Costly Mistakes for the Business & Tax Lawyer to Make and Also thier Clients
Course Materials by David W. Klasing Esq. M.S.-Tax CPA and the Tax Law Office of David W. Klasing, P.C. Note: A great deal of the information in this presentation package came from our website that is accessible at: www.taxesqcpa.net 2603 Main St., Suite 1180, Irvine, CA 92614, Phone (949) 681-3502 Fax: (949) 681-3504
David W. Klasing Esq. CPA M.S.-Tax has earned dual California licenses that enable him to simultaneously practice as an Attorney and as a Certified Public Accountant in the practice areas of Taxation, Estate Planning and Business Law. He provides businesses and individuals with comprehensive Tax Representation, Planning & Compliance Services and Criminal Tax Representation. He has more than 20 years of combined experience as a tax attorney and CPA, coupled with extensive knowledge about federal and state tax codes, regulations and case law.
As a former auditor, Mr. Klasing uses his past experience in public accounting to help his clients avoid tax problems before they develop where possible. As a Combo Attorney CPA he aggressively protects his clients’ interests during audits, criminal investigations or in Tax Litigation. Mr. Klasing has assisted thousands of businesses and individuals through the audit / litigation and appeal process, and Mr. Klasing has a proven and sustained record of achieving favorable results for the clients he serves.
Mr. Klasing is admitted to practice before all California State Courts, the United States District Court for the Central District of California and the United States Tax Court.
Mr. Klasing’s education includes a bachelor’s degree in business administration, with an emphasis in accounting, from California State University Los Angeles, a master’s degree in taxation from Golden Gate University and a Juris Doctor from Western State University College of Law.
Having earned a master’s degree in taxation with an emphasis in the estate and gift tax arena, along with having taken classes in Law School on Estate’s, Trusts and California Community Property, Mr. Klasing practices in the estate, trust and accounting areas.
Mr. Klasing’s professional involvement includes serving as the (2014/2015) chair of the American Association of Attorney – Certified Public Accountant Education Committee, the (2012/2013) chair of the California State Bar Association, Tax Procedure and Litigation Committee, the 2013 chair of the Orange County Bar Association Taxation Section. He is also a member of the American Bar Association Tax Section; the Orange County Bar Association, Tax, Business and Corporate Law, Trust & Estate Sections, the California Society of Certified Public Accountants State Committee on Taxation and the American Association of Attorney Certified Public Accountants. He is an “A” rated current member of the Better Business Bureau. He has a 10.0 AVVO rating (Superb)
Special Agent / Public Information Officer
Internal Revenue Service – Criminal Investigation
Los Angeles Field Office
Andrew Lee is a Special Agent (SA) with the Department of the Treasury, Internal Revenue Service – Criminal Investigation Division (IRS-CID) since 1995. SA Lee is currently assigned to the IRS-CID Los Angeles Field Office (LAFO), in the newly formed Cyber Crimes Unit (CCU). SA Lee is also the LAFO’s Public Information Officer and Use of Force instructor.
SA Lee previously worked in HIFCA (High Intensity Money Laundering and Related Financial Crime Area) Task Force composed of various federal, state, and local law enforcement authorities; prosecutors; and federal financial supervisory agencies. The HIFCA Task Force is responsible for efforts to disrupt and dismantle large-scale money laundering systems and organizations, including conducting Bank Secrecy Act related financial investigations, seizures and outreach programs. SA Lee has conducted asset forfeiture investigations, involving administrative, civil and criminal forfeitures of both personal property and real property. SA Lee was the MSB (Money Service Business) Task Force Coordinator, where he led of group of investigators from federal, state and local law enforcement agencies to combat emerging money laundering issues and develop best practices.
SA Lee previously served as a Supervisory Special Agent in the LAFO and managed a group of Special Agents assigned to a general program group, which investigates white-collar crimes, including tax evasion, off-shore trusts, abusive trusts, political corruption, money laundering, as well as violations of the Bank Secrecy Act.
SA Lee previously worked in OCDETF (Organized Crime Drug Enforcement Task Force), where he conducted narcotics-related money laundering investigations to identify, dismantle and disrupt the national, trans-national and international organized crime (IOC) syndicates along with their support systems that launder illicit proceeds.
SA Lee began his IRS-CID career in a general programs group, conducting criminal investigations of white-collar crimes, including tax evasion, off-shore trusts, abusive trusts, political corruption, money laundering, as well as violations of the Bank Secrecy Act.
SA Lee has given numerous presentations to various financial institutions, trade groups, and professional organizations and was featured in numerous news articles and TV interviews. SA Lee has taught several Financial Investigative Techniques courses to Korean National Tax Service, both in Korea and U.S.
Prior to a career in federal law enforcement, SA Lee was a former Revenue Agent with the IRS – Examination Division for approximately five years, conducting complex tax audits of corporations, partnerships and individuals. Before joining the IRS, SA Lee worked for State of California, Board of Equalization as a Tax Auditor for five years, conducting complex Sales and Use Tax audits and various other related tax audits. SA Lee holds a Bachelor of Science in Business Administration – Accounting from California State University, Northridge.
COSTLY TAX MISTAKES TO AVOID
(FOR BUSINESS OWNERS AND ATTORNEYS)
1. Tips to minimize your exposure to malpractice related to tax and business advice in general.
A. Understand the elements of the average malpractice case:
I. Malpractice cases are ordinarily based on either traditional tort or contract theories.
i. Under tort law a professional has a duty to exercise the level of skill, care and diligence normally exercised by other members of the profession under similar circumstances.
ii. Under contract law a professional has a duty to perform the task undertaken diligently and competently.
II. In practice, these two standards are very similar. The diligent professional, must demonstrate reasonable competence to avoid malpractice exposure. The professional must perform as a reasonably competent and careful professional would perform under similar circumstances. Those with advanced education and experience in tax and business law may be operating under a higher standard of care. Tax law is a field that has been recognized as requiring the higher level of a “specialist’s skill”. A specialist is required to perform at a similar level of skill and diligence as others in the same specialty.
B. Measure of Damages:
I. Under the tort measure of damages, a plaintiff may recover for all of their injuries that are proximately caused by a defendant’s negligent performance. The plaintiff may generally recover the difference between his or her post damages economic position and the position that he or she would have been in had the professional not performed negligently.
II. Damages can include indirect or consequential damages that were actually incurred but not merely damages that may arise in the future. Additionally, where a court deems it appropriate, a plaintiff may be entitled to recover punitive or exemplary damages.
III. Damages may include additional taxes caused by the malpractice (in certain circumstances), along with interest and penalties. Recoverable additional taxes are limited to solely taxes that could have been avoided had the plaintiff received non-negligent advice. If additional taxes would have been owed, but return preparation errors mislead the plaintiff to believe that less was owed, the additional taxes are non-recoverable as they were not proximately caused by the preparer’s malpractice. Beware, a tax practitioner can conceivably be held liable for taxes that were overpaid as a result of a preparer’s negligence if the taxes can no longer be recovered from the government by the filing of an amended return.
C. Analyze your firm’s exposure to malpractice related to tax and business advice and reduce the exposure where possible.
I. Malpractice claims and litigation costs can quickly strip the attorney of sizable profits and cause reputational damage. Even if you ultimately prevail in the malpractice litigation, or settle the case, you could become known as simply the “attorney who was sued” regardless of the outcome. The wise Attorney should always be looking for proactive steps that they can take to help prevent litigation and malpractice claims.
2. Tips to avoid tax malpractice:
A. Be careful when giving spur-of-the-moment tax and business advice. If your client calls with a “quick question,” take a moment to evaluate if the question is easy enough, and the client sophisticated enough, that you will be able to answer the question competently without taking the time to research the issue in full. If you do proceed with giving “quick advice,” dictate a file memo summarizing the advice. If your client is unsophisticated and/or the question is complex – or if large dollars are involved – confirm the advice with a short letter summarizing the information you were given, the advice you gave, and remind the client that it was a quick general discussion, and invite the client to discuss the matter in more detail with you when time permits.
B. Communications with Clients:
I. Document all client meetings and telephone communication.
II. Inquire often about the existence of any non-routine transactions.
III. Request copies of executed documents after large financial transactions and keep a running issue list for tax planning and preparation purposes.
I. Collect delinquent bills before renewing client engagements and consider taking a retainer for repeat offenders. Don’t routinely get paid this year for last year’s work.
II. Do not sue clients for nonpayment as this is the single fastest way to draw a counter mal practice claim.
D. The best practice is to make sure you have all the facts before you give sensitive tax and business advice. Tell the client you need more time and/or more facts before you can be in a position to give advice. Do not let the client rush you. If the engagement involves an unfamiliar area of law, consider consulting with a specialist.
E. Client acceptance procedures:
I. Discuss and document client goals on each individual engagement and avoid open-ended relationships with clients.
II. Inquire about past litigation with accountants, attorneys, financial advisors business partners or tax collectors. Avoid over litigious clients at all cost.
III. Assess a client’s attitudes toward law, regulations and deadlines.
IV. Be on the lookout for clients that are in divorce proceedings or in estate disputes with family members as they may exhibit volatile behavior and mood swings.
