Sensitive Tax Audits (Eggshell and Reverse)
When a US Taxpayer is under audit or examination by the Internal Revenue Service, it can be a stressful and overwhelming experience. Quite frankly, it is (usually) nowhere near as bad as some tax practitioners try to make it sound, but nonetheless, nobody wants to get caught in the IRS crosshairs if they can avoid it. There are different levels of a tax audit depending on the nature of the infraction or potential infraction and what information the IRS may or may not have at the time of audit. When the examination involves international informational reporting issues, it is more complicated than a typical audit because the penalties involving non-compliance can be devastating, and it has become a key enforcement priority for the IRS. Let’s go through five key facts about sensitive tax audits often referred to as eggshell audits or reverse eggshell audits.
How to Know if a Tax Audit Is Sensitive?
The concept behind a sensitive tax audit is the idea that a person has specific information that they do not want the IRS to know, or if the IRS does know, the person wants to carefully circumvent any potential willfulness penalty or criminal investigation, while not digging themselves into a deeper hole than they already are in. It is not as if the audit will be labeled a sensitive tax audit for your benefit by the IRS Agent or Examiner.
Is the IRS Bluffing or Not?
One key factor for Taxpayers who are subject to a sensitive audit is whether or not the IRS actually has the information at their disposal or not. A common example will be a Taxpayer audit for business deductions/expenses or something similar. They also have foreign accounts that have not been reported and the value of those accounts is substantial. The accounts are in a country in which the US has entered into a FATCA agreement for the exchange of information between both countries. The questions then become:
Did the foreign country already report the information to the IRS?
If so, is the IRS aware of the information?
Does the Auditor or Examiner have access to that information?
Eggshell Audit – Be Careful
With an eggshell audit, the main concern is that a Taxpayer may be audited for more than one issue, ie the Taxpayer has information about other issues that could possibly arise during the audit but that were not particularly called out in the examination notice or IDR. The question then becomes: How can the Taxpayer who is under audit avoid or circumvent those questions without making a false statement or omission under penalty of perjury? It is a fine line between avoiding information that may not have been introduced during the audit and which was not a direct question to the Taxpayer, versus being questioned on an issue and then avoiding the response through an intentional omission or misrepresentation – which could then be considered fraudulent and can lead to much worse issues down the line.
Reverse Eggshell Audit – Be Very Careful
The reverse eggshell audit is probably one of the most (if not the most) dangerous types of IRS tax audits. In this type of situation, the IRS Agent has information that may not have been identified in the Information Document Request or examination notice, so the Taxpayer is unaware that the IRS even has the information. Expanding upon the example above, if the Taxpayer is being audited for business deductions and then the Agent asks whether the Taxpayer has any foreign accounts… this is a defining moment for the Taxpayer. It is important that the Taxpayer not make any intentional misrepresentations or omissions at this stage, because with a reverse eggshell audit, the IRS Agent already has the information. If the Taxpayer did not initially disclose the foreign accounts and then doubles down during the audit by confirming they do not have foreign accounts, this could then lead to fraud allegations against the Taxpayer and the catalyst that leads to a criminal investigation.
Not Criminal But Can Lead to Criminal
An IRS audit is not a criminal investigation. The IRS Agent does not have the power to arrest or impose criminal sanctions against the Taxpayer during the audit. If the Agent believes that the Taxpayer acted criminally, then they are required to close the audit – although they will not tell you why they are terminating the examination. The matter is immediately referred to IRS Special Agents who will determine whether or not to launch an investigation.
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