Panel Presentation: Egg Shell Audits- How to Protect Your Client and Self
Course Materials by David W. Klasing Esq. M.S.-Tax CPA and the Tax Law Office of David W. Klasing, P.C. All Copyrights reserved. 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 Klasing, Tax Law Offices of David W. Klasing, P.C.
Vivian Hoard, TaylorEnglish
Mark McBride, Mark R. McBride & Associate
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 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.
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 gift and estate 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 current 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. He is an “A+” rated current member of the Better Business Bureau. He has a perfect 10 AVVO rating (Superb)
What is an egg shell audit?
An egg shell audit is a civil audit in which the return(s) under examination contain a material understatement of income, material overstatement of deductions or credits were claimed that the taxpayer was not entitled to, the end result of which was that the taxpayer showed less tax liability than they would have owed had a true, complete and accurate return been filed. These errors can be caused by mere negligence, which may result in a 20% negligence penalty on any additional income tax found to be owed under audit, or the errors may be intentional and caused by via willful intent which would indicate underlying criminal issues with the tax filings under audit, which may result in 3 to 5 years in jail at worst or a 75% fraud penalty at best.
What is a Reverse Egg Shell Audit?
Reverse egg shell audits are parallel and simultaneous civil and criminal investigations where essentially a criminal tax investigation is disguised as a civil audit. Reverse eggshell audits usually stem from a referral from a civil examiner (revenue agent) to a Fraud Referral Specialist whose sole job it is to work up the case for a handoff to a special agent in the criminal investigation (CI) division or upon a request by CI that a civil auditor be assigned to an ongoing criminal investigation. Ordinarily in a standard civil audit, the auditor is not on notice at the outset of an audit regarding a taxpayer’s potentially criminal tax conduct, however, in a reverse egg audit; it is the taxpayer and potentially their representative who is not on notice about the auditor’s true intentions.
Warning Signs that an Audit has led to a Criminal Referral
A criminal referral is likely to follow a civil audit if firm indications of fraud exist in the mind of the civil auditor. Common indications of fraud, often called “badges of fraud” include: omissions of income, inability to explain large items, substantial overstatements, two sets of books, fictitious items, etc.
Note: An omission of income greater than $10,000 in a single year will result in an automatic referral to a technical fraud advisor for possible development of the case for a hand off to the criminal investigation division.
Commonly recognized warning signs that precede a criminal referral include:
- A civil audit may be suspended before completion and referred to CI for criminal investigation without the knowledge of the taxpayer.
- The Revenue Agent becomes unexplainably unreachable
- The Revenue Agent focuses heavily on the “intent” of the client in taking positions on a return or worse yet mentions a pattern of noncompliance on several tax returns.
- The Revenue Agent focuses prepares a net worth analysis or subpoena’s bank records
- The Revenue Agent gathers an excessive amount of documentation or makes excessive copy requests
- The Revenue Agent makes undisclosed contact with third parties
- The Client receives a summons for records or for an appearance
- More than one revenue agent, the agent and their manager or worse yet two revenue agents, an attorney from chief counsel’s office and a court reporter attend a client interview
- The typical eggshell audit is said to reverse where a temporary suspension of a civil audit occurs which is often indicated where a civil auditor cancels a subsequent appointment and then fails to contact or return the taxpayer’s calls for several weeks while the referral process to CI progresses.
- An officer of the IRS criminal investigation department wearing a gun and a badge approaches your client and reads them something similar to a Miranda warning before speaking with them.
Why is a reverse egg shell audit so dangerous for a taxpayer?
Because of recent changes in IRS internal policy, parallel investigations are on the rise and are rapidly becoming a favorite tool of the IRS. The advantages to the government in utilizing reverse egg shell audits is that the ample investigatory tools available to the average civil auditor such as third party subpoenas to banks and witnesses can be utilized without the taxpayer having the opportunity to utilize the constitutional protections of the due process clause, the fourth amendment privilege against unreasonable searches and seizures, and the fifth amendment right not to self-incriminate which are the most powerful tools available to criminal defense counsel
Ordinarily an IRS civil revenue agent’s primary concern is supposed to be determining the correct civil tax liability for the tax years at issue, while an IRS Special Agent from the Criminal Investigation Division is primarily concerned with gathering evidence to prove criminal violations have occurred and to prove it at trial if need be. CI Special Agents are required to advise taxpayer’s of their constitutional rights against self-incrimination and of the taxpayer’s right to have an attorney present during an interview via a non-custodial reading of their rights which states that anything they say may be used in a subsequent criminal prosecution for tax crimes. Because of this requirement, the initial interview with the special agent will often be delayed while the investigated taxpayer obtains legal counsel. To avoid granting the investigated taxpayer this tactical advantage in a reverse egg shell audit, initial contact is often made via a civil revenue agent to avoid putting the investigated taxpayer on notice that they are under criminal investigation while the civil examiner continues to collect information and conduct interviews with the taxpayer (and more importantly their often unseasoned representative) is none the wiser.
Reverse egg shell audits therefore present grave danger to less informed taxpayers who often tragically employ less sophisticated & often less expensive tax representatives, (i.e.CPAs & E.A.’s) that lack attorney client privilege and usually have a conflict of interest with the client because they prepared the original returns at issue and thus need to protect their own reputation with the taxing authorities. These less sophisticated representatives will often blindly cooperate with the auditor under the misconception that the taxpayer is merely complying with a standard civil audit and thus unwittingly waive the taxpayer’s constitutional rights that experienced criminal tax defense counsel would have exercised if they suspected their client was facing a criminal investigation.
Moreover, Reverse egg shell audits / parallel investigations often involve cooperating federal agencies (such as the SEC, FBI, DEA, ABC and the DOJ) and the civil and criminal investigation functions of the IRS. This flavor of egg shell audits additionally carries the added risk that the examination conducted by the IRS will advance the criminal investigation of the cooperating federal agency.
Lastly, revenue agents commonly continue to collect information after the discovery of firm indications of fraud, and thus procedurally go off the reservation by effectively conducting their own personal reverse eggshell audit. The continued investigation by the revenue agent without proper notice to the taxpayer and their representative that subsequent statements made and information provided will likely be used in a subsequent criminal investigation and prosecution violates the taxpayer’s constitutional rights that would exist if they were approached by the criminal investigation division directly and received a Miranda like reading of their rights.
What are effective criminal tax defense counsel’s goals in an egg shell audit?
In the typical eggshell audit criminal tax defense counsel seeks to avert the emergence of a criminal investigation, by attempting to prevent a client from making any criminal admissions. In a reverse eggshell audit, they endeavor to discover any ongoing clandestine criminal tax proceeding and possibly limit the taxpayer’s cooperation in order to protect the taxpayer from criminal prosecution by protecting their constitutional rights against self-incrimination and unreasonable search and seizures.
Criminal tax defense attorneys representing a client in an eggshell audit commonly seek to achieve four overarching goals;
- To prevent a criminal investigation from beginning by attempting to keep a matter purely a civil examination.
- Avoid the imposition of civil fraud penalties that are possible under IRC § 6663 which imposes a 75% penalty on any portion of an underpayment that is attributable to fraud.
- Minimize additional tax, penalties and interest.
- Minimize the number of tax years that come under audit.
What are the possible outcomes of an egg shell audit?
There are generally three possible outcomes for egg shell audits;
- The Revenue Agent does not consider the misstatements found and adjustments made during the audit to be caused by fraud and thus do not discover criminal tax issues;
- The Revenue Agent discovers misstatements that they suspect might have been caused by fraud but because of effective lawyering the agent is inclined to keep the matter purely a civil examination because of lack of proof as to criminal intent;
- The Revenue Agent makes a referral to a technical fraud specialist so that the case will be possibly worked up for a referral to the Criminal Investigation function of the IRS (CI) for prosecution.
How are the 4 goals and outcomes 1 and 2 (delineated above) best obtained?
Taxpayers facing an egg shell audit should only be represented by experienced criminal tax defense counsel and the CPAs who perform via a Kovel agreement (United States v. Kovel, 296 F.2d 918 (2nd Cir. 1961)) effectively subordinating them to the attorneys supervision and rendering communication between the CPA and the client subject to the attorney client privilege. The original return preparer should never provide representation in an egg shell audit as they do not have attorney client privilege and are often subpoenaed to help make the government’s case in chief against the taxpayer. Also they cannot be trusted to be more concerned with protecting their own reputation than in helping the client avoid criminal prosecution.
Taxpayers faced with an eggshell audit are in dire need of an experienced criminal tax defense attorney who is able to advise the taxpayer on how exactly to comply with the auditor’s data requests, questioning, summonsing of records and all other investigatory techniques while simultaneously preventing the client from making criminal admissions or providing false information that can effectively waive the client’s 5th Amendment privilege against self-incrimination and 4th amendment privilege against unreasonable searches.
The Criminal Tax Defense Attorney’s largest concern in an eggshell audit is to dissuade the examining agent from referring the case to the criminal investigation unit of the IRS because CID’s primary mission is to deter the general public from committing tax crimes by criminally prosecuting a sample of taxpayers caught cheating to make an example out of them.
Once a revenue agent discovers significant and affirmative indications of fraud during a civil audit, he will first privately consult with his manager and upon receiving his managers approval he then secretly consults with a “fraud referral specialist” that works directly with the auditor to develop a “fraud development plan,” for the sole purpose of documenting the affirmative acts and firm indicators of fraud in order to refer the case to the criminal investigation function of the IRS. Criminal tax defense counsel must know when to weigh the benefit of continuing to cooperate with the civil revenue agent in an effort to quell the agent’s suspicion before a referral is made or choosing to advise his client to remain silent to protect the taxpayer from self-incriminating themselves by admitting to tax fraud or in making statements that the auditor later proves to be lies which amounts to a felony in and of itself as it is a felony to lie to a federal agent after a referral has been made.
Questioning the auditor regarding whether there is an open criminal investigation, grand jury investigation, associated technical fraud advisor or associated special agent of the criminal investigation division achieves different objectives in an eggshell versus a reverse eggshell audit. In an egg shell audit, this line of questioning may become necessary to protect the taxpayer but must be asked in such a manner as not to raise the auditor’s suspicion that tax fraud exists in the client’s fact pattern. If a reverse eggshell audit is underway, this line of questioning can help protect the taxpayer, because it will alert counsel to the existence of a clandestine criminal investigation or, if the revenue agent provides more than a tacit denial of the existence of a parallel criminal investigation, subsequent information and statements may be suppressible under Tweel.
One of the strongest protections available to criminal tax defense counsel is found under Tweel, which held that any auditor deception in a reverse egg shell audit has to be tacit rather than affirmative otherwise subsequently procured information will be suppressible. Thus when a revenue agent lies when he or she states that there is no parallel criminal investigation underway, a technical fraud advisor has not been associated with the audit, or if they continue their civil investigation after badges of fraud have been detected which are sufficient to trigger a halt to the civil examination and a criminal referral, any subsequently procured documents and statements are suppressible in a subsequent criminal prosecution.
An argument can also be made that all subsequent information and the taxpayer’s statements collected subsequent to the revenue agents original discovery of badges of fraud is inadmissible under Tousaint and thus can be suppressed. However contrary hair splitting case law holds that if the auditor’s conduct is merely a deception that violates IRS procedure but falls short of violating the U.S. Constitution or applicable federal statutes, the evidence collected by the auditor will not be held to be inadmissible in a subsequent criminal prosecution under Caceres and thus will not be suppressed. This split in federal case law creates a continuum of auditor behavior that requires measuring actions taken by an auditor that are often clandestine and thus hard to analyze and therefore makes the reverse egg shell audit extremely risky to the effected taxpayer.
It is often assumed that a taxpayer’s IRS master file is flagged if the taxpayer is involved in a criminal investigation, and thus a civil auditor could theoretically respond to an inquiry by a taxpayer’s representative whether there is an open criminal investigation, grand jury investigation, associated technical fraud advisor or associated special agent of the criminal investigation division. While the civil revenue agent will almost certainly be aware of the coding in the file, when queried, they will have to either answer honestly or more likely refuse to respond at all, in either event the criminal tax defense attorney will have learned something. In my opinion a refusal to deny a parallel tax criminal investigation is underway is as good as an admission that one is.
Accordingly, a taxpayer representative’s failure to ask the right questions at the sensitive juncture between an egg shell audit and it’s progression into a reverse egg shell, or failure to recognize the approaching juncture altogether, may result in a permanent loss of a taxpayer’s constitutional rights and privileges.
Procedures that this office commonly follows to minimize the risks of an eggshell audit are:
- To prevent the taxpayer from making criminal admissions by limiting their involvement in the audit, preventing or where necessary closely controlling a client interview, only having first thoroughly prepared our client for the expected questioning they will receive.
- We will attempt to relocate any interview originally scheduled to take place in the personal residence or the business establishment of the taxpayer because of the potential for an economic lifestyle analysis in their home and hard to control auditor access to the client’s business records and employees at their business premises. We also do not want to have the client or his or her employees present at any required business tour.
- We will create thorough records of any damaging positions taken or alluded to by the agent.
- Subsequent to the examination we may submit a FOIA request (Freedom of Information Act) to obtain a copy of the record created by the agent including his or her notes.
- We only provide copies of information requested during the audit where required by the auditor and we keep a detailed record of what was provided.
- Our client are thoroughly advised of the importance of not making false statements, as they can lead to obstruction charges in a criminal investigation and can constitute a felony in their own right even in a straight civil audit scenario.
- We remain calm and professional at all times and establish a rapport with the Agent from the outset. This rapport, combined with our firm’s excellent reputation with the taxing authorities, has consistently been the difference between an audit proceeding as a straight civil matter rather than the matter leading into a criminal referral.
- Our office is not afraid to have the client take the fifth in appropriate circumstances. Where a civil investigation has clear and definite indications of a clandestine criminal investigation the taxpayer can refuse to answer an auditor or subsequent criminal investigator’s questions on the grounds that the answers they provide may incriminate them. This action is sure to raise concrete suspicion on the part of the auditor but the failure of counsel to invoke the taxpayer’s Fifth Amendment privileges where appropriate can be far more damaging to a taxpayer in a parallel of subsequent criminal investigation as information gathered by the auditor indicative of fraud will certainly be used against them. Moreover, incriminating statements or information provided to an auditor may fully or partially waive the constitutional protections of the 4th and 5th amendments.
Do taxpayers have the right to know why they were selected for examination?
Section 3503 of the IRS Restructuring and Reform Act of 1998 (RRA 98) requires the publication of the general criteria and procedures for selecting taxpayers for examination. If a taxpayer under examination, or his counsel, requests the specific reason the taxpayer was selected for examination, the IRS examiner is required to provide the taxpayer with a response that is as accurate as possible, without revealing restricted use information.
What are a Taxpayer’s Rights if audited by the IRS?
When the IRS engages in discussions during audit with the taxpayer, the taxpayer is afforded certain rights.
(i) the taxpayer retains the right to receive professional and courteous treatment by the IRS;
(ii) the taxpayer has the right to privacy and confidentiality for his or her tax matters;
(iii) he or she has the right to know why the IRS requests information, how it plans to use, and what consequences would ensue if he or she does not comply with the information request;
(iv) the right to be represented by counsel; and
(v) the right to appeal the IRS’s decision, either before an IRS administrative hearing or before the courts. The taxpayer can appeal the auditor’s conclusions with an IRS supervisory conference with the auditor’s manager or administratively within the IRS. In addition, he or she can appeal an audit using the court system, and bring his case to the U.S. Tax Court, the U.S. Claims Court, or the local U.S. District Court.
