You have heard many times that we have a voluntary tax system. So the myth goes, U.S. taxpayers voluntarily report and pay their tax liabilities because they are honest and are willing to pay this price for civilized society. The truth is that our tax system is not voluntary. The law commands that taxpayers report and pay their tax liabilities. The law doesn’t simply say that they may volunteer to report and pay in whatever amounts they think appropriate. The law provides inducements for reporting and paying. Those inducements are the penalties that apply if certain minimum reporting and paying obligations are not met. The IRS has an enforcement program designed to impose these inducements. We focus here on these penalty inducements, particularly the criminal penalty inducements.
The IRS states its policy for penalties as follows: (1) “Penalties are used to enhance voluntary compliance”; (2) “Penalties provide the Service with an important tool to achieve that goal because they enhance voluntary compliance by taxpayers”; and (3) “In order to make the most efficient use of penalties, the Service will design, administer, and evaluate penalty programs based on how those programs can most efficiently encourage voluntary compliance.”
The IRM indicates that there are over 140 separate penalty provisions. Most practitioners usually encounter in practice only a small number of the applicable penalty provisions–most importantly, the accuracy related and civil fraud penalties for income tax and estate tax which are civil tax penalties. Practitioners must, however, assume that for every command in the Code there is a penalty for failure to meet the command.
Since the goal of the tax system is compliance, the penalties are properly viewed as incentives for compliance or, alternatively, disincentives for noncompliance. The Supreme Court in a famous criminal tax case (Spies v. United States, 317 U.S. 492, 497 (1943)) said that the tax system imposes “a system of sanctions which singly or in combination were calculated to induce prompt and forthright fulfillment of every duty under the income tax law and to provide a penalty suitable to every degree of delinquency.” The criminal penalties are viewed as the punishment for conduct deemed most offensive to the tax system; the panoply of civil penalties includes conduct for which a criminal sanction is appropriate independently of the civil penalty and conduct which is deemed to not justify the independent criminal sanction.
II. Criminal Penalties.
A. Introduction – Crime and Punishment.
Three general caveats to trying to understand tax crimes, even superficially from just reading the Internal Revenue Code.
- First, although the Internal Revenue Code defines tax crimes, there are other general federal crimes (found in 18 U.S.C.) that can be deployed against people cheating on taxes; these Title 18 crimes can be charged along with or in lieu of a tax crime in the Internal Revenue Code. For example, if a taxpayer lies to an agent in an audit, that lie may be an act of tax evasion or tax obstruction (defined in §§ 7201 and 7212(a), respectively, of the Code) or it may be a false statement usually prosecuted under 18 U.S.C. § 1001. Similarly, tax crimes often involve more than one person, thus potentially constituting a conspiracy crime under 18 U.S.C. § 371. Finally, Title 31 defines certain crimes and civil penalties often encountered where tax noncompliance is involved. Specifically, Title 31 requires periodic (annual) reporting of foreign financial accounts (called FBARs, for Foreign Bank Account Reports) with civil and criminal penalties for failure to file FBARs or misreporting on the FBARs. Treasury’s Financial Crimes Enforcement Network (“FinCEN”) is the Treasury agency that enforces FBAR reporting requirements, but it has delegated its enforcement authority to the IRS.
- Second, as with crimes generally, the Code words defining the crimes are not plain language, the depth of which is plumbed just by reading the Code provision. There is a body of interpretation behind virtually every word in the definition of a tax crime. If you practice in this area, you will need to know that body of interpretation. But, in the tax crimes and other criminal contexts, the body of interpretation is necessarily constrained more to the text because these are criminal provisions designed to put the nonspecialist public at risk of criminal conviction and thus the text itself needs to be more understandable to the public than Code provisions that just affect their pocket books. Indeed, there is an interpretive doctrine known as the rule of lenity that applies to construe uncertainties in the text of federal crimes in favor of a defendant. The rule of lenity, although generally applied to crimes, or some other general rule of strict interpretation may apply in civil penalty contexts. And there is a general notion that agencies such as the IRS cannot obtain deference (such as Chevron deference) through interpretation of criminal statutes. Even that notion is not without its conceptual difficulties because Chevron does permit the IRS to interpret ambiguous civil penalty statutes and substantive provisions which then set the legal duty which, for most tax crimes, the taxpayer must intend to violate (see the discussion of willful below).
- Third, along with defining the tax crime, the Internal Revenue Code states a maximum incarceration period and a maximum fine. Those Code maximums can be misleading to those not familiar with the federal criminal justice system. Monetary penalties are now set under a provision of the general criminal Code (18 U.S.C.), and both sentencing and monetary penalties are ultimately determined to make the punishment fit the crime. A principal factor–at least a starting point–in the sentencing matrix is the now advisory Federal Sentencing Guidelines which almost always set incarceration and monetary penalties of less than the maximum provided in the Internal Revenue Code or in Title 18.
I cover here only the Internal Revenue Code provisions, the tax crimes in Title 18, the general criminal Code often deployed for tax crimes, the tax related crimes in Title 31 related to foreign accounts, the Sentencing Guidelines, and the usual trajectory for a criminal tax investigation and prosecution.
The Government does not detect most tax crimes; perhaps more counterintuitive, the Government does not prosecute most tax crimes it detects. The Government has a limited budget for investigating and prosecuting tax crimes. Throughout the United States, in any given year, on average, by latest statistics, less than 2,500 tax crimes will be prosecuted. Many of these tax crimes are prosecuted as adjuncts to prosecutions for other offenses (such as drug offenses or money laundering). So, there will be less (significantly less) than 1,000 pure tax prosecutions a year. As I hope you can appreciate, the number of tax crimes in a system involving hundreds of millions of taxpayers (consisting of individuals and entities such as corporations, partnerships and trusts) is far, far larger than these prosecution numbers would indicate. Accordingly, the government uses the limited prosecutions in a manner that will not only punish the particular offender but will send a message to other taxpayers encouraging them to do right. This collateral goal is recognized in the
U.S. Sentencing Guidelines as follows (2021 Guidelines Ch. 2, Part T, par. 1, Introductory Comment):
The criminal tax laws are designed to protect the public interest in preserving the integrity of the nation’s tax system. Criminal tax prosecutions serve to punish the violator and promote respect for the tax laws. Because of the limited number of criminal tax prosecutions relative to the estimated incidence of such violations, deterring others from violating the tax laws is a primary consideration underlying these guidelines. Recognition that the sentence for a criminal tax case will be commensurate with the gravity of the offense should act as a deterrent to would-be violators.
Because of this collateral goal, criminal tax prosecutions and particularly convictions are often publicized by the IRS and DOJ Tax Division (hereafter “DOJ Tax”). (DOJ Tax must authorize all criminal tax prosecutions; the criminal function with DOJ Tax is within the Criminal Enforcement Section (“CES”) which is discussed later; for convenience I will refer to CES as “DOJ Tax CES.”)
The IRS and DOJ Tax perceive that it is very important that it obtain convictions in a very high percentage of the cases that it brings. The goal is a 90+% conviction rate. A significantly lower conviction rate would defeat the collateral goal of encouraging other taxpayers to do right. With a lower conviction rate, taxpayers might perceive the criminal enforcement effort as a paper tiger — i.e., there is not a very high chance that the taxpayer will be detected in criminal activity in the first instance, but if he or she is detected, there is not a very high likelihood that the government will choose to prosecute, and then, if the government does choose to prosecute, there is a significant chance of acquittal. By choosing its cases carefully, and insisting upon pursuing only cases where it is virtually certain to succeed, the government can publicize the particular convictions and a high conviction rate. The government feels that, given its resources, that achieves the maximum benefit for the buck.
