What is the CPA’s Responsibility When Faced with Client Financial and Tax Fraud?

 

If you have discovered that a client’s numbers are false, or you suspect they are, you are facing three questions at once. Can you tell the IRS? Must you resign? And can you be prosecuted for what your client did?

The short answers are these. You generally cannot report your client to a taxing authority without their permission, because the duty of confidentiality binds you. You must promptly tell the client about the error and recommend that they correct it. If they refuse, the professional standards push you toward withdrawal, both from the current engagement and potentially from the relationship. And yes, a CPA can be criminally prosecuted in connection with a client’s fraud, because the statutes reach anyone who aids, assists, counsels, or advises in the preparation of a false document, whether or not they signed it.

What follows explains each of those answers, the professional standards that produce them, the criminal statutes that create practitioner exposure, and what has happened to accountants who got this wrong.

How Are CPAs Regulated?

CPAs are licensed and regulated by their state boards of accountancy. Additionally, all AICPA members are required to follow a rigorous Code of Professional Conduct which requires that they act with integrity, objectivity, due care, competence, fully disclose any conflicts of interest (and obtain client consent if a conflict exists), maintain client confidentiality, disclose to the client any commission or referral fees, and serve the public interest when providing financial services. The vast majority of state boards of accountancy have adopted the AICPA Code of Professional Conduct within their state accountancy laws or have created their own, and in California the consequences of a violation reach the license itself.

What Does the AICPA Code of Professional Conduct Require?

Every AICPA member is bound by the AICPA Code of Professional Conduct, and the substance of that Code, rather than any single rule number, is what governs a CPA who suspects a client has committed fraud. Several principles matter most in that situation.

The Integrity and Objectivity Rule requires a member, in performing any professional service, to maintain objectivity and integrity, remain free of conflicts of interest, and refuse to knowingly misrepresent facts or subordinate professional judgment to others. A CPA who learns that a client’s numbers are false cannot simply adopt them to keep the engagement.

The Code’s conceptual framework recognizes that pressure from a client is itself a threat to compliance. It identifies an undue influence threat, meaning the risk that a member will subordinate their judgment because a client threatens dismissal, withholds future work, or otherwise pressures the member to change a conclusion on an accounting or tax matter. When a threat cannot be reduced to an acceptable level through safeguards, the framework directs the member to decline or withdraw from the engagement rather than proceed.

The Code squarely anticipates the fraud scenario in its treatment of ethical conflicts. It gives, as its own example, a member who suspects that a fraud may have occurred but whose duty of client confidentiality would be violated by reporting it. In that position the Code directs the member to weigh the relevant facts, laws, and professional standards, to consider consulting others within the firm, and, where the conflict cannot be resolved, to consider obtaining legal advice and documenting the issue. If the conflict remains unresolved, the member should reconsider their continuing association with the engagement, the client, or the employer.

On confidentiality, the Confidential Client Information Rule generally bars a member from disclosing confidential client information without consent, and the Code makes clear that a member may not inform a taxing authority of a client’s error without the client’s permission except where the law requires it. The Code also addresses the joint-return situation directly: when a member prepares a married couple’s joint return, both spouses are the member’s clients, which shapes what the member may disclose to each.

Finally, the Code treats a member’s own tax noncompliance as a professional matter. Under the Acts Discreditable Rule, a member who fails to timely file their own returns, or the returns of a firm or employer they are authorized to file, or who fails to remit payroll and other taxes collected on behalf of others, may be found to have committed an act discreditable to the profession. A practitioner with unfiled personal returns has a licensing problem as well as a tax problem.

These principles are enforceable, not aspirational. State boards of accountancy have overwhelmingly adopted the AICPA Code, or their own close equivalent, into their licensing rules, so a violation carries real disciplinary consequences.

What Do the AICPA Statements on Standards for Tax Services Require?

The Statements on Standards for Tax Services are the AICPA’s enforceable tax practice standards, and they bind every AICPA member providing tax services. Several states incorporate them into their own rules of professional conduct as well. The AICPA reorganized these standards effective January 1, 2024, replacing the former seven statements with four, arranged by the type of tax work performed, and adding new requirements addressing data protection and the use of electronic tools. A practitioner working from the older seven-statement framework is working from a superseded structure.

SSTS No. 1, General Standards for Members Providing Tax Services, sets the requirements that apply across all tax engagements. Section 1.1, Advising on Tax Positions, establishes the threshold a member must meet before recommending a position. Where the taxing authority has no written standard, or a lower one, a member should not recommend a position unless the member has a good faith belief that it has at least a realistic possibility of being sustained on its merits if challenged. A member may still recommend a position supported only by a reasonable basis, provided the member advises the taxpayer to disclose it appropriately. A member should never recommend a position that exploits the audit selection process, or that serves as a mere bargaining chip advanced to gain leverage in a negotiation with a taxing authority. Where the taxing authority imposes a higher standard, that higher standard governs. SSTS No. 1 also now requires members to make reasonable efforts to safeguard taxpayer data and to exercise due professional care when relying on software and other tools.