How to Avoid Negative Consequences from an IRS Interview?
If you are unable to dissuade the auditor from speaking, consider whether taking the 5th is in your client’s best interest. If you choose to allow the interview instruct your client to keep their answers short and refrain from elaborating on any answer unless asked to do so. Instruct the client to not answer questions they were not asked and to avoid trying to anticipate an auditor’s next question. Instruct your clients to not give the auditor more information than he or she is asking for, and to refrain from talking during the audit more than is absolutely necessary to address an auditor’s questions. I tell my client’s to watch my body language carefully as I will warn them when they are on dangerous grounds non-verbally. I have even been known to gently kick a client under the table when they are getting too relaxed, have dropped their guard and have become overly communicative with an auditor.
Instruct your client that If they begin to feel that they are not being treated properly or fairly by an agent and start to become agitated, they must remain in control of their emotions, remain respectful and continue to treat the auditor cordially. Make it clear that it’s your job to intervene on their behalf and ask to speak to the auditor’s manager if you think the auditor is treating the client unfairly or with a lack of respect. If the subject of tax fraud comes up during an audit, counsel must be prepared to advise the client to evoke their 5th amendment privilege against self-incrimination in which case the client should be counseled ahead of time to remain silent and speak only when and where you advise them to.
Do you have to submit your client to be interviewed by the taxing authorities?
Interviews are routinely used by the taxing authorities in the planning stages of an audit to gather information about a taxpayer’s financial history, standard of living, typical business operations, revenue and expense recognition principles and other pertinent accounting policies, to design the audit procedures necessary to determine the accuracy of the taxpayer’s books and records and to ultimately reach informed judgments about the likelihood of misstatements contained within the taxpayer’s returns.
The IRS uses information gleamed from interviews to develop leads as to other areas of potential misstatement and to establish evidence to be presented in subsequent litigation should it become necessary. The testimony of employees, other witnesses and the confessions or admissions of alleged tax violators are relevant to preparing for subsequent litigation. The government’s as well as the taxpayer’s position is presented to a jury through the testimony of witnesses.
Oral testimony often elicits information that would not otherwise be gleamed from the physical documentation provided to the auditor. Moreover, it has been said that 70% percent of communication is non-verbal. To that end, I often counsel my clients to be very cognizant of their body language during an audit and to make sure their words and body language are in agreement. Most auditors want to watch the taxpayer closely as they question them.
The taxing authorities have the ability to subpoena your client to force your client to submit to an in-person interview.
Risks of the client attending an IRS Audit without proper counsel.
Where a client chooses to attend an audit without proper representation, they may slip and make emotional rather than rational statements under the common feelings of helplessness, irritation, aggravation, and anxiety brought on by the experience of being audited and occasionally intentionally cultivated by the auditor. These emotions may result in the client saying the wrong thing at the wrong time to the auditor and inadvertently exposing themselves to greater financial and potential criminal liability. Lastly, Auditors are likely to capitalize on your client’s unfamiliarity with the audit process wherever possible.
“Communication Risk” is one of the principle reasons client’s need representation during an audit. If the examiner misinterprets or misstates a client’s utterances into a criminal admission, it becomes the client’s word versus the word of the auditor. An experienced Tax Attorney will endeavor to rehabilitate a client following a miscommunication.
What is the most common audit technique applied by the taxing authorities?
Governmental auditors are all taught to “take it to cash”. Commonly auditors will begin an audit by first assuring themselves they have identified all of the business, personal, checking, savings and investment accounts utilized by an individual or a business and its owners. They will then sum up all of the deposits into the client’s business and personal accounts. Their attitude is that every deposit is taxable income unless the client can prove otherwise.
Therefore, it will be necessary for the client to be able to substantiate any non-taxable deposits such as those out of their personal savings, interbank transfers, borrowed capital or funds from other sources that are not taxable business income. Moreover, the auditor will want to treat every withdrawal out of each of these accounts as non-deductible personal expenses unless the client can prove otherwise.
How does the government prove that a client “willfully” engaged in the act (or acts) that resulted in tax evasion?
Normally, the IRS seeks to prove the requisite willfulness element by using indirect evidence rather than direct evidence—like the taxpayer’s admission or confession—since direct evidence is rarely obtainable. That said, the Supreme Court allowed the willfulness requirement to be inferred from “any conduct, the likely effect of which would be to mislead or to conceal.” Spies v. United States, 317 U.S. 492, 499 (1943).
To be found guilty of tax obstruction must a person actually be successful in impeding the IRS’s functions?
The crime of “tax obstruction” exists when someone (anyone) “in any way corruptly . . . obstructs or impedes, or endeavors to obstruct or impede, the due administration” of the tax laws, IRC § 7212.
An “omnibus clause violation,” a specific type of tax obstruction, aims to prohibit taxpayers from impeding the collection of a person’s taxes, the taxes of another person, or the auditing of either. See, e.g., United States v. Kuball, 976 F.2d 528, 531 (9th Cir. 1992). http://openjurist.org/976/f2d/529/united-states-v-g-kuball
Normally, when a tax obstruction violation is asserted by the IRS, the person has actually succeeded in impeding the IRS in its administration of the tax laws. Even so, such success is not actually required. There is no requirement that the taxpayer’s actions actually adversely affected the IRS’s tax audit or investigation.
This question was raised in United States v. Rosnow, 977 F.2d 399 (8th Cir. 1992). There, the taxpayers (defendants) were investigated for various tax law violations, and they filed false Form 1099s “in an effort to cause tax problems for individuals involved in repossessing real estate and other property belonging to [the taxpayers] following the latter’s default on various loans.” The taxpayers issued this 1099 income to their creditors, attorneys, judges, sheriffs, law enforcement officials, and even IRS agents. Essentially, the goal was to force these individuals to pay more income tax than they were lawfully required to pay. One of the defendants claimed to have paid an individual $28 million; another defendant (Rosnow) filed 103 Form 1099s claiming to have paid out over $187 million; and another defendant filed 13 Form 1099s totaling over $86 million.
As it turned out, the defendants’ strategy did not actually impede the IRS’s investigation of them. The court was unimpressed with their defense that they could not be convicted under IRC § 7212’s omnibus clause on the putative assumption that successful obstruction is required. The Eight Circuit reasoned that the defendants were guilty of tax obstruction because their issuing false Form 1099s was an attempt to impede the IRS’s investigation of them. “All that is necessary is that the defendants intended to ‘intimidate or impede’ the IRS officers,” the court said.
For the government to find that a person committed tax perjury, it must show, among other things, that the document with a false statement was made under the penalty of perjury. Thus, if the document submitted to the IRS (or other taxing authority) was not made under penalty of perjury—i.e. there was no sworn declaration—then one cannot be found guilty of tax perjury.
The usual income tax return, Form 1040, contains the required declaration that its contents are submitted under penalty of perjury:
“Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge.”
Some taxpayers have tried to outsmart the IRS regarding the above declaration by crossing that language off when they submit their tax return. If the taxpayer files as just described, he or she can effectively avoid possible prosecution under IRC §7601—but the government could then assert a violation of the failure to file a tax return under IRC § 7203. http://www.law.cornell.edu/uscode/text/26/7203
Moreover, the taxpayer might be guilty of violating other statutes. For example, submitting a false document to the government is a crime under 18 U.S.C. § 1001. That statute provides that a person commits a crime, punishable by up to 5 years (and 8 years in certain other cases), when he or she “knowingly and willfully” (1) falsifies, conceals, or covers up by any trick, scheme, or device a material fact; (2) makes any materially false, fictitious, or fraudulent statement or representation; or (3) makes or uses any false writing or document knowing it contains a materially false, fictitious, or fraudulent statement or entry. http://www.law.cornell.edu/uscode/text/18/1001
Similarly, although not tax perjury, a person could be found to have committed a felony under IRC § 7206(2) for submitting a false document to the IRS. That Code Section provides that a person commits a felony whenever he or she “willfully aids or assists in, procures, counsels, or advises regarding the preparation or presentation, or in connection with any matter arising under, the internal revenue laws, of a return, affidavit, claim, or other document, which is fraudulent or is false as to any material matter, whether or not such falsity or fraud is with the knowledge or consent of the person authorized or required to present such return, affidavit, claim, or document.” http://www.law.cornell.edu/uscode/text/26/7206
In other words, if a person helps another prepare a false document to submit to the IRS, it can be a felony, even if it is not tax perjury.
What is the tax crime known as aiding or assisting a false return (IRC §7206(2))? How does that crime differ from the more general crime of “aiding and abetting” a non-tax crime?
There are various tax crimes and, upon initial review, some of them appear very similar. However, there are important differences. For Example, tax evasion, tax perjury, tax obstruction, failure to keep records, and so forth. There are two main reasons it is important to keep the tax crimes straight: First, they each have different associated penalties (fines and/or jail time); second, they have different legal “elements”—different things the government must prove, and that directly effects a taxpayer’s defense against the government.
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).
For tax crimes, a statement is “material” if it has a “natural tendency to influence, or [is] capable of influencing, the decision” of the IRS regarding whether to investigate, audit a tax return, or in verifying the taxpayer’s income. See United States v. DiVarco, 343 F. Supp. 101, 103 (N.D. Ill. 1972). http://leagle.com/decision/1972444343FSupp101_1420.xml/UNITED%20STATES%20v.%20DiVARCO
In other words, the taxing authorities ask whether the matter “would have a tendency to influence the IRS in its normal processing of tax returns.” Id.
This crime differs from the “tax perjury” crime found in § 7206(1). Tax perjury exists when one willfully making a false material statement on a tax return under the penalty of perjury. Unlike tax perjury, the crime of aiding another to prepare a false return (§7206(2)) does not require that the defendant sign the false document under a penalty of perjury; in fact, the defendant might not have signed any document whatsoever. For more on tax perjury, see: https://klasing-associates.com/faq/tax-crime-commonly-known-tax-perjury/
A violation of §7206(2) is also different from the more general crime of “aiding and abetting a [non-tax] crime.” The main feature that distinguishes the tax crime of “aiding and abetting a false return” (26 U.S.C. § 7206(2)) from the more general crime of “aiding and abetting a [non-tax] crime” under 18 U.S.C. §2 is whether the both the two guilty parties or just one is required.
Under Title 18, a person may be found guilty of only if another person actually commits a crime. However, under the tax crimes statutes (found in Title 26 of the U.S. Code, the Internal Revenue Code), a defendant may be guilty of assisting in the preparation of a false return even if the taxpayer himself or herself is innocent. This point was made clear in a somewhat recent case. In U.S. v. Bryant, 1996 WL 183010 (S.D.N.Y., 1996), aff’d, 128 F.3d 74 (2d Cir. 1997), the court explained that when an adviser violates § 7206(2), he is not merely an aider and abettor (as the term is commonly used in criminal law). Rather, he becomes “as much a principal [to the crime] as the taxpayer who owes the tax.” Moreover, the court said, the “guilt or innocence of the taxpayer for whom the return was filed is irrelevant to the question of the adviser’s guilt.” http://openjurist.org/128/f3d/74/united-states-v-bryant
To elaborate on this point, crucially absent from the above list of elements for a §7206(2) felony is the requirement that the defendant acted or helped another with that person’s consent or knowledge. Thus, the defendant could have acted without the taxpayer (the person the defendant is helping) even knowing he was being helped.
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).
What is the crime known as tax obstruction (§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 a Section 7212(a) omnibus clause violation, the IRS must prove three elements beyond a reasonable doubt: (1) that the defendant made a corrupt effort, endeavor, or attempt (2) to impede, obstruct, or interfere with (3) the due administration of the tax laws (Internal Revenue Code). U.S. v. Wood, 384 Fed. Appx. 698 (10th Cir. 2010).
With respect to the first element of the offense, an act is “corrupt” if the defendant performs the act with the intent to secure an unlawful benefit for himself or another. However, the Ninth Circuit clarified that having an improper, bad, or evil purpose is not enough. United States v. Hanson, 2 F.3d 942, 946-47 (9th Cir. 1993).
Unlike many criminal tax statutes (e.g. IRC §§ 7201 and 7203), an Omnibus Clause violation does not require the defendant to act “willfully.” United States v. Kelly, 147 F.3d 172, 176 (2d Cir. 1998). But it does require that the defendant act “corruptly.” This raises the question whether someone could act corruptly without doing so willfully.
The Kelly court stated that while the term “willful” is not contained in the statute it is nonetheless functionally present when jury instructions define acting “corruptly” as performing an act “with the intent to secure an unlawful advantage or benefit either for one’s self or for another.” (Alternatively, it is also present when “endeavors” is defined as “knowingly and intentionally act or to knowingly and intentionally make any effort which has a reasonable tendency to bring about the desired result”). The court stated that the “definition of the proof required for the section 7212(a) violation [is] as comprehensive and accurate as if the word ‘willfully’ was incorporated in the statute.” U.S. v. Kelly, 147 F.3d 172, 177 (2d Cir. 1998).
What about the second and third elements? When does a defendant’s act “impede, obstruct, or interfere with the due administration” of the tax laws?
In United States v. Hanson, 2 F.3d 942, 946 (9th Cir. 1993), the Ninth Circuit stated that this occurs when the IRS “expends a large amount of time discovering and remedying the problems caused by [a defendant’s] filing false forms.” U.S. v. Hanson, 2 F.3d 942, 946 (9th Cir. 1993).
In Hanson, the defendant was convicted for making false statements on a tax return “in violation of 26 U.S.C. § 7206(1), and attempting to interfere with the administration of the Internal Revenue Service in violation of 26 U.S.C. § 7212(a).” The factual basis for his charges came from false Forms 1096 and 1099, where he claimed to receive $46,996,669.41 in compensation. He also falsely filed Form 1040 claiming a tax refund of $33,837,602 generated from the falsely claimed income and withholding. “Hanson’s 1989 tax return falsely claimed a refund of $33,837,602. [His] attempt to secure an unlawful benefit for himself satisfied the corruption requirement. Moreover, Hanson testified that he intended for his conduct to spark an IRS investigation of the FHA officials.” The court affirmed his conviction for violating §7212(a), which is aimed to prohibit efforts to impeded the collection of one’s taxes, the taxes of another, or the auditing of one’s or another’s tax records. U.S. v. Hanson, 2 F.3d 942, 947 (9th Cir. 1993).
A tax obstruction statute (IRC §7212) is similar in wording to two other statutes found in the United States Code. The U.S. Code is broken up into many “Titles.” For example, the Internal Revenue Code is Title 26; and crimes and criminal procedure are dealt with in Title 18.
Like the tax obstruction statute, Sections 1503 and 1505 of Title 18 criminalize obstructive conduct. The focus of Section 1505 to prevent obstruction of “any department or agency of the United States . . . or Congress,” while the focus of Section 1503 is to prevent the more general obstruction of “the due administration of justice.” IRC §7212’s focus is more narrow: to prevent the obstruction of the “administration of the tax laws,” so it can be thought of as a more specified version Section 1505’s prohibition on obstructing government agencies (i.e. the IRS).
These statutes impose differing maximum sentences. The Internal Revenue Code imposes a three-year sentence; Title 18, Section 1505, imposes a five year (max); and Section 1503 has either a 10 year or a 20 year sentence. This would leave one to infer that Congress thinks obstructing the IRS (3 years) is not as severe an offense as obstructing Congress itself (5 years).