V. If possible speak frankly with prior accountants or legal counsel.
F. Clarify your responsibility with your client via clear and concise engagement letters:
I. Be contractually clear on what your firm’s responsibilities are and what your client’s responsibilities are:
i. Write engagement letters for each project limiting the engagement to a single year of work;
ii. Delineate professional services that are to be performed by other advisers if known;
iii. Identify tax or information reporting that is not covered by the engagement, such as state, payroll, or property taxes;
iv. Do not recommend individual investments unless you are a registered investment adviser.
II. Use practice management software to tracks deadlines:
i. It is critical that tax and information return deadlines are scheduled accurately and managed timely. There are several Practice Management Software packages available to CPA’s that track client data, employee time, outstanding projects and their associated deadlines. Partners and owners and firm management and responsible staff are able to see data (including pending deadlines) in real-time as time data is entered, projects are completed and client invoices are processed.
ii. Practice management software facilitates the tracking of individual projects which can be subdivided into multiple tasks, and assigned to individual staff members, review staff and partners. Workflow steps and due dates can be assigned and as work progresses on the individual projects, at the completion of a task, the appropriate users in the next workflow step are automatically notified and the next task may be started.
3. Actions you should consider taking if you are sued:
A. Do not bury your head in the sand or ignore the situation. Your inaction can make the situation exponentially worse and negatively affect your ability to defend against the suit.
B. Don’t attempt self-help including trying to talk the client or his counsel out of suing you. Anything you say to either of them can and will be used against you in the litigation to follow. Be careful with any conversations you have or documentation you create that relates to the litigation as it is discoverable.
C. Do not pull an Arthur Anderson and destroy documents. Document destruction is a crime in certain circumstances and will turn a jury against you.
D. Don’t augment your work papers with what your current recollection of what was done. Work papers are ordinarily contemporaneous documents and you could undermine their use as a defense tool. They can be used to refresh your memory at trial and be effective in convincing a jury that you were competent. Without them, you’ll have to convince the jury with solely your unsupported hindsight testimony.
E. Notify your insurance carrier as soon as you sense there may be a malpractice claim, in the precise manner called for in the policy. If you delay too long, your malpractice coverage might be denied.
F. Consider hiring a qualified lawyer so that the attorney-client privilege can be used to protect the subsequent communications and associated work product in preparation for litigation. Otherwise, preparation for the upcoming litigation may be discoverable.
4. Surviving a Tax Audit One of the most frightening and stressful experiences in a business, even for attorneys, is getting a letter from the Internal Revenue Service saying that you are under audit.
A. The first thing that comes to mind is:
I. Did I do something wrong?
II. Will I owe the government money?
B. Some people are even concerned that they may go to prison. Even though attorneys are usually skilled at solving problems, an audit can be a complex maze, and attorneys should be familiar with the basic procedural aspects of an IRS audit.
5. Type of Audits Generally there are three types of audits:
A. Correspondence Audit
B. Office Examination Audit
C. Field Examination Audit
6. Correspondence Audit
A. In a correspondence audit, a taxpayer receives IRS correspondence by mail, with either a notice of proposed changes based on a tax return not having the same information as the Internal Revenue Records, or a document request asking for substantiation of items claimed on a tax return. These audits usually require a taxpayer to respond to the notice received within 30 days.
7. Office Audit
A. In an office audit, a taxpayer will also receive a letter from the IRS in the mail, requesting the taxpayer to setup an appointment and bring certain records with him to the audit.
8. Field Audit
A. In a field examination audit, a Revenue Agent will conduct the audit at the taxpayers home or place of business.
9. IRS Examination Procedure
A. The Internal Revenue Service has specific Audit Techniques used to audit different professions. In order to provide guidance to their examiners, the IRS issues Audit Technique Guides (ATG’s) for specific industries. The IRS has a ATG specifically tailored to attorneys.
B. The IRS audits attorneys so often it has written an audit guide for its revenue agents to follow in doing so. We have pulled some of the more interesting facts from this guide but the guide is 52 pages long! As a personal note, in my opinion the IRS has a very low opinion of the overall tax compliance of attorneys as a group. A review of some of the past tax abuses documents by the IRS in the aforementioned audit guide supports my assertion:
I. Attorney deducted party given at a country club, some clients in attendance but no business discussed.
II. Attorney and two associates deducted wine stocked to his custom built cellar as office supplies
III. Attorney had his corporation pay all his living expenses resulting in a constructive dividend of over $200,000 a year.
IV. Audited attorneys known to use company credit card for personal travel, entertainment and other personal purposes
V. Audited attorneys know to pay paralegals and law clerks as independent contractors where case law generally holds that they should be paid as employees.
VI. Audited attorney known to fail to issue 1099’s to independent contractors that are paid out of their client trust accounts
VII. Audited attorneys that are corporate officers are known to be paid as independent contractors where case law has established that they are employees of the corporation
VIII. Audited attorneys known to fail to issue 1099’s to recipient of lawsuit proceeds
IX. Audited attorney found to have created false deduction for clients by accepting a retainer payment in year one and refunding it in year two.
10. A very good audit survival strategy for attorneys is to read and understand this document and develop office procedures and record keeping procedures to respond to the types of audit techniques the attorney is likely to encounter in the event of an IRS audit as this will be the play book the IRS auditor will be following.
A. The audit technique guide expects attorneys to keep the following records:
I. Appointment book;
II. Client card index;
III. Receipts Journal or Daily log;
IV. Disbursements journal, book or other record reflecting the breakdown of regular expenses paid from bank accounts as well as disbursements made from client trust funds. These disbursement records should provide a mechanism from which disbursements chargeable to a specific client can be noted on their records for billing purposes. The attorney may also maintain a petty cash journal;
V. Accounts Receivable journal showing billed receivables;
VI. Individual client accounts including a description of services rendered, charges and credits, a summary of unbilled charges and work in progress, and final invoices;
VII. Case time records per client;
VIII. Register of cases in progress, oftentimes organized by client’s name; and
IX. Time summary reports, sorted by attorney and by client, listing the time, dates of work, billings and/or charges.
11. The IRS can amass a very substantial amount of potentially incriminating information against an audited attorney before even approaching the attorney for an interview:
A. Currency Transaction Reports from the government’s Web Currency and Banking Retrieval Sytem (WEB CBRS) web based system showing cash deposits or withdrawals in excess of $10,000 involving various financial institutions. Individuals are required to file FinCen Form 105 whenever they carry more than $10,000 in or out of the united states, o Note: Attorneys are required to report cash payments received from clients in excess of $10,000 or the foreign currency equivalent on Form 8300 and established case law holds that Attorney Client Privilege does not protect this information. Note: Failure to do so is a violation of the bank secrecy act.
B. FinCen Form 103 shows cash received or disbursed in excess of $10,000 in one gaming day.
C. Attorneys known by the IRS to have a high likelihood of being paid in cash include criminal defense attorneys, estate and trust attorneys, real estate attorneys and tax attorneys.
D. IRP transcripts will routinely be examined for the three years preceding the audit that delineate the following information on the audited attorney: 1099’s, W2’s, Soc Sec Payments, Rental Income, Property Sales, Interest and Dividends paid in the attorney or his wife’s name.
E. IRP printouts show trust accounts that are in the attorney’s name and an a report called an EINAD may disclose the names and ID numbers under which an attorney keeps bank accounts.
F. Information from State licensing boards and internet searches to determine licensing status, areas of expertise, advertising, education, press releases, pro bono work, professional associations, referral services.
G. Examiners have access to a system called Accurint which provides them information on an attorneys business, professional standing, assets, pending or resolved litigation, and other matters. Information from this system helps the auditor verify the size and location of an attorney’s offices. Accurint will identify assets in an attorney’s name such as vehicles, property assessments, deeds, watercraft and aircraft.
H. The IRS will search various court’s websites regarding marriage and divorce actions of an audited attorney and bankruptcies, foreclosures, liens, judgements and lawsuits. The guide further states that “Examiners can test the validity of reported income by comparing and reconciling the data provided on the above listed reports.”
12. Client costs and advances:
A. One of the most common issues raised on audits for attorneys are client costs and advances. The IRS takes the position (and case law supports the position) that “Lawyers who advance court costs on behalf of their clients cannot deduct the costs as business expenses where the client is ultimately responsible for payment; such advances are treated as loans, not expenses.”
13. Representation- Circular 230 Practitioner:
A. The Internal Revenue Service allows a taxpayer to be generally represented by an attorney, certified public accounts, or an enrolled agent.
14. Tax Avoidance vs. Tax Evasion:
A. Federal tax law attempts to delineate a very clear distinction between tax avoidance, which can at worst only expose the Tax Practitioner and his or her client to potential civil penalties, and tax evasion, for which criminal penalties may apply to all parties concerned. The Supreme Court in Gregory v. Helvering, 293 U.S. 465 (1935) defined permissible tax avoidance as actions that “reduce, avoid, minimize, or alleviate taxes through wholly legitimate means”. In stark contrast, evasion involves tax avoidance that is ordinarily accomplished via an element of deceit or concealment and at times patently illegal means. Taxpayers are thus legally entitled to choose the most tax efficient alternative to structure a transaction. The court in Helvering stated “[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted”…
B. While it is well settled that taxpayers are entitled to avoid taxes, the historical controversy stems from the fact that in order for the structuring of a tax avoidance transaction (or transactions) to withstand governmental scrutiny and thus fend off being recharacterized or simply disregarded, the transaction structure must comply with the totality of tax law as currently enacted which includes statutory and common-law requirements such as the Economic Substance, Sham Transaction, Step Transaction, and Substance Over Form Doctrines, and the Business Purpose Test.