B. The Sentencing Guidelines.
The statutes defining the Title 26 tax crimes provide the maximum sentence and fine that can be imposed. The actual sentences are determined by 18 U.S.C. § 3553 and the U.S. Sentencing Commission’s Sentencing Guidelines (“Sentencing Guidelines”) which are easily available on the internet. Before the Sentencing Guidelines, federal judges imposed sentences and fines without any guidelines except the parameters set forth in the criminal statute itself. The Code provides a maximum sentence for tax evasion of up to 5 years. Thus, a judge could sentence from 0 to 5 years’ incarceration, with no guidance, prior to the Guidelines, as to the actual sentence. Sentencing varied depending upon a specific judge’s individual predilections, prejudices, etc. and sometimes upon regional attitudes. The Sentencing Guidelines thus note (2021 Guidelines § 2T1.1, Background):
Under pre-guidelines practice, roughly half of all tax evaders were sentenced to probation without imprisonment, while the other half received sentences that required them to serve an average prison term of twelve months. This guideline is intended to reduce disparity in sentencing for tax offenses and to somewhat increase average sentence length. As a result, the number of purely probationary sentences will be reduced. The Commission believes that any additional costs of imprisonment that may be incurred as a result of the increase in the average term of imprisonment for tax offenses are inconsequential in relation to the potential increase in revenue. According to estimates current at the time this guideline was originally developed (1987), income taxes are underpaid by approximately $90 billion annually. Guideline sentences should result in small increases in the average length of imprisonment for most tax cases that involve less than $100,000 in tax loss. The increase is expected to be somewhat larger for cases involving more taxes.
The Sentencing Guidelines create guideline ranges in months (e.g. 27-33 months) for sentencing based upon certain prescribed sentencing factors determined by the drafters, after significant review of historical sentencing practices, to be relevant to sentencing. These factors are reviewed and revised as appropriate based on experience. In a tax setting, the most important sentencing factor is the intended tax loss from the tax crime. The tax loss for sentencing purpose is that tax loss the taxpayer intended from the criminal activity. Generally, that is the portion of the tax underpayment that the taxpayer intended to evade, and, in the sentencing phase after conviction, the Government must prove that tax loss by a preponderance of the evidence. (Note that this is not necessarily the entire underpayment, for the Government may not be able to prove criminal intent as to some portion of an underpayment.) Other sentencing factors such as acceptance of responsibility may also be considered. For tax crimes, unless the tax loss number is truly very large, the incarceration periods actually imposed are significantly less than the maximums for the crimes prescribed in the Code. Since most tax prosecutions result in plea bargaining and a guilty plea to one or more counts, the major defense strategy will be to get the tax loss number to a sufficiently low amount that the guideline range will be acceptable to the taxpayer.
The Sentencing Guidelines ranges for incarceration and for fines serve as advisory guides to the sentencing judge. There are two ways the sentence can be outside the calculated guideline range. First, as recognized in the Guidelines, there can be “departures” for factors recognized in the Guidelines as bases for departures. The most prominent is providing significant cooperation to the Government, usually in further criminal investigation of other persons, which are referred to as 5K1.1 departures. Second, after consideration of the Guidelines (including departures), the judge may consider general sentencing factors in 18 U.S.C. § 3553(a) in setting the final sentence. That final sentence can be outside the Guidelines range (even with 5K1.1 departures) and, to that extent, is called a variance. If the judge sentences within the guideline range (with 5K1.1 departures), the sentence will generally not be reversed upon appeal (unless the judge articulated some improper consideration in setting the sentence or misapplied the guidelines). If, however, the judge chooses to sentence outside the Guideline range (usually below in tax cases), the judge must state the basis for the variance. (The variance process is usually called “Booker variance,” named for the major Supreme Court case recognizing the significant discretion sentencing judges have to vary. United States v. Booker, 543 U.S. 220 (2005).)
C. Return Reporting Crimes.
1. Tax Evasion – § 7201.
Section 7201 defines the felony commonly referred to as tax evasion or sometimes colloquially tax fraud–a willful attempt in any manner to defeat or evade tax. Incarceration is up to 5 years per count (per year of tax evasion).
b. Evasion of Assessment; Evasion of Payment.
Tax evasion usually occurs on a false return underreporting and thus underpaying tax liability. This is commonly referred to as evasion of assessment because by failing to report the liability, the taxpayer hopes to avoid assessment. Evasion of assessment can also occur by failing to file a return, but that type of evasion is rarely charged since Congress provided a separate criminal
penalty for the mere act of failing to file a return (§ 7203); for failure to file to be evasion, the taxpayer must commit some further affirmative act in furtherance of the evasion. Tax evasion may also occur through acts to avoid payment of tax after or in anticipation of an assessment of the tax. This is commonly referred to as evasion of payment.
c. Capstone of Tax Penalty System.
The Supreme Court has described tax evasion is the capstone of the federal system of penalties to encourage compliance with the Code. Spies v. United States, 317 U.S. 492, 497 (1943). Tax evasion carries the highest nominal sentence (5 years) and nominal monetary fines ($100,000 for individuals and $500,000 for corporations). (I say nominal because, as I note above, the actual maximum fine is stated elsewhere in Title 18 and, in any event, the sentence is likely to be a lot less except where the tax loss is quite large.)
d. Elements of the Crime.
As interpreted, a traditional formulation of the elements of tax evasion is: (1) a substantial tax evaded (other formulations being tax due and owing and tax deficiency); (2) willfulness (being an intent to evade payment); and (3) some affirmative act (however minimal) in furtherance of the intent. I offer some short comments on the key interpretations of these elements. (For the other crimes discussed below, I will just offer a short statement of the elements, but here offer more elaboration for tax evasion in order to introduce some of the key concepts.)
(1) Substantial Tax Evaded.
A substantial tax must have been evaded. The statute does not use the word “substantial” or any similar word. Courts thus sometimes state that substantial tax evaded is not required. Nevertheless, a substantial tax is present in every tax evasion prosecution because DOJ Tax CES authorizes prosecution only in the egregious cases where a significant sentence can be expected which is driven by the tax loss; if the tax loss is not substantial, the sentence will be light and hardly serve the deterrence purpose of the crime. In any event, the general feeling is that a jury is not likely to convict unless the tax evaded is substantial.
Tax evaded is not the same concept as tax deficiency which is a civil tax concept describing the difference between the civil tax amount owed and the amount the taxpayer reported. Example, taxpayer owes $100,000 in his civil tax deficiency amount, with (i) $75,000 being the evaded tax because the taxpayer intentionally (willfully) omitted $250,000 from his return and (ii) $25,000 being tax on a merger that technically failed the merger rules without any intent to evade tax. The evaded tax amount is $75,000 (and that is the amount used for the element for tax evasion and for the tax loss for sentencing purposes). This evaded tax number is also referred to as the “criminal tax number,” but keep in mind that it is just the tax due that the taxpayer intended to evade. (Despite the fact that the tax evaded is not the same as the civil tax deficiency, courts (including the Supreme Court) will often refer to this element as the tax deficiency.)
In proving this element of the crime, the Government will drop off all questionable items, leaving only the most egregious for proof in the criminal case. Then in a later civil proceeding, the IRS will assert the larger actual tax deficiency.
Note that the tax evaded element incorporates the mens rea element of the crime, although the mens rea element is stated as the separate element of willfulness.
Willfulness is a term of art and constitutes an element for most Title 26 tax crimes. In tax crimes where willfulness is an element, the thoroughness of the pretrial work will permit the Government to prove the other more objective elements of the crime with relative ease, so that often the issue that controls guilt or innocence is willfulness. Normally, in U.S. law, a defendant can be guilty of a crime simply by intentionally doing the act that constitutes the crime; the defendant need not know that the conduct constitutes a crime. The Supreme Court has said that this traditional rule does not apply in tax crimes because of the “willfully” element. The standard formulation is that willfully means a “voluntary, intentional violation of a known legal duty.” Cheek v. United States, 498 U.S. 192, 201 (1991).
Willfulness incorporates the concept that (i) the legal duty be knowable in some objective sense and (ii) that the taxpayer knew the legal duty. The Cheek definition certainly incorporates the latter; the jury makes that determination. The first part–that the law be knowable–is a legal determination made by the court rather than the jury. If the court determines that the state of the law at the time of the conduct was sufficiently uncertain that it did not give taxpayers clear instructions as to the legal duty, then the prosecution will be dismissed without ever getting to the second part (the taxpayer’s actual state of mind). James v. United States, 366 U.S. 213 (1961).
This willfulness element is explicit in most Title 26 crimes and other crimes deployed in the tax area. Even when not explicit, the crimes deployed in the tax area have elements that, as interpreted and applied in a tax setting, approach the willfulness element. So, willfulness is probably the most critical feature of the crimes deployed in the tax area.