As a final matter, most Omnibus Clause violations are charged as “corrupt endeavors”—and the government must prove the three above elements. However, in some instances, the defendant could be charged more simply with “corruptly obstructing the due administration” of the tax laws. In that case, the IRS would only have to prove two things: (1) that the defendant in some way (anyway) corruptly (2) obstructed or impeded the due administration of the tax laws.
What is the tax crime commonly known as tax perjury?
In a sentence, the crime commonly known as “tax perjury” occurs when a taxpayer makes a false statement (e.g. on a tax return) when it was made under the penalty of perjury. The relevant statute is IRC § 7206, which criminalizes the behavior of a person who “willfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter.”
A close reading of this statute would seem to entail (surprisingly) that a taxpayer could be guilty even if he submitted an entirely accurate tax return—but merely believed it not to be. Fortunately, the courts have not adopted this interpretation of Section 7206. Instead, the courts and the IRS require that the taxpayer have actually made a false statement as to a “material” matter. By requiring that a taxpayer actually make a materially false statement, it precludes the criminal punishment of merely having bad intentions. For example, the Ninth Circuit helpfully interprets Section 7206 in to require that the taxpayer make a false statement on a return. The Ninth Circuit identifies four elements for a tax perjury finding:
(1) the defendant made and subscribed a return, statement, or other document that was incorrect as to a material matter; (2) the return, statement, or other document subscribed by the defendant contained a written declaration that it was made under the penalties of perjury; (3) the defendant did not believe the return, statement, or other document to be true and correct as to every material matter; and (4) the defendant falsely subscribed to the return, statement, or other document willfully, with the specific intent to violate the law.
United States v. Scholl, 166 F.3d 964, 979-80 (9th Cir. 1999).
What is interesting about the tax perjury statute is that it is not limited in scope to individuals. Rather, even partnerships, trusts, corporations, and LLCs may be found guilty for committing perjury.
For example, in United States v. Ingredient Tech. Corp., 698 F.2d 89, 99 (2d Cir. 1983), a corporation was found guilty of subscribing to a false federal income tax return despite its contention that corporations cannot commit perjury. IRC § 7206(1). The corporation argued it could not commit perjury because a corporation “cannot take an oath to tell the truth.” Under the normal criminal law, the corporation would be correct. However, the court rejected that argument, holding that the concept is broader as used in the Internal Revenue Code. The court reasoned that a “person” under the Code can refer to corporations, and since the perjury statute defines the crime as occurring by “any person,” even corporations may be found guilty if they perform the relevant act (with the relevant mental state of willfulness). Moreover, court concluded that because a corporation itself lacks a “mental state”—for example, it cannot “will” to do anything—the “acts of individuals on [the corporation’s] behalf may be properly chargeable to it.” For example, in the Ingredient Tech. Corp case, the mental element was satisfied by the corporate officers. Willfulness is “a voluntary, intentional violation of a known legal duty.”
One can see how the court’s reasoning would be applied in other contexts. For example, with a partnership, the partners could be guilty; with a trust, it would be the trustee; for an estate return, it would be the executor; and with an LLC it would be the members. The basic point here is that the scope of who may be found guilty under the tax perjury statute is broad.
By contrast, if the scope of who falls under the tax perjury statute is broad, the corresponding penalty is less severe than the typical maximum penalty of 6 years of imprisonment for perjury; tax perjury imposes a 5 year maximum sentence.
What is a Klein Conspiracy?
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.
- Two Crimes Described in One Statute (18 U.S.C. § 371)
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.
- The Courts define Defraud Clause
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.
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.
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).
In actual practice, a convicted taxpayer’s sentence will often be less than the maximum fine allowed under the Internal Revenue Code. A judge’s sentencing discretion will ordinarily be influenced by the Federal Sentencing Guidelines Manual, accessible here:
The purpose of the criminal tax system
The purpose of the criminal tax system as described in the United States Attorney’s Manual follows:
The Government helps to preserve the integrity of this Nation’s self-assessment tax system through vigorous and uniform criminal enforcement of the internal revenue laws. Criminal prosecutions punish tax law violators and deter other persons who would violate those laws. To achieve maximum deterrence, the Government must pursue broad, balanced, and uniform criminal tax enforcement.
The above describes the policy reasons given for why the government has chosen to criminalize certain tax offenses. Looking carefully at the above quote, we see that the government seeks to achieve three main goals: (1) to uphold the integrity of the tax system because it is based on “self-assessment” (essentially, relying on the “honor system”—until one is audited or criminally investigated); (2) to punish tax violators; and thus (3) to deter others from doing the same. The Manual goes on to explain the importance of having uniformity in the tax laws because more individuals fall within its gambit than any other criminal statute:
Uniformity in tax cases is necessary because tax enforcement potentially affects more individuals than any other area of criminal enforcement. Broad and balanced enforcement is essential to effectively deter persons of varying economic and vocational status, violators in different geographic areas, and different types of tax law violations.
For many tax evaders, it is not the penalties, additional income tax and interest or even spending some time behind bars that is the worst part of a criminal prosecution. Rather, it is the ensuing shame, public humiliation and social ostracism that is associated with a prosecution that haunts them. Many taxpayers do not realize, until it is too late, that the government publicizes a person’s criminal tax convictions in an attempt to achieve maximum deterrence effect on the rest of society. Historically, people were hung, beheaded, or even burned at the stake publicly to warn citizens who contemplated committing the same crimes as they convicted. Today we do not hang, behead, or burn individuals at the stake. Instead, the government publicizes and broadcasts one’s criminal conviction.
High profiles taxpayers like sports figures, celebrities, and even well-known religious leaders are those that might fall the “hardest” as the result of their publicized tax crime conviction. For example, the tax fraud convictions of Wesley Snipes, Duke Cunningham, Darryl Strawberry, Lauryn Hill, and Al Capone—to name a few are widely known by the public. Even one of the former IRS Commissioners, Joseph D. Nunan, was found guilty of tax fraud.
Are there any good constitutional arguments against our tax system?
As a criminal tax law firm, we have the opportunity to hear about all sorts of clever augments for why the tax system is unjust, inaccurate, or unconstitutional. Unfortunately for taxpayers, historically the courts have not been persuaded by any of these arguments. One taxpayer who was not so keen on the United States’ tax system brought four different lawsuits, all challenging some aspect of tax law.
The man argued various things, like (1) that he was not a taxpayer within the meaning of the Sixteenth Amendment, (2) that wages were not income, (3) that the Sixteenth Amendment does not authorize the imposition of any income tax on individuals, and (4) that the Sixteenth Amendment was unenforceable. The various courts rejected each of these arguments, calling them frivolous. Later, the taxpayer brought a fifth lawsuit, this time making it all the way to the Supreme Court. The Supreme Court summarized the challenges he brought in his prior lawsuits thus:
In March, 1982, Cheek and another employee of the company sued American Airlines to challenge the withholding of federal income taxes. In April, 1982, Cheek sued the IRS in the United States Tax Court, asserting that he was not a taxpayer or a person for purposes of the Internal Revenue Code, that his wages were not income, and making several other related claims. Cheek and four others also filed an action against the United States in Federal District Court, claiming that withholding taxes from their wages violated the Sixteenth Amendment. Finally, in 1985, Cheek filed claims with the IRS seeking to have refunded the taxes withheld from his wages in 1983 and 1984. When these claims were not allowed, he brought suit in the District Court claiming that the withholding was an unconstitutional taking of his property and that his wages were not income.
As mentioned, the fifth, and last, suit the taxpayer brought was heard by the Supreme Court. The case was Cheek v. United States, 498 U.S. 192 (1991), where the Court held that a taxpayer’s actual good-faith belief that one is not violating tax law, based on a misunderstanding caused by the complexity of the tax law, negates the willfulness element (one of the requirements for finding tax fraud), even if that belief is irrational or unreasonable. However, the Court was quick to point out that one’s actual believe that tax is invalid or unconstitutional is not a “good faith belief” that is based on a misunderstanding of the tax laws, and thus would not be helpful to a taxpayer’s defense against tax fraud; such a belief would not result in denying the willfulness mental state element.
Can ignorance of the law be used as a defense?
In criminal law, the general rule is that ignorance of the law is not a valid defense. However, there are some exceptions where ignorance is such a defense. Some crimes are known as “specific intent” crimes. One’s “intent” refers to the defendant/taxpayer’s mindset when he commits the crime. A conviction of a specific intent crime requires that the prosecutor prove that the defendant had a particular purpose (intention) when he or she committed the crime. A shorthand way of thinking about this is that a “general intent” crime is one where the defendant intended to do the conduct in question (but maybe not the actual result), whereas with a “specific intent” crime, the defendant intended both the conduct and the result. This distinction is relevant to tax crimes. Federal tax crimes are specific intent crimes, so one’s actual ignorance of the law might be a valid defense. By contrast, a vehicular traffic offense is not a specific intent crime (it is actually a strict liability tort where one’s knowledge or ignorance of the law is irrelevant), so one’s ignorance of the speed limit is no defense.
What are some technical ways to defend against a tax evasion charge?
There are several rather technical defenses against a tax evasion charge. There is no general way to describe all of these defenses, so by way of example, we consider a distribution from a corporation to a shareholder.
As an initial matter, note that the government must prove three basic factors beyond a reasonable doubt, for tax evasion: attempt, willfulness, and the tax was “due and owing” (i.e. taxpayer had a tax liability). It is this last element that we focus on now.
The taxpayer’s attorney will defend against all three of these elements. Many of those attorneys, however, do not fully consider certain creative ways of showing that the taxpayer did not, in fact, have a tax liability. The IRS’s own Tax Crimes Handbook anticipates that a taxpayer will launch a defense against the “tax due and owing” element.
For example in a corporate context an often contested issue is whether a distribution received by a taxpayer is taxable income or just a return on the shareholder’s (taxpayer’s) investment. That is, the taxpayer’s counsel might argue the distribution is not taxable income because it is simply a return of a portion of the taxpayer’s capital investment in the corporation. To argue the contrary, the IRS must prove that the corporation possessed accumulated earning’s and profits (“E&P”) at the time of the distribution because a shareholder receives taxable income only when the C corporation makes a distribution from earnings and profits. Therefore, as a technical defense against the IRS’s charge that a shareholder/taxpayer committed tax evasion a taxpayer’s counsel could attempt to prove that the C corporation lacked accumulated earnings and profits at the time of the distribution.
The Difference Between Criminal Tax Evasion and Civil Tax Fraud
A criminal tax fraud offense under IRC § 7201 and a civil tax fraud offense under IRC § 6663 are very different. As explained below, they have different (i) burdens of proof, (ii) penalties, (iii) statute of limitations, and (iv) there are different defenses available to the taxpayer.
For several reasons, often the IRS will first pursue a criminal tax fraud suit (§7201) which before pursuing a civil tax fraud suit. According to the IRS’s own Tax Crimes Handbook, a criminal tax fraud conviction “carries the most severe penalty of the criminal tax offenses.”
Civil tax fraud and criminal tax fraud have different burdens of proof. The IRS carries a “clear and convincing” evidentiary standard for civil tax fraud. (This is otherwise known as a “preponderance of the evidence” standard). By contrast, criminal tax evasion requires proof “beyond a reasonable doubt”—which is a higher evidentiary standard. In other words, the government must prove “more” to show criminal tax fraud than civil fraud.
Civil tax fraud and criminal tax fraud also have different associated penalties. There are several categories of civil tax fraud—for example, there is (a) the fraudulent failing to file a return (IRC § 6651(f)), (b) accuracy related penalties under IRC §6662(b)(1)-(5), (c) spousal liability under IRC §663(c), and (d) the fraudulent tax return (IRC §6663(d)) for, e.g., failing to report income on your return, and (e) failing to pay tax (IRC §6651(a)(2). Each of these has different associated penalties. For instance, the penalty for fraudulently failing to file a tax return is 15% of the net tax due for each month (up to five months), with a maximum penalty of 75% of the unpaid tax. Similarly, the penalty for filing a fraudulent tax return (e.g. failing to report income) is 75% of the underpayment amount.
The penalties for criminal tax evasion are steeper. Under IRC §7201, a taxpayer found guilty of willfully attempting to evade tax (or its payment) could face a fine of $100,000 ($500,000 for a corporation) plus five years of imprisonment. Similarly, if a taxpayer is found to have willfully failed to pay tax, file a return, keep sufficient records, etc. he or she may face a penalty of $25,000 ($100,000 for a corporation) plus one year in prison.
Moreover, civil tax fraud and criminal tax fraud have different statute of limitations. For civil tax fraud, there is no statute of limitations, and the tax may be assessed at any time. By contrast, there is a criminal statute of limitations, but it applies only to the prosecution of the crime—the actual tax evasion—not the assessment of the tax owed. Typically, the statute is three (3) years after the taxpayer commits the offense. But there are certain, specified carved out offenses for which a six (6) year statute of limitations applies.
Finally, different defenses are available for civil tax fraud and criminal tax fraud. When a civil suit for tax fraud follows a criminal proceeding for tax fraud, the doctrine of “collateral estoppel” may apply. Under this legal theory, provided certain technical requirements are met, once an issue is decided in one proceeding, it may not be retried again in a second proceeding.
This doctrine may be helpful to either the government or the taxpayer, depending upon the order of the civil/criminal proceeding and the outcome of the first case.
Consider first a criminal proceeding followed by a civil proceeding. If the government wins the criminal tax evasion suit, the taxpayer generally is “collaterally estopped” in the second (civil) proceeding from contesting that he committed fraud. Why? Because the government already proved fraud “beyond a reasonable doubt” and for the civil suit it needs even less evidence than that (requiring only “clear and convincing” evidence).
Alternatively, suppose the taxpayer is acquitted of criminal tax evasion in the first suit. Does collateral estoppel help the taxpayer? Unfortunately for the taxpayer, no, it does not. The first suit showed conviction was not provable “beyond reasonable doubt.” It remains to be seen in the civil suit whether it can be established using the lower evidentiary standard of “clear and convincing evidence.”
Now consider the reverse order of the proceedings, with the government first bringing a civil suit and losing—and then tries to bring a criminal suit for tax fraud. Does collateral estoppel help the taxpayer? It may; the taxpayer may attempt to collaterally estop the government in the second (criminal) proceeding from asserting the existence of fraud. In other words, under this scenario the doctrine of collateral estoppel helps the taxpayer.
When the IRS investigates a client for for tax fraud, what method of accounting will it use to evaluate the client’s financial documents?
In general, the IRS is required to use the same method of accounting as the taxpayer when they determine their income. See Fowler v. United States, 352 F.2d 100, 103 (8th Cir. 1965), cert. denied, 383 U.S. 907 (1966).
What is the willfulness requirement for tax evasion?
The IRS must prove three basic factors beyond a reasonable doubt for a tax evasion conviction: attempt, willfulness, and that the taxpayer had a tax liability. Willfulness is defined as the voluntary, intentional violation of a known legal duty.
As the Eighth Circuit has clarified, “Willfulness, as construed by our prior decisions in criminal tax cases, requires the Government to prove that  the law imposed a duty on the defendant,  that the defendant knew of this duty, and  that he voluntarily and intentionally violated that duty.” See Cheek v. U.S. (1991) 498 U.S. 192, 201. In other words, for the government to prove a taxpayer committed tax evasion, it must prove that the taxpayer acted voluntarily and intentionally when he or she decided to violate the law, and also knew his or her actions were illegal. See also United States v. George, 420 F.3d 991, 999 (9th Cir. 2005).
