TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

The Internal Revenue Service recently announced the release of its IRS Criminal Investigation (CI) Annual Report for fiscal year 2013[1], identifying their investigative priorities for 2014 and reflecting significant increases in criminal tax enforcement actions around the country.[2]

CI investigates potential criminal violations of the Internal Revenue Code (Code) and related financial crimes. Together with local Offices of the U.S. Attorney, the Department of Justice actually prosecutes violations of the Code. Many tax prosecutions begin as civil tax examinations referred to CI for a criminal investigation and, when CI believes a tax crime has occurred, CI then refers the matter to the Department of Justice for consideration of a criminal indictment and prosecution.

A significant impact arising from the activities of CI is the overall deterrence effect associated with publicity surrounding criminal tax prosecutions resulting from their investigations as well as other tax related prosecutions conducted by the Tax Division of the U.S. Department of Justice.

Substantially every CI field office has someone responsible for publicizing criminal tax prosecutions (as distinguished from  investigations). When “Mom and Pop” business owners are convicted and sentenced to some period of incarceration, others notice. There is believed to be a significant deterrent effect associated with the announcement of a criminal tax indictment or conviction during “tax season” (the period leading up to the required filing dates for income tax returns) as taxpayers are consulting their advisors during the return preparation process.

Compliance with the U.S. tax laws relies on self-assessments of the amount of tax due, commonly referred to as voluntary compliance. Increased civil tax enforcement actions alone may have a limited effect on voluntary compliance. Increased penalties for noncompliance only penalize those who are actually identified. Accordingly, it is widely believed that the activities of CI greatly enhance voluntary compliance.

CI Investigative Priorities – Criminal Investigation’s current investigative priorities include:

 Identity Theft Fraud

 Return Preparer Fraud & Questionable Refund Fraud

 International Tax Fraud

 Fraud Referral Program

 Political/Public Corruption

 Organized Crime Drug Enforcement Task Force (OCDETF)

 Bank Secrecy Act and Suspicious Activity Report (SAR) Review Teams

 Asset Forfeiture

 Voluntary Disclosure Program

 Counterterrorism and Sovereign Citizens

Accomplishments – In FY 2013 there was a 12.5 percent increase in CI investigations initiated compared to the prior year and a nearly 18 percent increase in prosecution recommendations. Specifically, CI initiated 5,314 cases and recommended 4,364 cases for prosecution. These increases were accomplished at a time when agent resources decreased more than 5 percent. Overall, FY 2013 investigation statistics include:

 Subject criminal investigation initiations in FY 2013 were 5,314 investigations.

 Investigation completions in FY 2013 were 5,557, a 12.5% increase over FY 2012.

 Prosecution recommendations for FY 2013 were 4,364, reflecting an increase of 17.9% over FY 2012.

 Convictions totaled 3,311 in FY 2013 reflecting an increase of 25.7% in comparison to FY 2012.

 The FY 2013 conviction rate is 93.1% [0.1% more than the FY 2012 rate (93.0%)]. The conviction rate is the percentage of convictions compared to the total number of convictions, acquittals, and dismissals.

Legal Source Tax Crimes – CI’s core mission is to develop and investigate legal source tax crimes – tax violations committed by people in legally permissible occupations and industries. Some of these investigations are worked with other federal, state and local law enforcement representatives, as well as with foreign tax and law enforcement agencies. Legal source tax investigations involve taxpayers in legal industries and legal occupations, who earned income legally but knowingly and intentionally violate the tax laws.

Fraud Referral Program – Criminal Investigation receives information regarding many of their core mission tax investigations through the fraud referral program – referrals of criminal tax investigations from civil the IRS operating divisions, including the Small Business/Self-Employed (SB/SE), Wage and Investment (W&I), Large Business & International (LBI) and Tax Exempt and Government Entities (TEGE).

General Tax Fraud – In general tax fraud investigations, CI special agents use financial investigative techniques to uncover and quantify many different schemes, including the intentional under-reporting or omission of taxable income (“skimming”); maintenance of multiple sets of books, or making false entries in books and records; claiming clearly personal expenses as business expenses; claiming false deductions or credits against taxes; or concealing or transferring assets to avoid payment, etc.

