Representing a Taxpayer Prior to the Criminal Tax Investigation

September 13, 2007

For more information, contact Bob Webb.

Lawrence S. Feld, New York, NY
Lawrence S. Horn, Sills Cummis Epstein & Gross, New York, NY 
Stuart Abrams, Newark, NJ
Scott D. Michel, Caplin & Drysdale, Washington, D.C.
Peter Driscoll, New York, NY
Justin A. Thornton, Law Offices of Justin Thornton, Washington, D.C.

Introduction

Life is not simple for a taxpayer who has cheated on his taxes in the past. Filing a timely current return may very well call attention to a prior failure to file. Filing an accurate current return may highlight omitted income or false statements on prior returns. If the IRS selects a fraudulent return for audit, the taxpayer may be faced with a choice between admitting the fraud or committing further crimes to cover it up. And, because a new return comes due every year, his problems and his exposure tend to compound as time goes by.

If he wants to come clean by disclosing the prior fraud, there can be no assurance that he will not be prosecuted. Invocation of his Fifth Amendment rights on his current returns is likely to precipitate an IRS inquiry. Invocation of the Fifth Amendment in a civil audit will invite scrutiny by the IRS' Criminal Investigation Division.

A challenging part of criminal tax practice is advising such taxpayers who have committed tax crimes, are not yet under criminal investigation, and want to get off this treadmill. With knowledge of IRS policies and procedures, careful attention to professional and ethical responsibilities, and, on occasion, a good deal of luck, it is often possible to guide such taxpayers back into the system without attracting the attention of the Criminal Investigation Division.

I. Voluntary Disclosure

A client who has committed tax fraud may be able to avoid criminal liability by filing amended or delinquent returns before the IRS or any other government agency has begun an inquiry that might lead to discovery of the fraud. Because such a "voluntary disclosure" can backfire and lead to a criminal prosecution, it should be approached with caution and great care. The final decision should always be based on a careful analysis of all relevant facts of the particular case.

Legal Effect of a Voluntary Disclosure
1. The felonies of tax evasion (§7201) or filing false returns (§7206) are completed crimes at the time the taxpayer willfully files the false return. Subsequent correction of the error by an amended return will not absolve or mitigate the fraud. Similarly, the misdemeanor of failure to file (§7203) is completed on the due date of the return. Filing a delinquent return will not undo the crime.

2. The statute of limitations for tax crimes runs six years after the filing of a fraudulent return or the due date of that return taking into consideration any request for extension, whichever is later, and six years after the due date of an unfiled return or the expiration of any request for extension. §6531. An amended or delinquent return will neither toll nor extend the criminal statute of limitations. Rather, an amended or delinquent return will commence the running of a new statute of limitations on the amended or delinquent return or returns.

3. The legal effect of an amended or delinquent return is an admission of all but one of the elements necessary for a criminal prosecution. A taxpayer who files an amended return admits that the original return was materially false and that additional tax was due. A taxpayer who files a delinquent return admits that he was required to file and did not. In either case, the government need only prove willfulness to make out a prima facie criminal case.

4. Although an amended or delinquent return will not preclude criminal prosecution, it may have an impact on the likelihood of a conviction. Experience shows that a jury is less likely to find that a taxpayer acted willfully when it learns that he voluntarily admitted and corrected his error prior to any contact or inquiry by the IRS.

The Voluntary Disclosure Non-Policy
1. Because the IRS has limited investigative resources and cannot hope to detect more than a small percentage of non-filers or tax evaders, it is obviously in the government's interest to encourage taxpayers who owe additional tax to file amended and delinquent returns. Recognizing that fact, and the fact that a true voluntary disclosure makes conviction unlikely, the Treasury Department once had a limited amnesty policy under which it would not prosecute a taxpayer who admitted and corrected a false return or failure to file before the IRS began inquiring into his affairs. In 1952, the Treasury Department abandoned that policy in favor of an informal "non-policy" under which voluntary disclosure is merely a factor to be considered in the decision whether to initiate a criminal investigation or recommend prosecution. Periodic updates were announced between 1961 and 2003.

