Budget shortfalls fuel increased IRS heat on small and medium size businesses.

With federal and state government coffers dwindling, both bodies are now turning up the heat on the Internal Revenue Service (IRS) to become more aggressive in its large dollar audit work. As a result of this renewed audit energy exhibited by the IRS, small and medium size business owners; and broad classes of professionals in service industries: doctors, dentists, accountants, lawyers, real estate and insurance professionals are all receiving renewed scrutiny.

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Of particular concern is the new aggressiveness of the IRS in its conduct of civil examinations designed to determine the correctness of filed tax returns. Historically and currently, it is the policy of the IRS to seek voluntary cooperation of taxpayers under examination in the provision of requested records and information. Increasingly, however, IRS agents have been quick to use the broad summons enforcement power as a tool to secure information from third parties.

In recognition of a taxpayer's civil liberties and Fourth Amendment rights, IRS policy has historically been to withdraw from a civil examination upon a "clear indication" of fraud viewed by the examining agent. This permits others to evaluate the facts and circumstances before either continuing with the audit or embarking upon another more perilous path for the taxpayer. While the IRS policy remains unchanged, agents have increasingly made use of favorable case law to continue aggressive civil examinations with dire potential criminal consequences to the subjected taxpayer. So long as the examining agent has not made an "affirmative misrepresentation as to his or her purpose," courts have been willing to uphold information gathering by the examining agent resulting ultimately in criminal prosecutions of affected taxpayers. As a result, agents are staying in longer and probing deeper before making a fraud referral.

With increased pressures to raise federal revenue, the enforcement pendulum has again swung.

Robert E. Forrest is a partner at Raymond & Prokop, specializing in the handling and litigation of tax controversy matters with state and federal authorities. He can be contacted at [e-mail].