Reflections on practicing tax in today's world.

• Author: Gibbs, Lawrence B.

Introduction

Over the last five years, the Internal Revenue Service steadily has increased its emphasis on taxpayer compliance. The IRS initially targeted corporate tax shelters. The last two IRS Commissioners broadened that target by emphasizing across-the-board tax noncompliance by individuals, businesses of all sizes, and even tax-exempt entities. As a result, the IRS has gone from an agency that five years ago, in the wake of the 1998 IRS Restructuring and Reform Act, was either too intimidated or distracted to pursue audits and investigations to an agency that today is increasingly, and sometimes surprisingly, aggressive in its efforts to find, punish, and thereby deter what it considers to be noncompliant taxpayers.

Today, examination teams from the Large and Mid-Size Business Division often audit aggressively, frequently use summonses and third-party summonses, occasionally request tax accrual workpapers, and increasingly propose penalties for audit adjustments. Last year, Congress passed legislation that increased penalties significantly and provided for more public disclosures. In some cases, the IRS has indicated a willingness to make criminal referrals of companies and their tax executives. Recent changes to Circular 230 (prescribing rules for practicing before the IRS) signal an IRS determination to sanction tax professionals who, to paraphrase Commissioner Everson, become the architect of their clients' attempts to circumvent the tax laws.

In short, we practice tax today in an increasingly demanding regulatory environment. But as demanding as tax practices may have become, few, if any, tax practitioners were prepared for the actions in late August by the prosecutors in the Southern District of New York in a grand jury investigation of KPMG. In what the IRS described as "the largest criminal tax case ever filed," the prosecutors announced a deferred prosecution agreement under which KPMG agreed to the filing of a 1-count, 34-page criminal information charging KPMG with conspiracy to defraud the IRS, to commit tax evasion, and to aid and assist in the preparation and filing of false tax returns. KPMG accepted responsibility for violations of law, agreed to pay $456 million in fines and penalties, and committed to comply with a broad range of remedial requirements and guidelines for the future. In exchange, the government agreed (assuming KPMG complies with the agreement through the end of 2006) to dismiss the criminal information. (1)

The prosecutors also filed a 44-page indictment of 9 individuals, 8 former KPMG professionals and a former attorney at Sidley, Austin, Brown & Wood. The individuals' indictment is similar to the KPMG information in its allegations of conspiracy to defraud, commit tax evasion, and aid and assist in filing false tax returns. The indictment also alleges obstruction of IRS and Senate investigations, false responses to document requests and subpoenas, and false statements and testimony. (2)

On October 17, 2005, a grand jury in the Southern District of New York indicted 10 more individuals in the KPMG case and filed a 70-page superseding indictment of all 19 individuals. (3) The prosecutors have given repeated indications of expanding even further their so-called tax shelter grand jury investigations. Certainly, the IRS has manifested its intent to expand further its compliance and enforcement programs and activities at all levels to deal with what it perceives to be a continuing problem of widespread tax noncompliance.

The toughening attitude of the IRS and the Department of Justice toward compliance and the enforcement of the tax laws presents substantial risks for corporate taxpayers. For the most part, these risks are civil risks involving penalties and disclosure sanctions that can be expensive and damaging to a company's reputation. In a limited number of situations, however, criminal risks may be involved. For that reason, it is important that companies deepen their understanding of the basic principles of the criminal law applicable to the tax area and sharpen their awareness about how these principles may apply to tax planning, record retention, return preparation, and audits.

In other words, the government's emphasis on tax compliance and its increasingly aggressive actions to detect and deter noncompliance are important and deserve to be taken seriously by each of us as we advise and assist large companies in their day-to-day tax planning, compliance, and interactions with the government. That said, there is a danger in overreacting to these events, particularly...