Posted by: | October 2, 2014

IRS: Common Badges of Tax Fraud

Section 6663(a) provides that, if any part of an underpayment is due to fraud, there shall be added to the tax an amount equal to 75% of the portion of the underpayment which is attributable to fraud. The IRS bears the burden of proving by clear and convincing evidence that: (1) An underpayment of tax exists; and (2) some portion of the underpayment is attributable to fraud.[i]

In the case of a joint return, intent must be established for each spouse separately and the fraud of one spouse cannot be used to impute fraud to the other spouse. Thus, the civil fraud penalty may be asserted on one spouse only.

FRAUDULENT INTENT. To prove fraudulent intent, the IRS must demonstrate that the taxpayer intended to evade tax he believed to be due, by showing proof of conduct intended to conceal, mislead, or otherwise prevent the collection of such tax.[ii] Fraud can not be imputed or presumed – the government must prove by affirmative evidence that an understatement of tax set forth on the return is attributable to fraud.[iii]  Intent is distinguished from inadvertence, reliance on incorrect technical advice, honest difference of opinion, negligence or carelessness.[iv]

RELIANCE AS A DEFENSE. The existence of fraud is a question of fact to be resolved from the entire record.[v] Because direct proof of a taxpayer’s intent is rarely available, fraud may be proven by circumstantial evidence, and reasonable inferences may be drawn from the relevant facts.[vi] Mere suspicion, however, does not prove fraud.[vii] Reliance on a tax professional is a proper defense to the imposition of penalties, as the Supreme Court has observed:

            When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice. Most taxpayers are not competent to discern error in the substantive advice of an accountant or attorney. To require the taxpayer to challenge the attorney, to seek a “second opinion,” or to try to monitor counsel on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place (citations omitted). “Ordinary business care and prudence” do not demand such actions.[viii]

SENSITIVE ISSUE TAX EXAMINATIONS. In civil tax audits that include potentially sensitive issues, taxpayers often engage a team of representatives, including counsel and a forensic accountant.  Engagement of the accountant by counsel should extend the attorney-client privilege to advice rendered by the accountant pursuant to the engagement.[ix] Although Internal Revenue Code §7525 extended common law protections of confidentiality to tax advice rendered between a taxpayer and a federally-authorized tax practitioner (accountants, etc. to the extent such communications would be considered privileged if they occurred between a taxpayer and counsel), this statutory privilege only applies to non-criminal tax matters before the IRS and non-criminal tax proceedings in federal court.

Unfortunately, this statutory privilege is not available when it is truly needed the most – when a civil tax proceeding moves into the criminal arena.  It also may not be available in certain state-related tax proceedings, or non-tax civil litigation. However, if the accountant is appropriately engaged by counsel, the common law attorney-client privilege should apply to all communications rendered in furtherance of the legal services being provided to the client, both during the investigative stages of the audit and, if necessary, during any subsequent civil or criminal litigation. This privilege does not extend to the actual return preparation.

Counsel’s engagement of the accountant should be in writing, and should indicate that the accountant is acting under the direction of counsel in connection with counsel’s rendering of legal services to the client, communications between the accountant and the client are confidential and are made solely for purposes of enabling counsel to provide legal advice; the accountant’s work-papers are held solely for counsel’s use and convenience and subject to counsel’s right to demand their return; and the accountant is to segregate their work papers, correspondence and other documents gathered during the course of the engagement and designate such documents as property of counsel.

The critical inquiry is often whether counsel should retain the taxpayer’s prior accountant or a new accountant. Many practitioners prefer to engage a new accountant to avoid the necessity of delineating between non-privileged communications (communications prior to counsel’s engagement of the accountant), and privileged communications (communications following counsel’s engagement of the accountant).

In an IRS civil tax fraud examination, the IRS will follow up on all leads identified as fraud indicators (signs or symptoms); securing copies of all relevant data relating to indicators of fraud; and noting from whom and when obtained. Original documents obtained from the taxpayer or third parties should not be marked, indexed, hole punched, or in any way altered by the compliance employee. Also, it is critical that the compliance employee attempt to secure the taxpayer’s explanation(s) for any discrepancies.

Most civil fraud cases involve individual and business taxpayers with poor or nonexistent internal controls and/or where there is little or no separation of duties. When these occur, there is a greater potential for material misstatement of taxable income than in cases involving individuals earning salaries and wages. However, fraud may be present in any type of tax return. In cases where a return has not been filed and fraud is suspected, the IRS representative is instructed not to demand a return from the taxpayer.

Unusual, inconsistent or incongruous items should alert the IRS examiner to the possibility of fraud and the need for further investigation. Taxpayer misconduct is an early warning sign of possible fraudulent conduct. The method of operating a business (i.e., lack of internal controls, dealing in cash, etc.) may be indicative of improperly filed tax returns.

The initial contact by the IRS examiner provides the opportunity to obtain valuable information, which may not be readily available later. Indications of fraud may be disclosed in discussions, financial activities and nonresponsive answers. Questions asked should be recorded verbatim. Similarly, nonresponsive answers are to be noted verbatim and the IRS examiner will exercise their judgment in deciding what information is relevant (affidavits may be used). Examination work papers should be noted as to the tax year, the date of the contact, who was present during the contact, and the author of the examination work papers. IRS examination work papers will include the following information:

  • Who prepared the information used to complete the tax return,
  • Who approved and classified expense items,
  • Who deposited business receipts, and
  • How business gross receipts, per the tax return, were determined. 

“BADGES OF FRAUD.” Over the years, various courts have developed a list of “badges of fraud” from which fraudulent intent might be inferred. These badges of fraud generally include: (1) understatement of income; (2) inadequate books and records; (3) failure to file tax returns; (4) implausible or inconsistent explanations of behavior; (5) concealing assets; and (6) failure to cooperate with tax authorities.[x] The IRS Fraud Handbook sets forth a non-exclusive list of various indicators of potentially fraudulent conduct, including:[xi]

The IRS examiner will typically search behind the books and to probe beneath the surface to validate and determine the consistency of information provided and statements made to evaluate the credibility of evidence and testimony provided by the taxpayer. If fraud is discovered, it is important for the IRS to determine who is responsible for the fraudulent act(s) – the taxpayer, the tax return preparer or both.

If the taxpayer is not responsible, then neither criminal and/or civil fraud penalties should apply to the taxpayer although some courts have attributed fraud by the preparer to the taxpayer in the context of the civil fraud penalty and extending the unlimited statute of limitations associated with a fraudulent return.

Indicators of Fraud – Income

  • Omitting specific items where similar items are included.
  • Omitting entire sources of income.
  • Failing to report or explain substantial amounts of income identified as received.
  • Inability to explain substantial increases in net worth, especially over a period of years.
  • Substantial personal expenditures exceeding reported resources.
  • Inability to explain sources of bank deposits substantially exceeding reported income.
  • Concealing bank accounts, brokerage accounts, and other property.
  • Inadequately explaining dealings in large sums of currency, or the unexplained expenditure of currency.
  • Consistent concealment of unexplained currency, especially in a business not routinely requiring large cash transactions.
  • Failing to deposit receipts in a business account, contrary to established practices.
  • Failing to file a tax return, especially for a period of several years, despite evidence of receipt of substantial amounts of taxable income.
  • Cashing checks, representing income, at check cashing services and at banks where the taxpayer does not maintain an account.
  • Concealing sources of receipts by false description of the source(s) of disclosed income, and/or nontaxable receipts.

Indicators of Fraud—Expenses or Deductions

  • Claiming fictitious or substantially overstated deductions.
  • Claiming substantial business expense deductions for personal expenditures.
  • Claiming dependency exemptions for nonexistent, deceased, or self-supporting persons. Providing false or altered documents, such as birth certificates, lease documents, school/medical records, for the purpose of claiming the education credit, additional child tax credit, earned income tax credit (EITC), or other refundable credits.
  • Disguising trust fund loans as expenses or deductions.

Indicators of Fraud—Books and Records

  • Multiple sets of books or no records.
  • Failure to keep adequate records, concealment of records, or refusal to make records available.
  • False entries, or alterations made on the books and records; back-dated or post-dated documents; false invoices, false applications, false statements, or other false documents or applications.
  • Invoices are irregularly numbered, unnumbered or altered.
  • Checks made payable to third parties that are endorsed back to the taxpayer. Checks made payable to vendors and other business payees that are cashed by the taxpayer.
  • Variances between treatment of questionable items as reflected on the tax return, and representations within the books.
  • Intentional under- or over-footing of columns in journal or ledger.
  • Amounts on tax return not in agreement with amounts in books.
  • Amounts posted to ledger accounts not in agreement with source books or records.
  • Journalizing questionable items out of correct account.
  • Recording income items in suspense or asset accounts.
  • False receipts to donors by exempt organizations.

Indicators of Fraud—Allocations of Income

  • Distribution of profits to fictitious partners.
  • Inclusion of income or deductions in the tax return of a related taxpayer, when tax rate differences are a factor.

Indicators of Fraud—Conduct of Taxpayer

  • Testimony of employees concerning irregular business practices by the taxpayer.
  • Destruction of books and records, especially if just after examination was started
  • Transfer of assets for purposes of concealment, or diversion of funds and/or assets by officials or trustees
  • Pattern of consistent failure over several years to report income fully.
  • Proof that the tax return was incorrect to such an extent and in respect to items of such magnitude and character as to compel the conclusion that the falsity was known and deliberate.
  • Payment of improper expenses by or for officials or trustees.
  • Willful and intentional failure to execute pension plan amendments
  • Backdated applications and related documents.
  • False statements on Tax Exempt/Government Entity (TE/GE) determination letter applications.
  • Use of false social security numbers.
  • Submission of false Form W–4.
  • Submission of a false affidavit.
  • Attempt to bribe the examiner.
  • Submission of tax returns with false claims of withholding (Form 1099-OID, Form W-2) or refundable credits (Form 4136, Form 2439) resulting in a substantial refund.
  • Intentional submission of a bad check resulting in erroneous refunds and releases of liens.
  • Submission of false Form W-7 information to secure Individual Taxpayer Identification Number (ITIN) for self and dependants.
  • False statement about a material fact pertaining to the examination.Attempt to hinder or obstruct the examination. For example, failure to answer questions; repeated cancelled or rescheduled appointments; refusal to provide records; threatening potential witnesses, including the examiner; or assaulting the examiner.
  • Failure to follow the advice of accountant, attorney or return preparer.
  • Failure to make full disclosure of relevant facts to the accountant, attorney or return preparer.The taxpayer’s knowledge of taxes and business practices where numerous questionable items appear on the tax returns.