15. Criminal Investigation Division
A. If the original auditor or tax examiner determines that a taxpayer willfully attempted to evade taxes, the taxpayer’s case may be referred to the IRS Criminal Investigation Division. The case will then be assigned to one or more special agents who carry a shiny gold badge and a gun.
16. How Does the IRS Prosecute Suspected Tax Crimes?
A. Tax Crimes are investigated by the Criminal Investigation Division (CID) of the Internal Revenue Service. CID uses a variety of criteria in selecting cases for investigation, the heaviest weight placed on how likely a prosecution is to result in a conviction. Any recommendations by CID to prosecute an alleged tax crime are reviewed by the District Counsel of the IRS. If the IRS District Counsel approves the recommendation, the case is referred to the Tax Division of the Department of Justice. If after reviewing the case the Tax Division makes a recommendation to prosecute, the case is finally referred to the U.S. Attorney for possible prosecution if accepted by the U.S. Attorney’s office. If factors such as poor health or other factors that would tend to create sympathy for the taxpayer making it unlikely that the taxpayer would be convicted are present, prosecution may be declined at any point in this process.
B. A federal grand jury must vote to move forward with an indictment for a taxpayer to be charged with a tax felony. After a grand jury investigation, the U.S. Attorney makes a written recommendation either for or against prosecution of a grand jury target. This report is then reviewed by the Regional Counsel for the IRS for final approval.
C. CID Special agents have broad powers to conduct investigations, but their most important limitation is that they are usually required to inform taxpayers of their Fifth Amendment rights against self-incrimination (including the right to remain silent) where they suspect a Taxpayer of a Tax Crime. A special agent most often begins an investigation by gathering background information concerning the taxpayer, interviewing the taxpayer, examining the taxpayer’s books and records and returns from prior years, investigating the taxpayer’s education and employment history, and locating the taxpayer’s bank accounts.
D. CID identifies and investigates violations of the criminal statutes of the Internal Revenue Code, together with other crimes against the internal revenue laws such as conspiracy to defraud, false claims, false statements, presenting false documents at an audit, perjury, and failure to report currency transactions. Because CID has only limited resources, selection of cases for full criminal investigation reflects not only the potential for a conviction but also CID’s priorities and the availability of agents to investigate the case. Most CI investigations center on attempts to violate a known legal duty that continue over several years and involve substantial tax deficiencies. Although cases involving evasion of income tax involve most of CID’s focus, CID also takes cases involving estate, gift, employment, and excise taxes.
17. What tactics does the Criminal Investigation Division commonly employ in conducting an investigation?
A. Special agents of the Criminal Investigation Division (CID) understand all to well that the key to proving criminal tax cases is obtain evidence of the taxpayer’s criminal intent. The best sources of that evidence are admissions and false statements of obtained directly from the taxpayer. To this end, the Criminal Investigation Division systematically attempts to secure the cooperation from taxpayers (especially unrepresented taxpayers) under investigation and from third parties to develop maximum evidence of fraudulent intent. Criminal tax investigations normally cover many transactions over several years and since direct evidence of criminal intent is usually difficult to obtain, special agents are skilled at establishing intent through circumstantial evidence.
B. A special agent usually begins an investigation by gathering background information about the taxpayer. Other steps in the investigation may include interviewing the taxpayer his return preparer, examining the taxpayer’s books and records and returns from prior years, investigating the taxpayer’s education and employment history, and locating the taxpayer’s bank accounts. Investigating agents may resort to indirect methods of proof such as the net worth method to establish not only the largest possible tax deficiency but a clear intent to defraud. The government can also prove a tax deficiency by demonstrating that specified items were omitted from gross income.
C. Taxpayers can become the target of a criminal tax investigation by failing to file returns, by failing to pay taxes when due, by providing incorrect information to the IRS, or by being mentioned in an informant’s report. All the defense alternatives available to a taxpayer under investigation pose risks, including the risk of imprisonment, a substantial civil fraud penalty, and the loss in standing with business associates and neighbors when agents question them in connection with the criminal investigation. A broad investigation may produce evidence of the taxpayer’s poor reputation for truthfulness, which can be used by the government to rebut defense character witnesses.
18. CID Interviews of Taxpayer and Witnesses:
A. When initially contacted by the special agent, it is a common mistake for the taxpayer to agree to answer questions without first making use of his or her fifth amendment privilege against self-incrimination and his right to have an attorney present. Taxpayers are often shown copies of their previous returns and asked whether all his or her income has been reported on them in order to elicit a false exculpatory statement. By requiring narrative (as opposed to yes or no) answers the agent encourages the unsuspecting taxpayer with substantial opportunity to mislead or to confess in order to obtain circumstantial evidence of willfulness. Consequently, as soon as I am retained am retained, I will request that the my new client write up his or her recollection of the initial interview with CID. I also counsel that known Witnesses related to the client’s case should be requested to obtain copies of their statements made to the IRS for use in preparing the client’s defense.
19. CID Taking Return Preparer Statements:
A. Unfortunately, the return preparer or accountant is usually placed in a position of great trust. The bad news here is that ordinarily the vast majority of what is communicated by a client to their accountant or preparer is not privileged and they can and routinely are forced to be a Witness Against your client or yourself. CID knows that the testimony of the person who prepared the returns in question often is crucial to his or her case. If the CID special agent establishes that the taxpayer misled the preparer or withheld material information from him, then he has shown substantial evidence of criminal intent. To make matters worse, it is in the preparers best interest to throw the client under the bus rather than lose their own ability to practice in front of the IRS. This is why I counsel client’s to distance themselves from their preparers until proper legal tax counsel can be obtained where a possible Tax Crime or even Civil Examination is concerned. CID knows that it is quite difficult to prove a taxpayer’s criminal intent if the preparer takes all the blame for errors on a return. However, this is not likely to occur because preparer’s know that they may become an additional target of a client’s criminal investigation if it appears that he or she conspired with or aided the client in making false representations to CID or in preparing false returns.
B. The special agent generally requests or subpoena’s the accountant’s work papers used in preparing the returns and takes a statement concerning the records supplied by the taxpayer for the preparation of those returns. Evidence of intent may be found if the taxpayer supplies only summary sheets to the preparer without the underlying data. Since the preparer’s testimony is so critical to CID’s case, I encourage client’s to make sure I am present when he or she is interviewed. If the preparer has his own counsel I will brief them to make sure that the preparer’s testimony is accurate and precise. I will then debrief the preparer and preparer’s counsel after the interview in order to surmise valuable information about the scope and details of CID’s investigation.
20. CID Reviewing a Taxpayer’s Books:
A. In reviewing the taxpayer’s books and records, CID special agents may find evidence of intent if the books are inadequate, falsified, a duplicate set of books is discovered or the books and records are destroyed prematurely. Unorthodox books, that do not follow generally accepted accounting principles, and other accounting practices that yield deceptive results that understate income or overstate expenses may also be used to indicate criminal intent. If the records are kept by anyone other than the taxpayer, the CID agent may question the accountant extensively about instructions received from the taxpayer on how records should be kept, and also about any indications that may have be communicated to the taxpayer by the bookkeeper or accountant that something was wrong with the taxpayer’s accounting system.
21. CID Examining Prior Years’ Tax Returns:
A. The CID special agent will often investigate the taxpayer’s old returns even if the statute of limitations bars prosecution for those years. The IRS will use the old returns to attempt to establish a pattern of underreporting over a substantial period of time, thus evidencing willfulness. These prior returns may also be used to counter a taxpayer’s defense of reliance on an professional, by showing that a pattern of underreporting may have occurred where the taxpayer either prepared their returns personally or employed different return preparers than the professional that prepared the returns at issue. Special attention is paid by CID to the use of and prior fictitious names used by the taxpayer and to any extravagant expenses, since these matters may indicate willful misconduct.
22. CID Canvassing Financial Institutions:
A. CID agents use IRS computers to attempt to locate all bank accounts and brokerage accounts in which the taxpayer had any interest. Agents will review the deposits to the accounts discovered in an attempt to locate additional sources of previously unreported income. In some instances an analysis of deposits reveals hidden accounts, which are further evidence of willfulness. In other cases, large amounts of business deposits may indicate that income must have been underreported on returns.
23. CID and Badges of Fraud
A. CID will use evidence of the following to prove that a tax crime has occurred;
I. Maintaining inadequate records or destroying records
II. Failing to file tax returns
III. Providing implausible or inconsistent explanations during civil examination
IV. Concealing assets during collection of tax liabilities or examination
V. Failing to cooperate with tax authorities
VI. Displaying belligerent, rude, or disrespectful behavior to an IRS agent
VII. Prematurely destroying records
VIII. Excessive dealing in cash
IX. Filing false returns
X. Intentionally underreporting or omitting income
XI. Overstating deductions or claiming false deductions
XII. Hiding or transferring income with relatives or related entities
XIII. Keeping false records of your income or “second set of books”
XIV. Falsifying books or records “forgery”
XV. Claiming fake dependents
XVI. Falsely claiming credits
XVII. Arranging affairs for the sole purpose of tax avoidance in a manner that lacks economic substance
XVIII. Taking positions on a return that are “more likely than not” to be disallowed if discovered without sufficient disclosure
B. In my honest opinion the most dangerous part of a civil tax audit is the very real possibility that the IRS civil tax auditor upon suspecting that fraud may have occurred, because of his assessment of the Badges of Fraud that he or she suspects are present, might request a consultation with a fraud referral specialist whose sole job it is to covertly assist the examining agent in working up your case for referral to CID.