SSTS No. 2 governs tax compliance work, including tax return positions. Its requirements track the day-to-day realities of preparing a return. A member should make a reasonable effort to obtain the information needed to answer all questions on a return before signing it. A member may rely in good faith, without verification, on information furnished by the taxpayer or by third parties, but that reliance has limits: a member should not ignore the implications of the information supplied and should make reasonable inquiries where it appears incorrect, incomplete, or inconsistent, whether on its face or against other facts the member knows. Where the law conditions a deduction or other treatment on the taxpayer maintaining books, records, or substantiation, the member should inquire to their own satisfaction whether the condition has been met. A member may use a taxpayer’s estimates where exact data is impractical to obtain and the estimates are reasonable in the circumstances, but the estimates must not be presented in a way that implies greater accuracy than exists.

SSTS No. 3 addresses the provision of tax advice. A member should use professional judgment to ensure that advice reflects competence and appropriately serves the taxpayer’s needs and should assume that advice given will affect how the underlying transaction is reported. That means considering the applicable reporting and disclosure standards and the potential penalty consequences of the position. A member has no continuing obligation to update advice when subsequent developments affect it, except while assisting the taxpayer in implementing the plan or where the member has specifically agreed to do so.

SSTS No. 4 is new, and it governs members providing tax representation services before a taxing authority.

What Must a CPA Do After Discovering a Client’s Error or Fraud?

One duty runs directly to the situation this page addresses, and every CPA should know it cold.

On becoming aware of an error in a previously filed return, an error in a return that is the subject of an administrative proceeding, or a taxpayer’s failure to file a required return, a member should promptly inform the taxpayer, advise the taxpayer of the potential consequences, and recommend the corrective measures to be taken. That advice may be given orally. Critically, the member is not permitted to inform the taxing authority without the taxpayer’s permission, except where the law requires it.

The standard then addresses what happens when the taxpayer refuses to fix the problem. If the member is asked to prepare the current year’s return and the taxpayer has not taken appropriate action to correct a prior year error, the member should consider whether to withdraw from preparing the return and whether to continue the professional relationship at all. If the member does prepare the current year return, the member should take reasonable steps to ensure the error is not repeated. And if the member is representing the taxpayer in an administrative proceeding on a return the member knows contains an error, the member should request the taxpayer’s agreement to disclose it. Lacking that agreement, the member should again consider withdrawal, both from the proceeding and from the relationship.

Read those requirements together and the position of a CPA who suspects client fraud comes into focus. You cannot report your client to the IRS on your own initiative. You also cannot keep signing returns that perpetuate a known error, and you cannot represent a client in a proceeding while staying silent about an error you know exists. The professional standards leave you one reliable exit, which is withdrawal, and the manner of that withdrawal carries its own risks. Withdraw carelessly, and you may signal to the taxing authority exactly what you were not permitted to tell it. Stay on the engagement, and you risk becoming a participant in the conduct rather than a witness to it. This is the precise point at which a CPA should obtain independent legal advice for themselves, not merely for the client.

At the Tax Law Offices of David W. Klasing, we are happy to provide a reduced rate initial consultation, which you can arrange by calling (800) 681-1295 or by clicking HERE to schedule online.

What Can the California Board of Accountancy Do to Your License?

Article 13 – Denial, Suspension, and Revocation of Certificates, Permits, or Licenses

98. Disciplinary Guidelines.

In reaching a decision on a disciplinary action under the Administrative Procedure Act (Government Code Section 11400 et seq.), the Board shall consider the disciplinary guidelines entitled “Disciplinary Guidelines and Model Orders” (9th edition, 2013), which are hereby incorporated by reference. Deviation from these guidelines and orders, including the standard terms of probation, is appropriate where the Board in its sole discretion determines that the facts of the particular case warrant such a deviation, for example: the presence of mitigating factors; the age of the case; evidentiary problems.

Note: Authority cited: Sections 5010, 5018 and 5116, Business and Professions Code; and Section 11400.20, Government Code. Reference: Sections 5018, 5096, 5096.5, 5096.12, 5100 and 5116-5116.6, Business and Professions Code; and Section 11425.50(e), Government Code.

99. Substantial Relationship Criteria.

For the purposes of denial, suspension, or revocation of a certificate or permit pursuant to Division 1.5 (commencing with Section 475) of the Business and Professions Code, a crime or act shall be considered to be substantially related to the qualifications, functions or duties of a certified public accountant or public accountant if to a substantial degree it evidences present or potential unfitness of a certified public accountant or public accountant to perform the functions authorized by his or her certificate or permit in a manner consistent with the public health, safety, or welfare. Such crimes or acts shall include but not be limited to those involving the following:

• Dishonesty, fraud, or breach of fiduciary responsibility of any kind;
• Fraud or deceit in obtaining a certified public accountant’s certificate or a public accountant’s permit under Chapter 1, Division III of the Business and Professions Code;
• Gross negligence in the practice of public accountancy or in the performance of the bookkeeping operations described in Section 5052 of the code;
• Violation of any of the provisions of Chapter 1, Division III of the Business and Professions Code or willful violation of any rule or regulation of the Board.