I noted above that the willfulness element, although separately stated, is necessary to determine the evaded tax element. And it is also necessary to determine the affirmative act element to which I now turn.
(3) Affirmative Act of Evasion.
The statute requires “attempts in any manner to evade or defeat any tax.” The Supreme Court held that this requires an affirmative act to evade. Spies v. United States, 317 U.S. 492, 499 (1943).
By way of illustration, and not by way of limitation, we would think affirmative willful attempt may be inferred from conduct such as keeping a double set of books,
making false entries or alterations, or false invoices or documents, destruction of books or records, concealment of assets or covering up sources of income, handling of one’s affairs to avoid making the records usual in transactions of the kind, and any conduct, the likely effect of which would be to mislead or to conceal. If the tax-evasion motive plays any part in such conduct, the offense may be made out even though the conduct may also serve other purposes such as concealment of other crime.
Note the overlap of the willfulness element – “if the affirmative act element is satisfied, there is no question that willfulness is present.” United States v. Romano, 938 F.2d 1569, 1572 (2d Cir. 1991).
2. False Return (Tax Perjury) – § 7206(1).
Section 7206(1) imposes a felony criminal penalty for willfully making a material false statement on return or other document filed with the IRS under penalty of perjury. The elements of the crime are: (1) a return signed under penalty of perjury; (2) a false statement in the return; (3) the defendant knew the statement was false; (4) the statement was material; and (5) the defendant made the statement willfully with intent to violate a known legal duty.
The commonly encountered tax returns (income and estate and gift) are filed under penalties of perjury. There is no requirement, as in tax evasion, that there be an understatement of tax liability. Indeed, the tax liability can be correctly stated and even overstated and the tax fully paid or overpaid; the taxpayer can still be guilty of this crime if he or she made material misstatements on the return. For example, a drug dealer improperly stating on his Schedule C that his business is a retail clothing business can be found guilty for that reason alone. Perhaps I overstate the importance of the absence of tax evaded as an element of the crime because, if indeed there is no tax evaded, the IRS will usually not devote the substantial systemic resources (investigation, prosecution, trial, sentencing, incarceration), particularly where for a pure tax crime the Sentencing Guidelines would likely produce no incarceration time and thus would send a weak signal (at best) to others about not cheating on their taxes.
A material false statement is basically any statement that could mislead the IRS as to whether it should audit or in the event it did audit. This is basically any statement required by the return. For example, a taxpayer improperly answering the question on Schedule B of the Form 1040 (individual tax return) as to signatory authority over foreign bank accounts can be found guilty for that reason alone, even though no additional tax is due.
Because of the jurat, false statements on a return also are within the ambit of the general federal perjury crime, 18 U.S.C. § 1621. Such false statements on tax returns are, however, prosecuted under either § 7201 or § 7206(1) rather than under 18 U.S.C. § 1621, because they are the more specific provisions Congress intended to apply to tax return false statements. It is interesting to note that the general federal perjury statute imposes a 5 year maximum sentence whereas § 7206(1), tax perjury, imposes a 3 year maximum sentence. One could infer that § 7206(1)
evidences a legislative determination that tax perjury is only 60% as damaging to society than is perjury in the setting of other sworn testimony. By similar analysis, tax perjury could be viewed as only 60% as harmful as tax evasion.
Finally, although not a textual element of the crime, the crime only applies to a document signed under penalties of perjury that is actually filed with the IRS.
3. Aiding or Assisting – § 7206(2).
Section 7206(2) provides a felony criminal penalty for aiding or assisting in the preparation or presentation of a false return or tax relevant document. The elements of the crime are: (1) the defendant aided or assisted in preparation of a return or other document; (2) the document contains a false statement; (3) the defendant knew the statement in the document was false; (4) the false statement was material; and (5) the defendant aided or assisted in the preparation of or presentation of the document to the IRS.
This penalty is aimed primarily at tax return preparers but can hit others such as tax shelter promoters or corporate officers assisting a corporation in filing false returns or documents. There is no requirement that the taxpayer be a co-conspirator or even be aware of the crime. The Code’s maximum sentence for aiding and assisting is 3 years.
This felony is not the same as the general aiding and abetting crime under 18 U.S.C. § 2(a). Traditionally, aiding and abetting required a criminally culpable principal offender being aided and abetted; the principal offender was not required to be prosecuted, but there must have been a criminally culpable principal offender. Section 7206(2) permits the prosecution of a return preparer or other persons assisting some way in a false return even if the taxpayer involved is wholly innocent. Although it is not uncommon for courts to refer to § 7206(2) as an aiding and abetting provision, I hope my students will be a little more discriminating in description–aiding and assisting is the proper description.
4. Failure to File Return – § 7203.
Section 7203 provides a misdemeanor criminal penalty (imprisonment up to 1 year) for willful failure to file a return. The elements of the crime are: (1) the defendant was required to file a return; (2) the defendant failed to file a return; and (3) in failing to file, the defendant acted willfully, with intent to violate a known legal duty.
This act is complete on the date the return is due (either the original due date or the extended due date if an extension was obtained). Filing a delinquent return does not cure the criminal problem from a technical legal standpoint. (From a practical standpoint, filing delinquent returns before the IRS starts its investigation will generally cure the problem under the voluntary disclosure policy discussed below.)
As you can see, the crime of failure to file is significantly less serious in terms of the defined Code penalties than the crimes discussed earlier (tax fraud and tax perjury which are felonies carrying incarceration of up to five and three years, respectively). During the pre-Guidelines period when I first entered private practice, I heard that the difference between a tax-cheat doctor (who presumably was not aware of this difference) and a tax-cheat lawyer (who presumably was aware) was that the doctor filed a fraudulent return and the lawyer filed no return. This is just lore and probably not supported by empirical data, but those who practice in this area do know that there seem to be a lot of lawyers who fail to file returns. (The Sentencing Guidelines now lessen the difference between these crimes significantly, but precisely how that happens is beyond the scope of this course.)
There is one critical deviation in the misdemeanor status for failure to file. Section 6050I requires trades or businesses receiving more than $10,000 in cash one or a series of related transactions to report the transaction to the IRS on a currency transaction report (“CTR”). The reporting requirement applies to cash and certain types of cash equivalents (such as foreign currency and certain monetary instruments). Willful failure to file the § 6050I return is a felony punishable by 5 years’ incarceration.
Finally, in a Treasury Inspector General Report dated 3/6/23, the TIG recommended that the IRS recommend to Treasury’s Office of Tax Policy that it propose to Congress that § 7203 be amended to make failure to file a felony with a two-year maximum penalty. The IRS agreed to do so. But, so far as I am aware, there is no indication as to how much traction this will get at Treasury or in Congress.
D. Tax Administration Crimes.
1. Tax Evasion – § 7201.
As noted above, § 7201 is generally applied to fraudulent returns. However, it may apply also to fraudulent attempts to evade assessment or payment during the course of an IRS examination or investigation.
2. Concealing Assets – § 7206(4).
Section 7206(4) imposes a felony penalty upon acts designed to conceal assets upon which levy may be made to pay a tax with intent to evade or defeat payment. The acts covered by this provision would commonly be affirmative acts of evasion of payment and thus, are more commonly prosecuted under § 7201, tax evasion.
3. Impeding Administration (Including Conspiracy) – § 7212(a) and 18 U.S.C. 371.
There are two criminal provisions that are deployed to the crime generally described as impairing on impeding the lawful functions of a government agency, including the IRS. These are 7212(a) and 18 U.S.C. § 371 (which also describes a specific offense conspiracy in addition to the conspiracy to impair or impede the government agency).
a. § 7212(a).