C. A substantial majority of reported convictions in criminal tax cases involve taxpayers who cooperated fully early in the civil examination, without properly trained tax counsel, and either lied or made damaging admissions to civil examiners, or worse yet, to CID special agents.
D. Moreover, CID agents have the advantage during the first interview with a taxpayer in that they have reviewed tax returns, they have spoken with the civil examining agent and possibly with a fraud referral specialist and they know the direction and scope of the investigation, consequently unrepresented taxpayers are at a distinct disadvantage.
24. The Stakes where Tax Fraud May Have Occurred:
A. The stakes where Badges of Fraud exists in a taxpayer’s fact pattern going into a civil tax audit or CID criminal investigation range from at best, a civil tax fraud penalty, equal to 75% of the additional tax owed as adjusted in the civil tax audit, plus interest on the penalty back to the original filing date of the return being audited. To at worst, up to 5 years in jail, coupled with fines as high as $500,000, plus the costs to the government of prosecuting you for each separate crime.
B. The IRS historically obtains convictions in over 80% of their criminal tax cases. The average sentence imposed by the federal government for Tax Crimes is forty-eight months.
25. Aiding and Abetting a Criminal Tax Violation and the Associated Attorney
A. Several crimes set forth in the Federal Criminal Code can apply to Attorneys in their capacity as tax preparers, advisors and representatives of clients. They most commonly charged include aiding and abetting, presenting a false, fictitious, or fraudulent claim to the government, conspiracy, making false statements to a U.S. agency, mail fraud, bribery, and forgery. In practice, the aiding and abetting violations has historically been charged against persons who have aided and assisted another in tax evasion by concealing another person’s sources of income or assets, such as CPA’s and Attorneys.
B. Tax and business advisors can face a long list of misdemeanor and felony charges if he or she is not careful. The state of the law is such that he or she can be simultaneously charged with both the greater and any lesser-included offenses within the definition of the greater offense. Moreover, a single action may constitute a violation of several criminal tax statutes. The most common tax crimes an attorney or their client can be convicted of are:
I. Aiding and abetting a tax crime
II. Filing a false, fictitious, or fraudulent claim
III. Making a fraudulent or false statement
IV. Conspiracy to commit an offense or defraud the United States
V. Aiding or assisting the filing of a false return
26. Tax Crimes Generally
A. The Government has a variety of both felony and misdemeanor tax crimes, including attempted tax evasion, failure to file a return or pay tax, filing a false return, and aiding and abetting the filing of a false return at its disposal under the internal revenue code. The Government may also prosecute taxpayers under the Federal Criminal Code on charges of presenting false claims to the government, conspiracy, aiding and abetting the commission of an offense, and making false statements. However, in order to prevail, the government must prove each element of an accused tax crime beyond a reasonable doubt. Moreover, the Government must bring the action within the appropriate statute of limitations for prosecution which range from three years to six years under the internal revenue code and within five years for crimes prosecuted under the Federal Criminal Code.
B. To complicate matters further, individuals can be convicted of committing a tax crime with regards to another person’s or entities tax liability, like for example, where a corporate officer falsifies the associated corporate returns. Corporations and other legal entities such as Estates, LLC and Partnerships may also be prosecuted.
C. A taxpayer can be simultaneously charged with a main offense (greater offense) and with a lesser included offense within the legal definition of the greater offense (which often carries a lower burden of proof), and can be convicted of either individual charge, or both charges, although the law does not allow for consecutive sentences where a defendant is convicted of both the greater and the lesser included offenses. A single action on the part of a taxpayer may constitute a violation of several criminal tax statutes. When both criminal and civil remedies are available to the government, it has the discretion to pursue either criminal remedies, civil remedies or both under the law. The IRS will not rule in advance (private letter ruling) on whether a proposed transaction would subject a taxpayer to a criminal penalty.
D. A defendant can be convicted of attempting to evade tax if, a tax deficiency can be proven to exist between the return at issue and the correct amount of tax as proven by the government, the government can prove that the defendant took affirmative actions in an attempt to evade or defeat the correct amount of tax and the defendant acted willfully.
E. A defendant who is required to file a return and who willfully fails to file the return by the due date (or extended due date) can be convicted of failure to file a return.
F. A defendant who is required by law to pay tax and who willfully fails to pay the tax as it becomes due can be convicted of failure to pay tax.
G. A defendant can be convicted of making and subscribing a false return or other document if it can be proven that they willfully made and subscribed a return, the return contained a statement or included another document that included a statement that it is made under the penalties of perjury, and it can be proven that the defendant did not believe that the document was true and correct as to every material matter at the time of signature. Tax Preparers can also be convicted of the same crime if it can be proven that they aided or assisted in the preparation or presentation of a false return or other document. This creates an inherent conflict of interest between the tax preparer and the defendant taxpayer.
H. Any person who is required to collect, account for and pay over any tax and who willfully fails to do so can be convicted of a felony.
I. It is a crime for an employer to willfully fail to furnish, or to furnish a false or fraudulent, Form W-2, Wage and Tax Statement, to an employee.
J. Convictions can be obtained under the Federal Criminal Code offenses include aiding and abetting the commission of a substantive offense, presenting the government with false or fraudulent claims, conspiring to commit a substantive offense, making a false statement to the United States or any of its agencies, using the mails to execute a fraudulent scheme, bribery, and forgery.
K. Other miscellaneous tax crimes include making false statements, falsifying or destroying records or books, concealing property in connection with a compromise or a closing agreement, removing and concealing property that is subject to levy with the intent to evade or defeat tax, interfering with the administration of the internal revenue laws, and making unauthorized disclosures or inspections of returns or return information.
L. A person who willfully delivers or discloses to the Treasury Secretary (or his or her delegate) a list, return, account, statement, or other document that the person knows to be fraudulent or false as to any material matter can be convicted of a misdemeanor.
M. Any person who is required to keep any records or supply information and who willfully fails to do so can be convicted of a misdemeanor.
27. Non filer Criminal Exposure:
A. Spies Evasion:
I. When working with non-filers it is common wisdom that non-filers with large balances due that span several years should be referred out to a qualified tax attorney for evaluation for exposure to “Spies Evasion”.
II. The “Spies evasion” doctrine is, essentially, one of the ways of committing tax evasion. It is a legal theory that finds a taxpayer criminally liable when he willfully (1) fails to file a tax return(s), and (2) his actions are coupled with “affirmative acts of evasion,” like actively concealing or misleading the government. In Spies the Supreme Court identified at least seven examples of conduct that constituted affirmative acts of evasion. The Court stated: [We] “think [the] affirmative willful attempt may be inferred from conduct such as  keeping a double set of books,  making false entries of alterations,  or false invoices or documents,  destruction of books or records,  concealment of assets or covering up sources of income,  handling of one’s affairs to avoid making the records usual in transactions of the kind, and  any conduct, the likely effect of which would be to mislead or to conceal.” Spies v. United States, 317 U.S. 492, 499 (1943).
III. An “affirmative act” for purposes of the Spies evasion doctrine may be any number of things, including but not limited to, making a false statement to the IRS, either oral or written. Importantly, the statement could be made before, after, or at the same time as filing the tax return. Thus, for example, a taxpayer makes an “affirmative” act of evasion after failing to file his income tax return when he lies to the IRS about how much income he earned.
IV. What are the Penalties for Spies Tax Evasion?
i. Spies evasion is a more serious offense than willful non-filing of tax returns. This is because the mere non-filing of a tax return is typically a Section 7203 misdemeanor (which are rarely charged by the IRS) while a Spies evasion offense may cause that offense to rise to
28. Money laundering basics the attorney should be aware of:
A. Mail and wire fraud and income tax evasion are predicate offenses for money laundering.
I. Wire fraud basically only requires the use of telecommunications facilities to effectuate a scheme to defraud.
II. Mail fraud basically only requires the use of the postal system to effectuate a scheme to defraud.
III. Mail and wire fraud carry sentences ranging up to 20 years (30 where a financial institution is affected) and fines of up to $1,000,000.
IV. Money laundering is punishable by a fine of up to $500,000 or twice the value of the monetary instruments involved, whichever is greater, or imprisonment of up to 20 years, or both.