Indicators of Fraud—Methods of Concealment

    • Inadequacy of consideration.
    • Insolvency of transferor.
    • Asset ownership placed in other names.
    • Transfer of all or nearly all of debtor’s property.
    • Close relationship between parties to the transfer.
    • Transfer made in anticipation of a tax assessment or while the investigation of a deficiency is pending.
    • Reservation of any interest in the property transferred.
    • Transaction not in the usual course of business.
    • Retention of possession or continued use of asset.
    • Transactions surrounded by secrecy.
    • False entries in books of transferor or transferee.
    • Unusual disposition of the consideration received for the property.
    • Use of secret bank accounts for income.
    • Deposits into bank accounts under nominee names.
    • Conduct of business transactions in false names.

[i] IRC § 7454(a); Rule 142(b); DiLeo v. Commissioner, 96 T.C. 858, 873 (1991), aff’d. 959 F.2d 16 (2d Cir. 1992).

[ii] See Recklitis v. Commissioner, 91 T.C. 874, 909 (1988).

[iii] See Beaver v. Commissioner, 55 T.C. 85, 92 (1970); Senyszyn v Commissioner, T.C. Memo. 2013-274.

[iv] Internal Revenue Manual (10-30-2009)

[v] See Gajewski v. Commissioner, 67 T.C. 181, 199 (1976).

[vi] See Spies v. United States, 317 U.S. 492, 499 (1943); Stephenson v. Commissioner, 79 T.C. 995, 1006 (1982).

[vii] See Cirillo v. Commissioner, 314 F.2d 478, 482 (3d Cir. 1963); Katz v. Commissioner, 90 T.C. 1130, 1144 (1988); Shaw v. Commissioner, 27 T.C. 561, 569-570 (1956).

[viii] United States v. Boyle, 469 U.S. 241, 251 (1985); Henry v. Comm., 170 F. 3d 1217, 1220 (9th Cir. 1999).

[ix] United States v. Kovel, 292 F.2d 18 (2d Cir. 1961).

[x] Bradford v. Comm’r, 796 F.2d 303, 307 (9th Cir. 1986).

[xi] Internal Revenue Manual (IRM) Indicators of Fraud

Posted by: | September 22, 2014

IRS Interviews of Taxpayers and Return Preparers

Requests to interview the taxpayer and/or return preparer during an otherwise normal IRS examination have become somewhat common. During the examination, the examining agent is auditing the return for accuracy and the taxpayer’s representative is typically trying to determine the nature and scope of the examination, gather responsive documents and information, etc.

It is nearly impossible for the representative to be able to determine why an examination commenced but a good starting point is to simply ask the examining agent. A typical response may be that the return was randomly selected for examination. However, there are actually few random audits. Examinations are typically focused on issues, areas, or industries having a historically high rate of non-compliance. Other examinations begin because the IRS received information from a related examination of another taxpayer or, perhaps, someone purposely provided information to the IRS relating to the taxpayer. Informants usually include disgruntled employees, ex-spouses or business partners, competitors or financial mercenaries seeking a whistleblower reward.

Interviews of the taxpayer serve a dual purpose: (i) to further the tax examination and (ii) to identify potential violations by a tax return preparer.  During the initial interview and throughout the examination process, the examiner can be expected to ask questions regarding the return preparation as appropriate to the case and issues being developed. Whether through the interview process or other documentation, the examiner will also be determining whether return preparer penalties might be appropriate to the situation.

QUESTIONS WHICH MAY BE ASKED. Interview questions are often tailored to the individual taxpayer and situation. Did you meet with the preparer? What documentation was provided to the preparer? Did you receive a copy of the return or claim? How was the preparer compensated? Are you aware of any errors, omissions or mistakes on the return under examination? Did you disclose this transaction on your tax return? Why? Why not? Were there any concerns about how the transaction was reported? What sort of process is used to address those concerns and on what basis are decisions made? Was there any discussion regarding potential penalties? Was there any discussion regarding whether the transaction is subject to disclosure?

When interviewing the taxpayer or preparer the agent may ask if any other services have been provided by the return preparer’s firm and how long the preparer has been preparing returns for the taxpayer? These questions provide insight into the extent of the preparer’s knowledge regarding the taxpayer’s financial situation/status and may alert the agent to the applicability of penalties. A tax return preparer who has been preparing a client’s return for a number of years is more knowledgeable than a firm that is preparing a client’s return for the first time.

Examining agents are aware that, no matter how important the question, it is irrelevant if the response is not accurately understood. As such, they are to demonstrate an interest in the responses from the taxpayer and make sure that their non-verbal communication contributes to a comfortable atmosphere. If they appear overly relaxed and are not looking at the taxpayer, the taxpayer may believe they are not interested and will respond accordingly. Agents are not to interrupt the taxpayer and should allow a brief pause at the end of a response.

IRS INTERVIEW AUTHORITY. A taxpayer has the right to resist an examining agent’s request for an interview. Code Sec. 7602 authorizes the IRS to examine books and records and to take testimony under oath. Pursuant to Code §7521(c) the taxpayer’s representative may represent the taxpayer before the examining agent and is not required to produce the taxpayer for questioning, unless an administrative summons is served on the taxpayer. There are several considerations that the taxpayer’s representative should weigh before allowing the taxpayer to submit to an interview, especially if potential fraud issues are involved.

A question often presented is whether the taxpayer and others should consent to interviews,force the issuance of Summonses or invoke various Constitutional protections. There are several considerations that the taxpayer’s representative should weigh before allowing the taxpayer to submit to an interview, especially if potential fraud issues are potentially involved.

TIMING OF THE INTERVIEW. Agents usually seek to conduct an initial interview as soon as possible after opening a case and schedule subsequent interviews if all requested information is not provided, more detailed explanations are required or to review the progress of the examination.  The representatives pre-audit analysis should include preparation for the taxpayer interview. The representative should attempt to obtain as much information about the issues, the information within the agent’s possession, and the agent’s position with regard to the issues, before agreeing to submit the taxpayer to an interview.  Ideally, the interview should occur toward the end of the audit, possibly with an understanding that if the taxpayer submits to an interview and answers the questions, the agent will proceed to close the audit.  However, the representative must take extreme caution, since such an understanding is probably not a basis for challenging the use of statements from the interview in a subsequent civil or criminal proceeding.

PREPARATION FOR THE INTERVIEW.  The representative should try to obtain actual questions, or areas that the agent will question, in advance of the interview.  This will substantially assist the representative in preparing the taxpayer for the interview, especially for the “hard questions.”  The taxpayer should be strongly cautioned about making truthful responses, not speculating if the taxpayer is uncertain about a particular response, etc.

PLACE OF THE INTERVIEW.  The location of interviews will typically be set by the examining agent. The taxpayer’s representative should attempt to have the interview at the representative’s office. This is a much more supportive environment for what could be an extremely agonizing experience for the taxpayer.  Conversely, the taxpayer should be less intimidated and should hold up better under the pressure of the agent’s questioning if the taxpayer is not in the unfamiliar confines of an Internal Revenue Service office.  Also, the representative should in most instances attempt to keep the interview from occurring at the taxpayer’s place of business, to help ensure the taxpayer is better focused for the interview and also to avoid the intrusion in the taxpayer’s daily activities.

RECORDING THE INTERVIEW. All participants must consent to the recording of the interview.  Taxpayers may request to tape record an interview proceeding as long as 10 calendar days advance notice of intent to record is provided to the IRS. In addition, the taxpayer must supply his recording equipment. The IRS has the right to simultaneously produce its own recording and has the right to reschedule the interview if the IRS does not or will not have equipment in place. The IRS can initiate an audio recording provided it notifies the taxpayer 10 calendar days in advance of the interview. The Field Territory Manager must approve all IRS initiated recordings.

TYPES OF INTERVIEW QUESTIONS. The types of questions should be varied to establish a conversational atmosphere. When developing questions, agents are to focus on four types of questions: open-ended, closed-ended, probing, and leading described as:

  1. Open-ended questions are framed to require a narrative answer. They are designed to obtain a history, a sequence of events, or a description and are often asked regarding the taxpayer’s business, employment, education, and sources of income which may not be reflected on the return. The advantage of this type of question is that it provides a general overview of some aspect of the taxpayer’s history. The disadvantage is that this type of question can lead to rambling;
  2. Close-ended questions are specific and direct intended to identify definitive information such as dates, names, and amounts. They are frequently asked for personal background information such as the number of dependents or current address and are useful to help focus the taxpayer when they have difficulty giving a precise answer. They are also useful to clarify a response to an open-ended question. The disadvantage to close-ended questions is that the response is limited to exactly what is asked and can make the taxpayer uncomfortable;
  3. Probing questions combine the elements of open and close ended questions and are used to pursue an issue more deeply. For example, when questioning a taxpayer’s travel expense, the agent may ask “How many miles is it from your residence to your practice and where do you first travel to in the morning?” The advantage of this type of question is that the taxpayer’s response is directed, but not restricted;

Leading questions suggest that the interviewer has already drawn a conclusion or indicate what the interviewer wants to hear. Agents are to limit the use of leading questions and typically will only use them when looking for confirmation, since the answer is stated in the form of a question. For example: “So you did not keep a log or other written record of your auto expenses?