Section 7212(a) defines as a felony obstructing or impeding the administration of the tax laws either corruptly or by force or threats. This is often referred to as the “Omnibus Clause.” The conduct potentially within the scope of the provision is limited only by the imaginations of persons having a motive to impede. Some examples are filing unwarranted liens against IRS agent’s homes in the local real property records, filing unwarranted criminal complaints against IRS officials, and sending phony 1099s to IRS officials reporting that they received payments that they did not in fact receive. Actions within the scope of the Omnibus Clause might otherwise be legal except that they have no basis in fact and are designed to impede or harass the IRS from doing its job or from doing it efficiently. These actions are often employed by tax protestors. Mere harassment of an agent, if not done to obtain improper advantage, is not within the scope of the provision. One court thus said that:
[T] here is no reason to presume that every annoyance or impeding of an IRS agent is done per se “corruptly.” A disgruntled taxpayer may annoy a revenue agent with no intent to gain any advantage or benefit other than the satisfaction of annoying the agent. Such actions by taxpayers are not to be condoned, but neither are they “corrupt” under Section 7212(a).
Practitioners and courts have expressed concern regarding the potential sweep of this provision and its potential overlap with more specifically targeted tax crimes. Reacting to potential concerns of overbreadth, in 2018 In 2018, in Marinello v. United States, 584 U.S. , 138 S. Ct. 1101 (2018), the Supreme Court reacted to these concerns and held that the tax obstruction crime requires:
- A nexus to an administrative proceeding: “a ‘nexus’ between the defendant’s conduct and a particular administrative proceeding, such as an investigation, an audit, or other targeted administrative action. That nexus requires a ‘relationship in time, causation, or logic with the [administrative] proceeding.’”
- A pending or reasonably foreseeable proceeding: “the [administrative] proceeding was pending at the time the defendant engaged in the obstructive conduct or, at the least, was then reasonably foreseeable by the defendant.”
b. 18 U.S.C.§ 371.
Conspiracy is defined in 18 U.S.C. § 371 as two categories of conspiratorial conduct–(i) a conspiracy to commit an offense (the offense conspiracy, such as a conspiracy to commit tax evasion) and (ii) a conspiracy to impair or impede the lawful functioning of a Government agency (a defraud conspiracy, in this context, the IRS, often referred to as a Klein conspiracy). Conspiracy is a common charge in federal criminal cases, particularly in tax cases. The Klein conspiracy substantially overlaps with the tax obstruction crime, § 7212(a), discussed above, except that the Klein conspiracy requires more than one culpable actor and does not require a nexus to an administrative proceeding. Conspiracy is a common charge in federal criminal cases.
The Klein conspiracy is often charged in tax cases. The reason is that the proof requirements may be less onerous to the Government than for the offense conspiracy in a tax crimes setting. Another benefit of the Klein conspiracy is that, certainly in the case of larger conspiracies with more tax dollars involved, it offers the Government an opportunity to lard up the indictment with all sorts of salacious conduct (called “overt acts” in conspiracy parlance) and then put on all sorts of evidence at trial that might not be relevant to a more targeted substantive offense.
4. Willful Failure to Collect and Pay Over Trust Fund Taxes – § 7202.
The Code imposes a duty on employers to withhold from the pay to employees certain tax that employees are required to pay (withholding on employees’ remuneration; employee’s share of FICA and the like). These are called “Trust Fund” taxes because the employer becomes the agent of the IRS to collect from the employees’ remuneration and pay the withheld amounts over to the IRS. The trust fund taxes and the employers’ role in collecting them is critical to the IRS revenue stream. Failure to withhold and pay over can subject those individuals responsible for the failure to both civil and criminal liability. The civil liability is found in § 6672, often referred to as the Trust Fund Recovery Penalty (“TFRP”). (Technically, the civil liability may not be a penalty in the traditional sense of penalty because it is simply a mechanism to collect the Trust Fund taxes.) The criminal liability–a penalty–is found in § 7202, which provides a five year maximum sentence. In this sense, Congress has determined that this penalty is the same in seriousness to tax evasion, also a maximum five year sentence. The elements of the crime are: (1) failure to “collect, account for, and pay over any tax imposed by this title,” and (2) willfulness with respect to the failure. Prosecutions under this provision have become prominent in the overall prosecutions for tax crimes.
5. False Statements – 18 U.S.C. § 1001.
I noted above that the Code itself contains provisions for tax perjury and for aiders and assisters in filing false documents with the IRS. These usually come into play in connection with the filing of a return or submitting documents to the IRS. During the course of an investigation, however, the taxpayer or his representative or even a third party may make misleading oral statements to the IRS.
Title 18 U.S.C., § 1001 punishes any false statement made to a federal officer within the scope of his or her responsibility as a federal officer. This is not a tax specific crime–it can apply to false statements to any federal government officer. The crime is a felony, with up to five years’ incarceration. There is no requirement that the person making the statement be under oath (in the criminal law parlance, a false statement under oath is not an element of the § 1001 offense). Making false statements under oath is the separate offense of perjury and , if made on a tax return, is a separate offense of tax perjury under § 7206(1). The § 1001 offense is basically the same as perjury, but perjury requires that the statement be made under oath whereas § 1001 does not require an oath. Furthermore, whereas literal truth under oath is a defense to perjury even if the testimony is highly misleading, literally true but misleading statements may violate § 1001. In a tax setting, this offense is often charged for false statements during an IRS audit or IRS collection activity.
In addition to being independently prosecutable, a false statement during an audit can refresh the statute of limitations for tax evasion that otherwise would be triggered by the filing of the fraudulent return or can be charged as an overt act in a conspiracy.
E. Miscellaneous Tax-Related Crimes.
1. General – Myriad of Other Tax Related Crimes.
The foregoing are the principal tax crimes that you will see in your practice. There are, however, a host of other crimes in the Code and crimes in Title 18 and even other Titles that overlap or are frequent traveling companions with tax crimes. I discuss below only the significant ones you will see.
2. Offense Conspiracy.
As noted above, conspiracy is defined in 18 U.S.C. § 371 as two categories of conspiratorial conduct–(I) a conspiracy to commit an offense (the offense conspiracy, such as a conspiracy to commit tax evasion) and (ii) a conspiracy to impair or impede the lawful functioning of a Government agency (a defraud conspiracy, in this context, the IRS, often referred to as a Klein conspiracy). I discuss the Klein conspiracy above in connection with § 7212(a), tax obstruction. I mention here the offense conspiracy which is a conspiracy to commit an offense otherwise describe in the law. For example, there can be a conspiracy to commit tax evasion. I discuss the principal substantive offenses above. Offense conspiracies charged in tax cases include those provisions,
3. Money Laundering – 18 U.S.C. §§ 1956 & 1957 (Herein Also of Wire Fraud).
You will often also see money laundering charges traveling with tax crimes charges. Money laundering is beyond the scope of this book. These provisions are quite sweeping and generally impose stiff penalties on the attempt to use financial institutions or monetary instruments to further serious crimes or cleanse the fruits of serious crimes. The Government usually fields these
provisions to attack drug trafficking, organized crime and other major national criminal enforcement priorities. However, because of their sweep, the money laundering laws potentially apply in many other situations of lesser criminality and the Government will use them if it feels that other crimes it might charge are not adequate to punish the gravity of the overall criminal conduct.
Mail fraud or wire fraud (28 U.S.C. §§ 1341 and 1343) can be a predicate act for the money laundering crime. This type of fraud criminalizes use of mail and wires to commit fraud. Mail fraud or wire fraud (or both) is probably present in most tax crimes. Tax evasion or tax perjury by false return certainly will involve mail fraud or wire fraud. Conduct required for tax obstruction or Klein conspiracy will almost always in some way implicate mail or wires. Where the gravamen of the criminal conduct is, at core, a tax crime, DOJ Tax will generally approve charging the tax crime only and will not approve charging the mail fraud or wire fraud. The purpose of this general limitation is to charge the tax specific crime if that is the gravamen of the conduct. One other salutary benefit is that Government attorneys will not bootstrap a money laundering charge from a wire or mail fraud claim for conduct that is essentially a tax crime when Congress chose not to make the tax crime a predicate offense to money laundering.
4. FBAR Violations (31 U.S.C. § 5324; 18 U.S.C. § 1001).
U.S. persons with a financial interest in or signatory authority over foreign bank accounts are required to file a Foreign Bank Account Report (“FBAR”), FinCEN Form 114. Although the FBAR has other law enforcement objectives (such as money laundering and criminal activity behind money laundering), one objective is to identify and assure that income arising from or related to foreign accounts (including income activity producing proceeds deposited into foreign accounts) is properly reported and taxed in the U.S. There are civil and criminal penalties for failure to meet the FBAR requirement. The criminal penalty for failure to file an FBAR is 5 years. 31 U.S.C. § 5322. The criminal penalty does require willfulness in the Cheek sense noted above. Although not certain, the most likely criminal penalty for filing a false FBAR is 5 years, may be under § 5322 or under some other appropriate statute, most likely, 18 U.S.C. § 1001, false statements, which is discussed above.
