Posted by: evanjdavis | February 27, 2017

“Advice of Counsel” and Fifth Amendment Excuses for Late Filing Don’t Cut it With District Court by EVAN J. DAVIS

A Nevada federal judge recently denied a taxpayer’s summary judgment motion in a case that highlights the risks of non-compliance with federal laws, even when your lawyer is advising you to do so. It also shows why lawyers should avoid advising a client not to file a timely tax return, for their own sake as well as the client’s.

Theodore Lee waited three years to file his 2006 return, and the IRS assessed taxes as well as late-filing and late-payment penalties against him. Lee paid the taxes and filed suit against the IRS.  In a summary judgment motion, Lee asserted the penalties and interest should be wiped out, because he was under audit for 1999 to 2005 tax years and —on his attorney’s advice — he didn’t want to file his 2006 returns the same way as his 1999-2005 returns because the IRS might see yet another return as a criminal act.  Lee claimed that his choice not to file was protected by the Fifth Amendment, which meant any penalty would be unconstitutional.  Once the audit was over in 2010, he accepted the IRS’s findings from the 1999-2005 audit and filed the 2006 return consistent with the IRS’s findings.

The district judge didn’t buy the excuse, at least not as a reason to grant summary judgment. Generally, a taxpayer can’t refuse to file a return on Fifth Amendment grounds, and if she’s afraid of incriminating herself, she has to file the return and assert the Fifth Amendment on a line-by-line basis.  For example, if someone earns money from an illegal business, he needs to report the income on his return but may be able to write “Fifth Amendment” in the section that asks for the source of the income.

The judge found the taxpayer’s declarations lacking. His lawyer’s declaration stated that Lee delayed filing on the lawyer’s advice, because he feared prosecution if he filed a timely 2006 return.  Lee, whose explanations for non-filing appear to have changed over time, claimed the same thing in his declaration.  The district court was skeptical of the explanation, but said that even if it bought Lee’s current version, he couldn’t claim the Fifth Amendment as a reason for non-filing.  Further, it was unclear whether Lee was under criminal investigation or civil audit at the time, which would further impact whether his decision not to file was appropriate.  The case will proceed to trial.

Left unsaid in the opinion is how risky this advice was. First, a lawyer can get in trouble both with the State Bar as well as with federal prosecutors if, indeed, the lawyer advised a client to break the law.  It is a crime willfully not to file a tax return, and relying on advice of counsel isn’t technically a defense to this crime – none of the elements require bad faith that would be negated by advice.  If a client is already under criminal investigation – the record for Mr. Lee apparently did not support that he was under criminal investigation, beyond his lawyer’s assertion that he was “under investigation and audit” – then it is prudent to advise the client about the pros and cons of filing returns during the criminal investigation so the client can make his own decision.  But, that’s a far cry from telling a client not to file.

Moving beyond risk to the lawyer, this course is also risky for the client. If a client isn’t already under criminal investigation, then advising them not to file is almost daring the government to open a criminal investigation for non-filing.  Usually, the IRS waits until someone fails to file for three years before opening an investigation, but these aren’t hard and fast rules and the Revenue Agent conducting the civil audit may use the non-filing as a reason to refer the entire case to Criminal Investigation.  Although the taxpayer likely doesn’t feel this way, he’s lucky that he’s only arguing about having to pay civil penalties instead of trying to defend against a failure-to-file criminal charge.

A few different approaches can be considered when faced with a civil audit where the taxpayer has concerns about making incriminating admissions in a current-year return.

  • First, the taxpayer should, at a minimum, pay – either as a deposit or otherwise – the tax that the IRS might later claim is due. Even if returns aren’t filed with the payment, this will prevent non-payment penalties from being imposed, which can dwarf late-filing penalties.
  • A client should also consider filing the return based on the expected IRS position and include a statement that the IRS is auditing earlier returns, but the taxpayer is paying what the IRS may say he owes out of an abundance of caution. The taxpayer can pay the associated tax and file a claim for refund at the appropriate time. I would consider waiting until the last minute to file the refund claim, so as to avoid instituting a civil suit in which the government could depose the taxpayer and thereby get free discovery for any criminal case.
  • Alternatively, to the extent that a particular line-item could incriminate the client, the client should skip the explanation and instead write “Fifth Amendment” on each line in lieu of providing information. Generally, total income must be reported, but sources of income and similar information could be subject to a valid Fifth Amendment claim. By filing the return and paying the highest likely amount of taxes, the IRS couldn’t assess penalties and this could even take the wind out of the sails of any brewing criminal investigation.

Much of this advice applies with equal force even when there’s an ongoing criminal investigation. Regardless of the situation, a taxpayer should hire an experienced, careful lawyer to advise her before taking any of these actions.

EVAN J. DAVIS – For more information please contact Evan Davis – or 310.281.3200. Mr. Davis is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) handling civil and criminal tax cases and, subsequently, of the Major Frauds Section of the Criminal Division of the Office of the U.S. Attorney (C.D. Cal) handling white-collar, tax and other fraud cases through jury trial and appeal. He has served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the Criminal Division.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, federal and state white collar criminal investigations. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (OVDP, Streamlined Procedures and otherwise).

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