Can your tax client (or you) go to jail?

• Author: Hibschweiler, Arlene M.
• Position: Part 1

EXECUTIVE SUMMARY

* Even though criminal prosecution for tax law violations is unlikely, when they do occur, the consequences can be serious.

* Tax crimes include tax evasion, failure to pay tax due and filing a false or fraudulent return, all of which require proof of willfulness.

* A taxpayer acquitted of criminal charges, or who otherwise resolves a criminal investigation, can still face civil tax fraud penalties.

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Although most taxpayers will never face criminal charges, tax advisers should be familiar with the kinds of conduct that could generate prosecution. Part I of this two-part article describes the requirements and consequences of some common tax crimes under the Internal Revenue Code.

For the average client, the possibility of facing criminal sanctions because of tax law violations is a daunting prospect. In many cases, criminal prosecution, meaning legal action that could result in jail or other punishment, is unlikely. This is because many provisions under which a taxpayer could be prosecuted require proof that the violation was "willful," which is often difficult to show. When criminal prosecutions do occur, however, the consequences can be serious. In fiscal-year (FY) 2005, for example, 804 taxpayers were sentenced for tax crimes, and 79% of these cases resulted in time in prison, a halfway house, home confinement or some combination thereof. The average sentence length was 28 months. (1) Besides taxpayers, return preparers also are subject to prosecution; 118 were sentenced in FY 2005 and faced an average term of 18 months. (2) When the return preparer is a CPA, a conviction will also affect his or her license. (3)

Part I of this two-part article describes the more notable criminal provisions in the Internal Revenue Code (Code), including the prohibited conduct and its consequences. Part II, in the May 2006 issue, will discuss Federal criminal procedure and sentencing rules. In addition, it will examine steps CPAs can take both to help clients and to protect themselves against possible criminal investigation and prosecution.

Criminal and Civil Actions in General

Federal laws provide both criminal and civil consequences for taxpayers and tax preparers who violate the Code. Both types of sanctions may apply to the same case. According to the Internal Revenue Manual (IRM), civil action taken by the IRS to collect taxes usually follows the conclusion of criminal proceedings. At least in part, this is done because pursuing both investigations concurrently may jeopardize the success of the criminal prosecution. (4)

A taxpayer acquitted of criminal charges at trial can still face civil tax fraud penalties. (5) Likewise, a taxpayer who resolves a criminal investigation by entering a guilty plea to some or all of the charges can be subject to civil sanctions even if, in the plea agreement, the IRS promised to not prosecute the matter further. (6) Courts have consistently recognized a distinction between civil sanctions considered remedial in nature, and criminal penalties designed to punish and prohibit tax fraud. Thus constitutional protections, like the right of an indigent defendant to an attorney, do not apply in civil cases. (7)

The potential for overlap created under Federal law extends beyond the possible application of both civil and criminal sanctions to the same conduct. In many cases, the Code's criminal provisions overlap; for example, a taxpayer who files a false return, punishable under Sec. 7206(1), might also be charged with evasion (Sec. 7201). (8) For that reason, indictments of tax defendants often include multiple crimes. Further, some of the offenses listed in the general criminal provisions in Title 18 of the United States Code (U.S.C.) may be applicable too. For example, a false return also might generate a charge under Section 1001 of Title 18, which makes it a crime to make a false statement or submit false documents to a government official; see Exhibit 1 on p. 218 for some Title 18 offenses that can apply in tax cases.

The IRM contains rules generally prohibiting successive prosecutions for the same conduct. (9) Under the Federal Sentencing Guidelines, convictions of multiple counts in some cases may be treated as a single offense for sentencing purposes, when the crimes essentially represent the same wrongful conduct with the same ultimate harm. (10)

Crimes under the Code

Offenses defined as criminal under the Code may be limited or widespread in application. For example, Sec. 7202 criminalizes the willful failure to collect or pay tax. It targets employers that withhold Federal income and FICA taxes from employee wages. By comparison, Sec. 7203 is much broader. Among other things, it punishes the willful failure to supply any information required under the tax laws. The crimes discussed below, and summarized in Exhibit 2 on p. 219, are some of the more frequently used Code provisions,

Tax Evasion--Sec. 7201

Evasion is probably one of the more infamous crimes, being the charge that resulted in the conviction of Al Capone. (11) It involves a willful attempt to evade or defeat any tax imposed under the Code. To evade taxes is a felony, meaning punishable by more than one year in prison, under Sec. 7201. The Sentencing Guidelines, to be discussed in detail in Part II in the May 2006 issue, include rules for calculating the tax loss in an evasion case, as that loss affects the severity of the punishment the guidelines would impose. For example, if an individual taxpayer underreported gross income, the loss is presumed to be 28% of the unreported amount plus 100% of any false credits claimed, unless a more accurate determination Can be made. (12)

There are three elements the government must prove to convict a person of tax evasion under Sec. 7201. First, it must show a tax deficiency existed. Second, it must prove an affirmative act of tax evasion, and, finally, that the defendant acted willfully.

Tax deficiency: Some courts require proof that the evasion or attempted evasion involved substantially more tax than was shown on a return, (13) although this is not universal. (14) There is no test for determining substantiality. Rather, all the surrounding circumstances are considered. In some cases, courts have found relatively small amounts to be "substantial." (15) For example, in a 1987 case, the Seventh Circuit upheld an evasion conviction based on $3,358 in unpaid taxes. (16)

The tax due for criminal prosecution purposes may be less than what is considered outstanding for civil collection. There can be several reasons for this. For example, to...