COMMON INTERVIEW TECHNIQUES — IRS examining agents have been instructed on various interview techniques. These interview techniques are generally designed to put the person being interviewed at ease but to also ask pointed questions as the interview progresses. Many of these techniques include:

  1. Make eye contact.
  2. Put the taxpayer at ease.
  3. Use appropriate types of questions (probing, leading, open-ended, etc.).
  4. Use “silence” appropriately.
  5. Paraphrase or restate.
  6. Listen.
  7. Pace the interview.
  8. Know when to move on to the next question.
  9. Maintain a calm manner.
  10. Have the taxpayer demonstrate the flow of transactions.
  11. Read the taxpayer’s non-verbal language (body language).
  12. Be aware of the Examiner’s non-verbal language.
  13. Be conscious of note taking so as not to distract the taxpayer.
  14. Use humor when appropriate.
  15. Be courteous, business-like, and firm.
  16. Consider issues in the proper order (volatile vs. non-volatile).
  17. Schedule the interview at a convenient time and allow adequate time for completion.
  18. Appear interested.
  19. Control the interview.
  20. Appear confident.
  21. Maximize the value of what you know.  (Audit Technique Guidelines – ATGs)
  22. Adapt your appearance to be appropriate for the circumstances.
  23. Give feedback to the taxpayer.
  24. Be observant.
  25. Feign when appropriate (act dumb).
  26. Be prepared.
  27. Use spontaneous follow-up questions (react when you receive new information).
  28. Be yourself.
  29. Know yourself and your limitations.
  30. Read the taxpayer (know when you have lost their attention).
  31. Read the taxpayer’s perception of you.
  32. Dispel any negative image.
  33. Be on time.
  34. Use appropriate small talk.
  35. Use easily understood language.
  36. Don’t anticipate answers.
  37. Clarify responses.
  38. Use reflection.
  39. Ask for examples.
  40. Recognize your biases.
  41. Be assertive and persistent.
  42. Avoid debate or argument.
  43. Give the taxpayer an opportunity to ask questions.
  44. Express appreciation.
  45. Verbally pin down the taxpayer when appropriate.
  46. Have an open mind.
  47. Maintain composure.
  48. Adapt questions to the situation.
  49. Have the taxpayer explain their terminology.
  50. Be precise, come from a position of knowledge.  (MSSP Guidelines)
  51. Work to establish rapport with the taxpayer.
  52. Respect the taxpayer’s views.
  53. Know your authority.
  54. Make a positive first impression.
  55. Maintain an inquisitive mind.
  56. Contain your excitement (and surprise).
  57. Note unusual hostility or irritability on the part of the taxpayer.
  58. Consider the need to question both spouses.
  59. Don’t interrupt the taxpayer.
  60. Be methodical.
  61. Refresh the taxpayer about important points in prior interviews.

The foregoing list is not to be followed in every interview. However, it provides insight into the nature of “humanizing” the interview process. Representatives must always remember that the interview is designed to elicit statements and understandings directly from the person being interviewed. There are no “off the record” comments and even casual conversations can provide information that would have been better provided or explained in a more thoughtful environment.


Posted by: | September 15, 2014

Bankruptcy (Tax) Law Must Apply Equally to the Rich and Poor Alike . . .

Generally, subject to certain statutory exceptions, a debtor is permitted to discharge all debts that arose before the filing of his bankruptcy petition.[1] With respect to tax debts, the Bankruptcy Code provides that a debtor may not discharge any tax debts “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” [2]

Today, the Ninth Circuit Court of Appeals “reversed and remanded” a district court’s earlier affirmance of the bankruptcy court’s judgment that a chapter 11 debtor’s tax debts should not be discharged on the basis of his alleged “willful attempt to evade or defeat taxes” under 11 U.S.C. § 523(a)(1)(C).[3]

The Rich Are Different . . . They Have More Money. In a somewhat colorful opinion, the Ninth Circuit Majority stated “F. Scott Fitzgerald observed early in his career that the very rich ‘are different from you and me,’[4] to which Ernest Hemingway later rejoined, ‘Yes, they have more money.’[5] As with many bankruptcy cases involving the wealthy, our saga reads like a Fitzgerald novel, telling the story of acquisition and loss of the American dream, and the consequences that follow.”

In association with various “tax shelter” transactions, the IRS made aggregate assessments against the underlying taxpayer for tax years 1997–2000 totaling $21 million and the California Franchise Tax Board also made assessments which totaled $15.3 million. With overall limited financial resources, the taxpayer ultimately found himself attempting to resolve these debts in a bankruptcy proceeding. The bankruptcy court opinion determined that the taxpayer (and his wife) “did very little to alter their lavish lifestyle after it became apparent in 2003 that they were insolvent and that their personal living expenses exceeded their earned income.”

Changing direction, the Ninth Circuit noted that the taxpayer “sold his primary residence and paid the entire $6.5 million net proceeds to the IRS. A month later, the FTB seized $6 million from various financial accounts. In September of that year, the [taxpayer] filed a Chapter 11 bankruptcy petition, which the bankruptcy court found was for the primary purpose of dealing with their tax obligations. Shortly after filing, the [taxpayer] sold the La Jolla condominium for $3.5 million and paid the proceeds to the IRS. Even after these payments and the seizure by the FTB, the IRS filed a proof of claim for $19 million and the FTB filed a claim for $10.4 million.”[6] To settle the remaining IRS liability, the taxpayer submitted an offer in compromise of $8 million, which was rejected.

The Ninth Circuit deemed it important that most of the expenditures by the taxpayer along the way “were made consistent with [taxpayer’s] past spending practices, and investments were made in property that would be subject to tax liens. As far as the record discloses thus far, there were no financial transfers into nominee accounts or concealment of assets, although the government claims that some funds ordered paid into trust by the family court were done so with the intent of tax evasion.” It also appears the taxpayer was investing funds improving or preserving property encumbered with tax liens that would ultimately accrue in a benefit to be received by the government when the property was sold.

The IRS and FTB alleged that the assessed liabilities could not be discharged in bankruptcy pursuant to 11 U.S.C. § 523(a) (1) (c), which excludes from discharge any debt “with respect to which the debtor . . .  willfully attempted in any manner to evade or defeat such tax.” (Emphasis added).  The primary, but not exclusive, theory of the IRS and FTB was that the [taxpayers] maintenance of a rich lifestyle constituted a “willful attempt to evade taxes.”

The bankruptcy court rejected most of the other government theories, but stated that the [taxpayer's] personal living expenses from January 2004 to September 2006 were “truly exceptional.” The bankruptcy court estimated that the couples’ personal expenses exceeded their earned income by $516,000 to $2.35 million during the years at issue. Given these facts, the bankruptcy court concluded that, as to the Taxpayer-Husband, the tax debts were excluded from discharge; the district court affirmed and the appeal to the Ninth Circuit followed.

Specific Intent Required? The Ninth Circuit noted that “The key question in this case is the meaning of the word ‘willful’ in the statute. Unfortunately, the plain words of the text do not answer that question because, as the Supreme Court has observed, ‘willful . . . is a word of many meanings, its construction often being influenced by its context.’ Spies v. United States, 317 U.S. 492, 497 (1943). Context matters in this case. The Bankruptcy Code is designed to provide a “fresh start” to the discharged debtor. [Citation omitted]. As a result, the Supreme Court has interpreted exceptions to the broad presumption of discharge narrowly. See Kawaauhau v. Geiger, 523 U.S. 57, 62 (1998). As we have observed ‘exceptions to discharge should be limited to dishonest debtors seeking to abuse the bankruptcy system in order to evade the consequences of their misconduct.’ [Citation omitted].”

Further, “[t]hus, the ‘fresh start’ philosophy of the Bankruptcy Code argues for a stricter interpretation of ‘willfully’ than an expansive definition. . . . The structure of the statute also supports a narrow construction of ‘willfully.’ The discharge exception at issue, § 523(a) (1), lists tax and customs debts warranting exception in three categories. Under § 523(a) (1) (A), numerous types of debts are excepted from discharge on a strict liability basis. Under § 523(a) (1) (B), tax debts for which a return was not filed or was filed late may not be discharged. Section 523(a) (1) (C) is the grouping at issue here: no discharge is permitted for tax debts “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” 11 U.S.C. § 523(a) (1) (C). The grouping of the fraudulent return offense with the evasion offense in subsection (C)—rather than with the other offenses involving tax returns in subsection (B)—suggests that it is more akin to attempted tax evasion than to failing to file a timely return. If a willful attempt to evade taxation requires mere knowledge of the tax consequences of an act, and no bad purpose, then it is difficult to see how such acts resemble the filing of a fraudulent return. By contrast, if a willful attempt requires bad purpose, then such acts are naturally grouped with other acts requiring bad purpose, such as filing a fraudulently false return.” (Emphasis added).       

The Ninth Circuit Majority. Given the structure of § 523(a)(1) as a whole, the Ninth Circuit Majority concluded that declaring a tax debt nondischargeable under 11 U.S.C. § 523(a)(1)(C) on the basis that the debtor “willfully attempted in any manner to evade or defeat such tax” requires a showing of specific intent to evade the tax. Specifically, “[t]herefore, a mere showing of spending in excess of income is not sufficient to establish the required intent to evade tax; the government must establish that the debtor took the actions with the specific intent of evading taxes. Indeed, if simply living beyond one’s means, or paying bills to other creditors prior to bankruptcy, were sufficient to establish a willful attempt to evade taxes, there would be few personal bankruptcies in which taxes would be dischargeable. Such a rule could create a large ripple effect throughout the bankruptcy system. As to discharge of debts, bankruptcy law must apply equally to the rich and poor alike, fulfilling the Constitution’s requirement that Congress establish ‘uniform laws on the subject of bankruptcies throughout the United States.’ U.S. Const., art. I, § 8, cl. 4.”

The Dissent. With obvious passion, the dissent noted, in part,: “I respectfully dissent. I agree with the majority that the rich are different in many ways, but that difference should not include an unfettered ability to dodge taxes with impunity. . . . The majority’s conclusion, in my view, creates a circuit split and turns a blind eye to the shenanigans of the rich. . . . . Providing a fresh start under the Bankruptcy Code should not extend to aiding and abetting wealthy tax dodgers. I respectfully dissent.”

Conclusion. What mental state is required in order to find that a bankruptcy debtor’s federal tax liabilities should be excluded from a bankruptcy discharge under 11 U.S.C. § 523(a)(1)(c) because he “willfully attempted in any manner to evade or defeat such tax”? Consistent with similar provisions in the Internal Revenue Code, the Ninth Circuit Majority concluded that “specific intent . . . to evade or defeat such tax” is required for the tax debt to not be discharged in a bankruptcy proceeding and remanded the underlying case to the district for a re-evaluation under that standard.

The result in this case might seem obvious to most – to “willfully evade tax” it should be clear that the debtor took some actions with the specific intent of evading taxes, i.e., financial transfers into nominee accounts or concealment of assets, etc. Continuing to mostly live life as they had before the underlying debts accrued, selling assets such that all proceeds are distributed to the government, making investments in assets already subjected to the tax liens, etc. would not seem to support the requisite “specific intent . . . to evade or defeat such tax.

In tax nothing is obvious until various levels of courts and sometimes even the U.S. Supreme Court have had a chance to evaluate and re-evaluate potentially relevant events. Rich or poor, the tax code (and the bankruptcy code) apply to the taxpayer (debtor) and, at least in this situation (although the dissenting opinion certainly disagrees) the Ninth Circuit seems to have gotten it exactly right.


[1] 11 U.S.C. § 727(b) and 11 U.S.C. § 523

[2] 11 U.S.C. § 523(a)(1)(C) (emphasis added).

[3] See William M. Hawkins, III, aka Trip Hawkins, Appellant, v. The Franchise Tax Board of California; United States of America, Internal Revenue Service, Appellees (9th Circuit No. 11-16276; September 15, 2014).

