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IRS SPECIAL ENFORCEMENT PROGRAM AUDIT GROUP

What is an IRS SEP Audit?

If you have been selected for an IRS audit, it is important to find out information about the auditor, such as whether the auditor is a member of the SEP group. The IRS Special Enforcement Program (SEP) audit group is a specialized compliance program within the Small Business/Self- Employed Operating Division (SB/SE) directed toward taxpayers that derive substantial income from either legal or illegal activities. The goals of SEP is to determine whether taxpayers have “intentionally” understated their tax liabilities. SEP evolved from a Strike Force program focused on organized crime and illegal activity into a compliance program with emphasis on identifying, developing and investigating fraudulent income and expense issues of both legal and illegal entities. SEP examines cases which significantly impact the public and assists in the investigation and prosecution of prominent or notorious individuals who attempt to evade or defeat the tax system.

SEP cases normally involve in-depth examinations of sources of income and deductions. Section 7602(e) of the Internal Revenue Code (IRC) states that the Service should not use financial status or economic reality examination techniques, such as indirect methods, to determine the unreported income of any taxpayer unless there is a reasonable indication that there is a likelihood of such unreported income. The examination of income is a generally a mandatory audit issue. The depth of the examination of income and the techniques used will vary upon the facts and circumstances of the case. To determine whether unreported income exists, the SEP agent will: conduct the minimum income probes; resolve Large, Unusual and Questionable (LUQ) income items; perform a financial status analysis; and evaluate internal controls in the case of a business return. If the likelihood of unreported income has been suspected, the SEP auditor may attempt to use the Financial Status Audit Techniques (FSAT’s), such as the net worth method.

What is the role of IRS SEP Auditors?

SEP auditors generally have experience in fraud cases. A civil fraud penalty case may be developed based on facts and circumstances of a civil examination or result from a case initiated by Criminal Investigation (CI).

Civil fraud penalties should only be asserted by the IRS when there is clear and convincing evidence to prove that some part of the underpayment of tax was due to fraud. Such evidence must show the taxpayer’s intent to evade the assessment of tax, which the taxpayer believed to be owing. Intent is distinguished from inadvertence, reliance on incorrect technical advice, sincerely-held difference of opinion, negligence or carelessness. In the case of a joint return, intent must be established separately for each spouse as required by IRC 6663(c). The fraud of one spouse cannot be used to impute fraud by the other spouse. Thus, the civil fraud penalty may be asserted only on one spouse, unless there is sufficient evidence that both spouses participated in the fraudulent act(s) resulting in the underpayment reported in their joint return.

Since direct proof of fraudulent intent is rarely available, fraud must be proven by circumstantial evidence and reasonable inferences. Fraud generally involves one or more of the following provable elements:

  1. Deception
  2. Misrepresentation of material facts
  3. False or altered documents
  4. Evasion (i.e., diversion or omission)

The core roles and responsibilities of SEP are to:

  1. Identify and develop those issues, which have significant fraud potential, through the examination of complex financial/forensic accounting cases.
  2. Assist in financial investigations of taxpayers who derive legal and illegal income, but choose to evade their tax liability through one or more violations of the tax law.
  3. Serve as the cooperating agent in administrative investigations and in grand jury investigations.;
  4. Provide trial assistance as either expert and/or summary witnesses in criminal prosecutions.
  5. Assist Area Counsel in trial preparation.
  6. Protect the Government’s interest through the use of jeopardy and/or termination assessments.
  7. Ensure the civil disposition of closed criminal prosecutions.

SEP auditors focus their examinations on developing the badges of fraud to establish the fraud penalty. It is important that your interactions with a SEP auditor are made carefully so as not to allow the auditor to misunderstand elements of your tax returns. SEP examines matters such as:

  1. Unreported income
  2. False expenses/credits
  3. Abusive return preparers
  4. Frivolous filers/non-filers
  5. Abusive trusts/abusive trust schemes
  6. Tax Shelters
  7. Fraudulent specialty tax investigations (i.e., Employment Tax and/or Excise Tax Investigations)
  8. Health care fraud
  9. Embezzlement and theft
  10. Political corruption
  11. Credit card fraud
  12. Bank fraud
  13. Currency violations (CBRS/SAR)
  14. Offshore activities
  15. Promoter Investigations
  16. Voluntary Disclosure Program cases

SEP auditors can sometimes believe fraud exists where none does. It is imperative that taxpayers who are dealing with a SEP auditor understand their rights and take steps to successfully resolve their audit.

SEP agents do the following actions during an audit:

  1. Identify fraud issues and recognize indicators of fraudulent activity.
  2. Conduct in-depth examinations of cases with fraud potential.
  3. Conduct detailed interviews of taxpayers and third party witnesses.
  4. Secure evidence, with a summons if necessary, to determine taxable income.
  5. Submit referrals to CI on cases meeting criminal criteria.
  6. Participate as a tax law expert in joint investigations and assist in computing the criminal tax liability.
  7. Balance civil and criminal aspects in joint investigation cases, including the protection of the statute of limitations.
  8. Prepare examination reports, compute tax liability and propose applicable civil penalties.
  9. Act as technical advisor and assist the U. S. Attorney’s office with grand jury investigations.
  10. Assist U. S. Attorney’s office and Area Counsel in preparing tax computations and special schedules for trial.
  11. Testify as expert or summary witnesses in criminal and civil tax cases.
  12. Develop leads by networking with local, state and federal agencies.

Joint Investigations with SEP and CI

SEP agents devote a significant amount of time working joint investigations with the IRS Criminal Investigation division (CI). Joint investigations are also known as administrative tax cases and are comprehensive investigations conducted jointly by CI and an IRS civil auditor. The primary purpose of a joint investigation is to determine if criminal tax fraud is involved and whether criminal prosecution should be recommended.

In addition to assisting with the criminal tax computation, SEP agents are responsible for the civil aspects of the case including:

  1. Statute protection (see IRM 25.1.4.3.5, Administrative Joint Investigations)
  2. Consideration of subsequent year and related returns
  3. Preparation of the Revenue Agent workpapers and examination report of adjustments for prosecution and non-prosecution years
  4. Civil closing.
  5. Joint investigations can originate from the following:
  6. Referral Report of Potential Criminal Fraud Cases (Form 2797) or
  7. Request for Cooperating Examiner (Form 6544).

Contact a Los Angeles Tax Attorney

If you are the subject of an IRS audit, contact a Los Angeles tax attorney for advice regarding how to successfully resolve the audit. There are several types of IRS audits. Contact a tax lawyer at Disparte tax law today for a free consultation.

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