Note: Authority cited: Sections 5010 and 5018, Business and Professions Code. Reference: Sections 481 and 5100, Business and Professions Code.

California Code, Business and Professions Code – BPC § 5018

The board may by regulation, prescribe, amend, or repeal rules of professional conduct appropriate to the establishment and maintenance of a high standard of integrity and dignity in the profession.

Every licensee of the California Board of Accountancy in this state shall be governed and controlled by the rules and standards adopted by the board.

California Code, Business and Professions Code – BPC § 481

Each board under the provisions of this code shall develop criteria to aid it, when considering the denial, suspension or revocation of a license, to determine whether a crime or act is substantially related to the qualifications, functions, or duties of the business or profession it regulates.

California Code, Business and Professions Code – BPC § 5100

After notice and hearing the board may revoke, suspend, or refuse to renew any permit or certificate granted under Article 4 (commencing with Section 5070) and Article 5 (commencing with Section 5080), or may censure the holder of that permit or certificate for unprofessional conduct that includes, but is not limited to, one or any combination of the following causes:

(a) Conviction of any crime substantially related to the qualifications, functions and duties of a certified public accountant or a public accountant.

(c) Dishonesty, fraud, gross negligence, or repeated negligent acts committed in the same or different engagements, for the same or different clients, or any combination of engagements or clients, each resulting in a violation of applicable professional standards that indicate a lack of competency in the practice of public accountancy or in the performance of the bookkeeping operations described in Section 5052.

(h) Suspension or revocation of the right to practice before any governmental body or agency.

(i) Fiscal dishonesty or breach of fiduciary responsibility of any kind.

(j) Knowing preparation, publication, or dissemination of false, fraudulent, or materially misleading financial statements, reports, or information.

(k) Embezzlement, theft, misappropriation of funds or property, or obtaining money, property, or other valuable consideration by fraudulent means or false pretenses.

(l) The imposition of any discipline, penalty, or sanction on a registered public accounting firm or any associated person of such firm, or both, or on any other holder of a permit, certificate, license, or other authority to practice in this state, by the Public Company Accounting Oversight Board or the United States Securities and Exchange Commission, or their designees under the Sarbanes-Oxley Act of 2002 or other federal legislation.

(m) Unlawfully engaging in the practice of public accountancy in another state.

62. Contingent Fees.

A licensee shall not:

• Perform for a contingent fee any professional services for, or receive such a fee from, a client for whom the licensee or the licensee’s firm performs:
  • an audit or review of a financial statement; or
  • a compilation of a financial statement when the licensee expects or reasonably should expect that a third party will use the financial statement and the licensee’s compilation report does not disclose a lack of independence; or
  • an examination of prospective financial information; or
  • any other attest engagement when the licensee expects or reasonably should expect that a third party will use the related attestation report; or
  • any other services requiring independence.
• Prepare an original tax return for a contingent fee for any client.
• Prepare an amended tax return, claim for tax refund, or perform other similar tax services for a contingent fee for any client.
• Perform an engagement as a testifying expert for a contingent fee.

The prohibition in (a)(1) above applies during the period in which the licensee or the licensee’s firm is engaged to perform any of the services listed under (a)(1) above and the period covered by any historical financial statements involved in any such listed services.

Except as stated in the next paragraph, a contingent fee is a fee established for the performance of any service pursuant to an arrangement in which no fee will be charged unless a specific finding or result is attained, or in which the amount of the fee is otherwise dependent upon the finding or result of such service.

Solely for purposes of this section, fees are not regarded as being contingent if fixed by courts or governmental entities acting in a judicial or regulatory capacity, or in tax matters if determined based upon the results of judicial proceedings or the findings of governmental agencies in a judicial or regulatory capacity or there is a reasonable expectation of substantive review by a taxing authority.

Note: Authority cited: Sections 5010 and 5018, Business and Professions Code. Reference: Sections 5018, Business and Professions Code.

68.1. Working Papers Defined; Retention.

Working papers are the licensee’s records of the procedures applied, the tests performed, the information obtained and the pertinent conclusions reached in an audit, review, compilation, tax, special report or other engagement. They include, but are not limited to, audit programs, analyses, memoranda, letters of confirmation and representations, abstracts of company documents and schedules or commentaries prepared or obtained by the licensee. The form of working papers may be handwriting, typewriting, printing, photocopying, photographing, computer, data, or any other letters, words, pictures, sounds, or symbols or combinations thereof.

