According to the 2011 Internal Revenue Service DataBook, a total of 1,564,690 (approximately 1.1%) individual income tax returns were subject to audit in 2011. This rate increased to 3.6% for returns with total positive income of $200,000 to $1 million and showing business activity.
A section of the Audit Technique Guide (ATG) published by the IRS in 2011 is specifically geared to assisting examiners in their scrutiny of lawyers and law firms. A complete list of the types of client, case and financial records maintained by lawyers are listed and examiners are told to compare and reconcile the data in the reports to “test the validity of reported income”. The guide provides a comprehensive legal analysis of lawyer-client privilege in the context of a tax audit - to counter attorneys citing privilege in their refusal to disclose documentation. Furthermore, potential sources of noncash income (such as stock options and even bartering) are identified.
Attorneys whose relationships with staff members are less than stellar could have cause to worry if they have not been fully forthcoming with the IRS. In fiscal year 2010, the IRS accepted 7,600 new “smaller” whistleblower cases involving unreported income or payroll taxes in small business environments. Lawyers who come to the attention of the IRS face not only civil and criminal exposure but also disciplinary action by the state bar. Robert W. Wood, writing for Forbes.com reports the story of now disbarred Tennessee attorney John Threadgill whose “primary alleged crime was paying personal expenses from his law firm.” Subsequently convicted of tax evasion, it was found that he paid significant personal expenses through his firm such as country club bills, a wedding and personal travel.