Current Statement of the IRS Voluntary Disclosure Practice
On December 11, 2002, the Internal Revenue Service amended IRM 9.5.3.3.1.2.1 and redefined the definition of timeliness by broadening its definition significantly. It was accompanied by the following press release:

Internal Revenue Service officials announced on December 11, 2002, they have revised and updated a key practice that assists agency investigators in determining whether a case is recommended for criminal prosecution.

Specifically, a taxpayer’s timely, voluntary disclosure of a substantial unreported tax liability has long been an important factor in deciding whether the taxpayer’s case should ultimately be referred for criminal prosecution. The practice has been modernized to allow more taxpayers to voluntarily comply with their obligations and to reduce the uncertainty over what constitutes a "timely" disclosure.

A series of examples illustrate the new standards of timeliness and should help eliminate confusion over when a voluntary disclosure will be viewed as timely. For example, general publicity regarding enforcement and compliance efforts will not bar a taxpayer from making a voluntary disclosure.

"Sound tax administration, including the possible use of criminal prosecution, requires as much clarity as possible," said Bob Wenzel, Acting IRS Commissioner. "We want taxpayers, as well as their tax advisers, to better understand the steps they can take and the circumstances in which they can get back into compliance with the tax laws."

As before, the practice requires the taxpayer to make good faith arrangements with the IRS to pay in full the tax, interest, and any applicable penalties as determined by the IRS. This disclosure practice does not apply to those with income from illegal sources.

The revised practice continues to be a matter of internal IRS use and creates no substantive or procedural rights. As in the past, it is provided solely for the guidance of IRS personnel. A voluntary disclosure will not automatically guarantee immunity from prosecution.

The entire newly revised (2002) Voluntary Disclosure Practice now reads:

(1) It is currently the practice of the IRS that a voluntary disclosure will be considered along with all other factors in the investigation in determining whether criminal prosecution will be recommended. This voluntary disclosure practice creates no substantive or procedural rights for taxpayers, but rather is a matter of internal IRS practice, provided solely for guidance to IRS personnel. Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution.

(2) A voluntary disclosure will not automatically guarantee immunity from prosecution; however, a voluntary disclosure may result in prosecution not being recommended. This practice does not apply to taxpayers with illegal source income.

(3) A voluntary disclosure occurs when the communication is truthful, timely, complete, and when:

a. the taxpayer shows a willingness to cooperate (and does in fact cooperate) with the IRS in determining his or her correct tax liability; and

b.  the taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.

(4) A disclosure is timely if it is received before:

a. the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation;

b. the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance;

c. the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or

d. the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).

(5) Any taxpayer who contacts the IRS in person or through a representative regarding voluntary disclosure will be directed to Criminal Investigation for evaluation of the disclosure. Special agents are encouraged to consult Area Counsel, Criminal Tax on voluntary disclosure issues.

(6) Examples of voluntary disclosures include:

a. a letter from an attorney which encloses amended returns from a client which are complete and accurate (reporting legal source income omitted from the original returns), which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full and which meets the timeliness standard set forth above. This is a voluntary disclosure because all elements of (3), above are met.

b. a disclosure made by a taxpayer of omitted income facilitated through a barter exchange after the IRS has announced that it has begun a civil compliance project targeting barter exchanges; however the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intention to do so. In addition, the taxpayer files complete and accurate amended returns and makes arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable. This is a voluntary disclosure because the civil compliance project involving barter exchanges does not yet directly relate to the specific liability of the taxpayer and because all other elements of (3), above are met.

c. a disclosure made by a taxpayer of omitted income facilitated through a widely promoted scheme regarding which the IRS has begun a civil compliance project and already obtained information which might lead to an examination of the taxpayer; however, the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intent to do so. In addition, the taxpayer files complete and accurate returns and makes arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable. This is a voluntary disclosure because the civil compliance project involving the scheme does not yet directly relate to the specific liability of the taxpayer and because all other elements of (3), above are met.

d. A disclosure made by an individual who has not filed tax returns after the individual has received a notice stating that the IRS has no record of receiving a return for a particular year and inquiring into whether the taxpayer filed a return for that year. The individual files complete and accurate returns and makes arrangements with the IRS to pay the tax, interest, and any penalties determined by the IRS to be applicable in full. This is a voluntary disclosure because the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intent to do so and because all other elements of (3), above, are met.