Licensees shall adopt reasonable procedures for the safe custody of working papers and shall retain working papers for a period sufficient to meet the needs of the licensee’s practice and to satisfy applicable professional standards and pertinent legal requirements for record retention.

Licensees shall retain working papers during the pendency of any Board investigation, disciplinary action, or other legal action involving the licensee. Licensees shall not dispose of such working papers until notified in writing by the Board of the closure of the investigation or until final disposition of the legal action or proceeding if no Board investigation is pending.

Note: Authority: Sections 5010 and 5018, Business and Professions Code. Reference: Sections 5018 and 5037, Business and Professions Code.

Case Study: How One CPA Lost His License for Filing False Returns

STEVEN MARK PYBRUM, Certified Public Accountant Certificate No. 31088, and PYBRUM & COMPANY, LLP, Certified Public Accountant Partnership Certificate No. 7514, Respondents. Case No. AC-2013-36, OAH No. 2015060269.

FACTUAL FINDINGS (Excerpts)

On October 25, 2012, in the United States District Court, Central District of California, respondent was convicted by a jury of four felony counts charging violations of 26 United States Code Section 7206(1), willfully subscribing false federal income tax returns. On March 4, 2013, the court sentenced respondent to 36 months in prison. After completing his prison term, respondent was placed on and is currently serving his term of supervised release.

The facts and circumstances underlying the conviction were that respondent filed false individual income tax returns from 1999 through 2002. Respondent underreported individual income during these four years as part of a sophisticated scheme to avoid paying taxes on money he earned from accounting services. In 1998, respondent incorporated the “Foundation for Harmony and Happiness” (Foundation) as a 501(c)(3) charitable organization with the stated purpose of helping married couples with financial problems. During the four-year period noted above, respondent reported nearly all of the income he earned as a CPA for services he performed for accounting clients in the Foundation’s tax returns. He falsely characterized almost all of his income during this period as money the Foundation received through lawful charitable activities, when in fact this was income earned for the accounting services he provided for private accounting clients.

In 1998, respondent declared an individual gross income in the amount of $214,591. During the four subsequent years, which form the bases of his four-count conviction, respondent reported business gross income from his CPA practice in the following amounts: $5,782 in 1999; zero in 2000; $4,956 in 2001; and $2,705 in 2002.

Most of the income that respondent earned during the above-referenced years, for performing work requiring a CPA certificate, was reported in the Foundation’s tax returns as charitable gifts, grants or contributions.

Respondent testified that the IRS was well aware that the Foundation would perform tax related services, including preparation of tax returns for individuals and corporations. Respondent’s testimony is not credible. In respondent’s application for exempt status under IRS Code section 501(c)(3) (application), he stated that the purpose of the Foundation was to “conduct basic social research in the emotional and psychological differences between men and women, to increase public awareness about the importance of achieving and maintaining effective communication skills between married couples and adults generally, and to instruct married couples about the multiple methods and techniques for wealth accumulation which may lead to a more stable and enduring marriage or relationship.”

Respondent testified that he did not know that he was engaging in illegal or prohibited conduct. Respondent’s testimony is not persuasive. He had almost 20 years’ experience working as a CPA when he engaged in this fraudulent conduct.

LEGAL CONCLUSIONS (Excerpts)

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code sections 490 and 5100, subdivision (a), and 5106, based on respondent’s four-count felony conviction set forth in Factual Finding 4.

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code section 5100, subdivision (c), based on respondent’s dishonest conduct underlying his conviction, as set forth in Factual Findings 5 and 6.

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code section 5100, subdivision (i), based on respondent’s conduct evidencing fiscal dishonesty by willfully preparing and subscribing four false federal individual income tax returns, as set forth in Factual Findings 4, 5 and 6.

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code section 5100, subdivision (j), based on respondent’s conduct of knowingly preparing false, fraudulent and materially misleading financial statements, as set forth in Factual Findings 5 and 6.

Cause exists to suspend or revoke the respondent’s CPA certificate pursuant to Business and Professions Code section 5100, subdivision (g), in that respondent willfully violated the Accountancy Act, and the rules and regulations promulgated by the Board pursuant to the Act.

In this case, respondent committed felony offenses that are directly related to the duties, functions and qualifications of a CPA. When respondent became aware that he was under investigation by the IRS and federal authorities, he stopped his four-year practice of intermingling and applying his income from his CPA practice to the Foundation. Since his conviction, respondent has been in compliance with the terms of his probation and supervised release. However, respondent has not accepted responsibility for his criminal conduct.

ORDER (Excerpts)

Certified Public Accountant No. 31088, previously issued to respondent Steven Mark Pybrum, is revoked.

What Does Circular 230 Require of Tax Advisors?