There are significant civil penalties for FBAR violations. The categories of penalty are (i) willful and (ii) nonwillful.
Willful civil penalties, calculated per unreported account, are the greater of $100,000 or 50% of the amount in the account on the reporting date usually the return filing date. The willful penalties can apply, at least in theory, each year for each account. Thus for example, assume a static $1,000,000 in single overseas account, the penalty can be $500,000 per year with a six year statute of limitations. The Internal Revenue Manual has mitigations for the penalty that, generally speaking, limit the penalty to an amount equaling 50% of the high year amount.
The nonwillful civil penalties are $10,000 per annual form, regardless of the number of accounts or the amounts in the unreported accounts. Bittner v. United States, 598 U. S. (2/28/2023).
5. Some Other Representative Crimes.
In the employment context, there are failure to file criminal penalties for employers who fail to file information returns such as W-2’s and for employees who claim too many exemptions so as to improperly lower the amount of withholding.
There are numerous other criminal penalties which I cannot cover here. Suffice it to say that wherever you find an important civil tax obligation in the Code there will usually be some type of criminal penalty to give the persons subject to the obligation some incentive to comply “voluntarily.”
F. Voluntary Disclosure.
1. The General Voluntary Disclosure Programs.
a. General Description of the Programs.
The Government has a voluntary disclosure program that permits a taxpayer to avoid the criminal prosecution risk for tax noncompliance. In general terms, the program gives some assurance against criminal prosecution to a taxpayer who voluntarily reports his or her wrongdoing before coming into the criminal cross-hairs of the IRS. The IRS and DOJ Tax CES have each had some form of voluntary disclosure program for a long time. The nuances of the programs may change from time to time, but the broad outlines have been relatively stable.
The general parameters of the program in its various iterations over the years is: where the taxpayer who has committed or has possibly committed a tax crime related to a filed return or a failure to file and the IRS has not yet commenced a criminal investigation or, possibly even a civil tax audit, the taxpayer may be able to cure the criminal prosecution risk by making a “voluntary disclosure.” When a disclosure qualifies under the policy, the IRS exercises its discretion not to refer the case to DOJ Tax CES for further investigation or prosecution. The taxpayer is protected only from criminal problems; he or she is not insulated from civil taxes, penalties and interest. The policy thus operates as a form of administrative amnesty. If for some reason, DOJ Tax CES were to consider prosecuting a taxpayer who made a voluntary disclosure, it will consider the voluntary disclosure and compliance with the IRS program as a significant factor weighing against prosecution. (I discuss this in more detail below.)
The voluntary disclosure program reflects practical and fiscal imperatives. The practical imperative is that, in tax cases, a jury will often be less likely to convict where the taxpayer has corrected the criminal conduct by voluntarily filing an amended return or delinquent original return. The fiscal imperative–probably more important to the existence of the program–is that it is “win-win” as a revenue measure. A voluntary disclosure policy will generate significant additional revenue for the Government since the IRS would not have discovered or, if discovered, would not have prosecuted most of the taxpayers who voluntarily disclose under the policy. There are still plenty of taxpayers to prosecute who have not gotten right with the Government for the Government
to meet its criminal tax enforcement needs, so the additional revenue generated by the voluntary disclosure policy is a “freebie” for the Government. The Government gives up nothing of systemic importance and gets a material amount of revenue that, but for the policy, it would never get.
The key caveat here is that the disclosure must be voluntary and must be complete. In order to avoid fact intensive queries about what precisely is motivating the taxpayer to make a disclosure, the IRS has some rules that disqualify the taxpayer based on the “timeliness” of the disclosure. The key timeliness condition is that a disclosure after a civil or criminal investigation has started is not timely.
The foregoing are the general rules of the voluntary disclosure policy. It is more detailed, and the nuances with respect to the policy shift from time to time. Still, a taxpayer having a potential criminal problem on the original return or having failed to file a return should consider voluntary disclosure, even if the circumstances might suggest that the disclosure is not really voluntary (e.g., even if the spouse waging a nasty divorce has threatened to turn him in).
Within these broad parameters, there are actually two voluntary disclosure programs. The IRS has one, and DOJ Tax CES, which prosecutes all tax crimes, has one. The two substantially overlap, but from time to time there may be differences. The important point, however, is that if you fail to qualify for the IRS’s policy and the IRS forwards the case to DOJ Tax CES with a recommendation for criminal prosecution, the taxpayer may have another bite at this apple.
b. IRS Voluntary Disclosure Policy.
(1) The “Practice.”
The IRM states the IRS’s voluntary disclosure “practice” (in the past often referred to as a “policy”). IRM 126.96.36.199 (09-17-20), Voluntary Disclosure Practice. In relevant part, the key features of this practice are:
- “This voluntary disclosure practice creates no substantive or procedural rights for taxpayers,”
- “A voluntary disclosure will be considered along with all other factors in determining whether criminal prosecution will be recommended. A voluntary disclosure does not guarantee immunity from prosecution.”
- VDP is “is not available to taxpayers with illegal source income.”
- The disclosure must be “truthful, timely, complete” and include full cooperation and, if possible, payment of the tax, penalties and interest.
Voluntary disclosure is virtually daily grist of the tax crimes practitioner’s mill. It is important to consult the IRM early and often because certain features of the practice may change. The changes are often in nuance only. And you need to understand that the wording of the policy is fraught with words of art that are not explained, except perhaps by inference to the experienced
practitioner. In other words, the direct audience for the IRM is IRS personnel who, presumably, will know the terms of art (or have access to interpreters for the nuances). Practitioners need some experience or interpreters to understand the terms of art. I introduce below some of the major issues, but caution–or access to interpreters–is critical.
(2) How Is Disclosure Made?
(a) The “Quiet Disclosure.”
Prior to the foreign financial account brouhaha starting in 2009 and the special voluntary disclosure programs for foreign financial account noncompliance, the method most commonly used for implementing a voluntary disclosure was to file the amended return(s) or delinquent original return(s) by mailing them to the Service Center. If possible, the taxpayer will include with the amended return(s) or delinquent original return(s) a check or checks for the taxes and interest. The amended return may have some explanation of the reason for the amendment in the hope that the IRS will not assert a civil penalty or will assert a lesser civil penalty; some may also include a reference to voluntary disclosure either in a cover letter or somewhere in the attachments to the amended return. Care should be taken, however, that in attempting to avoid or lessen a penalty, the taxpayer not make erroneous or misleading statements as to the reason for the earlier erroneous return. This form of disclosure is referred to as a “quiet” voluntary disclosure. This type of quiet disclosure does not result in the IRS giving any affirmative assurance of qualification for the voluntary disclosure policy.
A major issue is whether the IRS or DOJ Tax would consider a quiet disclosure to be a qualified voluntary disclosure for avoiding criminal prosecution exposure. The IRS has never formally blessed quiet disclosures and has occasionally noised, particularly in the foreign bank account area, that quiet disclosures do not qualify. The IRS formal line has been that only the “noisy disclosure” qualifies. I think that most practitioners believe that, for run of the mine tax noncompliance without significant features of egregious culpability, the full and complete quiet disclosure with subsequent full cooperation as requested by the IRS will serve to avoid criminal prosecution. This is based on criminal practitioner understanding of how the IRS and DOJ Tax apply criminal tax enforcement priorities but the risk is that that understanding may not be perfect and certainly does not bind the IRS or DOJ Tax. Given the inherent uncertainty of the quiet disclosure to mitigate the criminal prosecution risk, except in more benign cases of criminal culpability, the noisy disclosure procedure should be followed. (Further mitigating in favor of the noisy disclosure is that the quiet disclosure runs more risk of greater civil penalties than offered under the noisy disclosure.)
(b) Noisy Disclosures.