Good Faith Belief Defense
One of the things the government must show to prove tax evasion is that the defendant knew of his or her duty, and voluntarily and intentionally violated that duty. In other words, the government must show that the taxpayer acted willfully in structuring his or her affairs.
A successful defense, therefore, may be put forth if it can be shown that the defendant had a good faith belief that the taxpayer was not violating federal tax law in taking the disputed action. For example, if a defendant honestly but mistakenly believed that a distribution from a corporation was a return of capital and therefore not income—and the jury believes him or her—then the IRS can be prevented from proving tax evasion because the willfulness element of evasion would not be satisfied. Cheek v. U.S. 498 U.S. 192, 202 (1991). However, the jury would be “free to consider any admissible evidence from any source showing that [the taxpayer] was aware of his duty to file a return and to treat the distributions as income.” Cheek v. U.S. 498 U.S. 192, 202 (1991). What this means is that one cannot simply claim ignorance when charged with tax evasion because the jury can consider all sorts of evidence to show a person really did know the duty imposed under federal or state tax laws.
How does the government prove that a client “willfully” engaged in the act (or acts) that resulted in tax evasion?
Normally, the IRS seeks to prove the requisite willfulness element by using indirect evidence rather than direct evidence—like the taxpayer’s admission or confession—since direct evidence is rarely obtainable. That said, the Supreme Court allowed the willfulness requirement to be inferred from “any conduct, the likely effect of which would be to mislead or to conceal.” Spies v. United States, 317 U.S. 492, 499 (1943).
Each element of a tax crime must be proved beyond a reasonable doubt just like other crimes. According to the Ninth Circuit, the evidence must be reviewed “in the light most favorable to the prosecution to determine whether any rational fact finder could have found the essential elements of the offense beyond a reasonable doubt.” U.S. v. Marashi, 913 F.2d 724, 735 (9th Cir. 1990).
For example, each of the three elements of tax evasion must be proved beyond a reasonable doubt: that (i) the taxpayer attempted to evade or defeat a tax or the payment of a tax; (ii) the taxpayer had additional tax due and owning, and (iii) he acted willfully in his attempt.
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.
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).
How serious must the affirmative act be?
The act need not be “serious” at all. Tax law does not overlook “minor” acts of evasion. The Ninth Circuit clarified that Congress did not intend “to establish a hierarchy of attempts or evasions and limit [the offense] to those of a more deceitful or troublesome character.” U.S. v. Carlson, 235 F.3d 466, 469, (9th Cir. 2000)(quoting Edwards v. United States, 375 F.2d 862, 866 (9th Cir.1967)). In other words, it is all black and white for the IRS and the government. In a sense, one lie to the IRS is as bad as one thousand—either way you may be found guilty of felony tax evasion under IRC §7201.
Client Failed to Tell IRS About their Nominee Account
Without knowing more, this may constitute attempted tax evasion, which is a felony under IRC 7201. If a client uses a “nominee” account to avoid paying their tax liability, the government may have a strong case for claiming they made an “affirmative act” of evasion.
Recently, in U.S. v. Memmott (E.D. Cal., Aug. 21, 2013, CR-S-08-402 KJM), 2013 WL 4496615, one court found that the taxpayer committed tax fraud when he embezzled money through the use of a “nominee account.” This is an account that is in one person’s name, although the “real” owner is another. Placing property in the name of another when it is really the clients, and subsequently failing to inform the IRS that the account is the client’s, are facts the IRS will look to when it asserts a client committed tax evasion.
There is a test the courts use to determine whether a client improperly used a nominee account. They will consider whether: (1) the client paid the other person (the “nominee”) any consideration or money to hold their property; (2) the client retitled the property to the nominee because they were concerned about a potential lawsuit or other liability; (3) the relationship the client has to the person; (4) how much possession/control the client retained over the account or property after the transfer; (5) whether the client documented the transfer; and (6) whether the client continued to benefit from property after the transfer. See U.S. v. Memmott, 2013 WL 4496615.
Audit Risk with Cash Based Business Transactions
There is an inherent audit risk with an all cash based business. However, it is by no means a crime to operate a cash business. That said, if a client structures cash transactions to avoid having to file certain required reports it may constitute tax evasion. For example, in United States v. Mounkes, 204 F.3d 1024, 1030 (10th Cir.), cert. denied, 530 U.S. 1230 (2000) the taxpayer attempted to evade personal and corporate income taxes by “structuring . . . payments to avoid IRS reporting requirements.” The court said that such actions rose to the level of “affirmative act[s] [of] evasion or attempted evasion” of income taxes.
How to Defend a Client Charged with Tax Evasion
At a general level, any defense will go to attacking one of the “elements” of the crime. In the case of attempted tax evasion, for example, the IRS must prove three elements beyond a reasonable doubt: that a client owed tax, acted willfully, and made an affirmative act of evasion. Thus, a legal defense against an evasion charge will seek to deny one or more of these various elements.
One of the methods of presenting a defense is to discredit the evidence offered against the client, either because it is false or, even if it is true, try and find an argument to render it “inadmissible.” Technical rules exist regarding when evidence is admissible at trial. Often times these rules bend in favor of the taxpayer. For example, in one case, the IRS alleged that the taxpayer committed an “affirmative act” of evasion before the date of his tax deficiency. The indictment, however, only mentioned that the “crime date” was the date of the deficiency—the IRS failed to mention the pre-deficiency period. Thus, because the government made a technical error with the indictment, the IRS was precluded from using any evidence during the time prior to the deficiency. As a result, the taxpayer had a stronger defense. United States v. Voight, 89 F.3d 1050, 1089-90 (3d Cir.), cert. denied, 519 U.S. 1047 (1996).
Tax Avoidance Versus Tax Evasion
It is important to note that tax evasion is a very different sort of thing from tax avoidance. Tax avoidance involves the careful, legal structuring of one’s affairs so his tax liability is reduced. Tax avoidance is legal. As one famous judge put it, “[o]ne 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. The distinction is sometimes subtle, but a competent tax attorney must know the difference.
Failure to file (misdemeanor or felony?) (Spies Evasion)
In general, IRC §7203 makes it a misdemeanor to willfully fail to file a tax return or pay one’s tax liability. However, a different Code Section (§7201) makes non-filing a felony if certain other facts are present. Specifically, Section 7201 makes it a felony if a client “willfully attempt in any manner to evade or defat any tax.” The crime resides with attempting evasion, irrespective of whether one is successful. Case law clarifies that in order for a taxpayer to “attempt” to evade a tax, he must undertake some affirmative action of evasion. Spies v. United States, 317 U.S. 492, 498-99 (1943). Case law also makes clear that a mere act of willful omission is not enough for an affirmative act. United States v. Masat, 896 F.2d 88, 97-99 (5th Cir. 1990).
Passively failing to file a tax return is not tax evasion. Thus, if a client fails to file a tax return, the government can assert that the client attempted to evade taxes (a crime) only if they also engaged in some “affirmative act” to conceal or mislead the government. Thus, two things need to be present: (1) the client failed to file their tax return(s) as it (they) become due, and (2) to engaged in some act to affirmatively conceal or mislead the government.
Unfortunately for many taxpayers, case law has greatly expanded what it means to engage in an “affirmative act of evasion.” It includes such things as making a false invoice, making fictitious accounting entries, maintaining a double set of accounting records, or destroying financial records. The Supreme Court even provided a catch-all: a taxpayer engages in an affirmative act of evasion whenever he engages in “any conduct, the likely effect of which would be to mislead or to conceal.” Spies v. United States, 317 U.S. 492, 499 (1943). The IRS’s criminal investigation division will always attempt to find this catch-all provision applies as they are generally ordinarily much more interested in felony rather than misdemeanor convictions.
Is inability to pay taxes a defense factor?
A taxpayer cannot avoid criminal liability for failing to pay his tax by pointing to his zero balance bank account as the courts reason that injustice would result if one could escape criminal liability by simply having insufficient funds to pay his taxes. All the taxpayer would need to do is spend his money as fast as he earns it. See U.S. v. Tucker, 686 F.2d 233, 250 (5th Cir.1982)( “[A] financial ability to pay the tax when it comes due is not a prerequisite to criminal liability under § 7203. Otherwise, a recalcitrant taxpayer could simply dissipate his liquid assets at or near the time when his taxes come due and thereby evade criminal liability”).
The practical implication of this that the court will consider the lifestyle and expenses the taxpayer made before months (or years) prior to the tax liability due date. A court may likely be less understanding if the taxpayer decided to pay for luxury expenses rather than his tax bill. Similarly, the judge or jury may be more sympathetic if he paid for large, unexpected medical expenses.
How does the government prove that a client “willfully” failed to pay their tax bill?
The offense of willfully failing to pay tax has three elements: (1) the taxpayer was required by law to pay tax; (2) that tax liability was not timely paid; and (3) his failure to pay was willful. The willful element requires that the taxpayer had the ability to pay, but he intentionally and deliberately refrained from doing so. Spies v. United States, 317 U.S. 492, 499 (1943).
Direct proof of a person’s intentions is typically hard to come by. Absent a clear verbal statement or a written record, the government is left with inferring the taxpayer’s intentional conduct indirectly.
The government’s practice is to offer up certain circumstantial evidence to infer that the taxpayer’s attempt was willful—like making a false invoice, making fictitious accounting entries, maintaining a double set of accounting records, maintaining an all-cash business, destroying financial records, or even failing to keep such records. Such evidence is sometimes called “Spies-type conduct” after the famous Supreme Court case Spies v. United States, 317 U.S. 499 (1943).
The taxpayer facing a charge of tax evasion may be uneasy after learning that, under case law, many actions qualify as Spies-type conduct. For example, a consistent pattern of understating one’s tax may be enough to show he acted willfully in evading taxes. Holland v. U.S., 348 U.S. 121 (1954).
Are there any rules that govern what an IRS criminal investigation special agent can and can’t do in investigating a client?
Special agents receive assignments from their managers as to information items or for full-scale investigations. Information item assignments are usually limited inquiries to determine whether sufficient potential exists to conduct a full-scale investigation of a taxpayer. If a full-scale investigation is authorized, one or more special agents are assigned and the investigation continues until the evidence is sufficient for the agent to recommend prosecution or until there is no longer reason to believe that a prosecutable case can result with available resources. The taxpayer is notified if CID closes its criminal case and returns the matter for civil disposition. An agent conducting an information assignment normally reviews the taxpayer’s returns and other related IRS documents. If the case has been referred from within the IRS, the referring employee is interviewed. Informants, if any, are also interviewed. The special agent often confers with supervisors or senior agents concerning the potential of the case, and recommends whether the case merits full-scale investigation or should be returned for civil disposition. The District Chief of the Criminal Investigation Division (CID) or the Chief’s designee makes the final decision.
Criminal Investigation Division (CID) special agents have broad powers in securing evidence, including authority to administer oaths, to take testimony of witnesses, to examine books and records, to serve administrative summonses, and to execute search and arrest warrants.
Taxpayers who are placed under arrest must be given Miranda warnings. The extent to which a taxpayer will be given Miranda warnings depends on whether he is in custody at the time of first contact by the special agent. If he is under arrest or imprisoned, the special agent must give the full Miranda warnings, even though there is no relation between the tax investigation and the reasons that the taxpayer is in custody. Interviews conducted in an IRS office or at the taxpayer’s home or business are normally noncustodial. Case law establishes that the filing of a Form 2848, Power of Attorney and Declaration of Representative, is not an invocation of the right to counsel that precludes the special agent from interviewing the signer without the representative present.
A taxpayer who was made aware that he was being investigated is generally notified when the investigation is terminated. A case in which an investigation is terminated may be referred back to the Examination or Collection Division of the IRS. If additional indications of fraud are found after the criminal investigation is discontinued, the revenue agent must refer the matter back to the Criminal Investigation Division (CID).
An action for damages may be brought against the government if it intentionally compromises the liability of a taxpayer’s representative in exchange for information that the taxpayer conveyed to the representative.
Is reliance on an accountant an effective defense?
Suppose a taxpayer maintains he is innocent in filing a false return because he relied on his accountant. Will this get him off the liability hook? In such cases, the issue comes down to whether the taxpayer knew when he signed the return that it was false. The court will infer that he acted willfully in filing the false return if he (1) was aware of the contents in the tax return, and (2) he knew that his actual income was significantly more than the amount reported. Thus, the answer to the original question turns on whether the government can prove those two things.
How does the Criminal Investigation Division of the IRS select a tax crime lead for full investigation?
From a policy perspective, CID chooses Cases for full investigation with the goal of deterring Criminal Tax violations by covering a wide cross section of taxpayers. CID’s aim is to encourage voluntary compliance throughout the nation by covering the widest possible cross section of taxpayers. In the past, subjects of Criminal Tax investigations have included persons from every economic and vocational group and every geographic location.
Cases are selected in areas of the tax spectrum that the IRS believes have significant compliance problems. The IRS attempts to identify the specific types of individuals and businesses responsible for the greatest amount of tax fraud. CID is currently focused on dishonest return preparers and persons engaged in the underground economy, believing these groups are involved in dishonest practices and make up a large segments of the population.
Cases believed to result in high-publicity are occasionally selected to publicize the enforcement effort often involving public figures such as movie stars and musicians. By contrast, media coverage of convictions of local citizens may be limited or nonexistent. Cases involving organized crime figures, narcotics traffickers, dishonest politicians, and other types of celebrities, often generate significant publicity for the enforcement effort.
Criminal investigations are extremely expensive, because of the time required for a full investigation (often more than a year) and the expense of securing and examining books and financial records. Criminal Investigation Division personnel from experience know that some cases have a higher chance of resulting in a conviction while other cases have a small likelihood of success due to factors such as the advanced age of the defendant, the uncollectible of witnesses, or the Justice Department’s dislike for a particular type of case. Annually CID has historically only had the resources to initiate less then 7,000 investigations nationally. Consequently, decisions to undertake an investigation or not often rest on the availability of resources as much as on any other factor.
Historically, the IRS has not prosecuted cases in which there is only a small deficiency at stake. The IRS’s internal CID guidelines require that a tax deficiency be at least $10,000 over three tax years to bring a tax evasion prosecution. Prosecution for signing false returns or failure to file requires a tax deficiency of at least $2,500 over three years. However, case law has shown that a taxpayer can be successfully prosecuted for filing a false return even when no deficiency is proven.
How can tax preparers, attorneys, or accountants be charged with aiding or assisting the crime of filing a false return? How can they be punished?
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;
- The defendant aided, assisted, procured, counseled, or advised the preparation or presentation of a document
- The document was false as to a material matter
- The defendant acted willfully.
Charges under this provision are most often brought against, accountants, bookkeepers and others (including an entity’s employee’s) 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 much broader in that the statute reaches any intentional conduct that contributes to the presentation of a false document to the IRS. Case law in the area provides the following examples:
- an individual who sold discounted winning horse or dog race tickets to others for cash, thereby causing the filing of a false Form 1099s, as well as the individuals who signed government forms provided to the racetracks that falsely stated that he or she was the winner of the horse or dog race
- a person who knowingly prepared overstated appraisals to substantiate overstated deductions for charitable contributions
- persons who fabricate and then sell fictitious invoices to others to support nonexistent deductions
- a breeder who, in furtherance of a fraudulent tax shelter, signed back-dated contracts for the purchase of live stock
- an employee who prepared false books and records that were eventually used to prepare the entity’s returns
The 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 statue 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 returns can be criminally charged with assisting in the preparation of a false return.