[4] F. Scott Fitzgerald, The Rich Boy, in The Short Stories of F. Scott Fitzgerald: A New Collection 317  Matthew J. Bruccoli ed., Scribner 1989) (1926).

[5] Ernest Hemingway, The Snows of Kilimanjaro, in The Snows of Kilimanjaro and Other Stories 23 (Scribner 1961) (1936). (Hemingway, quoting the critic Mary Colum without attribution, used Fitzgerald’s name in the original magazine version of the short story, but altered the name to “Julian” in the later published book. See Eddy Dow, Letter to the Editor, The Rich Are Different, N.Y. Times, November 13, 1988, available at different-907188.html.)

[6] The Ninth Circuit also noted that the IRS received a $3.4 million distribution pursuant to a  liquidating plan of reorganization, which was confirmed by the bankruptcy court.


Voluntary Disclosure. Practitioners often struggle with the issue of whether a taxpayer can avoid a criminal tax investigation by making a disclosure to the IRS.  A “voluntary disclosure” is generally the process of voluntarily reporting previously undisclosed income (or false deductions) through an amended return or the filing of a delinquent return. A taxpayer’s timely, voluntary disclosure of a significant unreported tax liability is an important factor to the IRS in considering whether the matter should be referred to the U.S. Department of Justice for criminal prosecution.

A voluntary disclosure must be truthful, timely and complete, and the taxpayer must demonstrate a willingness to cooperate (and must in fact cooperate) with the IRS in determining the correct tax liability. Further, the taxpayer must make good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable. Additionally, the policy only applies to income earned through a legal business – so called “legal source” income.

IRS and JOJ Voluntary Disclosure Practice. Importantly, the IRS Voluntary Disclosure Practice describes a voluntary disclosure to include: (6) Examples of voluntary disclosures include: a. 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. This is a voluntary disclosure because all elements . . . above are met.” See Internal Revenue Manual (IRM) If this process is pursued, it is important that all the appropriate “bells and whistles” set forth in the IRM are followed, exactly.

The Department of Justice maintains a voluntary disclosure policy that provides: “Whenever a person voluntarily discloses that he or she committed a crime before any investigation of the person’s conduct begins, that factor is considered by the Tax Division 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.” Section 4.01, Criminal Tax Manual, U.S. Department of Justice (2008).

Further, the Department’s Policy Directives and Memoranda provides: “. . . the Service’s voluntary disclosure policy remains, as it has since 1952, an exercise of prosecutorial discretion that does not, and legally could not, confer any legal rights on taxpayers. If the Service has referred a case to the Division, it is reasonable and appropriate to assume that the Service has considered any voluntary disclosure claims made by the taxpayer and has referred the case to the Division in a manner consistent with its public statements and internal policies. As a result, our review is normally confined to the merits of the case and the application of the Department’s voluntary disclosure policy set forth in Section 4.01 of the Criminal Tax Manual.” Section 3, Policy Directives and Memoranda, Tax Division, U.S. Department of Justice (02/17/1993).

A practitioner should always advise a client seeking advice about a potential voluntary disclosure that the client must comply with the next set of filing requirements. Any suggestion to the contrary by the practitioner could subject him or her to potential criminal liability for aiding or assisting in the failure to file a return or the filing of a false return. This precept becomes important because many clients express a fear that a current filing may trigger scrutiny of their prior conduct, and some change their minds about making a voluntary disclosure prior to actually filing. Thus, the practitioner should always advise the client of the legal requirements for the current filing season and memorialize in the file that such advice was given.

Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution.  A timely voluntary disclosure will not guarantee immunity from criminal prosecution, but a true voluntary disclosure will normally result in the IRS not even recommending a criminal prosecution to the Department of Justice.

Timely? To be timely, the disclosure must generally be received before: (i) the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation; (ii) the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance; (iii) the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or (iv) the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).

Any taxpayer who contacts the IRS regarding voluntary disclosure may be directed to IRS-CI for an evaluation of the disclosure. To determine whether the disclosure is truly voluntary, IRS will review the actual status of any prior interest in the taxpayer, the taxpayer’s potential knowledge of such interest, and the taxpayer’s fear of some potential trigger that could have alerted the IRS.  A voluntary disclosure cannot be made anonymously. Any plan by a taxpayer, or their representative, to resolve a tax liability, file a correct return, or offer payment of taxes for an anonymous client is not likely to be considered a voluntary disclosure.

A voluntary disclosure does not occur until IRS has actually been contacted.  As such, it is imperative that the disclosure occur as quickly as possible.  Since returns filed pursuant to a timely voluntary disclosure have significant audit potential, they should be “bulletproof” in correctly reflecting the taxpayer’s income and expense items.

Fed-State Information Sharing. Due to various federal-state information sharing agreements, any applicable state returns should be contemporaneously filed or amended with the federal returns. Returns for related entities should also be contemporaneously filed or amended. Questions or doubts should likely be resolved in favor of the government. If a return filed pursuant to a voluntary disclosure is less than accurate, the taxpayer is compounding – not helping the problem.

Qualified Amended Return (QAR). Under certain situations, a timely  filed amended return may reduce or eliminate accuracy-related penalties. The “amount shown as the tax by the taxpayer on his return” not subject to penalties includes an amount shown as additional tax on a QAR, except that such amount is not included if it relates to a fraudulent position on the original return. See Treas. Reg. § 6664-2(c).  A QAR effectively eliminates accuracy-related penalties by removing amounts shown on the amended return from the penalty calculation. Significantly, even if timely, an amended return does not qualify as a QAR if the tax deficiencies that are corrected in the amended return relate to a fraudulent position on the original filed return.

How many returns must be filed or amended?  While there is certainly no well-established rule as to how many returns must be filed in making a voluntary disclosure, the general consensus is probably six tax years since the applicable statute of limitations for most tax related crimes is six years.  The disclosure should eliminate any government concern that there might be any potential issues with respect to a particular tax year for which the applicable statute of limitations for criminal prosecutions has not already expired. Additional returns could be in order since the statute of limitations for a criminal prosecution is tolled for the period of time a taxpayer is outside of the United States or is a fugitive from justice.

Typically, in a civil context, it is also the IRS policy to enforce the filing of returns for the prior 6 tax years.  In considering whether shorter or longer periods should be civilly enforced, the IRS will determine the prior history of non-compliance, the possible existence of income from illegal sources, the effect on voluntary compliance, the anticipated revenue in relation to the time and effort required to determine the tax due, and special circumstances existing in the case of a particular taxpayer, class of taxpayer, or industry, which may be particular to the class of tax involved.

Should IRS be Contacted Directly? Counsel must determine whether to contact the IRS before submitting a voluntary disclosure and actually filing the delinquent or amended tax returns. Some practitioners prefer to submit a Freedom of Information Act (FOIA) request seeking income information already in the possession of the IRS before filing the returns.  Some simply choose to file the delinquent or amended returns, with payment of tax and interest, with the appropriate IRS service center (now referred to as a “campus”) by certified mail, return receipt requested.  Such filings occur during the typical tax return filing season (around April 15 and October 15 for individual returns).

Some prefer making the voluntary disclosure in a meeting with the Special Agent in Charge of the local IRS-CI where the investigation would be conducted.  At this meeting, the potential voluntary disclosure would initially be discussed in a hypothetical format.  Counsel would generally outline the facts in hypothetical form (probably in writing) and would request whether IRS-CI would consider the return filing to be a voluntary disclosure in order to avoid recommendation of a criminal prosecution.

Counsel may also attempt to secure an IRS waiver of all applicable penalties before revealing the taxpayers identity.  In the event that IRS-CI responds affirmatively, counsel would then disclose the client’s identity and taxpayer identification number. However, IRS will assert that there has not been the requisite “disclosure” until the taxpayers information has been provided to the IRS.Properly resolving these issues can mean the difference between a taxpayer being subjected solely to civil tax adjustments (and possibly civil penalties), criminally excused of a tax crime or being convicted on the basis of admissions derived from the voluntary disclosure itself.

Certainly, the IRS has a somewhat limited capacity to perform criminal investigations. However, a significant amount of time is not required to criminally investigate and seek to prosecute a non-filer, particularly one who files delinquent or amended returns following an IRS inquiry. Without adequate representation, the perceived light at the other end of the voluntary disclosure tunnel . . . may be the IRS train coming straight at the taxpayer!

Posted by: | September 8, 2014

IRS Non-Filers Beware: Who’s That Knocking at Your Door ?

For numerous reasons, many taxpayers fail to timely file required U.S. income tax returns and associated reports. A “non-filer” is described as a taxpayer (or someone who ought to be a taxpayer) who does not file their return before the deadline to file the next year’s return. A “late filer” is taxpayer who misses the deadline for the year in question, but files the return within the following year. Many non-filers analyze optional strategies given the probability of audit and detection and the extent of penalties, if discovered. Others claim to be trapped into non-filing status because of past decisions. Typically, non-filers fall into three categories:

i)          Procrastinators – Know they should file but need assistance and/or prompting.  They will typically respond and always indicate that they will cooperate when contacted by the IRS.  However, information is generally slowly provided in a piecemeal fashion.

ii)         Uncooperative Non-Filers – They refuse to acknowledge and respond to correspondence and/or phone calls and if contacted by the IRS clearly state that they will not cooperate.

iii)        Tax Protestors – Advocate and/or use tax protestor’s schemes (i.e. refusal to file because of alleged constitutional reasons).

Failing to file returns is not a reasonable response to the inability to pay the tax liability associated with the returns. If in doubt, file the returns and work out a payment arrangement with the IRS. Also, know that the civil “failure to file” penalty accrues at 5.0%/month (up to 25% of the tax deficiency). The civil  “failure to pay” penalty accrues at the rate of 0.5%/month (up to 25% of the tax deficiency). When you do the math and factor in the numerous other risk factors associated with the failure to file a tax return, the decision to file becomes somewhat obvious in most cases.

The IRS has identified at least 10 million delinquent returns and has been pursuing a cross-functional National Non-Filer Strategy to identify non-compliant taxpayers and design methods to encourage their compliance.  Before contacting a non-filer, the IRS will often attempt to identify the non-filer’s occupation, location of bank/savings accounts, sources of income, age, current address, last file returned, adjusted gross income of last file returned, taxes paid on last file returned – amounts and methods of payment (withholding, estimated tax, pre-payments), number of years delinquent, and the non-filer’s standard of living.

