What is an Eggshell Audit or Reverse Eggshell Tax Audit?

Eggshell Audit

What is an Eggshell or Reverse Eggshell Audit?

A typical tax audit or examination by the Internal Revenue Service is usually nowhere near as bad as some tax practitioners want to scare you into believing. While nobody would voluntarily want to subject themselves to a tax audit, at the end of the day oftentimes the taxpayer will not owe much in the way of tax or penalties and even if they do they may be able to negotiate or abate any potential fines. Likewise, in some scenarios, taxpayers may get the best of the IRS and at the end of the audit receive an NC ‘No Change” letter — meaning there was no change to the underlying taxes due — or even receive a credit or refund. But, when the taxpayers are subject to an eggshell or reverse eggshell audit, there are much bigger risks. That is because the concept behind the eggshell or reverse eggshell audit is that there is some information that may be considered willful or criminal that either the taxpayer has knowledge of but does not want to provide to the IRS — or the IRS already has knowledge of but the taxpayer is unaware whether the IRS agents already have this knowledge. It can put the taxpayer into a very precarious position because they have to be careful not to make any intentional misrepresentations or omissions while answering the questions — while not volunteering any unnecessary ancillary information that is not required truthfully to respond to the question. Let’s look at the difference between an eggshell audit and a reverse eggshell audit.

Eggshell Audit

An eggshell audit is typically a situation in which the taxpayer has certain information that they don’t want to provide to the IRS agent. For example, let’s take a situation in which the taxpayer has unreported foreign income. As part of the Information Document Request (IDR), they receive from the IRS, it asks for information about unreported foreign income. But, in addition to the unreported foreign income, the taxpayer is also aware that there is other unreported money in assets associated with the income even though they were not directly questioned in the IDR and it is not a direct relationship. While the taxpayer has a responsibility to be truthful, he is not required to provide the IRS a roadmap for them to bring criminal charges against. It is a very tight-rope the taxpayer has to walk which is why in these types of situations it is usually best to hire a Board-Certified Tax Law Specialist who specializes in whichever area of audit they are currently subject to (international tax and reporting, sales tax, employment tax, etc.)

Reverse Eggshell Audit

A reverse eggshell audit is similar but puts the taxpayer into a much more precarious position than the eggshell audit. That is because, with the reverse external audit, the IRS already has information that the taxpayer is unaware that the IRS already has or is unsure that the IRS has that information. In a common example, the taxpayer may have foreign accounts in which the Foreign Financial Institution has already reported the information to the U.S. government in accordance with FATCA (Foreign Account Tax Compliance Act). Meanwhile, the taxpayer was unaware that this FFI had reported his information to the IRS — and so when he was completing his tax returns, he indicated that he did not have any foreign accounts — because he did not want to disclose this information to the US government. Now, the taxpayer is under audit and is questioned as to whether or not he has foreign accounts. The taxpayer may believe that the IRS does not have the information and doubles down on the misrepresentation (potentially leading to a criminal investigation) or alternatively, the taxpayer may realize he is in deep and probably better to hire an attorney and disclose the account now and try to minimize or abate penalties than to go deeper into making false statements to the IRS.

Common Types of High-Risk IRS Tax Audits

In the rare situation that the taxpayer finds themselves in an eggshell or reverse eggshell audit, taxpayers must be very careful in how they respond to the IRS agent since these types of audits are high-risk. Taxpayers have to walk a tightrope between not intentionally omitting or misrepresenting facts, while not volunteering superfluous information that was not requested of them. In recent years, the U.S. government has turned its attention to international tax and foreign account and asset reporting-related compliance matters when it comes to its high-risk audit enforcement protocol. Let’s take a look at five types of high-risk foreign tax audits.

Intentionally Unreported Foreign Income

When a taxpayer intentionally underreports foreign income, this can be a form of tax fraud or tax evasion depending on how much income was underreported, the source of the income, and whether the income was legal or illegally sourced income. Taxpayers who have intentionally unreported income must be careful when responding to any audit notice from the IRS because if the IRS believes the taxpayer acted with intent, it could expand into a criminal tax situation.

Willfully Unreported Foreign Accounts Assets

Taxpayers with foreign accounts, assets, and investments may have various international information reporting forms they may be required to file each year depending on the category of assets they have and the value of the investments abroad. One of the most lethal types of penalties that the IRS can assess is international information reporting penalties for failing to file the FBAR. When the taxpayer is considered willful (including reckless disregard or willful blindness), it could lead to extreme penalties upwards of 50% maximum value of the unreported accounts.

Incomplete FBAR/FATCA

In addition to failing to file the annual FBAR or Form 8938, the IRS also enforces penalties against taxpayers who intentionally deflate the value of accounts or assets listed on their forms as well as eliminating them (if they do not want the IRS to know about the assets). In this type of situation, taxpayers must be very careful if they file the forms (so that they cannot take the position they were unaware of their filing requirement), but then fail to include certain high-dollar assets. As with other non-compliance issues, if the taxpayer made a mistake (such as not knowing that a foreign pension was reportable), that is usually not a big deal, versus a taxpayer who may have reported several accounts from a foreign financial institution but intentionally failed to include high dollar bank accounts at institutions they thought would not report them to the IRS.

Misrepresenting U.S. Person Status to Foreign Bank

With the introduction of FATCA (Foreign Account Tax Compliance Act), hundreds of thousands of foreign financial institutions report U.S. account holder information to the IRS and U.S. government. Typically, this is when the taxpayer is considered a U.S. person and falsely represents to the foreign financial institution that they are a foreign person instead of a U.S. person for tax purposes — and as a result, they are not included in the account information provided by the Foreign Financial Institution to the IRS. An important distinction is whether it was a mistake or intentional. If the taxpayer mistakenly represented their status to the foreign financial institution, then it would not be considered willful – but if the taxpayer did it intentionally this could lead to willful penalties and a much more intrusive tax audit.

3^rd Party Fraudulent Conveyance

Finally, some taxpayers believe that if they transfer assets out of their name to a third party, to avoid creditors or other issues but then maintain control and decision-making powers over the asset the IRS will not find them. Oftentimes, the IRS has various ways to uncover foreign assets held by an individual who they want to investigate and if the IRS determines that the taxpayer made a fraudulent conveyance, the taxpayer may find themselves on the receiving end of a very intrusive tax audit — which may also now bring in the third party that the taxpayer transferred the assets to.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

This resource may help taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.