V. A real malpractice danger to international estate planners is that there are specific circumstances under which an estate plan can result in violations of U.S. money laundering laws and result in forfeiture of the assets involved along with criminal exposure to both the attorney and client. Under federal money laundering statutes, the IRS is authorized to assess a penalty in an amount equal to the greater of the proceeds realized from the fraudulent activity or $10,000. All that is required to violate the money laundering statute is a financial transaction involving the proceeds of specified unlawful activity with the intent to either promote that activity or to violate 28 U.S.C. sections 7201 (attempting to evade of defeat tax) or 7206 (fraud or false statements). 18 U.S.C. section 981(a)(1)(A) permits property involved in a transaction that violates 18 U.S.C. sections 1956 (laundering of monetary instruments), 1957 (Engaging in monetary transactions in property derived from specified unlawful activity), and 1960 (Prohibition on unlicensed money transmitting business)to be civilly forfeited.
i. Note: IRC 7201 can be violated through the attempt to evade any type of federal tax, including income tax, employment tax, estate tax, gift tax, and excise tax. Following 9/11, United States law enforcement authorities, including those in the IRS, have doubled their efforts to prosecute taxpayers and advisors guilty of money laundering. In addition, the United States Justice Department has been closely monitoring the international movement of offshore cash both onto and off U.S. soil in an effort to close down and confiscate the assets of organizations suspected of financing terrorist activities. Additionally, there have been a number of recent criminal cases involving the use of offshore tax havens to launder criminal proceeds, and convictions of lawyers involved in the schemes. A couple of examples follow:
29. Example Convictions of Attorneys Engaged in Money Laundering for Their Clients:
A. In United States v. Tarkoff, the United States Court of Appeals for the Eleventh Circuit held a Florida criminal defense lawyer liable for money laundering for actions that took place largely outside the United States. The attorney at issue represented an individual who was convicted of Medicare fraud in Florida by recruiting sham patients to the defendant’s medical clinics where they provided their Medicare numbers to the billing clerk. The FBI advised the defendant’s attorney that all of the money in his client’s possession came from Medicare fraud, and thus was subject to government attachment, and was not to be moved. Shortly following the FBI advisory, funds were wire transferred from the defendant’s client brokerage account in Florida to an account in Curacao. Shortly thereafter, the defendant’s attorney traveled to Israel and opened a numbered account using a U.S. passport and thereafter accepted a wire transfer from his client’s account in Curacao. The defendant’s lawyer then wired deposits into his own Florida trust account from the numbered account in Israel.
I. The Court of Appeals, in affirming the lawyer’s conviction for money laundering, noted that the evidence showed that the attorney acted knowingly in conducting a financial transaction which involved funds that were the proceeds of some form of unlawful activity, and that the transaction involving the defendant was intended to conceal or disguise the nature, location, source, ownership or control of the proceeds of unlawful activity.
B. In United States v. Abbell, the United States Court of Appeals for the Eleventh Circuit affirmed the convictions of two Florida criminal defense attorneys for money laundering surrounding their client’s drug trafficking. The primary issue before the Court was whether the money involved in the financial transaction involving the defendant attorneys, was itself the proceeds of unlawful activity where the attorneys’ client had possession of both the client’s illegal and legal source income. The Court held that this was a question of fact for the jury but instructed that commingling of “clean” and “unlawful” moneys will irrevocably taint the “clean” money for purposes of the money laundering statutes.
30. Aiding or Assisting a False Return:
A. The crime known as “aiding or assisting a false return” is codified in IRC § 7206(2), which essentially makes it a felony for someone to “willfully aid . . . assist, procure, counsel, or advise” someone in the preparation of a document (e.g. a tax document) that is “materially” false.
B. Broken up into its elements, the government must prove five things, each one beyond a reasonable doubt: (1) the defendant aided, assisted, procured, counseled, or advised another in the preparation of a tax return (or another document in connection with a matter arising under the tax laws); (2) that tax return (or other document) falsely stated something; (3) the defendant knew that the statement was false; (4) the false statement was regarding a “material” matter; and (5) the defendant aided, assisted etc. another willfully (that is, with the intent to violate a known legal duty).
C. One thinks here of a CPA, enrolled agent, attorney or other tax preparer who is trying to help his or her client pay less tax, but that person (the taxpayer himself or herself) was not involved in the tax preparation process. But the tax crime of aiding another to prepare a false document captures more than just CPAs and enrolled agents. It includes anyone (including Attorneys) who prepares false documents—for example, an appraiser who values a business interest for tax purposes, or a tax shelter promoter. An appraiser might have to discern the value of a partial interest in a business or other asset contributed to a charity. An inflated value would achieve a higher charitable deduction to the taxpayer, but if that value is not defensible, the appraiser could be charged with “aiding in the preparation of a false return” under § 7206(2).
D. The basis for aiding and abetting violations is accomplice liability. An individual may be indicted as a principle for committing a substantive offense upon a showing of him or her to be an aider or abettor. In practice this means persons who have aided and assisted another in tax evasion by concealing another person’s sources of income or assets.
31. The War on the Fraudulent Use of Tax Havens by United States Persons:
A. Evidence gathered under the Offshore Voluntary Disclosure Programs proves that a large number of U.S. Taxpayers have utilized offshore tax havens to evade U.S. taxes.
B. Income tax evasion is defined, including under IRC § 7201, as follows: Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.
C. Note: Each count of evasion under 7201 carries with it a potential 5 year jail sentence. The average government conviction will consist of at least three tax years which bumps the exposure out to 15 years. Most taxpayers, when confronted with a strong possibility of conviction for a 15 year sentence, will accept a negotiated plea agreement that ranges between 3 to 5 years which usually saves the government the trouble of a trial. If income tax evasion is utilized as a predicate offense for money laundering, a single count of evasion can result in a 20 rather than 5 year sentence (although this is highly unlikely given the 3 year investigation commonly used by the criminal investigation division of the IRS).
D. The historical benefit provided by tax haven jurisdictions to tax evaders was secrecy guaranteed under foreign government drafted bank secrecy laws that made it difficult for the Internal Revenue Service, or any other creditor for that matter, to obtain information regarding the assets and financial affairs of the U.S. person with assets located in the offshore. Also essential to the appeal of a tax haven jurisdiction, are efficient and high quality financial services and little or no domestic tax on nonresidents’ passive income. These very qualities are the reason that tax havens are under attack by the IRS Criminal Investigation Division and the Justice Department especially where abusive trust schemes have been allowed to enable tax evasion over the past several years.
E. Promoters of the use of abusive offshore trusts here at home have also been under attack. For example, in United States v. Chappell, the Court of Appeals affirmed the conviction of tax shelter promoter that was advising his clients to place their assets “in a circular series of three domestic and foreign trusts, each a beneficiary of the next” and to fail to report the income earned in the trusts on their individual tax returns, even though they received economic benefit(income) from the trusts. Mr. Chappell’s son then prepared and signed the clients’ tax returns under his supervision.
F. The PATRIOT Act:
I. With mind boggling speed in the wake of the terrorist attacks of September 11, 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001. The Act broadened the application of Federal anti-money laundering regulations as to banks and financial institutions, investment advisors, casinos and brokers, to an increasing range of professional advisors such as estate planners. The Act substantially increased the responsibilities and potential liabilities of U.S. and foreign financial institutions with respect to countering money laundering and the financing of terrorist activities and requiring them to report to the appropriate government agencies any suspicion they may have of money laundering activity in a customer account.
II. Penalties for violations of the act are extremely severe, and can be levied where a bank knowingly allows loopholes, or creates blinds pots in their anti-money laundering rules and procedures. For example, In the Matter of ABN AMRO BANK, N.V., the bank was assessed a civil penalty in the amount of $110,000,000 for failure to audit and supervise anti-money laundering procedures. The penalty was levied because one of the Bank’s overseas branches was able to institute “special procedures” that allowed transactions with Iran and Libya that were illegal under U.S. law.
III. The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has publicly encouraged the American Bar Association and the American College of Trust and Estates Counsel (ACTEC) to develop guidelines that will apply the money laundering provisions of the Patriot Act in the discipline of their members.
G. The Foreign Account Tax Compliance Act (FATCA)
I. In 2010, largely in response to litigation with UBS, congress enacted the Foreign Account Tax Compliance Act (FATCA),which was drafted in an attempt to prevent U.S. taxpayers from utilizing foreign accounts and entities to evade U.S. tax. FATCA generally requires U.S. taxpayers, banks, brokers and foreign financial institutions that have failed to enter into an information sharing agreement with the Internal Revenue Service (IRS), to withhold 30 percent of certain payments made to a foreign entity unless the transaction qualifies for an exemption or the foreign institution complies with specified reporting requirements.
II. FATCA basically requires 12 foreign financial institutions to disclose account information related to any U.S. individual or in relation to accounts held by a foreign entity that has substantial U.S. ownership.
i. United States Bilateral Income Tax Exchange of Information Agreements with Tax Haven Nations
a. FATCA has, to date, been implemented largely through information sharing agreements with foreign nations. The United States currently has signed thirteen bilateral exchange of information agreements with nations generally considered to be tax havens, and currently has exchange of information agreements signed with over 100 nations.
32. How the Government Decides to Pursue a Criminal Tax Charge(s);
A. The final decision to prosecute a criminal tax case is the culmination of a lengthy and complex administrative process which affords experienced and qualified criminal tax counsel ample opportunities to attempt to present an effective defense. Tax Crimes are first investigated by the Criminal Investigation Division (CID) of the Internal Revenue Service. CID uses a variety of criteria in selecting cases for investigation, the heaviest weight is placed, however, on how likely a prosecution is to result in a conviction.
B. Any recommendations by CID to prosecute an alleged tax crime are then reviewed by the District Counsel of the IRS. If the IRS District Counsel approves the recommendation, the case is then referred to the Tax Division of the Department of Justice. If after reviewing the case the Tax Division makes a recommendation to prosecute, the case is referred to the U.S. Attorney for possible prosecution if accepted by the U.S. Attorney’s office. Effective criminal tax counsel can effectively argue that factors such as poor health, family problems, emotional problems est. that tend to create sympathy for the taxpayer and thus make it unlikely that the taxpayer would be convicted are present, and thus prosecution may be declined at any point in this lengthy process by effective tax counsel.