FALSE AS TO MATERIAL MATTER
The courts that have ruled on the 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 (the appeals court for Southern California and thus controlling precedent) 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.
STATUTE OF LIMITATIONS
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.
How Does the IRS Prosecute Suspected Tax Crimes?
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.
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.
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.
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.
How does the IRS reward informant leads concerning suspected tax crimes?
The most common informants that lead to CI investigations are former spouses and fired employees. Informants can be paid rewards where the IRS proceeds with any administrative or judicial action based on information provided by an informant, the informant shall receive a reward based on the amounts collected. The reward will be at least 15 percent, and no more than 30 percent, of the collected amount plus interest.
If the informant qualifies under Federal Whistleblower laws, the amount of the reward will be determined based upon a determination of the extent to which the information obtained from the Whistleblower substantially contributed to the administrative or judicial action and subsequent recovery of tax revenue. The reward may be reduced if it is determined that the claim was brought by an individual who planned and initiated the actions that led to an underpayment of tax or violation of the Internal Revenue Code. If the Whistleblower is subsequently convicted of criminal conduct arising from his or her role in the reported action themselves, any award will be denied. No award will be paid unless the information submitted to the IRS is submitted under penalty of perjury.
Reward claimants often send documentation to substantiate their claim with a completed Form 211 which includes an explanation as to how the information being reported came to the attention of the claimant, including the date(s) the information was acquired and a description of the claimants relationship to the person or entity which is the subject of the claim. CI special agents are not allowed to compromise the tax liability of an informant to obtain information about another taxpayer. A claim for reward may be filed by an executor, administrator, or other legal representative on behalf of a deceased informant if, before the informant’s death, the informant was eligible to file a claim for the reward. Certified copies of the letters testamentary, letters of administration, or other similar evidence must be attached to the claim for reward on behalf of a deceased informant to show the authority of the legal representative to file the claim.
How will the government attempt to prove a deficiency in a tax evasion case?
The government employs various standard methods of proof however it may offer any relevant evidence in an effort to establish the existence of a tax deficiency in a tax evasion case. The two basic methods of proof are classified as direct and indirect. The government may use any one method or may use several to corroborate one another, and may use different methods for different years included in an indictment.
Direct methods include offering proof that the taxpayer omitted or failed to report all or part of a specific item of income, overstated deductions or falsely claimed credits. For example, the government could attempt to prove that the taxpayer failed to report a particular item of income, such as a sales commission, the proceeds on the sale of an asset, or service revenue from a business. The government can also endeavor to show that the taxpayer received a total amount of income greater than that the amount reported on the return as direct evidence of a deficiency. For example the government could attempt to established through interviews with a Doctor’s clients that the amounts they had paid him during the three examined tax years exceeded the gross receipts the Doctor reported on his returns for those years.
Indirect methods are typically used when the taxpayer has no books and records or where the government cannot obtain, understand or has no faith in the books and records produced by the taxpayer. Moreover, the use of indirect methods may be resorted to when the taxpayer has purportedly complete books and records as a way of obtaining corroborating indirect evidence to support incomplete or insufficient direct evidence.
Do Prior Tax Crimes Factor into New IRS Tax Convictions?
Under the Federal Rules of Evidence, evidence of other crimes or acts, including prior convictions, is inadmissible solely to prove that the defendant likely acted in conformity with the previous crimes or acts in the case at bar. However, this type of relevant evidence may be admissible by the government to show a similar motive, opportunity, intent, preparation, plan, knowledge, or absence of mistake to the case at bar. For this type of evidence to be admissible, it must be held to be relevant to an issue other than the defendant’s character and, in the court’s opinion, its probative value must not be substantially outweighed by its tendency to unduly prejudice the jury against the defendant. As a result of these exceptions, evidence of other tax crimes, or other criminal convictions, often is admissible in a subsequent criminal tax trial.
Is it a good strategy to request a criminal investigation conference before an IRS special agent’s investigative report is finished?
The Criminal Investigation Division (CID) normally will grant the taxpayer or his representative a conference with the special agent’s group manager, a senior agent not connected with the case, or with the District Chief of CID before the special agent’s report is completed upon request. However, the IRS does not consider the conference to be a matter of right and there is no constitutional right to a pretrial conference. Since a conference is not required, effective tax defense counsel should make a written request for a conference as soon as he is retained.
CID grants conference requests as a matter of course believing them to be in the government’s best interest, since taxpayers and their counsel often make admissions or highlight weaknesses in the government’s case that can be remedied by additional investigation. Therefore, the Chief of CID for the district may offer a conference even when none is requested.
At the conference, the CID representative is required to inform the taxpayer of the alleged fraudulent features of the case, to the extent consistent with protecting the government’s interests. The CID representative must make available to the taxpayer sufficient facts and figures to acquaint him with the basis, nature, and other essential elements of the proposed criminal charges against him.
Since CID may attempt to use any inadvertent admissions by the taxpayer made at the conference. Most tax counsel, recommend that the taxpayer does not attend the conference. The investigating special agent often present and it is rare that a client is able to keep their composure while faced with the agent who may recommend that serious criminal charges be instituted.
Since the IRS may argue that counsel’s statements are vicarious admissions, counsel should bring a witness to the conference and state at the beginning of the conference that counsel is not authorized to make admissions of fact by his client. Factual representations should be couched in hypothetical language.
If the taxpayer tax defense counsel wishes to raise defense matters at the conference, it is wise to reduce them to writing. Even if the CID representative is not persuaded by the defenses raised, a record then exists to demonstrate to a court that the defense was raised at the earliest possible time and is not an afterthought. Sympathy factors such as a severe health problem should also be documented early.
Is it a good strategy to request a taxpayer’s conference after an IRS Special Agent Report (SAR) is finished but prior to a potential indictment or CI referral?
While every tax controversy and every tax matter is different, there are generally two critical stages in a pre-indictment process where positioning oneself to participate in a taxpayer conference can be substantively or procedurally advantageous. The first time is at the conclusion of the CID investigation when the special agent has prepared his or her SAR. The second is at or just prior to referral to the Department of Justice (DOJ) Tax Division. While entering into these conferences can improve the potential outcomes the taxpayer may face, an improper handling that reveals defenses too early in the process or results in inadvertent disclosures can exacerbate the situation.
As for the CID investigation, a pre-indictment conference request is granted as a matter of course because it is believed to be in the government’s best interest. However, if the conference is not in the government’s best interest or if the taxpayer is subject to a grand jury investigation it may not be held. If a pre-trial conference is held, the taxpayer is permitted to attend but, practically, it may be better for only the attorney to appear. If the taxpayer must attend the conference he or she should not engage in conversation beyond initial & closing pleasantries. Furthermore steps to avoid non-verbal communications should also be taken. The taxpayer must be told of the conference results.
The attorney will probably also wish to position the client to receive a conference at the DOJ Tax Division. These conferences are also routinely granted, but the taxpayer does not have a right to receive one. Therefore a defense attorney must take steps on the taxpayer’s behalf to increase the odds that said conference will occur. The government will not delay action to hold a conference if a showing that information will be useful to a prosecutorial decision is not made. If the taxpayer is informed of the fact that he or she will be referred to DOJ’s Tax Division for criminal prosecution, then the attorney will apply for or re-request a conference as quickly as possible.
At any DOJ Tax Division hearing, the taxpayer’s council will have the opportunity to present evidence or explanations regarding the alleged tax crimes and potential indictment. The conference is not an appropriate venue or time to examine the government’s evidence, but rather it gives the taxpayer a chance to present any important materials before the government authorizes a prosecution. If the taxpayer attends the conference special care must be taken because the government may use any statements made by the taxpayer at the conference in future proceedings.
However if the taxpayer is unaware about his or her status regarding a criminal referral the timing is more difficult. However, most tax defense attorneys would probably recommend a belt and suspenders approach here by requesting a conference. If the taxpayer does then face a CI referral he or she will already be best positioned to engage in a pre-indictment conference.
What are a Client’s Rights During an IRS Criminal Investigation?
IRS special agents that investigate potential criminal cases must following rules of conduct specified in the Internal Revenue Manual. Taxpayer’s under criminal investigation by CID must receive Miranda-type warnings at the first interview conducted by CID. The special agent is required to warn a taxpayer that he is being investigated for criminal violations of the tax laws, that he has a constitutional right not to say anything, and that anything he says can be used against him.
Should counsel possibly consider making a Voluntary Disclosure?
A taxpayer who suspects a criminal investigation might be under way, but who has not as of yet been contacted by the IRS, can possibly avoid prosecution by making a voluntary disclosure to the Criminal Investigation Division of the IRS. Taxpayers who fear a criminal investigation may be underway but who have not been contacted by the IRS may also be tempted to file delinquent or amended income tax returns or otherwise discuss with IRS representatives and in the process reveal the reason for their apprehension. Making an inadvertent disclosure to IRS personnel out of fear of an ongoing criminal investigation is a terrible way to attempt to avoid criminal investigation. A valid voluntary disclosure, requires at a minimum, that the taxpayer must not have reason to suspect that an investigation was about to begin when the disclosure was made, the disclosure is full and accurate, and the taxpayer must commit to cooperate with the IRS in determining the correct amount of taxes owed subsequent to making the voluntary disclosure.
The IRS has established policy surrounding voluntary disclosures that if properly complied with ensure that the vast majority of taxpayers who make a proper voluntary disclosure need not fear criminal prosecution. However, the IRS voluntary disclosure policy does not guarantee a grant of amnesty or immunity from prosecution. The IRS states that a voluntary disclosure occurs when a taxpayer makes a truthful, timely, and complete disclosure, and the taxpayer cooperates with the IRS and makes a good faith arrangement with the IRS to pay all determined deficiencies, including interest and penalties.
A Voluntary Disclosure is timely if it is received before:
- an IRS examination has begun, or before the IRS notifies the taxpayer that an examination is about to begin;
- a third-party whistleblower has supplied information to the IRS concerning the taxpayer’s noncompliance; or
- the IRS has acquired information concerning the taxpayer’s noncompliance through a criminal investigation or any other source.
Case law has shown that a taxpayer who merely makes an unsupported offer to pay taxes, rather than a taxpayer who makes valid arrangements to pay taxes, is not entitled to the protection of the voluntary disclosure policies. A valid arrangement to pay requires that a specific plan is accepted by the IRS to satisfy the outstanding tax liability. Case law has made it clear that the IRS must accept any reasonable payment arrangement and cannot withhold its assent to a voluntary disclosure capriciously or in bad faith. The IRS must afford taxpayers who act in reliance upon the published voluntary disclosure policy a reasonable opportunity to satisfy all of the conditions of the policy, including payment terms. However, if the IRS and the disclosing taxpayer cannot agree to a payment plan within a reasonable time, the IRS does not have to follow their voluntary disclosure policy.
Occasionally making a voluntary disclosure can be used tactically where Defense Counsel believes his client is likely to be criminally prosecuted. While making a voluntary disclosure in this circumstance is at best a gamble in light of the delineated requirements to making a valid voluntary disclosure listed above, the voluntary disclosure may possibly form a basis for mitigating a possible criminal sentence downward.
To qualify as a true voluntary disclosure, the disclosure must be made before the disclosing individual(s) is (are) aware of events that indicate the government is likely to discover the crime being disclosed. Thus, a disclosure is not voluntary if the IRS has already begun an inquiry that is likely to lead to the taxpayer and the taxpayer is reasonably thought to be aware of that activity. Moreover, a disclosure is not considered voluntary if the taxpayer has other reasons to believe that an examination of tax liabilities is likely to occur. For example, a voluntary disclosure would not be considered voluntary where the disclosing individual had reason to believe that an ex-spouse or dissatisfied business partner is going to inform to the IRS.
What are the usual defense tactics that make it hard for the government to prove willfulness?
Inadvertence and Negligence
Because willfulness requires an intentional violation of a known legal duty, the element of willfulness can be negated by producing evidence to show that the defendant’s conduct was inadvertent, careless, or otherwise negligent. The government will attempt to refute this defense by showing that the defendant’s conduct is inconsistent with the claimed inadvertence or neglect. For example, in failure to file cases, the government usually relies on multiple, consecutive failures to file to negate any claimed inadvertence or neglect.
Uncertain Legal Duty
Willfulness requires that there be a legal duty with which the taxpayer fails to comply. The courts have consistently held that where the state of the law is uncertain as to whether there is a legal duty, criminal liability will not be imposed. Moreover, the weight of legal authority in this area is that the taxpayer’s actual knowledge regarding the unsettled state of the law is irrelevant. The bottom line here is that if the law is in fact uncertain, the taxpayer has not committed a crime.
Since the government’s burden in establishing willfulness requires that the taxpayer violate a known legal duty, it is a viable defense to offer evidence that the taxpayer did not know of the specific duty at issue. The Supreme Court itself has held that willfulness may be negated by a good faith claim of ignorance or misunderstanding of the law or a good faith belief that there was no violation of the law, regardless of whether the belief was objectively reasonable. One rationale for this “good faith” defense is the criminal tax provisions were not drafted with the intention of penalizing a taxpayer for innocent mistakes caused by the inherent complexities of the Tax Code.
The Supreme Court’s line of decisions in the area have held that a taxpayer is not guilty of willful failure to file if he honestly believed his income was too low to require him to file a return or if the taxpayer believed that he was not required to file a return if he was unable to pay.
The defense of mistake is not limited solely to mistakes of law. A defendant who, through a mistake of fact, unknowingly violates a statute also does not act willfully.
Reliance on Others
Evidence establishing that a taxpayer relied on the advice of counsel or an accountant may successfully be used to negate willfulness if it can be shown that the taxpayer acted in good faith and that he or she provided the preparer with full and accurate information at the time the advice was sought. This defense may not be successful if the government can establish that full disclosure to the attorney or accountant was not made at the time the advice was rendered. Reliance on a lawyer’s advice has occasionally been held a valid defense, even where such reliance was objectively unreasonable.
Mental Disease or Defect
Because the government’s burden in proving willfulness requires a showing of a specific intent to disobey the law, the courts have consistently permitted expert medical testimony to establish that the defendant has developed a delusion about the tax laws that interfered with the mental ability to form the specific intent to disobey the law.
Filing of Amended Return or Late Payment of Tax
Under the government’s voluntary disclosure policy published in the Internal Revenue Manual, a taxpayer who, in essence admits to a potential tax crime by filing an amended or delinquent return may avoid prosecution, provided the disclosure was voluntary and made before the taxpayer was first contacted by the IRS regarding a potential problem with the tax liability. However, amended or delinquent returns filed after a taxpayer has been contacted by the IRS do not qualify for the voluntary disclosure policy, even though the courts tend to hold that the filing of delinquent or amended returns or the late payment of tax is admissible by a defendant on the issue of willfulness. The filing of amended returns after notice by the IRS that a particular return is under investigation is a patently bad idea. Case law shows that in numerous instances, the very act of filing of a delinquent or amended return during the course of an IRS investigation has been presented as a key piece of evidence that eventually led directly to a taxpayer’s indictment. Case law also shows that the government routinely relies on delinquent and amended returns as the very admission that establishes the existence of an understatement in tax liability of the original return.
Unsuccessful Defenses to Willfulness
When a taxpayer’s conduct can be shown to be intentional and knowing, the taxpayer’s personal reasons for taking the criminal action are irrelevant. Accordingly, presenting evidence of, a taxpayer’s disagreement with the law, inability to pay, marital or financial difficulties, or fear of filing are generally not effective defenses. Moreover, defenses that tend to explain a taxpayer’s reasons for taking an action, or refusing to act, that do not effectively rebut the required specific intent to disobey the law are not effective defenses to willfulness. Thus, presenting evidence to show that a taxpayer was a political tax protester, had religious objections or personal problems, are generally not effective defenses to negate the element of willfulness.
