How to identify a potential criminal tax matter requiring an attorney.

• Author: Holub, Steven F.

IRS COMPLIANCE EMPLOYEES ARE REQUIRED TO refer potential fraud matters to specialists within the IRS called fraud technical advisers (FTAs). An FTA is an experienced agent trained to assist the compliance employee behind the scenes in developing a plan of action to clearly establish affirmative evidence of fraud. The referral to an FTA is to be made when the compliance employee first sees any indications of fraud. Neither the taxpayer nor the taxpayer's representative is notified of the referral. The plan of action is intended to develop a firm case for referral to Criminal Investigation before the taxpayer is aware that he or she is being investigated for fraud. Interviewing the taxpayer and/or the tax return preparer is a key component of this plan of action.

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The indicators (badges) of fraud are listed by category in Internal Revenue Manual (IRM) Section 25.1.2.3. They include such conduct as omission of income; bank deposits from unexplained sources; concealment of bank and brokerage accounts; concealment of unexplained currency; failure to deposit receipts; substantial overstatement of deductions; false statements of material fact pertaining to an examination; failure to file required forms and returns; failure to maintain adequate records or maintaining more than one set of books; failure to make full disclosure of relevant facts to the accountant, attorney, or return preparer; and many more.

The IRM also advises that no single fact or circumstance by itself is a firm indication of fraud. There may be many reasons a return is not correct or that a taxpayer failed to file a required IRS form or make a required return. The U.S. Supreme Court has distinguished lawful conduct from an affirmative willful act of tax evasion. In Spies, 317 U.S. 492 (1943), the Court said, "[The law is complicated, accounting treatment of various items raises problems of great complexity, and innocent errors are numerous. ... It is not the purpose of the law to penalize frank difference of opinion or innocent errors made despite the exercise of reasonable care." On the other hand, an affirmative willful attempt to evade tax may be "inferred from conduct such as keeping a double set of books, making false entries or alterations, or false invoices or documents, destruction of books or records, concealment of assets or covering up sources of income, handling of one's affairs to avoid making the records usual in transactions of the kind, and any, conduct, the likely effect of which would be to mislead or to conceal" (emphasis added). This distinction is important because in cases were the law is not clear, such as tax shelter investigations and in certain collection investigations, misleading conduct is an important consideration in determining whether the IRS may view the matter as criminal.

In virtually every sophisticated criminal tax case with more than one defendant, the government also charges that the defendants conspired to obstruct the functions of the IRS by deceitful or dishonest means. This is the Klein conspiracy charge, the essence of which is obstructing the IRS in its audit or collection of taxes (see Klein, 247 F.2d 908 (2d Cir. 1957)). For example, in recent tax shelter cases, prosecution was based in part upon allegedly false statements made to the IRS during audits concerning profit motive and the business reasons for client investments (see, e.g., Coplan, 703 F.3d 46 (2d Cir. 2012)). In Beacon Brass, 344 U.S. 43 (1952), the Supreme Court held that a false statement to a revenue agent during an audit was a willful attempt to evade tax.

A problem for tax practitioners is that their investigation of underlying facts is not privileged if the IRS ultimately decides that the circumstances constitute a criminal matter. In that case, the practitioner's investigation could be harmful to the client because the practitioner could be required to testify in response to an IRS summons or a grand jury subpoena. Under these...