The Treasury Department dictates the rules governing practice before the IRS under Circular 230. Those rules were substantially strengthened after the IRS identified and attacked several high-profile individual and corporate tax shelters, and they were then significantly restructured. In T.D. 9668, effective for written advice rendered on or after June 12, 2014, Treasury removed the detailed covered opinion regime at former section 10.35 entirely, having concluded that it burdened practitioners and clients without necessarily improving the quality of the advice clients received. Practitioners no longer need the boilerplate Circular 230 disclaimer that once appeared at the foot of every email.

What replaced it matters more to a practitioner than what was removed. A new section 10.35 now imposes an affirmative duty of competence, requiring that a practitioner possess the knowledge, skill, thoroughness, and preparation necessary for the matter they have taken on. Circular 230 had contained no such explicit requirement before. All written advice on a federal tax matter now falls under a single standard at section 10.37, which requires a practitioner to base written advice on reasonable factual and legal assumptions, to consider all facts and circumstances the practitioner knows or reasonably should know, to use reasonable efforts to identify and ascertain the relevant facts, to relate the applicable law to those facts, and not to rely on unreasonable representations or assumptions. A practitioner may rely on the advice of another practitioner only where that reliance is reasonable and in good faith, and never where the practitioner knows or reasonably should know that the other person has a conflict of interest.

One prohibition survived the restructuring intact, and it is the one that most often catches advisers who talk themselves into an aggressive position. In evaluating a federal tax issue, a practitioner must not take into account the possibility that a return will not be audited, or that an issue will not be raised on audit, or that an issue will be resolved through settlement if it is raised. The strength of a position is measured on its merits, not on the odds of getting caught.

The IRS retains the power to censure, suspend, disbar, or impose a monetary penalty on a practitioner who is incompetent or disreputable, or who fails to comply with the conduct standards, and it can do the same where it establishes that a practitioner willfully and knowingly defrauded, misled, or threatened a client or prospective client.

Can a CPA Be Criminally Prosecuted for a Client’s Tax Fraud?

It is important to emphasize the obvious, that tax evasion is a very different concept than tax avoidance is. Tax avoidance involves the careful, legal structuring of one’s affairs so his or her tax liability is legally reduced or minimized. Tax avoidance is legal. As one famous judge put it, “one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934). Tax evasion, by contrast, is not legal and it involves the willful attempt to avoid paying one’s tax liability after it has been incurred.

A tax practitioner 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 any person for the evasion of another’s tax liability. The defendant need not be the taxpayer in question.

To successfully prosecute a violation of the aiding or assisting provisions for aiding or assisting another to file a false form, the government must prove beyond a reasonable doubt that:

1. The defendant aided, assisted, procured, counseled, or advised the preparation or presentation of a document;
2. The document was false as to a material matter; and
3. The defendant acted willfully.

Charges under this provision are most often brought against accountants, bookkeepers and others (including an entity’s employees) who prepare or assist in the preparation of tax returns. However, the statute is not limited solely to the direct preparation of a return but is actually much broader in that the statute reaches any intentional conduct that contributes to the presentation of a false document to the IRS.

To be charged under these provisions, one need only assist in the preparation of, and need not sign or file, the actual false document. The statute has thus been applied to individuals who communicate false information to their return preparers, thereby causing the tax preparer to file a false return. On the other hand, the statute specifically provides that the taxpayer who signs and files the return or document need not know of, or consent to, the false statement for the aiding and abetting statute to be brought against the preparer. For example, a tax preparer who inflates deductions, understates income, or claims false credits on a client’s return may be charged with aiding and abetting even if the taxpayer for whom the return is prepared is unaware of the falsity of the return he signed and filed. Moreover, a tax preparer who utilizes information provided by a client that the preparer knows to be false, in the preparation of a return can be criminally charged with assisting in the preparation of a false return.

The courts that have ruled on what constitutes a material matter have held materiality to be a matter of law to be decided by the court and not a factual issue to be decided by the jury.

To establish willfulness in the delivery or disclosure of a false document, the government need only show that the accused knew that the law required a truthful document to be submitted and that he or she intentionally violated the duty to be truthful. The crime of aiding or assisting in the preparation or presentation of a false return or document requires that the defendant’s actions be willful in that the defendant knew or believed that his or her actions were likely to lead to the filing of a false return. The Ninth Circuit has held that the government must prove not only that the accused knew that the conduct would result in a false return but must additionally establish that tax fraud was in fact the objective of the allegedly criminal conduct.

The statute of limitations for the crime of aiding or assisting the preparation or presentation of a false return or other document is six years. The statute of limitations for charges involving delivery or disclosure of a false document starts to run from the date the document is disclosed or submitted to the IRS.

Which Tax Professionals Have Gone to Prison for Tax Crimes?

