining and evaluating all available evidence (although the IRS has deep pockets, the audit procedures have to make economic sense.) Factors an examiner is required consider when establishing the depth of the examination include:
1) The risk that the taxpayer has made errors that are individually or collectively material. The factors involved are addressed during the evaluation of the taxpayer’s internal controls.
2) The risk that the audit tests will fail to uncover material errors. The factors involved are the depth of the examination, the examination techniques used, the nature of the errors (intentional or unintentional) and the reliability of available evidence.
1) Analytical Tests — such as analysis of Balance Sheet items to identify large, unusual, or questionable accounts. Analytical tests use comparisons and relationships to isolate accounts and transactions that should be further examined or determine that further inquiry is not needed.
2) Documentation — such as examining the taxpayer’s books and records to determine the content, accuracy, and substantiate items claimed on the tax return.
3) Inquiry — such as interviewing the taxpayer or third parties. Information from independent third parties can confirm or verify the accuracy of information presented by the taxpayer.
4) Inspection — such as physically examining the taxpayer’s assets, e.g., inventory or securities.
5) Observation — such as conducting a tour of the taxpayer’s business to observe the taxpayer’s daily business operations.
6) Testing — such as tracing transactions to determine if they are correctly recorded and summarized in the taxpayer’s books and records.
Factors the IRS examiner is required to consider when choosing an examination technique are:
1) Will the examination technique provide the needed evidence?
2) Will the benefits derived from using a particular technique justify the associated costs to both the examiner and the taxpayer?
3) Are there less expensive alternatives that will provide the same evidence?
The following Examination techniques used to gather evidence are discussed in this section:
* Tours of Business Sites
* Inspection of Residences
* Evaluation of the Taxpayer’s Internal Controls
* Examining the Taxpayer’s Books and Records
* Analyzing Schedules M–1 and M–2
* Bank Record Reconciliations
* Balance Sheet Analyses
* Testing Gross Receipts or Sales
* Testing Expenses: Cost of Goods Sold
* Testing Expenses: Operating Expenses
* Sampling Techniques
* Analyses of accounting systems.
We defend tax audits, not from just an accounting standpoint, but also from a legal perspective. There are a number of legal techniques that tax attorneys can utilize in order to reduce or eliminate audit assessments. Call us to find out what rights you really have during an audit.