They will search public records for evidence of additional unreported income, tax assessor and real estate records for assets held by the non-filer, and records of professional associations and business license bureaus for information on businesses being operated by the non-filer. They will also search sales tax returns and the state records to disclose corporate charter information including principals of any businesses that have failed to file returns. They will contact the last known employer to determine if the non-filer is still employed and the specific occupation of the non-filer.

Determining the specific occupation of the non-filer can lead to additional sources, such as labor unions, professional societies, trade associations, etc. The IRS will also determine whether there is a history of non-filing (multiple non-filed years provide a pattern of behavior), whether there have been repeated contacts by the IRS, indications that the non-filer had knowledge of filing requirements (i.e. professional with an advanced education, person who works directly in the tax field), whether there are a large number of cash transactions (i.e. purchases by cash, cash deposits as evidenced by currency transaction reports, etc.) and whether there are indications of significant unreported income (i.e. substantial interests and dividends earned, investments in IRA accounts, stock and bond transactions, high mortgage interest paid, etc.).

Tax Evasion and Fraud? If a non-filer is contacted by the government, the examiner will determine the cause (does the non-filer lack records, ability to pay, lack of education, etc.) and may offer necessary information or assistance (preparation of returns, payment arrangement information, etc.) to secure full cooperation. If the non-filer is not cooperative (won’t respond or refuses to cooperate), third party contacts may be made to determine the non-filer’s income and make an assessment.

When contacting the taxpayer, the IRS will attempt to gather as much information as possible to arrive at a substantially correct tax assessment.  They will also attempt to establish reasons for the non-filing by asking specific and direct questions (i.e. Why were returns not filed?  Did you know that you were required to file returns?).

If the examiner discovers subsequent acts of tax evasion (false statements, refusal to make records available, etc.), they will often consider whether the case should be referred for a criminal investigation. The examiner will also be alert to attempts by the non-filer to conceal or transfer assets to evade collection of tax later assessed. In these cases, a jeopardy (immediate) assessment may be considered.

The manner in which responses occur could dictate the future course of action by the IRS examiner (i.e., whether to pursue penalties and/or a referral for criminal investigation). Willful failure to file a tax return is a misdemeanor pursuant to IRC 7203. In cases where an overt act of evasion occurred, willful failure to file may be elevated to a felony under IRC 7201. If failure to file a return is fraudulent, a civil penalty known as the “fraudulent failure to file (FFTF) penalty” may apply under IRC 6651. The mere fact of failing to file a return does not constitute sufficient evidence to sustain fraud. Overt acts of evasion must be identified.

On the initial screening of a non-filer case, the IRS will attempt to determine if the facts indicate potential fraud. Indicators of fraud for consideration set forth in the IRS Internal Revenue Manual (IRM) include:

  • History of non-filing or late filing, and an apparent ability to pay;
  • Repeated contacts by the IRS;
  • Knowledge of the filing requirements (i.e., advanced education, business (especially tax) experience, record of previous filing etc.);
  • Experience of the taxpayer in tax matters such as a law professor, CPA or tax attorney;
  • Failure to reveal or attempts to conceal assets;
  • Age, health, and occupation of the taxpayer;
  • Substantial tax liability after withholding credits and estimated tax payments;
  • Large number of cash transactions, i.e., purchases by cash and large cash deposits evidenced by documented cash transactions, payment of personal and business expenses in cash when cash payment is unusual and/or the cashing (as opposed to the deposit) of business receipts;
  • Indications of significant income per Information Return Processing (IRP) documents (i.e., substantial interest and dividends earned, investments in IRA accounts, stock and bond transactions, high mortgage interest paid);
  • Refusal or inability to explain the failure to file; and
  • Prior history of criminal tax prosecutions for Title 26 violations.

If the IRS believes the possibility of fraud exists, the IRM instructs the IRS examiner to:

  1. DO NOT SOLICIT tax returns. If returns are submitted, they should be accepted but not processed, and clearly documented in the case history.
  2. DO NOT VOLUNTEER ADVICE to the taxpayer concerning any potential course of action to follow.
  3. DO NOT DISCUSS tax liabilities, penalties, fraud, or criminal referral possibilities with the taxpayer.

During non-filer examinations, the IRS examiner will determine if related returns (corporate, partnership, employment tax, and excise tax returns) have been filed as required.  They will also search for spin-off cases involving relatives, employees, employers, subcontractors, partners, and even return preparers!  If a non-filer is involved in a family business, the examiner will determine if all family members have filed returns.  If the non-filer is involved in a partnership, the IRS will determine if partnership returns have been filed and determine if all partners have filed returns.  For delinquent corporate returns, they will attempt to determine if all shareholders have filed returns. Penalties are not typically be easily waived in non-filer cases without reasonable cause.

During the non-filer examination, the IRM suggests that the examiner:

  1. Interview the taxpayer to determine the reason or the intent of the taxpayer’s noncompliance.
  2. Ask sufficient questions to determine the extent of the delinquency, including the periods and tax due.
  3. Document verbatim, if possible, the questions asked and the taxpayer’s response or lack of response.
  4. Identify any personal reasons that could affect the taxpayer’s ability to comply. If the information is not provided by the taxpayer, attempt to secure the information from third party sources.
  5. Attempt to get a definitive statement from the taxpayer regarding additional expenses not listed in the books and records. These expenses could include, but are not limited to, expenses paid in cash or “under-the-table” payments to employees.
  6. Attempt to establish year-end cash on hand for each year under investigation.

The role of IRS Criminal Investigation (IRS-CI) in the IRS non-filer strategy is the enforcement of the tax laws for individuals who are not responsive to outreach efforts. IRS-CI has historically devoted resources to identify these individuals, and in the more flagrant cases, criminal prosecution has been and will continue to be recommended. IRS-CI has developed and investigates high impact investigations of non-filers in various occupations and industries, as well as those who file non-processable returns or employ frivolous arguments which the courts have repeatedly rejected.

Substitute for a Return. If the taxpayer does not respond to government inquiries, the IRS may independently prepare a tax return and the related assessments under Internal Revenue Code § 6020 (b).  These assessments are generally based on very limited information, such as that gathered from Forms W-2 and 1099.  For these cases, IRS assesses the maximum potential tax owed based on gross receipts since they don’t have access to potential deductions, exemptions or credits available to the taxpayer. By failing to file a return, a taxpayer may also lose a refund of any amounts withheld. The failure to file and pay self-employment tax by self-employed individuals could cause them to be ineligible for social security retirement or disability benefits.

What to do? A taxpayer’s timely, voluntary disclosure of a significant unreported tax liability is an important factor to the IRS in considering whether the matter should be referred to the U.S. Department of Justice for criminal prosecution. Properly resolving this issue can mean the difference between a taxpayer being criminally excused of a tax crime or being convicted on the basis of admissions derived from the voluntary disclosure itself.

Counsel should likely determine whether to contact the IRS before submission of a voluntary disclosure and should be consulted before actually filing the delinquent or amended tax returns.  If not properly coordinated (or not timely), submission of amended or delinquent returns might be deemed an important admission in a later criminal proceeding. If timely and submitted in accordance with the IRM, a timely voluntary disclosure can avoid a criminal referral and may significantly reduce or possibly eliminate the imposition of civil penalties on any resulting tax deficiency.

Generally, people who come forward and file returns prior to being contacted by IRS are not pursued through a criminal investigation, might be able to reduce or eliminate potential civil penalties, and may be able to coordinate an effective installment payment arrangement (or Offer in Compromise) for any resulting deficiencies.  Regardless, a non-filer should not wait since the “first knock on the door” may be that of a special agent from IRS-CI.



AGOSTINO & ASSOCIATES –To download a few great articles prepared by our very close friends at the Law Firm of Agostino & Associates in Hackensack, NJ ( ), see the Agostino & Associates Newsletter*/ACFrOgB3DcF0a_jTmvIpYCiuNKqO7L9fgn3s-OoYgXI80f841xzDJ5w3W4RQJIos9LXs1ctCT2z8v3FIziSDS2y-W6ct63hwuBzvEW_vnXAgbmb31pJpOwZuVMW1Ou8=?print=true

DE NOVO REVIEW OF ASSESSABLE INTERNATIONAL PENALTIES By Frank Agostino, Brian D. Burton, and Lawrence A. Sannicandro    – Many taxpayers and tax professionals believe that Collection Due Process (“CDP”) rights do not attach to international information return penalties. This confusion likely stems from the (well known) fact that the usual CDP rights do not attach to penalties for failure to file a timely, complete and accurate Financial Crimes Enforcement Network (“FinCen”) Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”).

To this end, the TaxCourt has specifically  held that it “has no jurisdiction to review the [IRS’s] determination as to [taxpayers’] liability for FBAR penalties.” However, one must distinguish between FBAR penalties, a product of the Bank Secrecy Act of 1970 (“BSA”), which cannot be challenged via CDP procedures, and assessable international penalties for untimely, incomplete or inaccurate IRS Forms 926, 3520, 3520A, 5471, 5472, 8865, or 8938 which are products of the Code and subject to de novo CDP and Tax Court review. FOR THE FULL ARTICLE SEE



For further information, contact Frank Agostino at (201) 488-5400 or visit  

AGOSTINO & ASSOCIATES, with a national practice based in Hackensack, NJ, specializes in tax and tax controversies (civil and criminal), offers in compromise, voluntary disclosures, tax lien discharges,  innocent spouse determinations, forfeitures, estate planning and probate, contract and contract litigation.  A firm comprised truly great, caring people who want the best for their clients !

Posted by: | August 26, 2014


All tax planning is not to be condemned. “It is no surprise that a knowledgeable tax attorney would use numerous legal entities to accomplish different objectives. This does not make them illegitimate. Unfortunately such ‘maneuvering’ is apparently encouraged by our present tax laws and codes.” [1]

CIRCULAR 230 – Cir. 230 provides the regulations governing the practice of federally authorized tax practitioners before the IRS, authorizing specific sanctions for violations of the duties and obligations; and, describing the procedures that apply to administrative proceedings for discipline.