In more sensitive cases (for example, where an unusually large amount of additional tax is due), the taxpayer is concerned about some disqualifying event, or the taxpayer wants some
affirmative assurance from the IRS), the taxpayer’s counsel will recommend a “noisy disclosure.” The current IRS requirement if for the taxpayer to file Form 14457 Voluntary Disclosure Practice Preclearance Request and Application (February 2022). The Form requires the taxpayer to supply certain predicate information about the noncompliance in Part 1, titled Preclearance Request; if the preclearance request is granted, the taxpayer completes Part II, titled Voluntary Disclosure with considerably more detail than provided in Part I, including particularly a noncompliance narrative explaining the noncompliance and a disclosure of professional advisors assisting in the noncompliance.
(c) DOJ Tax Disclosure Policy.
Historically, DOJ Tax has had a voluntary disclosure policy that varied–at least in some of its nuances–from the IRS voluntary disclosure policy. See DOJ Criminal Tax Manual (“CTM”) 4.01 Policy Respecting Voluntary Disclosure. Key features of this policy are:
- The voluntary disclosure is considered “along with all other factors in the case in determining whether to pursue criminal prosecution”
- “If a putative criminal defendant has complied in all respects with all of the requirements of the Internal Revenue Service’s voluntary disclosure practice, the Tax Division may consider that factor in its exercise of prosecutorial discretion. It will consider, inter alia, the timeliness of the voluntary disclosure, what prompted the person to make the disclosure, and whether the person fully and truthfully cooperated with the government by paying past tax liabilities, complying with subsequent tax obligations, and assisting in the prosecution of other persons involved in the crime.”
Practitioners view this as bringing the DOJ Tax voluntary disclosure practice substantially in line with the IRS voluntary disclosure practice. But the wording does suggest that DOJ Tax might prosecute even if the taxpayer has made a voluntary disclosure that the IRS would view as consistent with its practice–which in turn the IRS views as consistent with its mission to enforce and administer the tax laws. This raises the issue of whether DOJ Tax would or could prosecute when the IRS says that prosecution is not consistent with its administration of the tax laws. That is a big and potentially distractive issue, so I forego it now.
c. Does the Voluntary Disclosure Practice Confer Rights?
Both the IRM and the CTM specifically state that the practice or policy confers no rights on taxpayers. What does this mean? Basically, it means that the IRS will not be second-guessed in its application of the practice by a court. In other words, its serves to caution taxpayers that the Caceres doctrine (which says that provisions of the IRM do not confer rights on the taxpayer) applies to the voluntary disclosure practice. So, you might ask, why should a taxpayer do a voluntary disclosure if he or she has no assurance that he or she will not be criminally prosecuted? The answer to that is that the IRS is not stupid, so it does a pretty good job of policing its application of the practice. The voluntary disclosure practice is win-win for the IRS. If it were to prosecute one or more taxpayers
who actually met or were perceived to have met the conditions for voluntary disclosure, it would cost the IRS far more that it could ever hope to gain, because voluntary disclosures would dry up.
Of course, there are cases where taxpayers have asserted that they met the conditions for prosecution and that, therefore, the Government should not be able to prosecute them. What you will find when you scratch the surface of those cases is that the taxpayers involved did not meet the conditions for voluntary disclosure and otherwise behaved in a manner inconsistent with the requirement that to cooperate completely.
d. Special Voluntary Disclosure Initiatives.
The IRS may initiate special voluntary disclosure initiatives from time to time. I mention here the prominent ones in the past.
(1) Foreign Account Initiatives.
I only summarize the broad noncompliance voluntary disclosures because they were in the past and not likely helpful a tax procedure course for law students whose practices are in the future. The IRS has had two broad programs for voluntary disclosures related foreign account noncompliance through tax have jurisdictions. First, in the 1990s, the IRS offered programs for disclosing offshore accounts. Second, beginning with a whistleblower disclosing Swiss Banks using their accounts to assist U.S. taxpayer evade tax, the IRS started a voluntary disclosure program that changed slightly after 2009 and was variously called Offshore Voluntary Disclosure Program (“OVDP”) or Offshore Voluntary Disclosure Initiative (“OVDI”). This disclosure program would resolve criminal exposure for both tax and FBAR crimes and require paying tax, a penalty and interest for a certain number of back years.
These programs no longer exist. Foreign account noncompliance voluntary is pursued through the regular VDP.
(2) Tax Shelter Initiatives.
Like tax havens, abusive tax shelters seem to have been a plague on the tax system for years. I offer the following definition of tax shelters. In the past, for many widely promoted tax shelters, the IRS has often had settlement guidelines to permit taxpayers to settle the cases before definitive litigation on a basis less than worst case. Often, some of the penalties otherwise applicable might be reduced or avoided. These initiatives were designed to clear out civil audits or cases otherwise in the pipeline. The IRS then began offering voluntary disclosure initiatives designed to have taxpayers volunteer the tax shelters by offering penalty mitigation without explicit assurance of no prosecution.
In the early 2000s after a wave of abusive tax shelters, the IRS announced initiatives as to particular highly marketed shelters permitting taxpayers to limit their risk by voluntary disclosure.
These initiatives usually facially offered relief only with respect to the taxpayer’s civil exposure (principally because the complexity of the shelters and the presences of “opinions” for major tax firms criminal prosecution would be unlikely). But, in situations where the opinions were mere window dressing which the taxpayer really did not believe (often with the assistance of his own independent counsel), careful practitioners would at least be concerned that there might criminal investigation or prosecution. The general thinking is that, in the unlikely event the taxpayer’s conduct might otherwise be potentially subject to criminal prosecution, participation in the program with full disclosure will avoid the criminal problem.
G. Statutes of Limitation.
The statutes of limitations for criminal prosecutions for tax crimes are provided in § 6531. For the crimes I expect you to know (the crimes discussed in these materials), the statute is 6 years from the last act. For tax evasion and false returns, it is six years from the date the false return was filed, although it is possible some subsequent act in furtherance of the criminal conduct will “refresh” the statute of limitations. For example, if a false return is filed and, during the audit, the taxpayer makes false statements in order to cover up the fraud, the new false statements will start the statute of limitations on § 7201 running from that date. Note in this example, that the misrepresentation in the audit could be viewed as tax evasion (covering up the original evasion) or simply as a false statement to a government agent punishable under the false statement provisions of 18 U.S.C. § 1001.
If the crime is tax related, but not defined in the Internal Revenue Code, the statute of limitations will usually be provided in the Code defining the crime. For example, for false statements under 18 U.S.C. § 1001 the statute of limitations is 5 years. There is one significant exception. Section 371 of Title 18 defines the conspiracy crime that applies in tax cases, meaning that the general 5 year statute of limitations would apply; the Internal Revenue Code, however, provides a 6 year statute (i) “for offenses involving the defrauding or attempting to defraud the United States or any agency thereof, whether by conspiracy or not, and in any manner” (covering at least the defraud/Klein conspiracy) or (ii) “where the object of the conspiracy is to attempt in any manner to evade or defeat any tax or the payment thereof” (the offense conspiracy for the tax evasion offense).
There are a number of provisions, beyond the scope of this introduction to tax procedure, that might cause the statute of limitations to postpone the start of the statute of limitations or suspend the running of the statute after it has started. As a general rule, any provision of the IRC that prevents the IRS from pursuing collection activity (such as while a CDP proceeding is in process), will have an extension of the civil and criminal statute of limitations. But there are others, such as:
- noncompliance with or proceedings to quash IRS summonses (including John Doe Summonses) may suspend the statute of limitations.
- The statute of limitations for Tax crimes in Title 26 and certain tax related crimes (such as conspiracy) in Title 18 is suspended while the defendant is outside the United States or a fugitive from justice within the meaning of 18 U.S.C. § 3290.
- Caveat: the prohibition on assessment, and thus collection, activity while a notice of deficiency or Tax Court redetermination proceeding is pending does not suspend the criminal statute of limitations although it does suspend the civil statute of limitations.
A literal application of the Wartime Suspension of Limitations Act (“WSLA”), 18 U.S.C. § 3287, would suspend the statute for any crime “involving fraud or attempted fraud against the United States or any agency thereof in any manner, whether by conspiracy or not.” This provision might apply to the Iraqi and Afghanistan wars or engagements, but it is not clear that it applies to tax crimes.
