IRS Audits & Investigations Targeting Tax Preparers
The IRS is Using Statistical Analysis to Target Tax Preparers Suspected of Helping Taxpayers Submit Fraudulent Returns
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Dr. Nick Oberheiden
As the Internal Revenue Service (IRS) continues to grapple with a backlog caused by the recent pandemic, it is looking for new, more-efficient ways to target taxpayers suspected of fraud. One way it is doing so is by targeting tax preparers. By looking for patterns in tax preparers’ filings, not only can the IRS uncover cases of tax fraud and tax evasion, but it can also target the tax preparers who facilitate taxpayers’ filing of fraudulent returns.
The IRS is relying heavily on statistical analysis to identify accountants and other tax preparers that the agency can target in audits and investigations. By examining tax preparers’ filings from a statistical perspective, the IRS is able to identify data trends that are indicative of fraud. The IRS can then launch targeted audits and investigations focused on individual tax preparers—and focused on imposing civil or criminal penalties as warranted.
Red Flags for Tax Preparer Fraud (According to the IRS)
When examining taxpayers’ returns for signs of tax preparer fraud, the IRS looks for a number of red flags. While these red flags are not necessarily indicative of fraud—which is critical from a defense perspective—the IRS views them as warranting scrutiny. This is especially true when the same red flags appear in multiple returns filed by a single tax preparer or firm.
Some examples of red flags for the IRS include:
Cash Contributions to Charities
Claiming cash contributions to charity is a common form of tax fraud. The Internal Revenue Code (IRC) allows a limited deduction for cash contributions, and the relatively low limit ($600 for the 2021 tax year) combined with the lack of documentation makes this an attractive target for taxpayers seeking to reduce the amount they owe.
But, while taxpayers and tax preparers might think that fraudulent cash contribution deductions will fly under the radar, this isn’t always—or even often—the case. When multiple returns filed by a single tax preparer or firm include claimed deductions for cash contributions, this is especially likely to garner attention from the IRS.
Earned Income Tax Credits
Abuse of the Earned Income Tax Credit is another common type of fraud that can get both taxpayers and tax preparers in trouble with the IRS. This includes fraudulently claiming the Earned Income Tax Credit as well as falsifying taxpayers’ income data in order to increase the amount of their credit.
The IRS expects taxpayers to take steps to prevent their clients from fraudulently claiming Earned Income Tax Credits. As the agency explains, “If you find the information provided by the client appears incomplete, inconsistent or incorrect, you should ask additional questions, document the answers and make a judgment as to whether the answers make sense. . . . If you are not comfortable with the answers or credibility of the client, then due diligence dictates you refuse to prepare the return.”
Education credits fall into the same category as cash contributions and the Earned Income Tax Credit in terms of being ripe for fraud. When clients claim to be eligible for education credits, taxpayers must obtain substantiating documentation. If they don’t, the IRS will deem them complicit when their clients’ claims prove to be false. If a tax preparer consistently files returns that claim education credits, especially credits in the same amount, this can also create an inference that the preparer is engaging in fraud on behalf of his or her clients.
Failure to Report Gross Receipts
Businesses have an obligation to report their gross receipts to the IRS. This includes gross receipts in all forms—cash, credit, checks, and cryptocurrency. Failing to report gross receipts is among the most common types of small business tax fraud; and, here too, the IRS expects tax preparers to do their part to prevent their clients from submitting fraudulent returns.
From comparing businesses’ gross receipts and expense deductions to obtaining information about businesses’ cryptocurrency transactions from their exchanges, the IRS can uncover businesses’ failure to report their taxable income in various ways. If a tax preparer knows, or should know, that a business’s claimed gross receipts are inaccurate, the tax preparer can face liability as a result.
Kickbacks Between Taxpayers and Tax Preparers
Kickbacks between taxpayers and tax preparers are common triggers for criminal tax fraud investigations. If a tax preparer accepts payment from a client in exchange for fraudulently enhancing the client’s refund or reducing the client’s income tax liability, this transaction alone can trigger criminal charges for both parties.