In R.J. Ruble, DC N.Y., 2009-2 USTC, a well-known attorney with the law firm of Sidley, Austin Brown and Wood was convicted of income tax evasion for designing and marketing a tax shelter. The government proved that attorney either knew or alternatively consciously disregarded the fact that the tax shelter he designed and marketed lacked economic substance. There was no business purpose to employ the shelter other than to obtain a tax benefit, and that there was no reasonable probability that the shelter would result in any profit apart from the anticipated tax benefits. He was sentenced to 78 months in federal prison.

The following BDO Seidman personnel were sentenced for their role in promoting a tax shelter. Charles Bee, the former Vice Chairman of BDO, received 16 months, Adrian Dicker, a former Vice Chairman of BDO, received 10 months, and Robert Greisman, a former partner at BDO, received 3 months. Michael Kerekes, a former principal, pleaded guilty for his role in the same scheme. All of these sentences were the results of plea bargains and involved cooperation in the prosecution of other related tax shelter promoters the most prominent of which is Paul Daugerdas, out of the Chicago office of the now defunct law firm of Jenkens & Gilchrist.

The reason that a disreputable minority of Accountants and Attorneys risk promoting tax shelters is crystal clear – Greed! Most partners of law firms and CPA firms are limited to the amount of profit that can make by selling the time and the expertise of themselves and their staff. Tax shelters are a commodity that can be sold and rapidly replicated in cookie cutter fashion and the profit potential is completely unrelated to the time necessary to provide the services but rather relates more closely to a piece of the tax savings generated by the scheme typically ranging from 3 to 5 % on average.

For example, Mr. Bee earned an estimated $23.6 million in fees as a result of promoting tax shelters and is purported to have encouraged other professionals at BDO to do the same even though he’s currently portrayed as part of a rogue group by his old firm. Paul Daugerdas generated $95 million in fees from the creation and marketing of tax shelters while simultaneously paying less than $8,000 in federal taxes when he in actuality owed more than $32 million in federal tax.

Additionally, the sentencing can occasionally seem light when compared to the financial damage done to the federal and state tax systems. For example, Mr. Bee only received a 16-month sentence because of evidence and cooperation he provided on Paul Daugerdas (a much larger fish in this example). The judge was quoted as stating that while he found Bee’s testimony to be credible and his cooperation significant, “it doesn’t change the fact that he helped perpetrate one of the largest tax frauds in the history of the United States.” Daugerdas, (a lawyer and certified public accountant by the way) created and selectively marketed tax shelter schemes named “Short Sales,” “Short Options Strategy,” “Swaps,” and “Homer” that produced $7 billion in fraudulent tax deductions for approximately 1,000 of the mostly wealthy clients of his and a handful of prominent public accounting firms and more than a billion dollars’ worth of sham losses. A report conducted by a consulting firm commissioned by the IRS estimated that illegal tax shelters cost the government between $14 and $18 billion in lost federal tax revenue in 1999 alone.

While Mr. Bee’s sentence may appear light, the federal government must send out the message that crime does not pay. To that end Paul Daugerdas was convicted and sentenced to 15 years for conspiring to defraud the IRS, aiding and abetting income tax evasion, mail and wire fraud and other crimes. He was ordered to forfeit $164,737,500 in proceeds traceable to his offenses and certain assets were seized including a lakefront home on Lake Geneva in Wisconsin, roughly $20 million in various securities and miscellaneous financial accounts and he was ordered to pay $371,006,397 in restitution to the IRS.

The economics that produced the shelter era have not changed, and neither has human nature. Whenever enforcement attention shifts, the perceived risk of aggressive promotion falls, and a small minority of practitioners recalibrates accordingly. The government’s sustained focus on offshore evasion over the past two decades drew resources away from domestic shelter enforcement, and history suggests that when attention returns to onshore structures, a further round of investigations and prosecutions will follow. The abusive syndicated conservation easement and micro-captive insurance cases of recent years show the pattern repeating in new forms. A practitioner approached to bless an arrangement that generates deductions wildly disproportionate to any real economic outlay should recognize the shape of what is being offered.

What Tax Crimes Can a CPA Be Charged With?

Both the federal and state taxing authorities can bring both felony and misdemeanor tax charges against Tax Attorneys, CPAs, E.A.’s, tax preparers and their client, the most common of which include tax evasion, failure to file a return or pay tax and filing a false return. The IRS also prosecutes taxpayers under the Federal Criminal Code on charges such as presenting false claims to the government, conspiracy, and making false statements.

In order for the federal government to prevail in a criminal tax prosecution, they 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 that range from three years to six years under the internal revenue code and within five years for crimes prosecuted under the Federal Criminal Code.

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. Thus, CPA’s should be aware of their own potential liability for tax crimes in preparing returns such as aiding and abetting the commission of an offense or conspiracy to commit tax evasion. The federal government has recently endeavored to expand the definition of a preparer to extend to anyone that provides advice or an opinion as to a position taken on a tax return which should be of great concern to Tax Attorneys.

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. 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.

