Tax examinations or audits can be conducted by the IRS or State of Maryland. The IRS audits federal tax returns; the Comptroller of Maryland audits state tax returns; and the Maryland Department of Labor, Licensing, and Regulation audits businesses regarding unemployment insurance taxes. Although audits can be daunting, they do not necessarily mean you are in trouble. Generally, you will only be assessed additional taxes or penalized if you did not report your tax liability or failed to make tax payments correctly in compliance with the tax laws. Keep reading for additional information on IRS and Maryland audits and how Maryland tax attorney Jim Liang can help you survive your audit.
IRS Examinations / Audits
An examination or audit is the process the IRS uses to thoroughly review a business's or individual’s financial information to confirm the information and tax liability have been reported correctly in compliance with the tax laws. Just because you are being audited does not mean the IRS has picked up on a mistake you made. The IRS may have selected your tax return for an audit based entirely on random selection or computer screening. Also, if a business partner or investor has been selected for an audit, the IRS may select your return as well, since it involves issues and/or transactions with the other taxpayer(s).
The IRS may complete an audit or examination of your tax return for a variety of reasons. Although many types of audits can occur, two specific types of audits used by the IRS to enforce tax laws are eggshell audits and worker classification audits. Both of these audits are discussed in more detail below. If your account has been selected for an audit of any kind, the IRS will notify you by mail. They do not initiate audits by phone.
Eggshell audits occur when a civil IRS examination is conducted with underlying criminal issues. Eggshell audits get their name because if you are subjected to one, you want to walk on eggshells, so as to guide the examination of the Internal Revenue Agent and not raise suspicion of criminal intent.
Eggshell audits are triggered by a material understatement of income or a material overstatement of deduction(s) and/or credit(s) in order to pay less taxes. Taxpayers with eggshell audits resulting in criminal charges could face 3 to 5 years in prison for tax evasion. Representation by a tax attorney during an eggshell audit is key to protect you from criminal charges and provide you with your best options, if you face criminal charges.
Should You Have an Attorney for an Audit?
As discussed in the federal court case United States v. Kovel, 296 F.2d 918 (2nd Cir. 1961), your tax preparer should not represent you in an eggshell audit. Only a tax attorney will be able to provide you with attorney-client privilege. Also, taxpayers are protected by the constitutional right against self-incrimination. This applies to eggshell audits, which means you do not have to speak with Internal Revenue Agents. This doesn’t mean you can ignore them, but you can hire a tax attorney to deal with the auditors for you.
For taxpayers and their representatives, eggshell audits have two main purposes: 1) prevent a criminal tax investigation; and 2) keep the tax matter a civil IRS examination. A lesser purpose is to minimize adjustments and avoid civil fraud penalties. Internal Revenue Code § 6663 allows a 75% penalty to be imposed to any underpayment of tax shown on a tax return due to fraud.
Typically, one of three outcomes result from an eggshell audit:
- IRS Agent finds there were no criminal concerns,
- IRS Agent finds there were some criminal concerns but is convinced to keep the audit a civil examination, or
- IRS Agent decides to refer the case to the IRS Criminal Investigation Division.
Another reason to be extremely careful during eggshell audits is because reverse eggshell audits occur. These occur when the IRS Revenue Agent is conducting the audit to collect evidence for a criminal investigation, not to keep the audit a civil IRS examination. Eggshell audits earn their name well.
Worker Classification Audits
The IRS conducts worker classification audits to ensure employers are classifying workers correctly. Classifying workers correctly is extremely important in order to avoid the assessment of additional employment taxes by the IRS. If workers can be classified as independent contractors, the employer does not have to pay their Social Security and Medicare taxes. Instead, the independent contractor is responsible for self-employment tax, which means they have to pay both the employer’s and employee’s share of Social Security and Medicare taxes, not just the employee’s share.
Independent Contractor vs. Employee
The general rule used in determining if an individual can qualify as an independent contractor as defined by the IRS is: "if the payer [employer] has the right to control or direct only the result of the work, not what will be done and how it will be done." Businesses that incorrectly classify employees as independent contractors without a reasonable basis can become liable for employment taxes.
If you have incorrectly classified employees, two types of relief provided by the IRS are the Voluntary Classification Settlement Program and Section 530 Relief.
Voluntary Classification Settlement Program
The Voluntary Classification Settlement Program gives employers the opportunity to reclassify workers as employees for tax purposes voluntarily for future tax periods. In return, the IRS will give the taxpayer partial relief from past due employment taxes.
Section 530 Relief
Section 530 Relief provides relief from employment taxes for employers who have timely filed tax returns “consistent with its treatment of the worker as a non-employee,” who consistently treated workers holding the same or similar position as a non-employee, and who relied on a prior audit, judicial precedent, industry practice, or other reasonable basis for purposes of treating the worker as a non-employee. Unlike the Voluntary Classification Settlement Program, taxpayers do not have to apply for Section 530 Relief. IRS examiners must review whether the taxpayer qualifies for Section 530 Relief even if the taxpayer does not request it.
If You Are Being Audited by the IRS ...
If you are under an audit or worried about an audit, contact Maryland tax attorney Jim Liang to review your available solutions. Jim has years of experience handling all different types of audits. He will work with you to establish your goals, guide you to the most favorable result, and minimize the burden and delay.
Jim can control the flow of information received by the IRS and try to limit the scope and duration of the exam. Most importantly, when working with Jim, you will have attorney-client privilege. Jim will help you be prepared and handle each step of the process. Schedule an appointment with Jim today for a free consultation to learn more about how he can represent you during an IRS audit.
Maryland Examinations / Audits
Generally, the Comptroller of Maryland relies on the IRS to notify them of changes to individual tax returns. Maryland returns cannot be completed until you have completed your federal tax return because you are required to report your income and deductions on your Maryland state return as they were reported on your federal tax return. This means if the IRS changes the amount of your income or deductions, it will affect your Maryland tax return. If your income or deductions are changed by the IRS, expect to receive a notification from the Comptroller of Maryland. Because the IRS notifies the Comptroller of Maryland of changes it makes, Maryland more actively audits businesses.
Common Maryland Tax Audits
Some of the most common business audits conducted in Maryland are:
- Admission and Amusement Tax,
- Sales and Use Tax,
- Unemployment Insurance Tax, and
- Residency Audits.
The Comptroller of Maryland conducts Amusement Tax, Sales and Use Tax, and Residency Audits, whereas Maryland’s Department of Labor, Licensing, and Regulation conducts Unemployment Insurance Tax audits.
Comptroller of Maryland Audit Process
The Comptroller of Maryland will either call or write taxpayers to schedule an audit. Usually, the auditor will give businesses a week to prepare, but additional time can be requested, if needed. During the audit process, the auditor will ask you general questions about your business and review your records for a sample period usually agreed upon by the auditor and you. Most audits do not require a complete review of all your records for the period of the audit but just a sampling. When the audit is completed, you will receive a complete copy of the auditor’s working papers and audit results at the audit’s closing conference. Just because you are being audited does not mean you are going be assessed additional taxes.
If you are being audited or are concerned you are going to be audited, contact Jim Liang. Jim has years of experience handling all different types of audits. He will work with you to:
✓ Establish your goals
✓ Guide you to the most favorable result
✓ Minimize the burden and delay
Jim will help you be prepared and handle each step of the process. This way you can concentrate more time on running your business, while Jim concentrates on the audit. Schedule an appointment with Jim today for a free consultation to learn more about how he can represent you during your audit.