A. Historically, by far the vast majority of the criminal tax indictments brought result in pleas. Each U.S. Attorney is authorized to accept a plea of guilty to the major count of an indictment without prior approval of the IRS. Federal prosecutors are required to initially charge the most serious, readily provable offenses that are consistent with the defendant’s alleged conduct. Typically, once charges are brought, they will not be dismissed or dropped under a plea agreement unless the prosecutor has a good faith doubt about the government’s ability to prove a charge based on either a perceived legal or evidentiary weakness in the case.
B. By contrast, the IRS does not typically settle civil tax matters as part of a plea agreement although it has the statutory authority to do so. This rational for this is to avoid the appearance that the IRS uses the criminal process to coerce the collection of civil tax liabilities. This policy does not prevent the defendant from agreeing to civil admissions, such as receiving unreported income or claiming fraudulent deductions, as part of the criminal plea agreement. Information that the taxpayer provides in a civil case may also be used in a criminal case against the taxpayer. Thus, cooperating with a criminal investigation with or without proper legal counsel may have unexpected drawbacks for the taxpayer.
34. Role of the Grand Jury Do in an IRS Tax Crime Prosecution:
A. A federal grand jury must vote in favor of issuing an indictment for a taxpayer to be charged with a tax felony. A grand jury is granted substantial investigatory powers, including the power to compel testimony and require production of physical evidence to facilitate this process. Tax misdemeanors need not be approved by grand juries, but prosecuting attorneys usually elect to present misdemeanors to the grand jury for investigation and vote when accompanied by a Felony Tax Crime charge. The grand jury’s is asked to weigh if it is more likely than not that a federal crime has been committed and is to weigh whether there is probable cause to believe that the crime was committed by a particular person under the same standard. A grand jury is composed of from 16 to 23 persons chosen at the direction of the appropriate U.S. District Court. In all cases, at least 12 jurors must vote to return an indictment. In cases where a grand jury declines to charge a person, a decision called a no true bill or a no bill is recorded.
B. The work of the grand jury is required by law to proceed in secret and therefore only the grand jurors, the government attorneys, the court reporter, and witnesses may be present during the Grand Jury investigation. Grand jury investigation is usually chosen as an alternative to administrative investigation when the IRS is informed that an existing nontax motivated criminal investigation has uncovered evidence of tax crimes and the U.S. Attorney desires to combine all criminal charges, including tax crimes, into one indictment. Other common reasons for the use of grand jury investigation are the need to investigate quickly, and the need to grant use immunity to reluctant witnesses. Since grand jury investigations occasionally begin without a definite target, a defendant’s counsel is wise to assess if a client has potential exposure to prosecution at the earliest practicable time within the course of the Grand Jury Investigation. If defense counsel determines it is in the client’s best interest to negotiate a plea to potential criminal offenses or to secure use immunity, defense counsel’s leverage in the associated negotiations is strongest at the start of the grand jury investigation. If defense counsel’s timing in the negotiation is off, other potential defendants could strike a deal with the prosecutor first, leaving little new material to offer in a plea negotiation, and worse yet, leaving open the possibility of the other potential defendants obtaining immunity in exchange for becoming a key witness in the government Criminal Tax Case against the defense counsel’s client.
35. Defenses to Tax Crimes
A. Willfulness is defined under law as a voluntary and intentional violation of a known legal duty and several defenses focus on preventing the government from being able to establish this element. Defenses available to defeat the element of willfulness include inadvertence, negligence, mistake, uncertain legal duty, reliance on others and diminished mental capacity.
I. Note: Willfulness is often the easiest element of a tax crime to defeat because the government is basically required to prove to a jury what he defendant’s state of mind was at the time of the complained of offense. The government is usually forced to resort to circumstantial evidence to establish this element. For this reason the government usually will not prosecute unless a pattern of complained of behavior can be established. The existence of the pattern itself tends to indicate to a jury that the behavior was intentional and willful rather than mere negligence for example. This is the reason that three years are often at issue in a criminal investigation.
B. Defenses commonly used in defending tax crimes include the First Amendment guarantee of free speech, the Fifth Amendment guarantee against double jeopardy and self-incrimination (right to remain silent), collateral estoppel and entrapment.
C. A Taxpayer’s disagreement with the law, inability to pay and personal difficulties such as health or family problems generally are not considered defenses per se but may be used to discourage prosecution as they might make it harder to convince a jury to convict by creating sympathy for the defendant.
D. Defenses commonly used in defending tax crimes by Tax Attorneys typically focus on the protecting the client’s fifth amendment privilege against self-incrimination and fourth amendment privilege against unreasonable searches and seizures.
E. A Taxpayer’s lack of education and personal difficulties such as health, advanced age or family problems generally are not considered defenses per se but may be used to attempt to discourage prosecution as they might make it harder to convince a jury to convict by creating sympathy for the defendant.
36. Lesser Included Offenses and Multiple Punishment:
A. A single action by a taxpayer or other person may constitute a violation of several criminal statutes. For example, the single action of filing of a false and fraudulent income tax return may constitute the felonies of; Willful attempt to evade taxes, Willful submission of a fraudulent return subscribed under penalties of perjury, and the misdemeanor of a willful delivery or disclosure of a false and fraudulent document. Where a single action by a taxpayer constitutes a simultaneous violation of several criminal statutes, the government prosecutor has the discretion to selecting among all of the applicable charges and the luxury of choosing one or more of them as he deems appropriate to charge against the defendant.
37. Vicarious Liability Involving Corporations and Other Entities:
A. Although most tax crimes involve a taxpayer’s own tax liability, a defendant may have vicarious criminal liability concerning actions he or she has taken regarding another person or entity’s tax liability in a multitude of ways. Through the legal concept of vicarious liability, a corporate officer, director or employee could possibly be accused and convicted of attempted evasion of the related corporation’s taxes. A corporations’ attorney or CPA could possibly be convicted of attempted evasion of their client’s taxes through vicarious liability as well. Similarly through the doctrine of vicarious liability, it is a crime to willfully subscribe false documents and accordingly, third party individuals are occasionally convicted for signing false documents relating to the tax liability of others, for example where an tax preparer knowingly signs a false return prepared for his or her client.
B. Another source of vicarious liability for third parties is the general federal aiding and abetting statute. This statute makes any person who aids or abets another person or entity in the commission of a federal offense subject to punishment as a principal. For the Government to impose aiding and abetting liability on a third party, it will be required to prove that third party defendant affirmatively assisted another person or entity to commit a federal crime and that they shared the criminal intent with the person or entity they acted on behalf of to commit the criminal offense. For example, a corporate officer may be criminally convicted of a corporation’s willful failure to pay trust fund taxes. In many of the situations where a charge of aiding and abetting is appropriate, the government can also charge third parties with the general federal conspiracy statute, for entering into an agreement with another person or entity to commit a federal crime.
I. However, a person can be found guilty to the same extent as the taxpayer who actually owes the taxes. This is because the scope of tax evasion is defined broadly in Section 7201. Specifically, Section 7201 provides that tax evasion includes a person’s attempt “in any manner”—including helping another—“to evade or defeat any tax” or its payment (emphasis added). Thus, the statute allows the IRS to prosecute a person for the evasion of another’s tax liability. The defendant need not be the taxpayer in question.
i. For example, in United States v. Wilson, 118 F.3d 228 (4th Cir. 1997), the court considered the evidence that the government introduced against the defendant that he (the defendant) attempted to mislead the IRS or conceal the taxpayer’s assets. The court considered the following evidence, among others: (1) that the defendant “prepared and executed false, backdated notes;” (2) that he “participated in a meeting where he discussed removing money from [another’s] bank accounts in order to prevent the IRS from attaching the money;” (3) that he provided the IRS revenue officer misinformation; (4) that he “prepared numerous corporate documents for [various parties], knowingly named “strawmen” as officers and directors;” and (5) that he instructed someone “how to funnel money” from one person to another to make it look like one of the parties had made an investment when he had not in fact done so.
C. Under Federal Law, the term “person”, which is used to describe corporations and other legal entities, is deemed to include corporate officers, partners, members and employees who have a duty to perform an act for their related corporation or entity for which a criminal violation occurs because the act does not occur. The government typically uses this definition of “person” in charging crimes involving a failure to act against third parties. For example, the president and sole operating officer of a corporation is held to be under an a legal duty to file the related corporation’s tax returns and thus may be criminally prosecuted for failing to file those returns. In summary, a “person” includes an individual, a trust, an estate, a partnership, an association, a company or a corporation.
D. Of course, corporations and other legal entities may themselves be subject to prosecution for tax crimes. Corporation’s or other entities are held liable for the criminal acts of its employees and owners if the criminal act is done on its behalf and the criminal act was within the scope of the employee’s or owner’s authority. For example, a corporation can be convicted of filing a false return where its president and majority owner deliberately caused it to file a false return, even though the individual employee who signed the return was unaware of the return’s falsity. Moreover, even though a partnership is not subject to income tax at the entity level, it can still be subject to criminal prosecution at the entity level for crimes committed on its behalf by its owner’s and employee’s such as attempted evasion or failure to file.