Evidence on, personal problems or preoccupation with business affairs may, where extreme, tends to negate willfulness if it can be used to show that the taxpayer may have been so disturbed by the problems that they prevented the formation of a specific intent violate the law. However case law shows that such defenses are rarely successful.
While inability to pay in and of itself is not generally an effective defense, such evidence may be a defense if it can be sown that the taxpayer had the erroneous belief that returns could not be filed without the associated payment of tax. Additionally a taxpayer’s inability to pay also can be an effective defense to a failure to pay charge if it can be shown that the defendant’s inability to pay was not the result of lavish and extravagant living.
Strategies to Defend Tax Crimes
Every CID recommendation to prosecute taxpayers for a Tax Crime are reviewed by District Counsel attorneys. An opportunity therefore exists for a Taxpayer’s representative to present defenses at a requested District Counsel conference. The reality is that District Counsel must be satisfied that evidence gathered by CID is sufficient to establish that a tax crime was committed and that reasonable probability of conviction exists. District Counsel is faced with two choices, decline to prosecute or return a particular case for additional investigation by CID. It is to be noted however that once a case is worked up and presented for review by District Counsel, Few cases are in fact declined.
If IRS District Counsel determines that prosecution is warranted or that grand jury investigation should take place, the case is referred to the Department of Justice. This referral takes place via a letter referred to as a Criminal Reference Letter (CRL), which sets forth the recommendation of District Counsel for prosecution, the evidence supporting the recommendation, details concerning the technical aspects of the case, and an assessment of possible prosecution problems. The CID special agent’s report and exhibits are also enclosed. A copy of the CRL is sent to the appropriate U.S. Attorney within the Department of Justice with instructions to charge specific crimes against the taxpayer and designating one or more major counts which may premise a plea agreement. Referral to the Department of Justice terminates the IRS’s authority to issue or enforce any further summonses to investigate the Criminal Tax matter. Declination, or refusal to take the case, by the Department of Justice restores the IRS’s authority to use administrative process. Cases that meet all the other requirements for prosecution may nevertheless be declined by the Justice Department simply because their trial attorneys are of the opinion that no jury would convict due to a combination of circumstances, such as the taxpayer’s age and health, the fact that the taxpayer has already suffered enough, or other circumstances likely to evoke jury sympathy. Defenses based on the lack of probability of conviction are of greatest value when conferring with the Department of Justice’s trial attorneys.
Tax Crimes Overview
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.
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.
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.
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.
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.
TAX CRIMES SYNOPSIS – MISDEMEANORS:
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.
TAX CRIMES SYNOPSIS – DEFENSES:
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.
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.
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.
LESSER INCLUDED OFFENSES AND DOUBLE PUNISHMENT
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.
VICARIOUS LIABILITY INVOLVING CORPORATIONS AND OTHER ENTITIES
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.
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.
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.
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.
What considerations should be taken into account where a client is faced with a continuing filing requirement when a criminal investigation is pending?
An issue sure to be encountered during a lengthy criminal investigation is whether or not the taxpayer should continue to file tax returns as they become due while the criminal tax investigation is pending. Under the circumstances any returns that are filed must be accurate or the taxpayer’s problems could be exacerbated with a charge of filing a false return. To further complicate matters, a taxpayer in this situation may have carryover items which are from years under investigation. Any currently truthful reporting of current income may confirm past underreporting or identify additional sources of income, when compared to the previously filed returns and carryover items. Since the privileges afforded by the Fifth Amendment against self-incrimination do not justify the failure to file a return, both the taxpayer, his counsel and any “Kovel” accountant, must carefully consider how to proceed under the circumstances. I recommend utilizing lawful extensions of the filing due date to the extent possible and where not, one published creative approach is to calculate and pay any taxes currently due and deferring any currently due filings. However, this approach is not without risks as failing to file a return is in and of itself a crime.
What Crimes in the Federal Criminal Code Apply to Tax Issues?
Several crimes set forth in Federal Criminal Code can apply to tax matters, including aiding and abetting, presenting false, fictitious, or fraudulent claim to government, conspiracy, making false statements to U.S. agency, mail fraud, bribery, and forgery.
AIDING AND ABETTING COMMISSION OF FEDERAL CRIMINAL CODE OFFENSE
In practice, the aiding and abetting charge is most often used to prosecute tax protesters. It has also been charged against persons who have aided and assisted another in tax evasion by concealing another person’s sources of income or assets. It has also been applied to officers of corporations who caused their respective corporation to fail to collect and pay over trust fund taxes.
ELEMENTS OF OFFENSE
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.
Any person who aids or abets the commission of a substantive federal offense is punishable as a principal in the underlying substantive federal offense. 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.
An accused must associate themselves in some manner with a criminal venture to be convicted of aiding and abetting the commission of an offense. Additionally they must participate in the criminal venture in a manner that demonstrates that it is something that they wish to bring about and seek by their actions to make succeed. However, the aider and abettor need not perform the substantive offense nor even know its details to be convicted. Moreover, the aider and abettor need not have been present when the offense was committed. To prevail 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 manor. For example, convictions for aiding and abetting have been secured against individuals who advised others to file false Forms W-4, Employee’s Withholding Allowance Certificate.
Because the aiding and abetting statute does not create a separate offense the applicable statute of limitations for bringing a aiding and abetting charge is the same as for the underlying substantive crime involved.
FALSE, FICTITIOUS, OR FRAUDULENT CLAIMS
It is chargeable as a felony to present to the government a false, fictitious, or fraudulent claim, which commonly arises where a taxpayer submits a false claim for refund of taxes. This crime is punishable by imprisonment of up to five years, a fine of up to $10,000, or both.
This statute has been applied to:
- a defendant who filed an income tax return falsely claiming a refund based on backdated documents
- a defendant who filed duplicate returns, one in his name and one in a fictitious name
- a defendant who filed returns claiming refunds in the names of other persons but using his own address
ELEMENTS OF THE OFFENSE
For the government to earn a conviction for the presentation of a false claim, it must prove beyond a reasonable doubt that:
- The defendant made or presented a claim for money or property to a department or agency of the United States Government;
- The claim was false, fictitious, or fraudulent
- The defendant knew that the claim was false, fictitious, or fraudulent at the time presented.
The statute of limitations for prosecution for making a false claim to the government is five years.
It is a felony to conspire against the United States. Conspiracy is defined as an agreement by two or more people to commit an offense against, or to defraud, the United States. Conspiracy is chargeable as a felony or a misdemeanor depending on whether the underlying criminal objective of the conspiracy is punishable as a felony or as a misdemeanor. If the underlying criminal objective of the conspiracy is a felony, conviction for conspiracy is punishable by imprisonment for up to five years and a fine of up to $10,000. If the underlying criminal objective of the conspiracy is punishable as a misdemeanor, conviction for conspiracy is punishable to the same extent as is the underlying misdemeanor criminal objective. In both felony and misdemeanor cases, greater fines may be imposed under the alternative maximum fine provisions.
The conspiracy statute defines two distinct offenses:
A conspiracy to:
(1) commit an offense against the United States; and
(2) defraud the United States.
Case law in this area shows the charges for conspiracy to defraud the United States have been use to attack agreements to impede, impair, obstruct, or defeat the lawful functions of governmental agencies such as the IRS. The IRS has used conspiracy charges surrounding attempts to impede and or impair the IRS in the lawful assessment or collection of revenue as a weapon in complex tax prosecutions typically involving corporations, abusive tax shelters and money-laundering schemes.
ELEMENTS OF THE OFFENSE
For the government to earn a conviction for conspiracy it must prove beyond a reasonable doubt that:
- Two or more persons made an agreement
- The substance of the agreement was to commit an offense against the United States or to defraud the United States
- One or more of the conspirators committed an overt act in furtherance of the agreement.
A six-year statute of limitations applies to offenses arising under the conspiracy provisions of the Federal Code.
AGREEMENT BETWEEN TWO OR MORE PERSONS
The agreement to violate the law does not have to be reduced to an express or formal agreement. Convictions have occurred where nothing more than a mere tacit understanding was able to be inferred from the apparent concert of action by two or more persons which evidenced a single design to accomplish a common criminal purpose. However, evidence presented by the government must be sufficient to show beyond a reasonable doubt that the conspirators had reached a mutual understanding involving the essential nature of the criminal plan. In the Tax arena for example, all that must be shown in a conspiracy to evade taxes case, is that the defendant knew of the conspiracy to evade taxes and knowingly participated in it. Moreover, the government is not required to establish that the conspirators agreed to the details of the plan for which the conviction was charged.
A corporation as a legal person can also be charged with conspiracy. Courts have held that a corporation may conspire with its officers or with its employees. Husband and Wife may also be found guilty of conspiring together against the United States.
The underlying substantive offense and the conspiracy to commit that offense are two separate and distinct offenses. Thus a person may be charged with both the commission of the underlying offense and with conspiracy to commit the underlying offense. Moreover, a conspiracy to commit an offense may be established even when the underlying substantive offense was not actually accomplished.
What’s the Penalty for Making, Subscribing, and Filing a False Return?
Any person who willfully makes and or subscribes a false return, statement or other document under penalties of perjury, or aids or assists in the preparation or presentation of a false return or other document or simulates or falsely executes or signs any bond, permit or entry required under the internal revenue code commits a felony.
Any person who willfully makes and or subscribes a return, statement, or other document containing a declaration that is made under penalties of perjury and who does not believe it is true and correct is guilty of a felony.
These felonies are punishable by up to a $100,000 fine ($500,000 for corporations) and three years imprisonment. The statute of limitations is six years for these crimes.
The willful delivery or disclosure of false document to the IRS is a misdemeanor that is punishable by a $10,000 fine ($50,000 for corporations) and up to one year in prison. The statute of limitations for this crime is three years.
What is commonly contained in a CID special agent’s report recommending criminal prosecution for a tax crime when finished?
The special agent’s report (SAR) normally contains a narrative of the agent’s investigative findings. Attached to the report are commonly exhibits containing statements of witnesses that were interviewed, copies of documentary evidence, schedules and computations of income prepared by the agent, and any other materials necessary for a fair administrative review of the case. The SAR and the exhibits are normally the only material on which reviewing attorneys at the District Counsel and the Justice Department base their recommendation either to prosecute or to return the case to the IRS for processing as a civil case.
Access to the SAR and accompanying exhibits are seldom available to the Taxpayer or Tax Counsel before charges are filed. Requests for the special agent’s investigation materials under the Freedom of Information Act (commonly called a FOIA request) have been consistently denied under the investigatory record exemption and the exemption for material exempt by statute. Courts have occasionally required the government to supply an index of material contained in the SAR. The complex interaction among the Freedom of Information Act, the Privacy Act of 1974, and the disclosure provisions of the Code have left many questions unresolved. The SAR should become available to the taxpayer’s tax counsel at any trial in which the agent testifies. For this reason, the IRS usually has two agents present for every interview so that the government can present its case at trial without calling the special agent to testify that wrote the SAR. In such cases, the SAR is never disclosed.
What is the Discovery Process in a Criminal Tax Case?
From a criminal tax defendant’s perspective, discovery in a criminal case usually begins with a written request submitted with the applicable federal court that requests the court to order the government to provide a bill of particulars to the defendant. The bill of particulars will be ordered by the court because it allows the defendant to prepare an appropriate defense, prevents double jeopardy where the defendant may have been charged a second time for the same previously adjudicated crime, and helps to avoid surprise or prejudice at trial. However, the court will not require that information that is evidentiary in nature be included in the bill of particulars.
Historically courts have required that Taxpayers be provided with the following types of information, where applicable, in a bill of particulars:
- the identity of any co-conspirators
- a description of any means of deception the government was planning on proving at trial
- a description of which of the taxpayer’s records the government copied
Historically Taxpayers have not been entitled to the following information in a bill of particulars because this type of information is considered “evidentiary”:
- alleged dates, times, and places that the taxpayer received items of gross income
- details of a conversation that the government alleged as an overt act that it intends to offer as proof of willfulness
In federal criminal cases, depositions ordinarily are not allowed to be taken of government personnel or other witnesses by the defendant. However, under exceptional circumstances when a deposition is held to be in the interest of justice, the taxpayer may depose a prospective witnesses to preserve their testimony for trial if some doubt exists as to the witnesses availability for appearance at a subsequent trial. Where a court does allow a deposition it might additionally order that any book, document, record, recording, or other nonprivileged material be produced at the time and place of any such deposition.
In a federal criminal case, the taxpayer is entitled to discover:
- any relevant written or recorded statements the government asserts were made by the taxpayer and the substance of any oral statement made by the taxpayer
- a copy of the taxpayer’s prior criminal record if applicable
- the existence of photographs, books, papers, tangible objects, documents, and buildings and places that are relevant to preparing the taxpayer’s defense, that are intended by the government to be used as evidence at the trial, or that were obtained from or belong to the defendant by the government.
- The results and associated reports of any physical or mental examinations and scientific tests and or experiments that are material to the taxpayer’s defense or that are intended by the government to be used at trial.
Except as delineated above, the memoranda, reports, or other internal documents prepared by the government in connection with the case are not subject to discovery by the defendant. Moreover, statements made by government witnesses can only be obtained in limited circumstances as provided in the Jencks Act. Under the Jencks Act, no statement or report of a government witness in a federal criminal prosecution can be discovered until after the witness has testified on direct examination in the trial of the case at issue. Only after the witness has testified on direct examination, can the taxpayer draft a motion to compel the United States produce any statements of the witness that relates to the subject matter of the testimony given at trial.
What is the government required to include in an indictment or an information in a criminal tax case?
An indictment is required by law to contain the elements of the offense the defendant is charged with and must fairly inform the defendant of the offense so charged. The defendant is also entitled to conduct discovery as to material considered relevant to the government’s case him or her. At any subsequent trial, the Government is prohibited from presenting evidence of other crimes for the sole purpose of showing that the defendant was likely to have committed the charged offense, however other crimes may be used to show criminal intent for the charged offense if they are held to be relevant by the court. For example, if the defendant is an admitted tax protester and was previously convicted of tax evasion the previous conviction would be relevant to show the defendant most likely intended to evade taxes as to the current charges and thus the previous conviction would most likely be admitted by the current court of law.
Felonies, (defined as crimes punishable by a sentence exceeding one year), must be charged by an indictment returned by a grand jury, unless the defendant waives the right to be indicted. Misdemeanors (defined as crimes punishable by a maximum sentence of one year or less), may be charged by grand jury indictment or by information. An information is legal document listing the charges against a defendant and is filed by the appropriate federal prosecutor. An indictment or information, must be written in plain, concise, and definite terms and must include a statement of the essential facts the government is asserting constitute the charged offense.
The Supreme Court has held that the word “willfully” has the same meaning in all the criminal tax statutes whether they be felonies or misdemeanors. In defining willfulness, Federal Courts have consistently stated that, despite their earlier references to “bad faith and evil intent”, a current finding that a defendant acted willfully does not require any proof of motive other than an intentional violation of a known legal duty. Courts have consistently held that willfulness may be negated by establishing good faith claim of ignorance or misunderstanding of the law or a belief that there was no violation of the law by a taxpayer, regardless of whether the taxpayer’s belief appears to be objectively reasonable. However, establishing a good faith taxpayer belief that the tax laws are unconstitutional will not negate the element of willfulness.