“Practice before the IRS” generally includes all matters connected with a presentation to the IRS, or any of its officers or employees, relating to a taxpayer’s rights, privileges, or liabilities under laws or regulations administered by the IRS. Such presentations often include preparing tax and information returns; filing documents; corresponding and communicating with the IRS; rendering oral and written advice with respect to any entity, transaction, plan or arrangement, or other plan or arrangement having a potential for tax avoidance or evasion; and representing a client in front of an IRS representative at conferences, hearings and meetings. A copy of Cir. 230 is available at [2]

OFFICE OF PROFESSIONAL RESPONSIBILITY – The Mission of the IRS Office of Professional Responsibility (OPR), formerly known as the Director of Practice, is to “Interpret and apply the standards of practice for tax professionals in a fair and equitable manner.” OPR supports the IRS’s strategy to enhance enforcement of the tax law by ensuring that tax professionals adhere to tax practice standards and follow the law by, in part, enforcing the regulations governing the practice of federally authorized tax practitioners, generally defined to include attorneys, certified public accountants (CPAs), enrolled agents, enrolled actuaries and appraisers before the IRS as set forth in Treasury Department Circular No. 230 (Cir. 230; Rev. 06/2014). [3]

OPR has the authority to impose suspension, disbarment and/or significant monetary fines on federally authorized tax practitioners, firms and other entities. In addition, as part of any OPR investigation they may contact current and former clients. OPR has exclusive responsibility for practitioner conduct and discipline, including instituting disciplinary proceedings and pursuing sanctions, functioning independently of the Title 26 enforcement components of the IRS.

The IRS Internal Revenue Manual (IRM) indicates that misconduct under Cir. 230 which could warrant an OPR investigation include the following:[4]

  1. Failure to exercise due diligence – § 10.22(a).
  2. Conviction of any criminal offense under the revenue laws of the United States – § 10.51(a)(1).
  3. Conviction of any criminal offense involving dishonesty or breach of trust – § 10.51(a)(2).
  4. Conviction of any felony under Federal or State law for which the conduct involved renders the practitioner unfit to practice before the IRS – § 10.51(a)(3).
  5. Giving false or misleading information or participating in any way in the giving of false or misleading information in connection with any matter pending or likely to be pending before the IRS, knowing the information to be false or misleading -§ 10.51(a)(4).
  6. Willfully failing to make a Federal tax return in violation of the Federal tax laws, or willfully evading, attempting to evade, or participating in anyway in evading or attempting to evade any assessment or payment of any Federal tax – § 10.51(a)(6).
  7. Disbarment or suspension from practice as an attorney, certified public accountant, public accountant, or actuary – § 10.51(a)(10).
  8. Giving a false opinion, knowingly, recklessly, or through gross incompetence, including an opinion which is intentionally or recklessly misleading, or engaging in a pattern of providing incompetent opinions on questions arising under the Federal tax laws – § 10.51(a)(13).
  9. Contemptuous conduct, in connection with practice before the IRS, including the use of abusive language, making false accusations or statements, knowing them to be false, or circulating malicious or libelous matter – § 10.51(a)(12).
  10. Assertion of penalties under Internal Revenue Code (IRC) §§ 6694, 6695, 6700 and 6701.

REFERRALS TO OPR – Section 10.53 of Cir. 230 requires IRS employees to make a written report to OPR when there is reason to believe that a tax practitioner has somehow violated Cir. 230.[5] When disciplinary action is deemed appropriate, the report will include sufficient detail, documentation, and exhibits, to substantiate the character and extent of the violation.  IRS examiners are cautioned to exercise discretion in making referrals of asserted IRC 6694(a) (Understatement of liability due to an unreasonable position) penalties to OPR for attorneys, CPAs, enrolled agents, enrolled actuaries, enrolled retirement plan agents, and appraisers.[6] However, referrals to OPR can arise when the following penalties are asserted against a practitioner[7]:

  1. Referrals of asserted IRC 6694(a) penalties to OPR should be based on a pattern of failing to meet the required penalty standards under IRC 6694(a).
  2. Asserted preparer penalties under IRC 6694(b) (e.g., a willful attempt to understate the liability for tax) for attorneys, CPAs, enrolled agents, enrolled actuaries, enrolled retirement plan agents, and appraisers are mandatory referrals to OPR.
  3. For IRC 6695(a) through (g)(generally the (a) failure to furnish copy of return; (b) Failure to sign return; (d) failure to keep a copy of tax return or list of taxpayer), examiners should exercise discretion in making referrals to OPR.
  4. Anytime a penalty for promoting abusive tax shelters under IRC 6700 is assessed.
  5. Anytime injunctive action under IRC 7407 (injunction of a tax return preparer) or IRC 7408 (Injunction of specified conduct relating to tax shelters and reportable transaction) is pursued.[8]

Referrals are mandatory for violations of IRC §§ 6694(b), 6700, 6701(a), 7407 and 7408. Referrals are discretionary for violations of IRC §§ 6694(a), 6695 and 6702 (frivolous tax returns or submissions). However, the referral should be anticipated if any of the above penalties appear to become a pattern across taxpayers, tax issues or tax years since this could indicate reckless conduct or lack of competence.

Other circumstances that might anticipate a referral to OPR include inaccurate or unreasonable entries/omissions on tax returns, financial statements and other documents; a lack of due diligence exercised by the practitioner; a willful attempt by the practitioner to evade the payment/assessment of any Federal tax; cashing, diverting or splitting a taxpayer’s refund by any means, electronic or otherwise; “Patterns” of misconduct involving multiple years, multiple clients or inappropriate/unprofessional conduct demonstrated to multiple IRS employees; potential conflict of interest situations, such as representation of both spouses who have a joint liability or when representation is affected by competing interests of the practitioner; and any willful violation of Cir. 230.

OPR may, after notice and an opportunity for a conference, negotiate an appropriate level of discipline with a practitioner; or, initiate an administrative proceeding to Censure (a public reprimand), Suspend (one to fifty-nine months), or Disbar (five years) the practitioner. OPR may also, after notice and an opportunity for a conference, disqualify an appraiser from further submissions in connection with tax matters.

OPR may also, after notice and an opportunity for a conference, propose a monetary penalty on any practitioner who engages in conduct subject to sanction. The monetary penalty may be proposed against the individual or a firm, or both, and can be in addition to any Censure, Suspension or Disbarment. The penalty may be up to the gross income derived or to be derived from the conduct giving rise to the penalty. The OPR web site also has a searchable database containing the names of all the individuals currently under suspension or disbarment.[9]

NOTIFICATION OF STATE LICENSING AUTHORITIES – Many States have statutes and regulations requiring the notification of the State licensing authority in the event a practitioner receives notification of a practitioner penalty or an inquiry investigation from an agency such as the OPR. A failure to timely notify the licensing authority within the required time period (typically 30 days from receipt of knowledge of the notification or inquiry) could result in a separate, additional violation.

An example of a State statute requiring notification of the State licensing authority is the requirement in California Business & Professions Code § 5063 for California Certified Public Accountants to notify the State Board of Accountancy of a practitioner penalty. In part, California Business & Professions Code § 5063 provides:

“California Business & Professions Code § 5063.

(a) A licensee shall report to the board in writing of the occurrence of any of the following events occurring on or after January 1, 1997, within 30 days of the date the licensee has knowledge of these events: . . . (3) The cancellation, revocation, or suspension of the right to practice as a certified public accountant or a public accountant before any governmental body or agency.

(c) A licensee shall report to the board in writing, within 30 days of the entry of the judgment, any judgment entered on or after January 1, 2003, against the licensee in any civil action alleging any of the following:….(5) Any actionable conduct by the licensee in the practice of public accountancy, the performance of bookkeeping operations, or other professional practice.

(d) The report required by subdivisions (a), (b), and (c) shall be signed by the licensee and set forth the facts which constitute the reportable event. If the reportable event involves the action of an administrative agency or court, then the report shall set forth the title of the matter, court or agency name, docket number, and dates of occurrence of the reportable event.

(f) Nothing in this section shall impose a duty upon any licensee to report to the board the occurrence of any of the events set forth in subdivision (a), (b), or (c) either by or against any other licensee.”


Practitioners should routinely review their own procedures for gathering and documenting the information they process on behalf of taxpayers. Preparers should be documenting or know how they have arrived at reporting positions for transactions that might not meet the appropriate practice standard. Further, the preparer or their firm must have review procedures and these procedures must be followed.

Preparer penalty issues will most often arise during or at the conclusion of an IRS examination of the taxpayers return when some or all of an undisclosed or improperly disclosed position has been disallowed. Is it reasonable to believe that an agent, having disallowed a questionable position, will be convinced there was the requisite “substantial authority” for the undisclosed position? Is it reasonable to believe that an agent, having disallowed a questionable position, will be convinced there was a “reasonable basis” for the disclosed position? Also, most return positions are comprised of several sub-positions. If each sub-position has a 40% chance of success on the merits, the primary position might not have a similar overall 40% chance of success on the merits (40% of 40% of 40% is not 40% overall).

Although the preparer penalty regime is mostly intended for the “bad actors,” it can be applied to any preparer. The combination of a somewhat inattentive preparer and a somewhat aggressive government agent could result in preparer penalties being assessed in many otherwise unintentional situations.