38. Concealing Assets from the IRS During a Collection Action:
A. If one conceals assets from the IRS, or hides sources of income, then the willfulness requirement for proving tax evasion is already present—and one may not utilize a good faith defense based on ignorance of the law. See United States v. Brooks, 174 F.3d 950, 954-55 (8th Cir. 1999).
39. Tax Obstruction
A. One’s attempt to interfere with the administration of the internal revenue laws by “corruptly or by force or threats of force . . . obstructs or impedes or endeavors to obstruct or impede, the due administration of the [tax law],” which is described in IRC § 7212(a), is a felony. It is punishable by a fine up to $5,000, or imprisoned up to 3 years, or both.
B. A person “backdates” a document when he or she dates a document an earlier date than the date that the document was originally drafted. Usually, when it is done for tax reasons it is illegal and it may rise to the level of a tax obstruction violation. IRC § 7212. The same is true of concealing assets from the IRS. The following explains the relevant law on this, and discusses two cases that illustrate the concept.
C. The crime “tax obstruction” is an umbrella term for several tax crimes, but an “Omnibus Clause” violation (discussed in more detail on this website: https://klasing-associates.com/faq/crime-known-tax-obstruction-7212/) exists when someone “in any way corruptly . . . obstructs or impedes, or endeavors to obstruct or impede, the due administration” of the tax laws. IRC § 7212. This violation is a specific kind of tax obstruction. There are three things the IRS must prove for this crime: (1) that the taxpayer/defendant made a corrupt effort, endeavor, or attempt (2) to impede, obstruct, or interfere with (3) the due administration of the tax laws.
I. In U.S. v. Wilson, 118 F.3d 228 (4th Cir. 1997), the defendant backdated corporate documents to help hide his client’s assets from the IRS. That is, the appellate court determined that a tax attorney helping his client (the taxpayer) violated IRC § 7212(a) when he acted with the intent to secure unlawful benefits for himself, and acted with the intent to conceal his client’s assets.
II. The court noted several ways the attorney engaged in “concealment activities.” For example, he removed funds from his client’s three bank accounts in an effort to prevent the IRS from attaching them. In taking the money out of these accounts, he documented their removal as a loan to a corporation that was formed after he knew the IRS planned to levy them. It was discovered that many of the corporate documents were backdated—the promissory notes, bylaws, board of directors minutes, and stock certificates. In short, he tried to conceal his assets in a corporation.
D. One can commit an Omnibus Clause violation even without backdating documents, though. For example, in U.S. v. Williams, 644 F.2d 700 (8th Cir. 1981), the court found the taxpayer guilty of tax obstruction when he “assiste[d] [in the] preparation and filing of false W-4 forms” because that constituted an “endeavor to impede or obstruct the due administration of the Internal Revenue Code.” The court was unapologetic: “We conclude that section 7212’s omnibus clause plainly comprehends this conduct.”
E. Tax obstruction is a serious offense. In addition, because it exists when one “in any way corruptly” attempts to impede the IRS, it is fairly broad—capturing a lot of types of conduct.
40. False Statements:
A. Lying to a federal officer is a felony in its own right. Title 18, United States Code, Section 1001 makes it a crime to: 1) knowingly and willfully; 2) make any materially false, fictitious or fraudulent statement or representation; 3) in any matter within the jurisdiction of the executive, legislative or judicial branch of the United States.
I. A number of courts have held that if a taxpayer makes a false statement to a Treasury agent relating to the fraud in question it helps prove the “attempt” element of attempted tax evasion, which requires an “affirmative act” by the taxpayer. For example, the 11th Circuit explained that “an affirmative act constituting an evasion or attempted evasion of [a] tax occurs when false statements are made to the IRS after the tax was due, and an allegation to that effect satisfies the affirmative act element of the crime.” U.S. v. Winfield, 960 F.2d 970, 973 (11th Cir. 1992).
41. Klein Conspiracy
A. In a sentence a Klein conspiracy exists when one conspiracies to “impair or impede” the lawful functions of the federal government. But, as explained below, the real scope of a Klein conspiracy is presently a bit murky. To better understand this a little background is necessary.
B. Two Crimes Described in One Statute (18 U.S.C. § 371)
I. The general conspiracy statute is 18 U.S.C. § 371, which criminalizes two different types of conduct. The statute makes it an offense “[i]f two or more persons conspire either to commit any offense against the United States, or to defraud the United States, or any agency thereof in any manner or for any purpose.” The first part of this statute is called the Offense Clause. It prohibits one from conspiring to commit any federal offense (i.e. one that is defined elsewhere). The second part is called the Defraud Clause—it seeks to prohibit a conspiracy to “defraud the United States.” It does not require proving that the taxpayer committed any other offense; it “stands on its own” as it were.
C. The Courts define Defraud Clause
I. Congress never defined what it means to “defraud the United States.” Consequently, over the years the courts have sought to fill in this phrase with their case law. And the courts took a broad interpretation of the phrase; it has been interpreted to prohibit one’s conspiracy to “impair or impede” the lawful functions of the federal government—so called “Klein Conspiracies.” Usually, the phrase has been used to litigate one’s acts of impairing the IRS’s ability to collect tax.
II. As mentioned, the courts took a broad interpretation. They captured conduct within this definition that is not a crime under other federal statutes. Is it true that making the IRS’s job harder is criminal? A recent case casts serious doubts on the foundational interpretation of Section 371. Historically, the Supreme Court interpreted Section 371 broadly.
III. But the Second Circuit case (United States v. Coplan, 703 F.3d 46 (2d Cir. 2012)) gave the Supreme Court a chance to revisit that foundational interpretation. If the Court heard the case, and it were taxpayer favorable, then the IRS’s prosecutorial legal theories could have been curtailed; and the opposite is true if the case were favorable toward the government. But if the Court were to decide against hearing the case (denying certiorari) then the matter would continue to be unclear. Unfortunately, in October 2013, the Supreme Court declined to hear the case. The Second Circuit decision seemed favorable to the taxpayer’s position regarding the limited interpretation of Section 371, but it was ultimately bound by the Supreme Court’s prior interpretation of it. (The defendants argued that there existed no textual basis for interpreting the Defraud Clause as anything other than depriving another of property rights).
D. There are three elements to a Klein conspiracy: (1) the existence of an agreement to defraud or impede by dishonest means the IRS in its assessment or collection of tax; (2) the taxpayer knew of the agreement and voluntarily partook in the conspiracy; and (3) the conspirators committed an overt act to further a conspiracy.
E. Why does the IRS like to assert a Klein conspiracy?
I. The short answer is because it is easier. It is easier for the IRS to prove that a taxpayer made the government’s job harder than it is to prove that he or she actually committed a specific crime—and the IRS has discovered this much with its prosecution of “tax shelters.”
II. A taxpayer can commit tax evasion in one of several ways. One such type dubbed a “Spies evasion” violation occurs when a taxpayer (i) fails to file his tax return, and (ii) his action is coupled with an “affirmative act of evasion,” that has the effect to mislead the government or conceal something from it. Spies v. United States, 317 U.S. 492, 499 (1943).
III. But this raises the question what “willfulness” means. According to U.S. v. Pomponio, a taxpayer acts willful when he “voluntar[ily], intentional[ly] violate[s] a known legal duty.” The Spies Court recognized a distinction between one’s good faith misunderstanding of the tax laws and affirmative acts of willful tax evasion. It acknowledged that the tax laws were “complex” and that one should not be penalized “frank differences of opinion or innocent errors made despite the exercise of reasonable care.” Nearly three-quarters of a century later, the tax laws have become even more complex. Partly due to its complexity there is spawned various “tax shelters”—legal structured that lack business purposes but achieve tax benefits to a client. Many of these shelters make it difficult for the IRS to audit the structure.
IV. To combat these tax shelter structures the IRS increasingly asserted Klein conspiracies against those involved. In that case, all the IRS would need to show is that the person involved made an attempt, by using dishonest means, of preventing the IRS from carrying out its tax collecting and assessment.
V. What makes Klein conspiracy cases so interesting—and frustrating—is that the IRS will assert a conspiracy charge even if the taxpayer complied perfectly with the letter of the tax law. That is, even if the tax position taken by the taxpayer is perfectly correct, the IRS may still assert a Klein Conspiracy on the grounds that he has attempted to avoid the IRS’s ability to detect and conduct an audit. The idea here is that the combined tax positions, while individually are innocent, are collectively “fraudulent in context,” or, as U.S. v. Coplan 703 F. 3d 46 (2nd Cir. 2012) says, “decepti[ve] in context.”
VI. The taxpayer in the Coplan case was said to make it difficult for the IRS to audit the taxpayer. The IRS asserted that the taxpayer “engaged in various acts [that were] not inherently deceptive” but were “deceptive in the context of [the] case.”
42. Employment Tax Fraud
A. Employment tax offenses, which are described in IRC § 7204 (fraudulent statement or failure to make statements to employees), IRC § 7205 (fraudulent withholding exemption certificate or failure to supply information), and IRC § 7215 (offenses with respect to collected taxes).
I. In addition to hefty fines and penalties, sentences can also include confinement to federal prison, halfway house, home detention, or some combination thereof.
