What tax litigators wish other tax professionals knew.

• Author: Andreozzi, Randall P.

Although civil litigation and criminal prosecutions may be the exception to tax practice and not the rule, (1) the specter of a file blowing up nonetheless looms as a possibility for even the most careful and experienced tax professionals. Most CPAs, and indeed many tax lawyers, have rarely, if ever, seen the inside of a courtroom and are unfamiliar with tax litigation procedure. By virtue of their training and competence, tax professionals who work on compliance or planning matters can help clients avoid enforcement measures. However, the possibility of a civil or criminal proceeding, even if remote in most cases, nonetheless exists and means that tax professionals should consider what steps tax litigators and defense attorneys might wish, in hindsight, had been taken in the routine process of working with a client.

This article offers practical tips to help professionals engaged in tax compliance and planning to better position their clients for possible civil or criminal federal tax enforcement actions. It discusses steps that can help protect the taxpayer and the adviser and includes suggestions for interactions with both the client and the IRS. Although the recommendations offered are not foolproof, they can help to minimize the likelihood of enforcement actions and, if these actions do occur, may lead to a better outcome, achieved in a more time-effective manner. This, in turn, reduces both the expense and far-reaching consequences that litigation, whether civil or criminal, can generate for the taxpayer and the tax professional.

Client records, notes, and workpapers

To begin with the obvious, the importance of a well-maintained client file cannot be overstated. The IRS can easily obtain taxpayer records under Sec. 7602, which requires it to show only that its inquiry is related to a legitimate purpose, the information sought is relevant to that purpose, the information is not already in the IRS's possession, and proper administrative steps were followed. (2) Practitioners representing clients in an IRS audit will likely experience these inquiries informally through an Information Document Request (IDR) and formally, though less frequently, through the IRS "summons" procedures. Probable cause to believe a violation of the tax laws has occurred is not required. (3)

Sec. 7602 permits the IRS to both access books and records and take testimony under oath; failure to comply can lead to contempt proceedings under Sec. 7604. Client documentation that is sufficient to withstand scrutiny, meaning it is correct, current, and complete, (4) will help the taxpayer and tax professional ensure timely compliance with proper IRS demands. It will also be useful in refreshing recollections where Sec. 7602 is used to require testimony to be given under oath.

The IRS agent will request information that relates to positions taken on the tax return. As a result, organizing information in the client's return file based on each deduction claimed or item of income reported will prove beneficial if the IRS audits the return. When generating workpapers, memoranda, or other materials, be careful not to commingle documents relating to specific positions. Organization is even more important where a tax professional works on return preparation and other matters such as tax planning. In other words, keep tax return and compliance papers pure. Tax planning and other nonreturn issues are unrelated to return preparation and should be treated as such. If they are commingled, it may be difficult to separate them years later when searching the file for documents responsive to an IDR, summons, or subpoena.

As an example, consider a memorandum that separately discusses return issues and tax planning matters. It is likely the entire memo will have to be produced to answer a summons, even if some of the information it contains is not responsive. In a worst-case scenario, the unrelated matter could lead to additional IRS inquiries, which would be an extremely unfortunate outcome for both the client and the tax professional.

Also bear in mind that the tax practitioner privilege in Sec. 7525 does not apply to criminal matters. Get an attorney involved before the case goes too far, so that materials gathered on behalf of the taxpayer need not be surrendered to the IRS. Under Kovel, the attorney-client privilege extends to persons hired by a lawyer to assist in his or her representation of the client, including accountants. (5) Taxpayers may resist this step if the IRS appears to have dropped the matter. However, long periods of IRS silence are not necessarily golden. It may mean that the IRS is continuing the development of its civil audit or, worse, that the case has been referred for criminal investigation, which makes the ability to claim attorney-client privilege even more important.

Document all submissions to the IRS

The IRS has been understaffed for several years, and despite recently hiring 4,000 to 5,000 new employees (with more to be added to replace dwindling staff), its backlog of mail and processing of returns has continued to be a problem. (6) Commentators have noted that this has resulted in underreporting and under-collection of tax. (7) It should also result in increased practitioner concern that items submitted to the IRS may become lost. To protect a taxpayer's interests, taxpayers or their representative should retain a copy of anything submitted on paper to the IRS, and it should be sent via certified or registered mail, return receipt requested.

With respect to registered mail, Sec. 7502(c)(1) provides that the registration is prima facie evidence that the document was delivered to the address indicated and further provides that the date of registration is treated as the postmark date. Certified mail is covered under Sec. 7502(c)(2), and the regulations thereunder state, "If the document or payment is sent by U.S. certified mail and the sender's receipt is postmarked by the postal employee to whom the document or payment is presented, the date of the U.S. postmark on the receipt is treated as the postmark date of the document or payment." (8) The regulation concludes, "Accordingly, the risk that the document or payment will not be postmarked on the day that it is deposited in the mail may be eliminated by the use of registered or certified mail." (9)

Many federal tax returns are required to be submitted electronically in accordance with the IRS's e-file program. (10) It is imperative that the preparer's e-filing procedures for income tax returns comply with the requirements of Rev. Proc. 2007-40. (11) An electronically filed document or return is generally treated as filed on the date of its electronic postmark. (12) The preparer should keep a copy of any e-filed return and its transmittal documentation. (13) The IRS takes 24 to 48 hours to notify the electronic return originator if an e-filed return has been accepted or rejected. (14) A copy of that notification should also be preserved as proof of filing.

It bears noting that income tax returns, as well as information-reporting forms such as Forms 3520, 5471, 5472, and FBARs (15) are not deemed filed for purposes of penalties or triggering statutes of limitation unless they are filed with the correct office and in meticulous compliance with the rules and regulations. (16) Therefore, even if a return is given to an IRS agent at that agent's direction, it may not necessarily be deemed filed unless and until it makes its way to the correct office. (17) Given the severity of the fines and penalties for failure to timely file these returns and reports, and the risks associated with failure to start the three-year limitation period, attention to detail is important to avoid an IRS "gotcha" moment.

Role of a good organizer

The use of a tax organizer in recording clients' information for the tax year along with the clients' pertinent documents is not new, but tax litigators still cringe when organizers are used ineffectively, as failures reflect poorly on both the client and the preparer. An organizer, partially complete or ignored altogether, can be used by the government against a client on many levels. It can serve as evidence that the client knew of an applicable tax obligation but chose not to comply, even though clients may argue that they did not know or have reason to know of the requirement. (18)

Further in this vein, the client who fills out the organizer in a negligent manner may create just as much harm to themselves as the client who ignores it altogether. Organizers prepared haphazardly or lacking in accurate and complete information can essentially become documentary evidence of negligence or reckless disregard. Worse still, if accompanied by an intent to mislead or conceal, organizer documentation could itself become evidence establishing civil fraud (19) or possibly Title 26 tax crimes. A risk of such dire consequences can be...