In doing representation, planning and compliance work Tax Practitioners should be especially aware of the legal definitions of Obstruction and Aiding or Assisting a False Return.

What is Tax Obstruction Under Section 7212?

The crime known as “tax obstruction” is found in IRC § 7212, which actually lists several crimes. However, there is one clause in this statute—known as the “Omnibus Clause”—that is the focus here. An Omnibus Clause violation exists when someone (anyone) “in any way corruptly . . . obstructs or impedes, or endeavors to obstruct or impede, the due administration” of the tax laws. § 7212.

To establish an Omnibus Clause violation, the government must prove beyond a reasonable doubt that the defendant made a corrupt effort, endeavor, or attempt to obstruct or impede the due administration of the internal revenue laws. For years the government read that language expansively, on the theory that because the IRS administers the Code continuously, almost any conduct interfering with that administration could support an obstruction charge.

The Supreme Court rejected that reading in Marinello v. United States, 584 U.S. 1 (2018). The Court held that to secure a conviction under the Omnibus Clause the government must additionally show a nexus between the defendant’s conduct and a particular administrative proceeding, such as an investigation, an audit, or another targeted administrative action, and must show that the proceeding was pending when the obstructive conduct occurred or was at least reasonably foreseeable to the defendant at that time. Writing for a seven-justice majority, Justice Breyer reasoned that a taxpayer’s general awareness that the IRS reviews returns every year does not transform every violation of the Code into an obstruction charge, and that a broader reading would deprive defendants of fair warning. The Department of Justice subsequently revised its Criminal Tax Manual to reflect the decision.

For a tax practitioner, Marinello is significant protection and should be understood precisely. Conduct that occurred before any audit or investigation existed, and before one was reasonably foreseeable, generally cannot support an obstruction charge under the Omnibus Clause, however irregular that conduct may have been. The exposure attaches once a particular proceeding is pending or on the horizon. That is exactly the moment when a practitioner who suspects a client problem is most tempted to tidy up files, revise workpapers, or coach a client’s answers, and it is precisely the moment when doing so becomes most dangerous.

What is Aiding or Assisting a False Return Under Section 7206(2)?

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.

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).

One thinks here of a CPA, enrolled agent, 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 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).

The basis for aiding and abetting violations is accomplice liability. An individual may be indicted as a principal 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. To prevail in bringing a charge under the federal aiding and abetting statute, the government must prove beyond a reasonable doubt that:

A substantive criminal offense was committed.

The defendant, by affirmative conduct, participated in, counseled, or assisted in the commission of the substantive offense.

The defendant shared with the principal the criminal intent to commit the substantive offense.

An accused must associate themselves in some manner with a criminal venture to be convicted of aiding and abetting the commission of an offense. This is established by a showing of participation in the criminal venture that demonstrates a desire to seek and bring about the criminal result. However, the aider and abettor need not perform the substantive offense nor even know its details to be convicted or even be present when the offense is committed. To be successful in bringing an action for aiding and abetting, the government need only show that the defendant intentionally assisted in the commission of a specific crime in some substantial manner.

In order to sustain a conviction, the government must present evidence showing an underlying offense, this means aiding and abetting is not an independent crime. However, the principal who was aided and abetted does not need to be identified or convicted for the government to convict the party accused of aiding and abetting. Moreover, an outright acquittal of the principal will not bar the prosecution of the aider and abettor. Because the aiding and abetting statute does not create a separate offense, the applicable statute of limitations for bringing an aiding and abetting charge is the same as that of the underlying substantive crime that is at issue.

Where Is the Line Between Aggressive Planning and Tax Fraud?

I’m amazed at how many shades of grey there appear to be depending upon the point of view of the observer. Unfortunately, how dark or light a shade of gray is often in the eye of the beholder. I have heard it said that like one man’s tax avoidance is another man’s tax evasion which is invariably affected by which side of the fence the beholder sits on (the government’s or the Tax Profession). Through the drafting of this paper I’ve come to the conclusion that tax evasion is a lot like the Supreme Court’s holdings on pornography – the government knows it when they think they see it! In the end the exposure of being on the wrong side of this determination can be a career ender and thus the prudent Tax Practitioner should endeavor to use an abundance of caution, generous amounts of due diligence and common sense in order to avoid “to good to be true” tax planning arrangements like the plague. A practitioner with a developed sense of smell should be able to detect the odor coming from sham transactions and with ordinary due diligence avoid the life altering consequences encountered by Mr. Bee and Mr. Daugerdas.

Case Study: Theater Owner Pleads Guilty to Tax Evasion and Financial Fraud

Ted E.C. Bulthaup III is the former owner of both the Hollywood Boulevard and Hollywood Palms theaters. Bulthaup pleaded guilty to tax evasion and financial fraud charges due to mistakes and untenable positions he had taken with the business. At the outset, Bulthaup faced more than 100 indictments charging that he engaged in activities including mail fraud, wire fraud, and sales tax fraud. The plea deal resulted in the dismissal of most of these charges.