An intentional violation of a known legal duty can be shown by a taxpayer’s reckless disregard for the law. Courts have held that a taxpayer’s knowledge of the law is not limited to his actual knowledge but includes a reckless disregard of a legal obligation that the defendant can be shown he or she was aware of in some manner. For example, to prove that a taxpayer attempted to evade taxes the government needs only show that the taxpayer had the specific intent to evade a tax that the taxpayer knew was owing. Similarly, to prove that a taxpayer willfully failed to file a return, all that need be shown is that the taxpayer knew of the obligation to file the return and intentionally failed to do so.
Willfulness & Failure to Pay Offenses
The willfulness requirement in failure to pay taxes cases raise the issue of whether a defendant’s inability to pay the tax in and of itself negates the element of willfulness or whether the government must present evidence to show that the defendant was financially able to pay the tax on or about the time the tax was due to establish willfulness.
Proof of Willfulness
The government’s production of proof on willfulness ordinarily consists of admissions made by the defendant (often in the absence of counsel) to government investigators or witnesses that are called to establish willfulness (often employees, whistleblowers and ex-spouses). Statements tending to indicate willfulness made by a taxpayer’s representative under a power of attorney on behalf of a defendant may also be used by the IRS in a criminal prosecution. However, absent an admission by the defendant or his counsel, the government will attempt to prove willfulness through the use of circumstantial evidence. The government will attempt to meet its burden of proof as to willfulness by examining the taxpayer’s entire course of conduct and will encourage a Jury to make reasonable inferences that can be properly drawn from the examined conduct. Historically, the government has had great success in establishing willfulness based on proper inferences drawn from any conduct that appears to have been engaged in by a defendant in order to mislead or conceal.
Proof of willfulness is both the criminal and civil contexts can also be very effectively established by through the use of objective facts that indicate willfulness on the part of a defendant. These objective facts are commonly referred to in the tax profession as “badges of fraud”. The government has relied on the following circumstances to meet is burden of proof as to willfulness surrounding tax crimes:
- The withholding of financial information from accountants
- The keeping a safe deposit box under an assumed name
- The consist overstatement of deductions
- The claiming of excess withholding exemptions
- The claiming of false or overstated charitable deductions for property
- The false claiming of exemption from income taxes
- Leaving the United States with valuable assets in the face of or following an audit
- Engaging in a pattern of tax evasion in previous and subsequent years
- The supplying of false information to a return preparer (underreporting income or overstating deductions)
- The prematurely destroying of records
- The failure to keep adequate books or records
- The concealing assets or sources of income while in collections
- The keeping of a double set of books or records
- The handling one’s affairs so as to avoid making the usual records in transactions of the kind (excessive cash transactions)
- The failure or refusal to cooperate with, (including lying to), investigating agents
- The participation in illegal activities
- The taking of business deductions for personal expenses
- The withholding of relevant information from tax preparer
- Failing to file tax returns where a filing requirement existed
- The filing of objectively false tax returns
- The making of false journal entries or alterations to the books to lower taxable income
- The creating of false documents (such as receipts to support fictitious deductions)
- Understatement of Income
While the understatement of income in and of itself is usually insufficient to establish willfulness, a proven pattern of substantial understatement can successfully be used by the government to establish the element of willfulness.
State of Mind
When a taxpayer’s state of mind on a particular date is critical to the government’s case on willfulness, as in willful failure to file cases, the government will present evidence of events that occurred after that particular date as evidence of the taxpayer’s earlier state of mind. Both the government and the taxpayer generally can admit evidence on subsequent events for the facts that can reasonably be inferred from them. For example, evidence of a taxpayer’s previous noncompliance with the filing rules and requirements in a year immediately subsequent to the tax year or years at issue has been deemed relevant by the court’s to show the taxpayer’s willfulness and absence of mistake in filing false returns during the tax years at issue.
Education or Sophistication
Evidence concerning a taxpayer’s education or degree of sophistication has been deemed by the courts to be relevant in determining willfulness. Thus, the government will present evidence to show that a taxpayer was a professional or a sophisticated businessperson for its circumstantial effect on proving willfulness. On the other hand evidence establishing that a particular taxpayer was poorly educated or unsophisticated would tend to negate the government’s case as to willfulness.
What methods of gathering circumstantial evidence does the IRS Criminal Investigation Division commonly employ in proving a tax crime?
The strongest evidence of a taxpayer’s willfulness is typically the size of taxpayer’s tax deficiencies that can be proven to occur over a number of years. Experience has shown the Government that a greater amount of tax deficiency can usually be established by including the use of circumstantial evidence than by the use of direct evidence of omitted income alone.
Circumstantial Methods of Proof:
Net Worth Method
Under the net worth method, the taxpayer’s net worth (total assets minus total liabilities) at the end of one year is compared with his or her net worth at the end of the next year. The method calculates net income for a year by measuring the increase in net worth over a particular year which is reduced by any nontaxable sources of income received by the taxpayer such as loan proceeds or inheritances. The agent then compares the taxable income reported for the year being tested with the results of the net worth computation and thereby identifying any unexplained increase in net worth for the year tested as unreported income.
The expenditures method for uncovering omitted income is similar to the net worth method and is sometimes referred to as the cost-of-living test. This method focuses on the amount of income needed to cover the taxpayer’s identified personal expenditures for the year being tested. The agent totals all the identified personal expenditures of the taxpayer for the year tested and reduces the total by any nontaxable sources of income used to pay for the expenditures. Since one possible source of nontaxable income for the expenditures tested is wealth acquired and taxed in previous years, the agent must take into consideration all of the taxpayer’s assets and liabilities at the start of the prosecution period, in the same manner as in a net worth case. Commonly the IRS combines the net worth and personal expenditures methods to assure that its computations reflect the income used to purchase assets as well as the income used for personal expenditures.
Bank Deposits Method
Taxpayers who run Schedule C businesses and make periodic deposits to at best, a business bank account, and at worst, a commingled personal account, are typically investigated by the IRS using the bank deposits method. The agent totals deposits to all accounts (bank and brokerage) under the taxpayer’s control and then eliminates any deposits from identified nontaxable sources, such as gifts, loans, and transfers between accounts. The adjusted total of deposits is considered income. The IRS uses these methods to establish an income-producing business which allows the jury to infer how the unreported taxable income was generated. This method is also commonly used for businesses run through entities such as LLCs, S and C Corporations, and Partnerships.
Specific Item Method
Under the specific item method of proof, the government attempts to show that the taxpayer’s return at issue inaccurately reflects a specific transaction, or set of transactions, such that income is omitted, deductions are inflated or a source of income is falsified. The government is not burdened with having to prove an exact amount of unreported income to prevail but rather must prove that a substantial amount of income was unreported.
Extraordinary Criminal Investigation Division Techniques
Where appropriate, CID special agents employ surveillance, issue search warrants, implant undercover agents and utilize scientific experts to aid in a criminal investigation. For example, CID Agents have been known to go so far as to sift through a suspect’s trash to secure evidence. Note: Courts have held that a client generally has no expectation of privacy in their trash and thus are not subjected to an unreasonable search when evidence is obtained from their trash. Good defense attorneys can sometimes suppress evidence obtained by the IRS using these extraordinary techniques. In one reported case, the IRS obtained a search warrant to search a taxpayer’s real estate office and seized all the documents contained therein. At trial, none of the documents seized were allowed to be introduced because defense counsel successfully argued that the search warrant was overbroad. Defense Counsel can also exploit the detailed restrictions on the use of these extraordinary techniques as contained in the Internal Revenue Manual.
What Does a Grand Jury Do in IRS Tax Crime Prosecution?
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.
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.
What specifically are the crimes of failure to keep records or supply information and how are they punished?
FAILURE TO KEEP RECORDS
Historically, prosecutions for the willful failure to keep records or supply information are very rare. Every person or entity liable for any tax is required by law to keep records, render statements, and comply with regulations that the IRS may from time to time prescribe. Additionally, persons or entities subject to income tax are required to keep permanent books of account or records, including inventory records, sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown in income tax returns of those persons or entities. Moreover, a person or entity that prematurely disposes of accounting records kept on magnetic media is subject to the criminal penalty for failure to keep records.
FAILURE TO SUPPLY INFORMATION
The crime of failure to supply information may apply when a taxpayer files a return that is complete enough to qualify as a return but however omits required information. For example, a failure to supply information criminal charge was brought against a partnership when it filed a return that was complete except for the required balance sheet information. This action could have also be prosecuted as a felony for the filing of a false return.
This crime is a misdemeanor punishable by up to one year in prison and/or fine of up to $25,000 ($100,000 for corporations). The statute of limitations is three years.
What specifically is a failure to make a return, supply information, or pay tax? How is it punished?
Any person who willfully fails to keep records, supply information, make a return or pay tax and who is required to do so commits misdemeanor punishable by up to one year in prison and/or fine of up to $25,000 ($100,000 for corporations). The statute of limitations for failure to file returns or pay tax is six years and the limitations period for failure to keep records or supply information is three years. The statute above does not apply to a failure to pay estimated tax if there is no penalty for underpayment of estimated tax by individuals or corporations.
The statue applies to officers or employees of a corporation, members or employees of a partnership, who, in their capacity as officers, employees, or members, are under a duty to perform an act to which a violation occurs. Thus, when a corporation or partnership is under a duty to file a return and the individual responsible for the filing willfully fails to file the entity’s return, the individual may be subject to prosecution under this statute. The failure to timely file an income tax return is the most common charge brought under this statute.
FAILURE TO MAKE RETURN
To prevail in a failure to make a return case, the government is required to prove beyond a reasonable doubt that the defendant:
was required to file a return
failed to file the return within the time required by law
A taxpayer must make an honest and genuine effort to satisfy the applicable tax law, thus, even through the proper tax forms may have been filed, they may not be considered a return if sufficient information was not supplied. Failure to file a return may be proved by taxing authority testimony that a diligent search failed to discover the return in question. Willful failure to file a return does not by itself constitute an attempt to evade tax. Failure to make a return can be mitigated by making a voluntary disclosure of the failure to the IRS prior to the commencement of criminal prosecution or investigation. The IRS has historically passed on prosecuting the vast majority of taxpayers who have made proper voluntary disclosures.
What is Attempting to Evade Payment of Taxes?
Unlike an attempt to evade taxes, an attempt to evade payment of taxes does not require the existence of a tax deficiency. A tax deficiency exists when the true amount of tax due on a particular return substantially exceeds the amount shown on the original return that was previously filed. A charge of attempted evasion of payment of tax only requires that there be taxes due and owing that remain unpaid. Therefore, a charge of attempted evasion of payment of tax may be brought even when a taxpayer has filed a correct return, so that no tax deficiency exists, but subsequently takes actions with the intention of avoiding payment of the tax due on the correctly filed return by purposefully concealing income or assets during the subsequent collections process. Thus, all that is required is that the taxpayer owes tax, regardless of whether the IRS has yet assessed the taxes. Whether taxes are actually due and thus owed is a question of fact for the jury.
EVASION OF PAYMENT OF TAX – AFFIRMATIVE ACTS CONSTITUTING AN ATTEMPT
The mere failure to pay assessed taxes, even where intentional, does not constitute the crime of attempted evasion of payment of tax. Some affirmative criminal act, the likely effect of which would be to mislead or to conceal the existence of income or assets in an effort to avoid the payment of tax due and owning is required. Examples of such actions would include transferring title to assets that you own to hide their existence, conducting business under a false identity or through an undisclosed entity to conceal assets or income (frequently involving family members), fraudulently causing an employer to eliminate wage withholding, engaging in the extensive use of cash or cash structuring to avoid the $10,000 cash reporting requirement, or removing of cash and assets out of the country. On the other hand, the willful failure to pay tax, in the absence of an affirmative act, can only be punished as a misdemeanor.
What specifically is income tax evasion and how is it punished?
The Term “Income Tax Evasion” actually describes a few different types of criminal tax acts. The most well-known, Felony Income Tax Evasion, is defined as a willful attempt to evade or defeat any tax or payment of any tax and is punishable by imprisonment for up to five years and fine of up to $100,000 for individuals and up to $500,000 for corporations. The closely related charge of willful attempt to evade taxes, is by far the more commonly charged crime under the umbrella of “income tax evasion”, and is defined as an attempt to evade the government’s effort to ascertain a citizen’s tax liability or to avoid determination or assessment of the tax. Lastly, willful attempt to evade the payment of taxes, involves an attempt to evade payment of taxes that have already been determined to be due.
An individual or entity can be charged with tax evasion as to any tax imposed by the Internal Revenue Code (IRC), including income, estate, gift, employment, and excise taxes. The income tax evasion provisions were intentionally drafted in sweeping language and were designed to cast a wide net that captures a wide spectrum of criminal behavior. Moreover, since the statute applies to any “person” who attempts to evade or defeat any tax, and the term “person” in this context carries a very broad definition under the IRC, it has been interpreted by the courts to apply to attempts to evade another’s taxes as well. For example, an partner in a partnership may be convicted of attempting to evade the partnership’s taxes even though no taxes are typically paid at the partnership level. Similarly, an accountant or attorney may be convicted of attempting to evade the taxes of his or her client by preparing an intentionally fraudulent return, or an executor or surviving spouse may be convicted of attempted evasion of an estate tax liability by substantially understating the estate tax liability on an estate tax return. Finally, the attempt may apply to any intentionally fraudulent action taken to reduce a tax liability such as purposefully omitting income, overstating or claiming false deductions (such as claiming personal expenses as business expenses), or claiming overstated or false credits.
What Is Attempted Income Tax Evasion?
To make a case for a charge of attempt to evade tax, the government must prove each of the following elements of the crime beyond a reasonable doubt:
- a tax deficiency exists (a return was filed with an understated tax liability or tax was owed and no return was filed)
- the defendant engaged in an affirmative act that constituted an attempt to evade or defeat the tax
- the defendant’s affirmative act was willful
ATTEMPTED EVASION OF TAX – EXISTENCE OF TAX DEFICIENCY
For the Government to make a case for attempted evasion of tax it will be required to present proof of the existence of a tax deficiency which it will attempt to establish by arguing that there was a greater tax due and owed than the amount previously reported on the tax return at issue. To prove the existence of a deficiency in tax, the government must be able to prove that the tax that lawfully should have been imposed on the taxpayer substantially exceeds the tax that was shown on the original return, if indeed a return was ever filed. If the taxpayer never did not file a return, the government will be required to prove that the taxpayer in fact had a tax liability for the time period at issue and was thus required to file. Unlike in a civil case, the government bears the burden of proof on the existence of a deficiency and may not rely on the presumption of correctness afforded to it in civil cases on this issue. The existence of a deficiency for purposes of attempted evasion of tax is determined at the time the return is filed or if no return is filed, at the time the return was originally due.
Several factors lessen the governments burden in proving that a tax deficiency exists. A tax deficiency is not required to have been assessed by the government against the taxpayer for the taxpayer to be convicted of tax evasion and thus it is rare for there to actually be an assessment of tax before the government has concluded the criminal tax proceedings. Moreover, the government is not required to quantify the exact amount of the alleged tax deficiency. Accordingly, it is somewhat irrelevant for the government to establish with certainty that the true deficiency is greater or less than as charged. All that is required under the law is that the government prove that the alleged tax deficiency is substantial. Whether a tax deficiency is substantial is a question of fact for the jury, but case law shows that relatively small amounts have been found to be substantial. In one published case, proof of successive annual deficiencies in the amounts of $3,656, $900, and $2,209 was held by the court to be sufficient to send the case to the jury.
