In the Crosshairs

 IRS AUDIT 01Here are steps to consider if your business becomes the subject of an IRS audit.   

By Gregory Seador

The Internal Revenue Service has ramped up its efforts to curb tax fraud in the construction industry. Just last month, two separate construction-related cases made headlines. In one case, the owner of several engineering firms was sentenced to five years in prison for failing to pay employment taxes and for diverting business funds for his personal use. In another case, a construction business owner failed to pay nearly $1 million in payroll tax withholdings to the IRS and now faces a maximum five-year prison sentence.

The construction sector has come under increased scrutiny recently and, in addition to potential prison time, construction companies are being assessed thousands of dollars in penalties, as well as back taxes and interest for not complying with the tax laws. If the IRS notifies your business that it is under audit or investigation, it is important to quickly understand the issues that have triggered the IRS’s attention and respond promptly. 

An IRS Audit

An IRS audit is a review and examination of a business’s accounts and financial information to verify the accuracy of information that was reported to the IRS, and that the business’s reported amount of tax is correct. If a business’s tax return is selected for an audit, it does not always mean that the IRS has detected a problem. 

The IRS sometimes selects tax returns for audit randomly or because the tax return involves transactions with other businesses whose tax returns were selected for audit. For a construction business, audits will almost always be a field examination, where a revenue agent visits the business to examine its books and records. Generally, one should be able to tell from the initial IRS notice letter that the IRS is conducting an audit, as opposed to a more serious investigation, as well as the tax issues under examination.

Responding to an IRS Audit

Carefully review the initial audit notice letter from the IRS and identify and research the tax issues under audit. Gather and carefully scrutinize all tax returns and documents related to the identified issues, then organize and categorize the documents according to the issues under audit to streamline the presentation of the information to the IRS revenue agent. Audits can take an extended period of time to complete. The average business audit often takes upwards of a year. This time can be shortened through preparation, and by devoting the resources necessary to timely respond to the auditor’s requests for information as early in the process as possible. 

Careful preparation for the visit by the IRS revenue agent is required. Many times, in addition to examining the business’s books and records the revenue agent will want to review accounting and record keeping systems. A knowledgeable employee should be available to answer any financial questions that the revenue agent may have.

While the audit process may be frustrating, always maintain a professional demeanor with the auditor. Avoiding confrontation and making things as easy as possible for the auditor shows that the company has nothing to hide and is eager to conclude the audit in a positive manner.

If the tax issues under audit are complex, hire a certified public accountant, enrolled agent or tax attorney to represent you. A tax professional will deal directly with the IRS on your business’s behalf and facilitate the information exchange between your business and the IRS auditor. An experienced tax professional can also advocate for the tax positions the business has taken on its tax returns.

IRS Civil investigations 

An IRS civil investigation typically is not an income tax examination. Rather, the investigation is carried out to determine if an individual or a business is subject to penalties and/or an injunctive action as a result of involvement in an abusive tax avoidance transaction (ATAT). The IRS generally defines an ATAT as the organization or sale of a plan or arrangement promoting false or fraudulent tax statements or gross valuation misstatements; aiding or assisting in the preparation or presentation of a return or other document to obtain tax benefits not allowed by law; and actions to impede the proper administration of Internal Revenue laws. 

Depending on the type of conduct involved, the investigation likely will be conducted by a revenue agent who specializes in abusive transactions such as an ATAT revenue agent. The investigating agent has the authority to issue an IRS summons to the subject business or to third parties for documents and information related to the matter being investigated. 

IRS Criminal Investigations 

An IRS criminal investigation is the most serious type of tax investigation and is significantly different from an audit or a civil investigation. A criminal investigation is conducted by Special Agents from the Criminal Investigation Division (CID). 

Special Agents have additional tools at their disposal to gather information about your business and its finances, including search warrants and subpoenas.

A criminal investigation can be initiated through tips that are provided to the IRS, or, often is initiated when a revenue agent detects “badges of fraud” during an audit or civil investigation. In a nutshell, if the tax issue is significant enough and does not look unintentional, a criminal referral may be made to CID. 

The state and local agencies and regulators charged with enforcing state tax laws vary by jurisdiction so it is important to consider the implications of a parallel state tax investigation if there is a federal investigation underway.

The minute a business suspects it is the subject of a civil or criminal investigation, a document hold should immediately be put in place and all routine record destruction should be suspended. Employees should be instructed that all documents and electrically stored information, such as email, related to the allegations must be preserved. Do not shred or alter any documents! 

The business should engage legal counsel experienced in IRS tax investigations immediately. Particularly in the criminal context, it is not advisable to speak with or write to anyone about the investigation without first consulting an attorney experienced in tax investigations. Nothing that is said or given to a federal agent is “off the record.” Documents and other records also should not be provided to investigators voluntarily without a summons or subpoena. 

When the company’s legal counsel determines that it is appropriate to speak with IRS Special Agents or revenue agents – tell the truth! Lying to a federal agent is a felony independent of any tax offense. Federal investigators are well-prepared and likely will already know the answers to the questions they are asking. Counsel should be present during any interview or statement given to federal investigators. 

Depending on the nature of the investigation, the company may also want to consider conducting a thorough, independent internal investigation. Generally, the aim of an internal investigation is to make sure the practices that caused the investigation have ceased, and to implement procedures to prevent problems from reoccurring. A secondary goal of an internal investigation is to demonstrate to federal investigators that you are taking the matter seriously and are working to avoid problems in the future. Use outside counsel for an internal investigation to demonstrate that an impartial third party has taken a serious look at the matter.

As the IRS continues to scrutinize the construction industry for tax law violations, it is imperative that construction companies pay close attention. Should your construction company get wind that the IRS is targeting the business for a tax audit or investigation, responding quickly and proactively may assist the company in achieving a positive result.

Gregory Seador, vice president of Shapiro, Lifschitz & Schram, is an experienced trial attorney with more than 15 years of complex litigation experience and is member of the firm’s Litigation and Trial, Construction, and Power & Energy Construction groups. A litigator with an emphasis on serving the construction sector, Seador’s practice is focused on complex litigation matters, including those on behalf of governmental and private owners, regional, national and international contractors, construction managers, subcontractors and design professionals, among others. Contact him via email [email protected]

 

 

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