Finally, FBAR criminal violations have a 5-year period of limitations.
H. Criminal Investigations and Prosecutions.
A prototypical tax criminal investigation and prosecution involves two broad phases. The first phase is an IRS administrative investigation by IRS’s Criminal Investigation (“CI”). Upon completion of this phase, CI either (1) decides not to pursue the matter further criminally and releases the matter to the civil branches of the IRS for any further appropriate consideration or (2) sends the case to DOJ Tax CES. The second phase of the case is then conducted by the DOJ Tax CES working with and often through the local United States Attorney which is a branch of DOJ. Government attorneys from the DOJ Tax CES and/or the United States Attorney’s office conduct all further proceedings through prosecution and sentencing.
2. The Usual Criminal Tax Investigation.
a. Sources for CI Investigation.
The most significant single source for CI’s criminal investigations is the IRS through its various civil functions. The IRS has a Fraud Referral Program in each of its operating divisions – Small Business/Self-Employed, Wage and Investment, Large Business & International, and Tax Exempt and Government Entities. See IRM 25.1.2 Recognizing and Developing Fraud. In brief, this program asks the agents, collection officers and other employees to be alert to “first indicators of fraud” and then, in conjunction with the employee’s manager and with the division Fraud Technical Advisor, to do such work as necessary to determine whether the matter should be referred to CI. The key point at which significant civil investigative work should cease is when the civil
division has firm indicators of fraud. Taxpayers sometimes try to suppress the fruits of a civil agent’s interview of the taxpayer on the basis that, by the time of the interview, the agent had firm indicators of fraud without giving the appropriate noncustodial Miranda warning. Generally, those attacks fail, but in some rare cases a court may hold that, in the interview, the taxpayer had been affirmatively misled about the nature of the interview and therefore suppress the statements made in the interview.
Other sources for CI investigations include disgruntled business partners, spouses or significant others, unhappy clients who turn on their professionals, publicity such as newspaper articles, etc.
(2) IRS Whistleblower Program.
One prominent source that seems to be developing more traction is the IRS whistleblower program. The Code has provided for many years whistleblower awards in § 7623(a). Essentially, that program permits a lot of discretion to the IRS and the IRS seemed not to be too interested in aggressively working that field. In 2007, Congress enacted § 7623(b) which provides a much more robust incentive to whistleblowers and, since has repeatedly signaled to the IRS that it is serious about rewarding whistleblowers.
This more robust reward applies where the tax, penalties, interest, additions to tax, and additional amounts in dispute must exceed $2,000,000. Once that threshold amount is reached, the whistleblower is entitled to an award of from 15% to 30% of “collected proceeds (including penalties, interest, additions to tax, and additional amounts) resulting from the action (including any related actions) or from any settlement in response to such action.” As an additional sweetener to the whistleblower, the statute provides an above-the-line deduction is allowed for attorneys fees and court costs related to whistleblower rewards, so that the taxpayer is taxed only on the net amount he or she receives without the miscellaneous items deduction or the AMT tax haircuts that normally attaches to recoveries other than personal injury damages. The IRS denial of a whistleblower claim or its granting a claim less than the whistleblower believes is due may be judicially contested by filing a petition in the Tax Court within 30 days of the WBO determination letter.
Perhaps the most prominent recent example of whistleblower awards is that Brad Birkenfeld was given a whistleblower award for essentially jump starting the IRS initiative for offshore accounts that have resulted in many criminal prosecutions of U.S. persons with foreign bank accounts, prosecutions and threats of prosecutions of foreign banks (now principally Swiss banks), and many billions of dollars of tax revenue, penalties and interest and FBAR penalties. I don’t have a current total, but I suspect that the aggregate amount collected in this initiative exceeds $50,000,000. Mr. Birkenfeld was awarded $104 million. Another example that I suspect involves an IRS whistleblower is the current criminal investigation of Caterpillar that Jim has mentioned in the class.
The IRS Whistleblower’s Office must give an annual report to Congress on how the program is working. The latest Whistleblower Office Report (for 2021 Report) reports the following statistics on awards:
The awards are reported prior to sequestration which reduces the amount of the award by around 5%. For an explanation of sequestration, see CBO web page titled “Sequestration” (viewed 3/11/23).
b. CI Investigation.
The general flow of a CI criminal investigation is as follows:
Based on information it receives from whatever sources, CI will start an investigation. Sometimes it is just preliminary testing to see if CI wants to spend its limited resources on the matter. If it determines to open an investigation, the IRS will assign one or more CI Special Agents to the investigation. Sometimes a civil agent will be assigned to assist.
The CI Special Agent will conduct such investigation as necessary using whatever investigative resources are appropriate. Those investigative resources can include the IRS administrative summons.
The CI investigation may be unknown to the taxpayer or his representatives at the inception and in the early stages. At some point, however, the CI investigation will surface. It can surface in several ways, but one of the ways frequently used is with two CI Special Agents showing up at the taxpayer’s home (often in the early morning) to introduce themselves, reading the taxpayer modified
Miranda warnings advising him of his rights (including right not to answer questions and right to consult with an attorney), and ask the taxpayer if he will answer some question. The taxpayer is not in custody and can terminate the interview at any time. The IRS makes this surprise visit to catch the taxpayer off guard and hope that he will talk. Often he does and what he says often plays prominently in the ultimate prosecution.
At some point, the taxpayer will become aware that a criminal investigation is being pursued. The taxpayer’s attorney will want to track the investigation so that, to the extent possible, the taxpayer’s attorney knows what IRS CI knows.
Upon conclusion of the CI investigation, if the investigating Special Agent desires to pursue prosecution or further investigation by a grand jury, CI will have several review processes, including a review by a CI attorney (whom the Special Agent would have used as a resource during the investigation). The Special Agent in Charge (“SAC”) of the CI district will then decide whether to forward the case to DOJ Tax CES. The taxpayer’s attorney will usually have the opportunity for a conference with the SAC or deputy and the CI attorney. The purpose of the conference is to permit the taxpayer’s attorney to make any argument he or she desires to make to convince the SAC that the case should not be forwarded to DOJ Tax CES.
If the SAC approves the recommendation for referral, the case file (including most prominently the Special Agents Report (“SAR”)) will be forwarded to DOJ Tax along with a Criminal Referral Letter providing certain key information including the recommended counts of prosecutor and the tax loss involved. The taxpayer’s representative will also be sent a letter advising of the referral and providing the recommended counts and tax loss involved.
If CI does not recommend criminal prosecution, CI closes the criminal aspect of the case and, if appropriate, sends the case to the examination function for any further civil tax investigation and assessments.
c. DOJ Review Through Prosecution.
If CI recommends that the taxpayer be prosecuted or that the case be further investigated through a grand jury, the case will be referred to DOJ Tax CES. The taxpayer and his attorney will be notified that the case is being referred for prosecution, the counts that are being recommended, and the tax loss associated with the recommendation. Taxpayer’s counsel should then immediately notify DOJ Tax CES that the taxpayer does want a conference before DOJ Tax CES makes its decision whether to authorize prosecution.
DOJ Tax CES may return the case to the IRS with a final decision of no prosecution or may return the case for the IRS to conduct such further investigation as appropriate and then refer the case again if that is appropriate. Alternatively, DOJ Tax CES may forward the case to the local United States Attorney to either present the case to a grand jury for indictment or, alternatively, to have the grand jury investigate further. In all events, DOJ Tax CES retains final authority as to whether a tax
crime will be indicted and prosecuted. DOJ Tax CES retains this authority because the government systemically has limited resources to investigate and prosecute tax crimes, and DOJ Tax CES is charged with the responsibility to insure that the government’s enforcement efforts are consistent with priorities and resources. Technically, DOJ Tax CES does not have responsibility over the IRS’s CI which generates most tax criminal cases, but DOJ Tax CES sends powerful signals to CI by which cases it prosecutes or declines, thus influencing CI’s criminal investigations.