Repeatedly Claiming Losses
Claiming losses year after year is another red flag for the IRS. If a tax preparer regularly files returns for clients claiming repeated losses, this can trigger an audit or investigation into the tax preparer’s practices. If a tax preparer does not have adequate substantiating documentation from his or her clients to support annual loss claims, the tax preparer could be at risk for civil or criminal enforcement action.
Residential Energy Credits
Residential energy credits are another common source of taxpayer and tax preparer fraud. Tax preparers who offer to claim residential energy credits for their clients without the requisite documentation will be at risk for facing liability in the event of an IRS audit or investigation.
The IRS views dependents as “suspicious” under various circumstances. This includes circumstances ranging from differences between taxpayers’ and claimed defendants’ last names to the repeated use of Social Security numbers and disparities between taxpayers’ and claimed defendants’ tax returns. Once again, tax preparers have a duty to address any questions before filing their clients’ returns (if they file them at all), and they can face criminal culpability if they intentionally help their clients make false statements to the IRS.
Underreporting Taxable Income
Tax preparers who help facilitate their clients’ underreporting of taxable income can face either civil or criminal liability depending on the role they play. This applies to income from all sources—including wages and salary, independent contractor income, gig economy income, and income from cryptocurrency and other self-managed investment accounts. If an IRS audit or investigation reveals that a tax preparer has either helped falsify clients’ returns or looked the other way when clients underreported their income, the tax preparer can potentially face criminal penalties under the IRC.
What To Do if You are Facing an IRS Audit or Investigation as a Tax Preparer
Given the broad range of issues that can lead to liability, what should you do if you are facing an IRS audit or investigation as a tax preparer?
When facing IRS scrutiny, it is imperative to engage defense counsel promptly. The sooner you hire an attorney to represent you, the more opportunities your attorney will have to resolve the inquiry in your favor. If you are facing an audit, it may be possible to resolve the audit without further action. If you are facing an investigation, it may be possible to resolve the investigation without charges being filed.
But achieving these outcomes requires in-depth knowledge of the law and the IRS’s auditing and investigative practices. As a tax preparer, an IRS audit or investigation is not something you should try to handle yourself. The stakes are far too high, and determining what defenses you have available requires the ability to apply all relevant provisions of federal statutory and common law to the specific issue (or issues) underlying the IRS’s inquiry. If you make assumptions about why the IRS is targeting you, or if you overlook issues that are pertinent to the audit or investigation, you could end up putting yourself—and your tax preparation practice—in jeopardy unnecessarily.
FAQs: Defending Against an IRS Tax Preparer Audit or Investigation
Can a Tax Preparer Be Held Liable for Submitting a False Return if He or She Relies on Information a Client Provides?
Yes. Under federal law, tax preparers must take reasonable steps to ensure that they are submitting accurate information to the IRS on behalf of their clients. If a tax preparer should have known a client’s return was false, the tax preparer can potentially face liability for fraud, conspiracy, and various other federal offenses.
What are the Risks of Facing an IRS Audit or Investigation for Tax Preparers?
Depending on the allegations involved, an IRS audit or investigation targeting a tax preparer can lead to civil or criminal penalties. In addition to fines, tax preparers can also face loss of their IRS registration and the possibility of federal imprisonment.
How Can Tax Preparers Defend Against IRS Audits and Investigations?
From providing a valid explanation for an apparent “red flag” to challenging the timing of the IRS’s inquiry, there are several potential ways to defend against an audit or investigation as a tax preparer. The key to mitigating any potential risk is knowing what defenses you can assert based on the unique facts and circumstances of your case.
Speak with an IRS Defense Lawyer at Oberheiden P.C.
Are you facing an IRS audit or investigation as a tax preparer? If so, we encourage you to speak with a lawyer at Oberheiden P.C. promptly. Call 888-680-1745 or contact us online to arrange a complimentary initial consultation today.