Tax Representation In Sensitive Tax Audits And Criminal Investigations

Client representation before the Internal Revenue Service in the context of a "sensitive" or "egg-shell" tax audit or criminal investigation virtually always involves the client's concern that "sensitive" matters will be exposed to scrutiny. This concern is quite naturally exacerbated by insinuations of some impropriety evidenced in one's client's actions in respect to tax obligations. The experienced criminal tax lawyer knows that one does not have to come a long way before a critical point of tension is reached in such situations.

When asked to produce a certain document or answer a certain question, the experienced criminal tax lawyer will have a sense for the implications of a response. He will be aware that where a response is required, that response must be truthful and not evasive or misleading. He will be aware of his client's legitimate interests in refusing to respond to invasive questioning, and may choose to invoke certain protections on his client's behalf, known as privileges. These are rights guaranteed constitutionally, embodied in federal statutes, and interpreted in case law. Their purpose is to hold the government, in its lawful investigations, to standards of due process of law, and to shield citizens from unwarranted intrusion or self-incrimination.

A criminal tax investigation has the sole purpose of developing evidence to support a charge that a taxpayer willfully violated a known legal duty. Evidence to support allegations of fraud carries a certain "weight." Evidence upon which to charge a taxpayer under a criminal tax statute must be seen by the government to have the weight of proof "beyond a reasonable doubt." Such proof is required to support the dual proposition that there has been an intentional violation of a known legal duty and that there exists a reasonable probability of conviction. Evidence need not be seen to rise to a level of proof "beyond a reasonable doubt" during a criminal investigation for such an investigation to continue. Perhaps this is too simple to be missed, but it is. Too often, you see, one who is under audit and perhaps facing a criminal investigation will leap to the conclusion that the Government will prosecute. One’s misgivings, in other words, often become conclusions against one’s interests, and project guilt. But the mere existence of a criminal standard does not mean that the Government will employ it in a criminal investigation. Evidence [proof] may be seen to establish guilt for a tax omission or misrepresentation, but that "level" of proof may rise only to the standard of evidence which "clearly and convincingly" supports a finding of an intentional violation of a known legal duty. In such a case, the government does not have proof beyond a reasonable doubt, thus, no prosecutorial discretion. A case may then proceed administratively, and the criminal investigation will end. With the objective of establishing civil fraud, pursuant to which the taxpayer faces a penalty equal to seventy-five percent (75%) of the tax loss to the Government, IRS Revenue Agents will seek to obtain a finding of tax loss to the government due to civil fraud, supporting the imposition of the penalty. The imposition of the fraud penalty can be challenged in a filing in Tax Court, or, if the taxpayer chooses to first pay the tax and then pursue his remedies on a claim for refund, in a filing in a federal district court for refund.
Subtle distinctions in evidence make the difference between whether a criminal charge is put forward by the Government or not. Admissions are virtually always considered to be proof of a taxpayer's knowledge of a legal duty, and, thus, are to be avoided when one is approached by an Internal Revenue Special Agent until one speaks to a competent criminal tax attorney.

The importance of an interview with the client at or near the time at which an audit letter or criminal investigation initiation letter or summons is received, and before the client responds to questions asked by the IRS in respect to such a letter or summons cannot be understated. Effective representation requires a thorough review of the taxpayer's financial activities and of all issues which might be raised in the context of the audit or investigation. During the information gathering stage of an audit or criminal investigation, the IRS agent may or will issue administrative summonses requiring the keeper of records for the taxpayer and any third parties to provide relevant books and records and testimony to the government agent at an appointed time. It can be anticipated that through the information so obtained the revenue agent or special agent may focus upon a method for reconstructing a taxpayer's income.

Criminal exposure can be based on items set forth on a return, such as unreported income, improper deductions, or some other false statement made on a return or before government agents. Where an accountant has prepared the tax returns in question, the attorney must consider engaging the tax return preparer on behalf of the taxpayer under the doctrine of United States v. Kovel, 292 Fed. 2nd 18 (2nd Cir. 1961), which holds that the accountant employed by the taxpayer's attorney is clothed with the same privileges as the attorney.

Most methods of proving civil or criminal tax fraud are based on the supposition that circumstantial rather than direct evidence will support a case. For that reason, "life style" and other objective indications of financial activity become qualitative considerations to be weighed against reporting positions on tax returns. A source and application of funds method of proof to support an alleged understatement may be used. This method compares all known expenditures during a taxable year with all known receipts of income for the same year and challenges the taxpayer to explain sources of funds for expenditures that exceed documented sources. The bank deposits method uses total bank deposits for the tax year in question to determine gross receipts and leaves it to the taxpayer to prove adjustments. The net worth method uses the hypothesis that a taxpayer's net worth has increased from a beginning year to an ending year, and the increase is not explained by filed returns. This method is similar to the life style analysis.

None of the circumstantial methods approved involve any shifting of the burden of proof to the taxpayer in a criminal case. In practice, unless the taxpayer moves affirmatively to prove the contrary of government conclusions from a criminal investigation, the government will proceed with its proof to initiate the process of charging the taxpayer with the violation of a criminal tax statute.

Agents for the government maintain a record of all conversations with the taxpayer's lawyer during an investigation. All matters discussed are taken as admissions. A taxpayer has the right to resist an agent's request to an interview pursuant to Internal Revenue Code Section 7521(c) unless an administrative summons is served on the taxpayer. Where potential fraud issues are involved, the lawyer must carefully weigh the benefit of submitting his client to an interview. The client must be cautioned in any case against making any false or misleading statements or making damaging admissions. If it appears that a client's records might alone suggest that there has been a willful violation of a known legal duty, the experienced criminal tax lawyer will advise his client of the implications of testimonial self-incrimination concerning intent, and must consider whether his client must assert the Fifth Amendment privilege against self-incrimination. This means that the taxpayer must not give evidence against himself from his own lips, but, rather, place the burden back on the government to prove its case on the evidence without support in damaging, irreversible admissions of fact or of intent which the government, in its zeal to prosecute tax offenders, will use against him to support proof elements of a tax crime.