During 2010, 2011 and 2012, Bulthaup “caused partnership income tax returns for Naperville Theater LLC, doing business as Hollywood Palms, to be created.” During this period of time, Bulthaup allegedly engaged in an array of fraudulent conduct. Prosecutors charge that Bulthaup both overstated and understated his income. As far as overstating his income, Bulthaup inflated sales and gross receipts on fraudulent tax documents to secure business loans. Regarding the understatements of income, prosecutors claimed that Bulthaup failed to report and pay taxes on more than $18 million in revenue generated between 2009 and 2013.

What Penalties can the Former Business Owner Face for His Tax Fraud?

Originally, Bulthaup faced more than 100 criminal charges. The plea agreement he agreed to dismissed these other charges and resulted in Bulthaup facing only two criminal charges. First, Bulthaup faced a single count of sales tax evasion. Sales tax evasion charges are appropriate when an individual or business endeavors to defeat the assessment of sales taxes or endeavors to defeat the payment of the sales taxes after a valid assessment has occurred. Under the Illinois state law that Bulthaup pleaded guilty to violating, he could face between four to fifteen years in prison for the sales tax fraud.

Bulthaup also faced charges related to his fraudulent loan activities. Due to intentionally presenting fraudulent tax returns and financial information to secure a loan, Bulthaup also pleaded guilty to a single count of financial institution fraud. In this case, financial institution fraud can be punished by a prison sentence of between three and seven years.

However, the situation could have been significantly worse for Bulthaup. While he could end up serving a maximum of 22 years under the plea deal, the hundreds of charges he originally faced would have almost assuredly resulted in more prison time. Business owners who consider engaging in sales tax or payroll tax fraud should understand that they can face significant and life-altering consequences due to behavior of this type.

Judge Daniel Guerin presided over the case in DuPage County.

Case Study: CFO Sentenced to Prison for Tax Evasion and Check Kiting

According to court documents, Brian M. Quimby was employed as the CFO for Thayer Power and Communications. During his tenure as CFO, Mr. Quimby engaged in a scheme known as check kiting. Check kiting is a well-known and long-established form of check fraud, but due to the inherent nature of how checks work, it is difficult to detect such a scheme until a sufficient number of transactions have been completed or until the scheme begins to unravel. However, essentially, a check kiting scheme is a type of financial fraud where a check is transformed from a method of exchange – a negotiable instrument – to an unauthorized loan. That is, the check is written for an amount where the account it is drawn against has insufficient funds to cover the check. While this would normally trigger a message for non-sufficient funds (NSF), an individual engaged in a kiting scheme will falsely inflate the perceived balance of the account by writing a check from a second account to cover the draw on the first account. While there are many variations of the check kiting fraud, this captures the essential elements of the fraud.

In any case, Mr. Quimby engaged in a check kiting scheme that defrauded Thayer Power and Communications and Key Bank. Mr. Quimby also failed to file income taxes in 2007 – likely in an attempt to conceal his fraudulent income gained through the check kiting scheme. Despite knowing that he had not filed taxes, Mr. Quimby apparently lied to an IRS agent stating that he did file. Mr. Quimby was sentenced to a 27-month federal prison sentence.

Contact the Tax Law Offices of David W. Klasing if You Suspect a Client Has Committed Fraud

A CPA who discovers client fraud occupies one of the most difficult positions in professional practice. You owe the client confidentiality, and you owe the tax system honesty, and in the moment those duties point in opposite directions. Resolve that tension badly and you risk your license, your practice, and in serious cases your liberty.

The mistake we see most often is a CPA trying to solve the problem alone, or worse, trying to quietly correct it inside the engagement. Amending returns, revising workpapers, or preparing the current year filing while a known prior year error sits uncorrected can convert a client’s problem into the practitioner’s problem. Once an audit or investigation is pending or reasonably foreseeable, those same well-intentioned steps can support an obstruction charge. Where the client’s exposure is genuinely serious, a properly structured voluntary disclosure is almost always the better route than a quiet correction.

At the Tax Law Offices of David W. Klasing, our dual licensed Civil and Criminal Tax Attorneys and CPAs advise practitioners in exactly this position. We assess your own exposure separately from the client’s, advise on whether and how to withdraw, evaluate whether your file supports a good faith reliance defense, and where your own conduct is in question, defend you. Because we are attorneys, our communications with you carry the attorney client privilege and the work product protection, which conversations with another accountant do not, and which the limited federal privilege for non-attorney practitioners does not supply in a criminal tax matter.

We are happy to provide a reduced rate initial consultation, which you can arrange by calling the Tax Law Offices of David W. Klasing at (800) 681-1295 or by clicking HERE to schedule online.

About the Author

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 professional tax, accounting and business consulting experience, 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.