  1. Your Client is Not Your Friend. If you need a friend, get a dog!
  2. Think “Substantial Authority.” Penalties generally require a “substantial authority” standard, or “reasonable basis” plus disclosure. Take the time to analyze relevant facts and authorities before making the determination to disclose, or not.
  3. Think Disclosure. Appropriate disclosures within the return can generally avoid penalties, for the taxpayer and the preparer. All disclosures should be in writing. Review Rev. Proc. 2014–15[10] regarding disclosure within a taxpayers return and the appropriate form of disclosure. Signing Preparer - Disclosure on Forms 8275 or 8275-R, as appropriate, filed with the return. The “signing preparer” is generally the person who prepares the most entries on the return. Non-Signing Preparer - “Disclosure” is appropriately advising the client or the preparer. There can be more than one preparer for each return.
  4. Tax Advice is Sufficient for IRC §6694 Penalties to Apply. It is not necessary to see the return to be the preparer. A person who renders advice which is directly relevant to the determination of the existence, characterization, or amount of an entry on a return or claim for refund, will be regarded as having prepared that entry. Whether a schedule, entry, or other portion of a return or claim for refund is a substantial portion is determined by comparing the length and complexity of, and the tax liability or refund involved in, that portion to the length and complexity of, and tax liability or refund involved in, the return or claim for refund as a whole. There can be more than one preparer for each return.
  5. OPR Referrals. Be aware that IRS employees are required to make a referral to the OPR if there is a “pattern” of certain conduct and a preparer penalty is sustained. Although in some situations not required to make the referral to OPR in the event of a single violation, some within the IRS may feel compelled to make the OPR referral for a single violation.
  6. Limit the Nature and Scope of Services to be Provided in the Engagement Letter. Have separate engagement letters for separate engagements. Do not exceed the scope of an engagement letter without another engagement.
  7. Requirements to Notify State Licensing Authorities. Many States have requirements for a licensee to notify the State licensing authority in the event of a preparer penalty. Failure to provide timely notification could be a separate violation.
  8. Establish a System of Checklists for Preparation and Advice – and Follow the System. Best practices in the office strongly suggests a system for promoting accuracy and consistency in the preparation of returns or claims and should generally should include – in the case of a signing preparer – checklists, methods for obtaining necessary information from the taxpayer, a review of the prior year’s return and possibly all related returns, and internal review procedures.
  9. Emails Have a Life of Their Own. “Delete” merely takes the email off your screen. Experienced investigators will locate deleted emails. Only render such advice that you reasonably believe is accurate and appropriately supported by relevant facts and authorities.
  10. There Are No Hypothetical Questions. Do not respond unless you are confident you have received and understand all relevant facts. Responses should be limited to the facts presented.
  11. Fight, Fight, Fight . . . if Facing a Preparer Penalty. The primary issue is often the reasonableness of the preparer’s belief and good faith in the reported position. Although the economic penalty under IRC §6694(a) may not be significant when compared to the effort involved to dispute it, the related investigations by OPR and the State licensing authorities may destroy the preparers practice (and reputation). Anticipate that potential malpractice claims will routinely include allegations of a failure to comply with federal tax standard of care and Cir 230. Anticipate the government may contact the current and former clients and that they may require the preparer to also disclose the violations to their clients with a full explanation. Your reputation for integrity and credibility is at issue – protect it!
  12. Maintain the Appearance of Cooperation and Reasonableness When Representing Clients in a Tax Dispute. Many OPR referrals arise as a result of the examination of a taxpayer’s return and conduct of the representative during the examination. Respond timely, cooperate as reasonably required, inquire when faced with uncertainty, push back when necessary and watch your back at all times.
  13. New Clients. Each firm should set practical guidelines re the acceptance of new clients. Consider speaking with the clients prior representatives to ascertain potential issues. The prospective client who talks poorly of the last representative(s) may only be including you in the list for next year. Sometimes it’s not the horse but the jockey who loses the race.
  14. Supporting Data. Although the preparer is not required to independently examine or verify all supporting information, make sure to inquire as to whether such data has been satisfactorily maintained. Encourage the client to maintain proper information supporting the positions set forth within the return. Best practices suggests retaining documentation resulting from any tax related research (including authorities both for and against the tax position), the reasoning behind the conclusion, and relevant authorities supporting the conclusion.
  15. Preparer Judgment. The judgment of the preparer and other tax advisors, not the client, should be the determining factor regarding positions set forth on the return. If the client refuses to comply with the recommendations, the significance of each recommendation in relation to the return may be the deciding factor re whether to withdraw from representation.
  16. Document Your Advice to Clients and Others in Writing. Enough said – protect yourself and your firm.
  17. No Good Deed Goes Unpunished. “Off the cuff” advice and quick email responses may, in certain circumstances, be sufficient for penalties or Circular 230 sanctions to apply. Tax positions should be appropriately analyzed and discussed with the client, including: (a) review and document all relevant facts; (b) explain that the position is an opinion based on information presented by the client; c) include a discussion re any possible penalties that may be assessed; and (d) avoid technical terms that may be misunderstood by the client.
  18. Anticipate Potential Assertion of Preparer Penalties. The increased attention on preparers and their conduct may result in an increase in incidences of assertion of preparer penalties and sanctions. Referrals might occur as a result of confusion about the appropriate standard, inadvertent oversight, less than adequate disclosures or relatively minor infractions.
  19. Be Prepared, Not Paranoid. If a situation arises, handle it in a clear and appropriate manner. It will not go away if you ignore it or are simply “too busy” to respond to inquiries from the IRS or OPR. OPR understands the realities of a busy tax practice and good faith efforts to comply with an extremely complex IRC.
  20. Be Proud of Your Profession. It is an honor and a privilege to represent taxpayers before the IRS. Tax practitioners often devote untold personal hours being educated on new tax provisions, software updates, policies and procedures. Tax practice is a profession and professionals help other professionals. If struggling with a tax issue, ask an experienced colleague for advice. If asked by a colleague for advice, take the time to listen and provide whatever meaningful assistance you can and remember, someday you may be the person placing that call for assistance . . .

Be prepared, exercise your best judgment, document your recommendations . . . and know that 98% of the problems in practice emanate from 2% of the clients. Clients who refuse to comply with your valued recommendations should be encouraged to seek other representation.

Be proud of your profession and remember that today is the tomorrow that you worried about yesterday  . . . at the end of the day, if you are proud to go home and tell others about your day, you are practicing in the right profession!!

SUBSCRIBE TO NEWS AND UPDATES FROM IRS OPR – Subscribers will be notified by e-mail regarding OPR disciplinary actions, Press releases,  New items, Rules governing those who practice before the IRS and related updates, and Educational info about OPR, its mission and priorities. See

[1] Ballard v. Commissioner, Nos. 01-17249 (11th Circuit, April 7, 2008).

[2] Circular 230 is the common name given to the body of regulations promulgated from the enabling statute found at Title 31, United States Code § 330. This statute and the body of regulations are the source of OPR’s authority.


[4] Referrals to the Office of Professional Responsibility, IRM  (01-14-2011)

[5] 31 C.F.R. Section 10.53(a)).

[6] Referrals to the Office of Professional Responsibility, IRM  (01-14-2011)

[7] Id.

[8] Id.

[9] See

[10]Rev. Proc. 2014-5 (Internal Revenue Bulletin 2014-5; January 27, 2014)

Posted by: | August 20, 2014


Has this happened to you? You are in your office toiling away in the tax trenches when a colleague down the street who works the offshore cases sends you an e-mail:

“I’m sending over an OVDP client. He has a problem and I can’t represent him anymore.”

Eventually the client sits in your office and spins the following tale. He is a lawyer. He had an undisclosed account at UBS with about $1.5 million in it. He entered the 2009 OVDP represented by another tax practitioner and successfully obtained a closing agreement in 2012 after paying all of the necessary taxes, penalties and interest for 2003, 2004, 2005, 2006 2007 and 2008 as required by the 2009 IRS Offshore Voluntary Disclosure Program (OVDP).

THE INITIAL – FALSE – OVDP SUBMISSION. Recently the client received a letter from a second Swiss bank telling him, in effect, that the second Swiss bank would turn his bank data over to the United States unless he did a whole bunch of things, including waiving his rights to bank secrecy under Swiss law, proving he has complied with his filing and reporting obligations under the U.S. Internal Revenue Code and the U.S. Bank Secrecy Act, or in the alternative, proving he is participating in the OVDP. The client reveals that this second Swiss Bank account has held around $4 million since 2003, funded with unreported taxable income.

In 2012, after he “successfully” (in his mind) completed the 2009 OVDP, he transferred all of the money from the second Swiss bank to a more secure foreign bank in Vanuatu where it sits today. The client did not bother to mention this second Swiss bank to the lawyer down the street until a few days ago. Needless to say, he did not comply with any of his obligations under the U.S. Internal Revenue Code or the U.S. Bank Secrecy Act regarding this second Swiss account, let alone his Vanuatu account. The client is about ready to file his 2013 federal and state income tax returns which, like every return he filed for the last decade, will be fraudulent.

So what advice can you give this taxpayer client? You obviously can not advise him to flee to Vanuatu and live with his money, not only because it is unethical to say so but it may well also be a crime to provide such advice. Let’s look at some other options:

1. Do Nothing. A default move considered by many when confronted by life’s problems, but it is not indicated here. Any of FATCA or The Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks (the “Program”) will reveal this second Swiss bank account to the United States with plenty of time on the statute of limitations to develop their criminal case. This case is a tax prosecutor’s dream. It has significant unreported income, lots of “badges of fraud,” a lawyer defendant, and an open statute of limitations.

Thanks to the client’s affirmative acts of evasion during the 2009 OVDP, his 2003 through 2008 criminal tax statute of limitations on tax evasion (26 U.S.C. Section 7201) is open until six years after he signed the closing agreement in 2012. Fortunately the statute of limitations for prosecuting FBAR crimes is fixed at six years. Count up the fraudulent original and amended federal and state income tax returns since 2003 and you get thirty-two. Thirty-four if you let the client follow through on his plan for 2013.

2. Do a “Quiet Disclosure.” Assuming the client can meet the basic requirements of the IRS Voluntary Disclosure Practice set forth in Internal Revenue Manual (IRM) in IRM (12-02-2009) the client may simply choose to file correct amended tax returns, with payment, with the appropriate IRS campus (a “quiet” voluntary disclosure). Since the criminal statute of limitations allows prosecution of the 2003 through 2012 income tax returns, the client would need to amend each of these returns. Although the IRS and Department of Justice have a dim view of quiet voluntary disclosures in the context of undeclared foreign bank accounts, we are aware of no situation where a taxpayer has been prosecuted for tax crimes after a proper quiet voluntary disclosure that FULLY complies with each of the terms and provisions set forth in the IRS Voluntary Disclosure Practice, IRM (12-02-2009).

Rather, the quiet voluntary disclosures that are later identified by the IRS are sometimes subjected to multiple 50% civil FBAR penalties as a punishment. That being said, if the client attempts a quiet voluntary disclosure here, it will not cure his willful failure to file his FBARs which alone, provides plenty of ammunition to the government for a tax related criminal prosecution. We have not seen FBAR prosecutions on a stand-alone basis, but in the appropriate case the government might well prosecute the FBAR counts alone. On balance, a “quiet” voluntary disclosure is not likely something the taxpayer should consider as a completely safe landing.

3. Try to Get Back into the 2009 OVDP. This could work, if at all, where the undisclosed second foreign bank account overlapped precisely the first foreign bank account. There you could work with the implicit, but always unspoken, excuse that the client basically “forgot” the second account. You would need to get someone in the IRS to reopen the client’s 2009 OVDP so that you could correct the first closing agreement and file amended income tax returns and amended FBARs and pay all of the necessary additional taxes, penalties and interest. Without help from the IRS, the IRS could reject your subsequent tax payments as beyond the collection statute of limitations and would likely ignore any increased FBAR penalty that you attempted to pay. If the IRS refuses to accept these payments, the client obtains no protection under the 2009 OVDP.

In our case, the client’s noncompliance on the second Swiss account stretches though the six 2009 OVDP years and also takes in 2009, 2010, 2011 and 2012. So what do you do with 2009, 2010, 2011 and 2012? It is unlikely the IRS would fold these later years into the 2009 OVDP.

4. Go into the 2012 OVDP. On the face of things, the client seems to qualify for the 2012 OVDP. This would allow you to correct 2005 through 2012. What about those pesky 2003 and 2004 tax years where your client lied to the government during the 2009 OVDP, filed false income tax returns and false FBARS and the statute of limitations for tax prosecutions is still open for those years? Maybe you could convince your OVDP Revenue Agent into expanding the closing agreement to pick up 2003 and 2004. If accepted, that should solve the problem.

