TAX FRAUD

by Brett Newberry

You answer the door at your home and an agent who said he is from the IRS Criminal Investigation Division wants to ask you some questions. What should you do?

Every taxpayer should be alert to a taxpayer’s possible exposure to allegations of fraud or other criminal misconduct. The consequences to the taxpayer from conviction are generally imprisonment and substantial monetary penalties. Once a taxpayer’s actions appear potentially to constitute fraud or another crime, they should seek legal counsel with an attorney experienced and skilled in this area.

Investigations conducted by the IRS Criminal Investigation Division (CI) are generated from various sources, but the largest source is IRS civil examinations. Generally, single instances of wrongdoing will not result in criminal prosecution; rather, the government looks for multiple years of ongoing wrongful behavior before it charges a taxpayer with a crime, as opposed to civil penalties.

Part 25 of the Internal Revenue Manual gives examples of indicators of fraud that, if uncovered during an examination, can trigger a criminal investigation or the assertion of a civil fraud penalty. They include:

• Omissions of entire sources of income
• Substantial unexplained increases in net worth, especially over a period of years
• Substantial amounts of personal expenditures claimed as business expenses
• Keeping two sets of books or no books
• Amounts on return not in agreement with amounts in books
• Backdating of applications and related documents
• Assets placed in others’ names

The first indication that a taxpayer is under criminal investigation may come when an IRS special agent requests an interview with the taxpayer. A taxpayer who is interviewed before he or she has obtained representation by a criminal attorney may make incriminating statements that can later be used against him or her in a criminal prosecution.

At least one court has held that statements made by taxpayers during a civil examination can later be admitted as evidence in a criminal case, even where IRS agents fail to follow the Internal Revenue Manual’s instructions to suspend the examination and refer the case to the criminal division once a firm indication of fraud has surfaced.

CPA firms need to have effective client acceptance policies and procedures related to potential fraud. These policies and procedures should include that when a CPA screens a new client, if any potentially criminal matters come to light, the CPA should request that the prospective client engage the services of appropriate legal counsel before beginning the engagement. Screening of a client may include procedures such as background checks and other information searches that would bring to the attention of the CPA relevant information concerning the prospective client’s business and personal affairs.

The client should be aware of the need to retain legal counsel and the potential lack of protection that is provided with respect to communications between the CPA and the client. When the CPA advises the client of the need to engage legal counsel, the client should be aware that any communication made between the CPA and the client could be subject to an investigative summons or grand jury subpoena.

A taxpayer who has committed tax fraud may be able to avoid criminal liability by making a voluntary disclosure before the IRS has discovered the fraud. However, such a disclosure should be approached with caution and after obtaining the advice of legal counsel, since it can backfire and lead to criminal prosecution.

The most familiar tax offense is tax evasion under Internal Revenue Code Section 7201. Tax evasion is a felony, with a maximum sentence of five years in prison. The elements of tax evasion are (1) a deficiency in tax, (2) an affirmative act or attempted act of evasion, and (3) willfulness. An affirmative act of evasion means something more than a failure to perform a duty, such as file a return. An affirmative act of evasion is conduct that has the likely effect of misleading or concealing wrongdoing. Willfulness requires the intentional violation of a known legal duty, as opposed to a careless disregard for the truth or negligence.

Until next time,

The Business Doctor