If DOJ Tax CES forwards the case to the U.S. Attorney for indictment or grand jury investigation, either a local Assistant U.S. Attorney (“AUSA”) or a DOJ Tax CES attorney will handle such further processes as are required. If the grand jury indicts, the case will proceed to trial. As in the federal criminal system generally, most criminal tax cases are resolved by plea agreement. Indeed, because of the care with which DOJ Tax CES picks its cases, the cases are generally stronger than the average criminal case and produce pleas in 95%+ of the cases. That does not mean that the target pleads to the charges as framed by the prosecutor and grand jury; rather, it means that some compromises are made that from the parties’ perspectives is better than going to trial.
If a plea does not result, the case goes to trial.
If the taxpayer is convicted either by plea or after trial, the court will sentence under the Sentencing Guidelines noted above.
d. Taxpayer Conferences.
At each critical stage in this process, the taxpayer’s attorney will usually have an opportunity for a meeting with decision makers to attempt to influence their decision as to whether to ratchet the case toward criminal prosecution. At the CI level, the taxpayer’s attorney will usually interface with the Special Agent and have an opportunity to advance such arguments as appropriate to prevent the Special Agent from recommending prosecution. At the conclusion of the investigation if the Special Agent is recommending referring the case to DOJ Tax CES, the taxpayer will have an opportunity for a meeting either with the SAC or a designated management representative to attempt to persuade CI not to forward the case to DOJ. These opportunities are usually afforded, but are not inalienable rights of the taxpayer.
Similarly, at the DOJ Tax CES level, the taxpayer will usually have an opportunity for a meeting to attempt to persuade DOJ Tax CES not to pursue the matter. This meeting is also not a matter of right, but a taxpayer request for the meeting will usually be honored.
The taxpayer will have a final opportunity to meet with the local AUSA handling the case. By this time, the wiggle room for the AUSA may not be great because of CES’s control. Still, some opportunities may be available.
3. Unusual Processing of Criminal Tax Investigations.
The foregoing is a general discussion of the flow of a criminal investigation from CI through DOJ Tax CES on to the United States Attorney for further investigation or prosecution. Tax criminal cases sometimes take a different route. There are two such routes.
Sometimes DOJ Tax and CI may determine that a grand jury investigation is the preferred investigation route from the beginning. This happened, for example, in some areas of the country in the fuel tax excise tax scams that were rampant in the late 1980’s and early 1990’s. This also happened in the investigation of major tax shelter abuses by the large accounting firms, including most prominently KPMG and Ernst & Young which have produced several indictments. The administrative investigation by CI is not used in such cases, but one or more CI Special Agents are assigned to assist the grand jury in its investigation.
The second route involves a grand jury investigating nontax crimes that uncovers evidence also of tax crimes. It is not unusual for tax crimes to accompany other illegal activities that are governmental enforcement priorities, such as mob activity and drug dealing. If the prosecutor (an AUSA or DOJ attorney) leading that nontax investigation discovers tax crimes that he or she wants to pursue, the prosecutor can seek appropriate approvals from CI and DOJ Tax CES to pursue the tax crimes via the grand jury investigation and indictment process. In both of these situations, there may be no significant investigative activity conducted by CI as CI (as opposed to CI agents assisting the grand jury).
4. Secrecy Rules in Criminal Tax Investigations.
Two secrecy rules play a prominent role in this division of investigations between CI investigations and grand jury investigations.
First, as I mentioned above, § 6103 generally precludes the IRS from disclosing tax return information. Information developed by CI in a CI investigation is tax return information that cannot even be disclosed to DOJ attorneys until CI refers the case to DOJ Tax CES. This information can be used by the IRS for any purpose, civil or criminal. Once the case is referred to DOJ Tax CES, the IRS can no longer use the IRS administrative summons or begin a proceeding to enforce a previously issued summons; further compulsory investigative process must be only through the grand jury processes, most significantly the grand jury subpoena.
Second, Rule 6(e), Federal Rules of Criminal Procedure, prohibits disclosure of information developed by the grand jury, so that even tax relevant information developed by the grand jury cannot be shared with the IRS, except for IRS personnel (usually Special Agents) assigned to assist the grand jury.
The combination of these rules requires that the IRS CI investigation be kept distinct from the grand jury investigation. Of course, the fruits of any CI investigation may go to DOJ Tax CES
when the case is referred, but the fruits of the grand jury investigation can only be shared with the IRS’s CI to the extent necessary to obtain approvals for criminal prosecution. The fruits of the grand jury investigation cannot be used for any other IRS purposes, including civil tax assessment.
To illustrate, I mentioned above that a nontax grand jury may learn of tax crimes and, if DOJ Tax CES and the IRS determine that tax indictments would be consistent with tax enforcement priorities, the prosecutor of that grand jury may seek an indictment on the tax crime. The IRS can use that information for the limited purpose of recommending prosecution for the tax crime. The IRS cannot use the information for its own use either civilly or in an IRS administrative investigation. Any of the grand jury information that is subsequently publicly disclosed in the criminal prosecution phase can be available to the IRS for civil tax and other purposes, but often in a plea bargain situation much of the grand jury information will not be disclosed of public record and thus available for general IRS purposes. Thus, the investigative efficiency achieved through using grand jury processes is mitigated by the limitations upon the use of the fruits of the grand jury investigation for civil tax purposes.
5. Sentencing Guidelines Strategy.
I mentioned above that the Government’s enforcement priorities for tax crimes is to select the relatively few cases it selects well so that it obtains a 90+% conviction rate. That does not mean conviction as to all counts charged. Most activity that generates a tax crime charge such as evasion (§ 7201) or tax perjury (§ 7206(1)) will be activity that itself can draw other charges (e.g., Klein conspiracy) or will be accompanied by activity that can draw other charges (e.g., 18 U.S.C. § 1001). Such separate charges would be separate counts in an indictment. Furthermore, if only evasion or tax perjury is charged, each year involved will be a separate count. So most tax crimes indicted will involve multiple counts.
In authorizing the indictment, DOJ Tax CES will designate a major count or, in more serious cases, perhaps two major counts as to which it desires conviction; the AUSA is then authorized to negotiate a plea as to the major count(s) with the other counts falling by the wayside. For example, in a case I handled, the indictment charged two related defendants with one count each of conspiracy (Klein tax conspiracy), two counts of tax perjury for one (one count for each of two years) and two counts of aiding and assisting (§ 7206(2)) for the other (one count for each of the same two years of the returns). The Government’s major count was, respectively, the second year tax perjury count for the one and the second year 7206(2) count for the other, thus evidencing a willingness to drop the conspiracy charge, the tax perjury count for the first year and the 7206(2) count for the second year. This may sound like a good deal for the taxpayer, but it is deceiving.
The reason is that the Sentencing Guidelines recognize that the Government plays games with counts. Thus, in tax crimes (as well as other economic crimes), the Guidelines base sentencing principally upon the tax loss numbers rather than the number of counts. The tax loss numbers will include all relevant conduct, including the tax loss in the counts that were not included in the indictment or are included in the indictment but the taxpayer was acquitted of the counts or the counts were dropped. Hence, in order to obtain a plea, the Government is really not giving up anything substantial by dropping non-major counts so long as it obtains a plea to the major counts.
Why then, you have surely questioned by now if you understood what I just said, does the Government charge multiple tax related counts in the first place? I can’t crawl into the Government’s collective mind, but certainly multiple counts give the Government a chip to play (or give up) without really giving up anything material. An unsophisticated defendant or worse, lazy or incompetent counsel, might think that requiring a plea to only one major count is one hell of a deal, when four or five or 20 other counts are dismissed. Moreover, I suspect, the Government feels that it is sometimes helpful to have multiple counts to charge the atmosphere before the jury in the Government’s favor if it is unable to force a plea. The more counts may project to the jury that the defendant is a really bad character. If the Government can coax out several different law violations and package them as separate counts from the same basic tax misconduct, it will have achieved an advantage at trial–if nothing else it gives the jury some room to compromise and still obtain a felony conviction. (It may also, of course, have an opposite effect if the jury or the judge were to believe that the Government were just piling on counts for one basic crime.) Also, by charging Klein conspiracy, a frequent traveling companion for tax crimes, the Government can better shape the evidence that it may get admitted at trial. There are thus reasons for the Government to allege several or even many counts even though they will not affect sentencing.
Source – Federal Tax Crimes: https://federaltaxcrimes.blogspot.com/2023/05/tax-crimes-outline-for-uva-law-tax.html