5. Combinations of the Above. The six year statute of limitations for criminal prosecutions relating to FBARS has expired for 2007. This means that the client might consider simply amending returns for 2003 through 2007 eliminating criminal tax exposure without worrying about any FBAR criminal prosecution. The client then could consider OVDP participation for 2009, 2010, 2011 and 2012.

WHAT TO DO? There are no clear “rules of thumb” for a situation where a taxpayer previously provided the IRS with a false or misleading submission seeking participation in an IRS OVDP. However, the taxpayer must somehow get into compliance with their filing and reporting obligations, fully into compliance.

Consult with experienced tax counsel at the earliest opportunity. For whatever reason, we seem to be seeing more of these scenarios are able to appropriately respond, if contacted in a timely manner. All relevant facts must be fully identified and developed by counsel with the assistance of others working for such counsel. The sensitive nature of things surrounding the initial false OVDP submission must be carefully handled.

The taxpayer and the prior representative are likely candidates for an interview by IRS representatives in the best case scenario.The IRS will likely inquire about what was disclosed to the representative who handled the initial, false OVDP submission. Did the representative make sufficient inquiries or simply look away?

Overall, the government seems able to acknowledge, to some degree, the benefit of this taxpayer coming into compliance the second time before the government had to go drag the person off the street. Regardless, all involved should be sure this taxpayer gets educated and, going forward, fully understands and respects their obligation to comply with all applicable domestic and foreign filing and reporting requirements.

EDWARD M. ROBBINS, Jr. – For more information please contact Edward M. Robbins, Jr. Mr. Robbins is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., the former Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at


Posted by: | August 12, 2014

HIDDEN RESOURCES: IRS Audit Techniques Guides

Historically, IRS examiners were assigned to audit taxpayers in many different industries. On one day, an examiner audited a grocery store and on the following day the examiner may have audited a computer retailer or a medical doctor. As a result, experience gained in one audit did not significantly enhance the examiner’s experience for purposes of conducting other audits.

More recently, the IRS has been attempting to identify and reduce non-compliance through efficiency, tax form simplification, education, and enforcement. In addition, the IRS has significantly modified its examination process in a manner designed to increase the available resources and experience of its examiners.

The IRS Audit Techniques Guides (ATGs) focus on developing highly trained examiners for a particular market segment or issue. A market segment may be an industry such as construction or entertainment, a profession like attorneys or real estate agents or an issue like passive activity losses, hobby losses, litigation settlements or executive compensation – fringe benefits. These guides contain examination techniques, common and unique industry issues, business practices, industry terminology, interview questions and procedures and other information to assist examiners in performing examinations.

IMPROVED IRS AUDIT EFFICIENCY.  The ATGs significantly improve IRS audit efficiency and compliance by focusing on taxpayers as members of particular groups or industries. These groups have been defined by type of business (artists, attorneys, auto body shops, bail bond industry, beauty shops, child care providers, gas stations, grocery stores, entertainers, liquor stores, pizza restaurants, taxicabs, tour bus industry, etc.), technical issues (passive activity losses, alternative minimum tax), and types of taxpayer or method of operation (i.e. cash intensive businesses). As examiners focus on the tax compliance of a particular industry, they have gained experience on specific issues to be examined for a particular type of business, whether or not the issues are set forth on a tax return. Examiners often spend the majority of their time auditing taxpayers in the particular market segment for which the examiner has become a specialist. Some may specialize in examining the construction industry while others may specialize in examining restaurants.

IRS examiners are routinely advised about industry changes through trade publications, trade seminars and information sharing with other examiners. As such, there is an increased understanding of the market segment, its practices and procedures, and the appropriate audit techniques required to identify issues unique to the market segment under examination. Utilizing an ATG, examiners attempt to reconcile discrepancies when income and/or expenses set forth on a taxpayer’s return are inconsistent with a typical market segment profile or where the reported net income seems inconsistent with the standard of living prevalent in a geographical area where the taxpayer resides. As a result, information and experience gained through the examination of returns for other taxpayers becomes the barometer for judging the accuracy of a particular return under examination.

Issues are continually being identified by their unique features requiring specialized audit techniques, technical or accounting knowledge, or the need to comprehend the specific business practices, terminology and procedures. The IRS has published numerous ATGs, including attorneys, auto body/repair shops, bail bondsmen, beauty/barber shops, car washes, child care providers, check cashing establishments, childcare businesses, construction contractors, farmers, restaurants and bars, various segments of the entertainment industry (motion picture/television, athletes and entertainers, music), garment industry, gasoline distributors, grocery stores, insurance agencies, jewelry dealers, liquor stores, mobile food vendors, parking lot operators, pizza parlors, real estate agents/brokers, real estate developers, recycling businesses, scrap metal businesses, taxicabs, the trucking industry, direct sellers and auto dealers.

DEVELOPMENT OF AN ATG. Once the IRS identifies a particular market segment project, an audit group may develop an ATG based upon the market segment’s unique business activities. Information developed during IRS examinations of similar issues or taxpayers is coordinated into what eventually become an ATG for such issues or type of taxpayer activity. The audit guides are then used by examiners throughout the country to develop a pre-audit planning strategy. As such, utilization of the ATG allows the examiner to streamline their examination resulting in more efficient examinations often targeting sensitive issues or issues involving industry non-compliance.

The ATGs explain the nature of each respective market segment or industry, the type of documentation that should generally be available, and the nature and type of information to search for during a tour of the business premises. They identify potential sources of additional income not otherwise readily apparent from the type of business activity being examined. As an example, the “Attorney ATG” identifies potential sources of revenue other than from the attorneys general practice, litigation, tax, and probate fees. The ATG indicates that the attorney “may also receive revenue from performing services as board directors for clients and non-clients, speaker’s honoraria, and other outside professional activities. Inquiries about these types of revenue should be made during the initial interview.”

ATG INTERVIEW QUESTIONS. The ATGs identify issues to be raised during an audit interview with the business owner/operator, including the need for a detailed discussion about internal controls (weak internal controls in a small business environment does not preclude the necessity of determining the reliability of the books and records since every taxpayer has a method of conducting business and safeguarding business operations), source of funds utilized to start the business, a complete list of suppliers, identification or business records that might be available and the individual that maintains the business records. The examiner will also explore the manner of business operations, including the hours and days it is open, the number of employees, the responsibilities of each employee, identification of the individual that maintains control over inventory (beer, wine, etc.), cash and credit card receipts, and the cash register tapes. Examiners are advised to search out payments of non-business or personal living expenses by the owner/operator from the business operations.

ATGs are designed to focus IRS examiners on the typical methods of operation for businesses operating within a particular market segment. For example, with respect to cash intensive businesses, the audit guides identify the potential for skimming in liquor stores, pizza restaurants, gas stations, retail gift stores, auto repair shops, restaurants and bars. However, the ATGs acknowledge that “chain” or “franchise” businesses may not participate in skimming to the same extent due to the somewhat intensive internal controls typically required in their operations. Internal controls are often stronger in franchises due to independent audits and verifications performed by the franchisor. Typically, the franchise fee is based on the gross revenue of the business. The franchisee usually must buy products from the franchisor to maintain the franchise. The franchisor also requires maintenance of certain books and records in a format determined by the franchisor and may conduct audits of the franchise operations.

The “Cash Intensive Business” ATG sets forth various ideas for the initial interview of the taxpayer, including:

  • Principal Products?
  • How long in business?
  • Who are your principal customers?
  • Ask if the taxpayer has any other source of income.
  • How are sales handled?
  • Method: cash or accrual?
  • Basis for recording?
  • If accrual, does he/she have a list of accounts payable and receivable?
  • How are prices set?
  • What is your markup percentage? (Ask for markup % on each major product)
  • How often is inventory taken, by whom?
  • Who keeps the books?
  • How did they learn recordkeeping?
  • What bank accounts maintained?
  • Do they deposit everything? Who deposits?
  • How do they get cash to spend?
  • Check to cash?
  • Personal withdrawals – how handled?
  • Safe deposit box?
  • How do they record expenses?
  • How were the return figures arrived at?
  • How are the expenses paid?
  • Cash-on-hand
  • How much?
  • Where located?
  • Non-taxable income.
  • Pensions, loans, gifts, inheritances?
  • Investments:
  • Stock?
  • Real Estate?
  • Major personal property?
  • Major Expenses:
  • Loan repayments?
  • Asset acquisitions? When? How?
  • Schooling?

SPECIFIC INDUSTRY APPLICATIONS OF AUDIT TECHNIQUES. IRS examiners are advised to make specific inquiries based on the type of taxpayers under examination. For example, in the retail liquor industry, examiners are advised to search for off-book inventory including purchases outside of the liquor distributor, i.e. local wholesaler, bottle redemption and check cashing as well as contacting for check with local/state beverage department for pending or completed investigations involving taxpayer and/or known suppliers of the taxpayer. For pizza restaurants, examiners are cautioned to reconcile the difference of the number of boxes sold verses the number of boxes used (less some account for spoilage boxes) as possible additional unreported sales. For gasoline service stations, examiners are advised use the indirect mark-up method of determining income (gallons purchased multiplied by the average selling price as representing total sales) and inquire about imaging reimbursements, incentive agreements, accommodations, blending and rebates.

For restaurants and bars, examiners are advised to inquire about rebates to franchisees from suppliers, compare restaurant averages (sales v. cost), reported net profits as compared to the industry average, spillage, whether “point of sales” machines, using bar averages (pour) to calculate income, etc. With respect to grocery stores, examiners are advised to search for potential sources of  unreported income that might include coupon processing rebate fees, cash discounts from vendors, rebates from vendors, receipt of high dollar promotional items from vendors, use of vending machines (i.e. newspaper), pinball machines/arcade games, bottle/can redeeming, money orders, credit card sales, food stamp sales and prepaid telephone cards.

PUBLIC ACCESS TO THE ATG. While ATGs are designed to provide guidance for IRS employees, they’re also useful to small business owners and tax professionals who prepare returns and are also quite helpful for business and tax planning purposes. Tax professionals should consider consulting the appropriate ATG before preparing returns or commencement of an IRS examination involving a type of taxpayer or issue covered in an ATG. Knowing what issues are important to the IRS is, quite simply, important.

Many of the IRS ATGs are publically available at See


Posted by: | August 8, 2014

Am I “Non-Willful” Under the IRS OVDP Streamlined Procedures ?

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