43. California’s War on Cash Skimming:
A. One of the major initiatives of the California Franchise Tax Board or FTB and Board of Equalization or BOE over the past few years has been lobbying the state policymakers to pass legislation that outlaws the ownership and operation of technology that is used to reduce the amount of taxable income recorded and reported to tax agencies. But it isn’t just businesses in California that are susceptible to being investigated for criminal tax conduct related to such illegal practices. A family from Wisconsin is experiencing the income tax enforcement power of the IRS first hand and will need the help of an experienced tax attorney in a hurry. If you own a small to medium sized business that is being investigated for using skimming, zappers, or similar technology, it may be in your best interest to seek the help of a tax attorney as soon as possible.
B. Family Faces a Collective 123 Years In Prison For Cash Skimming (Blog Excerpt)
I. Paul Bouraxis (age 65), his wife Freida Bouraxis (age 60), their son, Andreas Bouraxis (age 38), and son-in-law, Reiad “Ray” Awadallah (age 44), all of the Franklin area of Wisconsin were charged last week on multiple counts that stem from the operation of several family restaurants located throughout the state. According to a Department of Justice press release, the family members were charged with a laundry list of crimes including tax evasion for intentionally cash skimming or taking some of the cash received from patrons of the Omega Burger in Franklin, El Beso in Greenfield, and El Fuego in Milwaukee.
II. Tax Evasion Through “The Cash Skimming Process”
i. Cash skimming is the process by which cash-based business owners reduce the amount of cash received on their books and reports sent to the IRS and state tax agencies in an effort to pay less income tax. Skimming has been going on for years but only recently has technology played a large part in the effort to defraud the government. Point of service systems can be implemented that automatically reduce the amount of cash received for record-keeping purposes. This will allow a business owner to effortlessly generate fraudulent tax documents. Further, the technology is often in the form of software installed on the computers of the business, allowing the process to work clandestinely without the knowledge of the front-line employee collecting the cash from the customer.
ii. As we mentioned previously, the California legislature saw skimming and the technology behind it as major threat to the integrity of the income tax system in the state and enacted a law that criminalized the possession or use of skimming devices, known as zappers. But it isn’t just the California Franchise Tax Board or Board of Equalization that are on the lookout for the use of zapping technology. In the case featured in this posting, the IRS was the agency that audited and investigated the actions of the defendants and referred the case to the Department of Justice for prosecution.
iii. The investigation uncovered that between 2007 and 2011, Bouraxis and his family had not only skimmed a significant amount of money off of the records of their several restaurants, but some family members who were in charge of the individual establishments were paying employees in cash and not withholding or paying employment taxes. In addition to the tax evasion charges, Paul Bouraxis was also charged with crimes related to banking fraud with respect to loans taken out at a local bank. He could face a total of up to 85 years in prison and fines of up to $3.75 million. His relatives that were charged in the case face a combined 38 years behind bars, as well
44. Attorney Client Privilege and Tax Advice:
A. The bulk of tax attorney-client privilege cases involve federal evidence law. Federal Rule of Evidence 501, which states simply: “The privilege of a witness, person, government, State, or political subdivision thereof shall be governed by the principles of the common law as they may be interpreted by the courts of the United States in the light of reason and experience.” Thus, the basic rules of the federal attorney client privilege are not codified and are established entirely through case law.
B. A number of federal cases have held that confidential attorney-client communications associated with the giving of tax advice are protected by the attorney-client privilege. A number of courts, however, have also long expressed that the privilege does not protect certain documents and communications in the return preparation context-hereafter referred to as the return preparation exception.” Unfortunately, the return preparation exception has not always been well explained or consistently applied by the courts.
C. When a taxpayer/client follows an attorney’s advice with respect to tax issues, that advice will in some fashion ultimately be reflected on the taxpayer/client’s tax returns filed with the government. In this sense, almost all tax law advice is, in some regard, associated with return preparation activities. As a result of this relationship to the tax return, a minority of the legal community have held that the return preparation exception is so broad in scope that the attorney client privilege simply does not apply at all to the “practice of tax.” Consequently, amongst the Tax Bar, tremendous uncertainty exists as to the scope of protection available.
I. The “better view” seems to be that communications related to tax return preparation are protected by attorney-client privilege as long as they relate to substantive legal issues and contain material beyond that which is to be disclosed on the return.
45. IRS Office of Professional Responsibility (OPR) and your License:
A. Tax Fraud is an act or moral turpitude that can cost you your law license and is routinely communicated to the applicable state bar by OPR.
46. Voluntary Disclosures (Domestic):
A. A voluntary disclosure is a process whereby the client’s tax attorney basically knocks on the door of the IRS Criminal Investigation Division and states something to the effect as this: I’m bringing in a tax cheat. The tax cheat is willing to correct their previous behavior by amending previously filed fraudulent tax filings and make payment, or arrangements to pay, of the additional tax interest and penalties owed in exchange for the IRS passing on criminal prosecution.
B. Historically, between 1934 and 1952, the IRS had a written policy of refraining from prosecuting taxpayers who made a voluntary disclosure. Today, that written policy has changed so that a taxpayer’s voluntary disclosure is a factor that is heavily weighted in a facts-and-circumstances evaluation of whether or not to prosecute, but the actual of practice of the IRS is quite similar to its past written policy.
C. The IRS’s behavior is indicative of its true policy. Since 1952, the IRS has only decided to prosecute a handful of cases after a receiving a taxpayer’s valid voluntary disclosure. Because of the IRS’s previous written policy and the IRS’s lack of prosecution of valid voluntary disclosure cases; many tax attorneys are generally convinced that the IRS has an unwritten de facto disclosure policy of refraining from prosecution.
D. The IRS’s unwritten policy can be seen from its behavior, specifically, its decision to decline prosecution. One court admits, “there appears to have been few, if any, prosecutions of true voluntary disclosures [by] the IRS.” United States v. Hebel, 668 F.2d 995, 998 (8th Cir. 1982).
E. Indeed, the IRS’s conduct seems to show that it will prosecute after a voluntary disclosure only when extraordinary facts and circumstances are present. A number of tax scholars agree: “[T]he practice of the IRS has been that it will not prosecute taxpayers who satisfy all of the requirements of the voluntary disclosure program because, if it did initiate such prosecutions, no taxpayers ever would be willing to make a voluntary disclosure in the future.” New York University Annual Institute on Federal Taxation § 27.06 (2010).
F. Thus, even though the IRS’s official, written position is to leave the door open to pursuing criminal prosecution after a voluntary disclosure, it is unlikely it will do so.
G. Voluntary disclosures typically occurs in two situations:
I. The taxpayer’s wrongdoing is disclosed to his attorney or accountant because he wants to set matters straight; or
II. The taxpayer discloses his wrongdoing to an attorney or accountant after he has been personally contacted by the IRS. Generally, if a taxpayer has not been contacted by the IRS, or is not currently under audit, examination, or investigation, it is not likely he will be prosecuted after a voluntary disclosure – unless the IRS disputes the voluntary disclosure, or the IRS believes the taxpayer has engaged in an illicit income-producing activity (or is a threat to the voluntary assessment system, where the taxpayer is deemed a tax protester).
i. Note: The decision whether or not to make a voluntary disclosure to the IRS is not a simple one and should never be made without the counsel of an experienced tax attorney.
H. The following bolded content is the actual language of the IRS’s Voluntary Disclosure Practice:
I. It is currently the practice of the IRS that a voluntary disclosure will be considered along with all other factors in the investigation in determining whether criminal prosecution will be recommended. This voluntary disclosure practice creates no substantive or procedural rights for taxpayers, but rather is a matter of internal IRS practice, provided solely for guidance to IRS personnel. Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution.
II. A voluntary discosure will not automatically guarantee immunity from prosecution; however, a voluntary disclosure may result in prosecution not being recommended. This practice does not apply to taxpayers with illegal source income.
III. A voluntary disclosure occurs when the communication is truthful, timely, complete, and when:
i. The taxpayer shows a willingness to cooperate (and does in fact cooperate) with the IRS in determining his or her correct tax liability; and
ii. The taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.
I. A disclosure is timely if it is received before:
I. The IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation;
II. The IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance;
III. The IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or
IV. The IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).
J. Any taxpayer who contacts the IRS in person or through a representative regarding voluntary disclosure will be directed to Criminal Investigation for evaluation of the disclosure. Special agents are encouraged to consult Area Counsel, Criminal Tax on voluntary disclosure issues.
K. Examples of voluntary disclosures include:
I. A letter from an attorney which encloses amended returns from a client which are complete and accurate (reporting legal source income omitted from the original returns), which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full and which meets the timeliness standard set forth above.
II. A disclosure made by an individual who has not filed tax returns after the individual has received a notice stating that the IRS has no record of receiving a return for a particular year and inquiring into whether the taxpayer filed a return for that year. The individual files complete and accurate returns and makes arrangements with the IRS to pay the tax, interest, and any penalties determined by the IRS to be applicable in full. This is a voluntary disclosure because the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intent to do so and because all other elements of (3), above, are met.
III. It has been our experience that taxpayers who have in many times blatantly and knowingly violated the tax laws, are none the less able to effectively avoid prosecution by self-reporting their prior tax violations to the IRS before the IRS has had the opportunity to begin an investigation by taking advantage of the IRS Voluntary Disclosure Program for domestic or international issues.