TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

Bankruptcy ruins your credit score but comes with the promise of a clean slate, reducing or even wiping out debts including tax assessments.  However, to earn a discharge one has to reveal all assets and income, and the temptation to hide assets often proves too great for less scrupulous debtors.  Obtaining a discharge while secretly retaining substantial assets seems like a no-lose proposition.  Unless, that is, you get caught.  However, the consequences of getting caught for committing bankruptcy fraud historically haven’t been as bad as one might think, as often the most serious punishment was simply a denial of discharge of indebtedness.  The IRS’s trumpeting of relatively lengthy sentences such as the 18-month sentences below belies the truth, namely that such sentences are rare because bankruptcy fraud prosecutions are rare.

One of us (Evan) was the Bankruptcy Fraud Coordinator in the Los Angeles U.S. Attorney’s Office for a number of years, and was disappointed that bankruptcy crimes were so low on the FBI’s priority list that only a few investigations were approved each year in a judicial district whose 18-million-plus population is as large as New York State’s (the fourth most-populous state).  Given that IRS Criminal Investigations also did not work many bankruptcy cases, despite the existence of a specialized Bankruptcy Fraud Unit, this meant that bankruptcy crimes by and large went uncharged.  This enforcement gap frustrated just about everyone involved with the bankruptcy system, including judges and the Office of the United States Trustee, an arm of the Department of Justice charged with protecting the integrity of the system.  The US Trustee has personnel assigned to refer cases for investigation and to support any bankruptcy investigation and prosecution, which is a severely underutilized resource given how few bankruptcy fraud investigations take place. 

Because debtors typically owe taxes along with other debts, the IRS is often among the hardest-hit victims of bankruptcy fraud.  With so many tax crimes to prosecute and so few resources, this has not historically been an area of focus, however, for its Criminal Investigation division. 

Current IRS Commissioner Chuck Rettig has prioritized enforcement since taking office in late 2018, and one of his important reforms was to create a “Fraud Enforcement Office” in March 2020 to develop civil cases for referral to Criminal Investigations and to identify audits involving less severe conduct that should remain as civil fraud matters.  When the head of the Fraud Enforcement Office identifies focus areas, it’s a signal to IRS civil agents to look for viable criminal cases amongst their inventory, and to criminal defense counsel to expect more of that type of case in a year or two. 

Last week, Damon Rowe, head of the Fraud Enforcement Office, announced “Operation Liquidation,” which he said would focus on taxpayers who commit bankruptcy fraud as a means of cheating on their taxes.  He used an example familiar to those of us who have prosecuted or defended bankruptcy fraud cases – someone who transfers assets to a nominee shortly before filing bankruptcy with an unwritten agreement that the nominee would hold the assets until after discharge and then return them to the debtor.  If the debtor has a tax debt, this run-of-the-mill bankruptcy fraud (18 U.S.C. Section 152, concealment of assets) is two frauds in one, as it also is an attempted  evasion of payment of tax (26 U.S.C. Section 7201) at the same time. 

Commissioner Rettig has been beating the drum for more evasion-of-payment referrals from Revenue Officers and focusing on bankruptcy cases is a smart move.  Further, bankruptcy cases frequently offer something that standard Revenue Officer referrals do not: judicial findings that the debtor/taxpayer has committed fraud.  Where a judge has already found fraud and the debtor owes substantial tax debts, turning that case into a criminal investigation or civil fraud examination is almost a no-brainer.  Damon Rowe is a former Special Agent who just moved over from Criminal Investigation, meaning he knows which levers to pull on the criminal side including contacting Bankruptcy Fraud Coordinators with whom he no doubt interacted during his decades as a Special Agent.  Those who really pay attention will also note that the IRS refreshed the “Criminal Investigation Strategies” section of its bible, the Internal Revenue Manual, in August 2020 to further underscore that agents should be looking for criminal tax fraud within bankruptcy.  https://www.irs.gov/irm/part9/irm_09-005-003#idm139666666427792