Refund Fraud Program – The Refund Fraud Program includes the Return Preparer Program and the Questionable Refund Program (which also includes identity theft investigations).

Return Preparer Program – The Return Preparer Program includes investigations relating to the preparation and filing of false income tax returns, in either paper or electronic form, by dishonest preparers who may claim artificially inflated personal or business expenses, false deductions, excessive exemptions, and/or unallowable tax credits. The preparers’ clients may or may not have knowledge of the falsity of the returns.

Questionable Refund Program – The primary focus of the Questionable Refund Program is to identify fraudulent claims for tax refunds. Generally, these claims involve individuals filing false multiple tax returns supported by false information or using the identifiers of other individuals knowingly or unknowingly.

Identity Theft – Currently CI participates in more than 70 task forces/working groups throughout the country which investigate both financial crimes as well as identity theft crimes. CI’s has a designated management official serving as the National ID Theft Coordinator overseeing national efforts concerning policy, procedures, etc. In addition to a National Coordinator there are ID Theft Coordinators within each of the 25 CI field offices.

Non-Filer Investigations – Taxpayers who are required to but fail to file income tax returns (typically for more than one tax year) provide a target rich environment for CI.

Employment Tax Fraud – Employment tax investigations often include “pyramiding,” various wrongful employee leasing schemes, paying employees in cash, filing false payroll tax returns or failing to file payroll tax returns. Some investigations also include the withholding of taxes from the employees’ paychecks, but intentionally failing to remit such withheld taxes to the IRS. Employment taxes generally include federal income tax withholding, social security taxes, and federal unemployment taxes.

Bankruptcy Fraud – One of CI’s goals in bankruptcy fraud investigations is to increase voluntary compliance with federal tax laws through the prosecution of those committing significant crimes within the bankruptcy arena.

International Operations – CI’s Office of International Operations (IO) coordinates a comprehensive international strategy in responding to global financial crimes and provides support in combating offshore tax evasion. CI has special agent attachés strategically stationed in 11 foreign countries including Beijing, China; Bogota, Colombia; Bridgetown, Barbados; Frankfurt, Germany; Hong Kong, China; London, England; Mexico City, Mexico, Ottawa, Canada; Panama City, Panama; Sydney, Australia; and The Hague, the Netherlands. Special agent attachés build strong alliances with their counterpart foreign government representatives providing CI with the ability to develop international case leads and to support domestic investigations with an international nexus.

Avoiding a Criminal Tax Investigation Through a Voluntary Disclosure. The complexity found within the Code will long continue to be a significant problem for effective tax administration. However, the IRS receives volumes of electronic information from outside sources and other taxing authorities. Numerous civil examinations and criminal tax investigations are in the administrative pipeline. Notwithstanding an increasingly significant possibility of detection and potential punishment, many taxpayers continue to believe they will escape detection. Certainly, the whale only gets harpooned when it surfaces for air. However, at some point it must surface to survive.

Practitioners often struggle with the issue of whether a taxpayer can avoid a criminal tax investigation by making a disclosure of prior tax crimes to the IRS. A “voluntary disclosure” often involves the process of voluntarily reporting previously undisclosed income (or false deductions) through an amended return or the filing of a delinquent return.[3] 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 Department of Justice for criminal prosecution. A voluntary disclosure is also a factor the Department of Justice will consider in deciding whether to prosecute a taxpayer.

The IRS voluntary disclosure policy creates no substantive or procedural rights for taxpayers, but is a matter of internal IRS practice, provided solely for internal guidance to IRS personnel. A timely voluntary disclosure will not automatically 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. In practice, a true voluntary disclosure is a strong deterrent for the IRS from initiating a criminal investigation.

An imperfect disclosure might result in providing admissions of wrongful conduct to the government actually increasing the possibility of a criminal investigation or prosecution. An organization looking to publicize statistics as a method of deterrence might seem remiss to move past such low hanging fruit . . .

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. As such, competent, experienced counsel should be engaged before pursuing a voluntary disclosure with the IRS.