To establish that additional tax is due and thus a tax deficiency exists, the government will attempt to prove that income was understated or omitted, deductions were overstated or an improper credit was claimed on a previously filed return or that a return was required to be filed and was not. Even where the government is able to prove omitted items of income or overstated deductions, no deficiency exists and thus no finding of tax evasion can be proven if the taxpayer can find offsetting overstated income or understated deductions somewhere else on the return. However, the burden of producing evidence of any offsetting overstated income or understated deductions is on the defendant.
ATTEMPTED EVASION OF TAX – AFFIRMATIVE ACT
The attempt to evade tax statute has been judicially interpreted to require an affirmative act constituting the attempt to evade tax in any manner. By far the most common method of proving the affirmative act element in bringing an attempted evasion of tax charge is for the government to attempt to prove that the defendant filed a false return. This is because the filing of a false return can constitute tax evasion alone even in the absence of any other affirmative act(s). Case law has shown that even a return that is unsigned by the taxpayer can constitute an attempt to evade, as can a false return signed by a taxpayer’s agent. Moreover, a taxpayer need not file a return to be convicted of attempt to evade taxes.
The mere failure to file may, when combined with other actions, constitute an attempt to evade taxes. However, the Supreme Court has held that the mere willful failure to file a return, without more, is only a misdemeanor. The willful failure to file must be coupled with some other affirmative action or willful commission to constitute a felony attempt to evade taxes. The following are examples of affirmative acts that, coupled with a failure to file, could result in an attempted evasion charge:
- Keeping a second set of books;
- Prematurely destroying books or records
- Concealing assets or covering up sources of income
- Handling one’s affairs to avoid making the records usual in transactions of the kind (cash structuring)
- Engaging in any conduct, the likely effect of which would be to mislead or to conceal
- Making intentionally false entries, alterations, invoices, or documents
- Examples of acts that have been held by the courts to be considered attempts to evade tax:
- filing returns with knowingly incorrect social security numbers
- instructing employees not to talk to investigating agents about illegal income and advising them to inform their employer of any such contacts
- prematurely destroying books and records in the face of an examination
- intentionally ignoring relevant books and records in computing gross profit
- failing to report personal expenses paid by a corporation as income or claiming personal expenses as business deductions
- lying or intentionally misleading government investigators
- filing a false Form W-4, Employee’s Withholding Allowance Certificate to improperly reduce withholding
- willfully and knowingly filing a false return
- Intentionally concealing assets from a revenue officer that was attempting to collect tax, even though the identical assets were contemporaneously revealed to a revenue agent that was examining the taxpayer’s income tax returns
The government is not required to prove each affirmative act alleged but must only prove a single act.
ATTEMPTED EVASION OF TAX – WILLFULNESS
Willfulness, as discussed elsewhere, is typically the hardest element of a tax crime to prove and is typically proven from inferences drawn by a jury from the affirmative act(s) that formed the attempt. For example, the government could prove willfulness by presenting evidence to show that a criminal tax defendant concealed assets for the purposes of fraudulently reducing the estate tax. The very amount of the taxpayer’s allegedly evaded tax liability from prior and subsequent years is admissible in a tax evasion case to show willfulness as it bears directly on the defendant’s intention to evade and is probative as to whether the taxpayer’s actions were deliberate rather than inadvertent.
Willfulness, in the specific context of attempted tax evasion, means that a defendant must have had the intent to evade a tax that the defendant knew or belied to be owed. Other courts have defined willfulness in this context as an attempt by a defendant to defraud the government of a tax known or believed to be owed.
ATTEMPTED EVASION OF TAX – STATUTE OF LIMITATIONS
The statute of limitations for prosecution of attempted tax evasion is six years. However, the affirmative act(s) constituting evasion need not occur before or at the time the return is filed or at the time it became due which can effectively create exposure periods for evasion that can well exceed the six years following the due date or filling date of the fraudulent return at issue. Events that occur after the return is filed or due, such as lying to government agents, are commonly relied on to establish attempted evasion. The statute of limitations will also be held to start running from the last affirmative act thus a taxpayer may be prosecuted within six years of the final affirmative act constituting an attempt to evade.
The typical event starting the statute of limitations running is the filing of a false return. However, if a taxpayer, after filing a false return, commits additional affirmative acts directed at evading the same tax, usually by taking actions designed to perpetuate or cover up the fraud committed in the original false return, those additional acts will constitute attempts to evade tax and will alone extend the period for commencing a prosecution by another six years from the subsequent act. The extended statute of limitations scenario just described usually occurs when a taxpayer first files a false return and then subsequently makes false statements to IRS agents for the purpose of concealing his previously unreported income. For example, one particular court held that an indictment for tax evasion brought after the six year statute of limitation had run on the original fraudulent return was untimely and was thus dismissed but allowed a charge of attempted evasion for making false statements as to the fraudulent return to proceed.
A perhaps more relevant example would be where a taxpayer commits an affirmative act to evade tax where he fails to report income that he in turn used to open a foreign bank account, and subsequently commits additional affirmative acts when he fails to annually report his interests in the foreign accounts on form TDF 90-22.1 where his account balance exceeded $10,00
What specifically is the crime of failure to pay tax and how is it punished?
Ordinarily, when a taxpayer does not file a return or pay any tax, the government will charge for the failure to file rather than for the failure to pay. However, if a taxpayer does file a return but fails to pay the tax shown on the return, the government may charge for the failure to pay where evidence is lacking as to additional affirmative acts, such as concealment of assets in the face of collections, which would then constitute the basis for a more serious attempted evasion charge.
Under the law, tax must be paid at the time the return is required to be filed, not including extensions (the original due date of the return). Thus for example, when an individual has obtained an extension of time to file an income tax return to October 15, the tax nevertheless is due and must be paid by the original due date of April 15. However, it is possible under the law to obtain limited extensions of time to pay taxes. Moreover, the failure to pay provisions expressly apply to the willful failure to pay estimated taxes as they become due (roughly quarterly), but the statute specifies that there is no criminal liability for failure to pay estimated tax if the taxpayer is not liable for civil penalties for that failure which are calculated on the annual return.
This crime is a misdemeanor punishable by up to one year in prison and/or fine of up to $25,000 ($100,000 for corporations). The statute of limitations is six years.
What steps should a CPA take to protect him or herself where they are involved in a potential criminal tax matter?
A CPA should take necessary steps to protect any materials or documents related to services rendered related to a criminal matter. Such documents will help the taxpayer’s attorney identify potential issues and protect the CPA from any further exposure. To facilitate this, the CPA should have a document retention policy that extends the retention period to prevent inadvertent disposal or destruction of important documents. To the extent the CPA is engaged on behalf of the client through a Kovel arrangement, the CPA should look to the attorney for direction with respect to the maintenance and retention of any materials that are related to the potential criminal matter. Where the attorney does not provide the CPA with such direction, the CPA should consider taking measures to adequately label the materials, segregate the materials from other client-related materials, and adopt access restrictions as appropriate.
Having effective client acceptance policies and procedures in place is advisable when meeting with new clients. When the CPA screens or performs investigative procedures regarding a new client, the issue of potential criminal matters may be uncovered. In these cases, the CPA should take precautions to ascertain whether the potential criminal matters are indicative of the nature of the client and other potential risks that may be associated with the business relationship.
When a CPA becomes aware that a current or former client could be exposed to allegations of fraud or other criminal misconduct, the CPA should advise the taxpayer to consult with an attorney before the taxpayer takes any action. Additionally, the CPA should consider whether to withdraw from the performance of further tax (or other) services for the client and whether to continue a professional or employment relationship with the client.
If a client has obtained legal counsel for a potential criminal matter, in order to best protect the client’s rights, the CPA should work with the client’s attorney. In this regard, the CPA should avoid any unsupervised communication with IRS personnel. The nature and content of any and all information that is to be shared with the IRS once the investigation has commenced should be approved in its entirety by the client’s legal counsel.
Can a third party be liable for actions taken by corporations or other entities?
Yes, generally most tax crimes involve a taxpayer’s own tax liability but a defendant may have vicarious criminal liability (legal principle to hold liable one person for the actions of another when engaged in some form of joint or collective activity) concerning actions he or she has taken regarding another person or entity’s tax liability. Through this doctrine a corporate officer, director, or employee can possibly be accused and convicted of attempted evasion of the related corporation’s taxes and it extends to corporate tax preparers as well as attorneys. Along the same lines, 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.
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 that the act be completed. 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.
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 even may include employees who have a duty to perform and do so in a manner that constitutes a criminal violation. Of course, corporations and other legal entities may themselves be subject to prosecution for tax crimes. Corporations 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.
How can a CPA help a client avoid criminal tax prosecution?
As a preparer, the CPA can help clients avoid criminal tax prosecution by knowing the procedures that the IRS uses to prosecute taxpayers. The majority of criminal tax investigations start as regular audits of returns in which the examiner discovers possible taxpayer fraud. The Internal Revenue Manual instructs IRS personnel on how to identify indicia of fraud during routine examinations. See IRM Part 25. The IRM instructs the agent to look for signs such as taxpayer or representative procrastination, uncooperative attitude, and quick agreement to proposed audit adjustments or desire to immediately closing the case. Many other indicia of fraud, commonly called “badges of fraud” are identified in the IRM. Any one or a combination of these “badges of fraud” may then be interpreted as indicia of fraud and subject the taxpayer to a potential fraud investigation.
Once a Revenue Agent decides that there is a high indication that fraud is involved in a civil examination, they will ordinarily contact employees within the IRS called Fraud Referral Specialists. The Fraud Referral Specialist’s job is to determine whether this is solely a civil issue in a given examination, or whether the case should be referred to the Criminal Investigation Division for development for possible criminal prosecution. In the past, a Revenue Agent would suspend the audit without telling the taxpayer or the CPA the reason for the sudden and unexplained suspension. However, in 2009, the IRS changed their fraud procedures in a very quiet manner by not publicizing the change and by instituting the use of parallel criminal investigations while the civil audit is still ongoing creating a dangerous scenario for both the CPA and his or her client. The Revenue Agents are instructed not to tell the taxpayer, or his representative that a criminal investigation has started or is ongoing. These types of audits are commonly called “eggshell audits” in the Tax Controversy Representation legal community.
This change in policy obviously makes the CPA’s representation in an audit much more critical in minimizing his or her client’s criminal exposure and thus creates much more malpractice exposure for the CPA. The CPA, now, more than ever, needs to be very diligent in regards to being cognizant of the additional risks faced by his or her client in light of this policy change. CPAs should investigate for any issues in a client’s fact pattern that could turn criminal prior to the outset of a routine civil audit. If indicia of fraud is detected the CPA should advise the client of the possibility that the issue may silently turn criminal during the civil examination and advise the client to consult with a tax attorney. It is also advisable that the CPA seek the counsel of an experienced tax attorney themselves about whether or not it is a good idea to continue representation in light of all the facts of the particular case especially where the client refused to seek legal counsel.
What are voluntary disclosures and how can they work for my client?
A voluntary disclosure is a process whereby the client’s tax attorney approaches the IRS Criminal Investigation Division and acknowledges that their client has cheated in some way on their taxes and wants to remedy the situation. This is achieved by amending the previously filed fraudulent return and making payments of taxes and penalties owed in exchange for the IRS passing on criminal prosecution. 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. Voluntary disclosures typically occur in two situations:
- The taxpayer’s wrongdoing is disclosed to his attorney or accountant because he wants to set matters straight, or
- The taxpayer discloses his wrongdoing to an attorney or accountant after the IRS has personally contacted him.
The actual language of the IRS’s Voluntary Disclosure practice states: A voluntary disclosure 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.
A voluntary disclosure occurs when the communication is truthful, timely, complete, and when:
- 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;
- 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;
- The IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or
- 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).
A disclosure is timely if it is received before:
- 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;
- 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;
- The IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or
- 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).
Examples of voluntary disclosures include: 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.
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.
There are two methods of making a voluntary disclosure, loud or quiet. Quiet disclosures are achieved by sending in delinquent original or amended prior tax returns, with a check(s) in full payment through normal channels and gambling that the returns get processed without the taxpayer every hearing from the Criminal Investigation Division of the IRS because of the sheer volume of returns the taxing authority processes. However, loud disclosures should be preferred because if a taxing authority has begun an investigation prior to receipt of the “quiet” submission the “quite” disclosure will not be deemed to be voluntary and thus will not comply with its Voluntary Disclosure Practice.
To make matters exponentially worse, the amended return could potentially be viewed as a criminal admission of the amount by which the tax liability was understated on the original return. This renders the taxpayer’s effort to mitigate criminal exposure futile because the IRS can use the amended return to meet its burden of proof as to willfulness (which is by far the hardest element of its case to prove) if it decides to prosecute. Additionally there is some support for a growing government position stemming from the 2009 and 2011 Offshore Voluntary Disclosure Initiatives that a quiet disclosure does not comply with the terms of its Voluntary Disclosure Practice because a quite disclosure bypasses the required communication with the Criminal Investigation Division of the IRS and only the Criminal Investigation Division of the IRS can recommend that the taxpayer not be referred to the Justice Department for Criminal Investigation.
The most common way the government establishes the element of willfulness is to subpoena the original tax preparer, or subsequent non-attorney tax adviser, to testify regarding the client’s conversations. Many taxpayers mistakenly believe that the communication privilege they enjoy surrounding communications with their CPAs and enrolled agents can be asserted in a criminal matter. Once an attorney has been engaged, the attorney can engage an accountant to assist him in the calculation of the correct tax under a “Kovel letter” in order to bring the client’s communications with the accountant within the umbrella of the attorney client privilege.
Once a tax attorney has been consulted he or she can determine whether the client is eligible for a voluntary disclosure. The attorney will contact the IRS with the client’s information and do a “pre-check” to see if the client can enter the program. If the client is accepted in the pre-check stage the voluntary disclosure can begin. If the client is not accepted, it may mean that a criminal investigation has already begun. Upon entering the program the attorney can use the services of the CPA to amend all previous false returns and submit these with the extra income, and the penalty calculations associated with the disclosure can been submitted to the IRS.
When do tax violations turn into tax crimes?
Tax avoidance is the method of organizing a client’s finances in accord with the legal usage and interpretation of the United States tax code. As the famous quote by Judge Learned Hand accurately states, “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes.” However there can be a very fine line between legal tax avoidance, as stated by Judge Learned Hand, and illegal tax fraud or tax evasion.
Understanding the types of things that IRS agents look for when determining whether a tax crime has been committed can enable counsel to help client’s avoid serious civil or criminal tax consequences. However, it is the taxpayer who is ultimately responsible for and liable for the information that is contained in his or her tax return.
According to the Internal Revenue Manual, utilized by IRS agents, “. One who avoids tax does not conceal or misrepresent. He shapes events to reduce or eliminate tax liability and upon the happening of the events, makes a complete disclosure. Evasion, on the other hand, involves deceit, subterfuge, camouflage, concealment, some attempt to color or obscure events, or making things seem other than what they are.” This portion of the manual delineates one of the distinctions between mere tax avoidance and a tax crime. That is, one may arrange his or her affairs to minimize tax owed, but actions that are taken solely to conceal the nature of income or to conceal income solely for tax purposes likely cross the line. In short, is there a financial justification for the act beyond the minimization of tax?