As with all such operations, the real question is whether the IRS will devote its scarce civil and criminal fraud resources to these investigations.  We suspect that the IRS will decide that selecting from among cases where a judge has already found fraud and where the US Trustee is willing to assist, is akin to fishing with dynamite and they will soon have more good cases than they know what to do with.  This focus, added to the IRS’s increased use of data mining to select cases, cryptocurrency training for special agents, and increased enforcement resources under this Commissioner, means the IRS hopes to see a substantial uptick in the number and quality of criminal investigations from the low point a few years ago. 

Of course, whenever the IRS publicizes an increased focus and enhanced presence in any area of enforcement, it is not only the taxpayers who are put on notice; practitioners (in this case, bankruptcy lawyers) are also put on alert.  This serves the IRS’s continual goals of increasing compliance and providing practitioners with a point of contact for a client who may have an interest in reporting allegations of fraud in any particular area of interest to the IRS.

Like any federal crime, bankruptcy fraud, even more so if charged along with tax evasion, carries significant penalties, most notably a sentence of incarceration and an order of restitution, of which the later the IRS can hold a taxpayer accountable for up to 40 years. 

Perhaps merely being denied a discharge won’t continue to be the worst consequence that befalls taxpayers who try to use a bankruptcy filing to evade payment of taxes.              

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis has been a principal at Hochman Salkin Toscher Perez P.C. since November 2016.  He spent 11 years as an AUSA in the Office of the U.S. Attorney (C.D. Cal), spending three years in the Tax Division where he handed civil and criminal tax cases and eight years in the Major Frauds Section of the Criminal Division where he handled white-collar, tax, and other fraud cases through jury trial and appeal.  As an AUSA, he served as the Bankruptcy Fraud coordinator, Financial Institution Fraud coordinator, and Securities Fraud coordinator.  Among other awards as a prosecutor, he received an award from the CDCA Bankruptcy Judges for combatting Bankruptcy Fraud and the U.S. Attorney General awarded him the Distinguished Service Award for his work on the $16 Billion RMBS settlement with Bank of America.  Before becoming an AUSA, Mr. Davis was a civil trial attorney in the Department of Justice’s Tax Division in Washington, D.C. for nearly 8 years, the last three of which he was recognized with Outstanding Attorney awards. 

Mr. Davis represents individuals and closely held entities in federal and state criminal tax (including foreign-account and cryptocurrency) investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, and white-collar criminal investigations including campaign finance, FARA, money laundering, and health care fraud. 

SANDRA R. BROWN – Ms. Brown has been a principal at Hochman Salkin Toscher Perez P.C. since March 2018.  Prior to joining the firm, Ms. Brown spent more than 26 years as a federal trial attorney, including serving as the Acting United States Attorney, the First Assistant United States Attorney, and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal).  Ms. Brown’s broad range of experience in complex civil tax controversies and criminal tax investigations and litigation includes having handled over 2,000 cases on behalf of the United States before the United States District Court, the Ninth Circuit Court of Appeals, the United States Bankruptcy Appellate Panel, and the California Superior Court.  In addition to other honors, commendations, and awards, Ms. Brown has received the Internal Revenue Service Criminal Investigation Chief’s Award and the IRS’s Mitchell Rogovin National Outstanding Support of the Office of Chief Counsel Award, respectively, the two most prestigious criminal and civil awards available for presentation by the IRS to a Department of Justice employee.Ms. Brown represents individuals and entities on a national and local level in complex federal criminal investigations and litigation as well as sensitive civil tax controversy examinations and litigation matters.  Ms. Brown obtained her LL.M. in Taxation from the University of Denver, is a fellow of the American College of Tax Counsel, co-chair of the NYU Tax Controversy Section, and a member of the Women’s White Collar Defense Association.  Ms. Brown may be reached at brown@taxlitigator.com or 310.281.3217.