(7) Examples of what are not voluntary disclosures include:

a. a letter from an attorney stating his or her client, who wishes to remain anonymous, wants to resolve his or her tax liability. This is not a voluntary disclosure until the identity of the taxpayer is disclosed and all other elements of (3) above have been met.

b. a disclosure made by a taxpayer who is under grand jury investigation. This is not a voluntary disclosure because the taxpayer is already under criminal investigation. The conclusion would be the same whether or not the taxpayer knew of the grand jury investigation.

c. a disclosure made by a taxpayer, who is not currently under examination or investigation, of omitted gross receipts from a partnership, but whose partner is already under investigation for omitted income skimmed from the partnership. This is not a voluntary disclosure because the IRS has already initiated an investigation which is directly related to the specific liability of this taxpayer. The conclusion would be the same whether or not the taxpayer knew of the ongoing investigation.

d. a disclosure made by a taxpayer, who is not currently under examination or investigation, of omitted constructive dividends received from a corporation which is currently under examination. This is not a voluntary disclosure because the IRS has already initiated an examination which is directly related to the specific liability of this taxpayer. The conclusion would be the same whether or not the taxpayer knew of the ongoing examination.

e. a disclosure made by a taxpayer after an employee has contacted the IRS regarding the taxpayer's double set of books. This is not a voluntary disclosure even if no examination or investigation has yet commenced because the IRS has already been informed by the third party of the specific taxpayer's noncompliance. The conclusion would be the same whether or not the taxpayer knew of the informant's contact with the IRS.

The “triggering” events which distinguish a “voluntary” disclosure from a “compelled” disclosure have been narrowed significantly and are very IRS specific. Moreover, as the new examples set forth in the Manual reveal, the fact that the IRS is conducting a civil enforcement program into the very area of non-compliance by the taxpayer does not disqualify that taxpayer from making a voluntary disclosure so long as the IRS has not yet specifically focused on the taxpayer or entity to which the taxpayer is affiliated.

D. Cases

Courts have been unanimous for more than forty years in holding that the IRS policy does not give any taxpayer immunity from prosecution. See United States v. Hebel, 668 F.2d 995, 997 99 (8th Cir.) (voluntary disclosure "does not insulate the taxpayer from prosecution"), cert. denied, 456 U.S. 946 (1982); United States v. Choate, 619 F.2d 21, 23 (9th Cir.) (there is "no longer a policy affording immunity for voluntary disclosure," and the fact that taxpayer made a voluntary disclosure "is not conclusive" on whether prosecution will be authorized), cert. denied, 449 U.S. 951 (1980); Plunkett v. Commissioner, 465 F.2d 299, 303 (7th Cir. 1972) (rejecting argument that "United States Attorney was foreclosed from prosecuting Plunkett" because he had voluntarily disclosed and amended his false returns).1 Thus, a taxpayer may be prosecuted even if he or she makes a valid voluntary disclosure. Some highly experienced commentators have noted that, when a truly valid voluntary disclosure is made, a taxpayer is seldom prosecuted. The reason for this is plain:

Where a taxpayer makes a true voluntary disclosure before the Service has made any investigation into his returns, the case simply does not have the deterrent impact desired by the Service. Rather than encouraging compliance with the tax laws, such prosecution might well encourage other taxpayers to continue to conceal whatever omissions they may already have been guilty of in the hope that they will avoid detection. Not only do taxpayers who make voluntary disclosures make poor examples for deterrent purposes, but prosecution of such taxpayers can present significant trial hazards, since a disclosure is evidence from which a finder of fact may determine that the original act was not "willful" in a criminal sense.

M.I. Saltzman, IRS Practice and Procedure (Revised 2nd ed. 2002 (Hereinafter “Saltzman”)), 12.03[3][c], at 12-37.

E. Timeliness

As a result of the December 11, 2002 changes the IRS has significantly broadened the definition of timeless. As stated previously, it is very IRS vis a vis taxpayer specific and even an inquiry by the Service Center inquiring as to whether the taxpayer filed a return for a given year will not disqualify that taxpayer from implementing a successful voluntary disclosure. Care must be given to verify that any entity to which a taxpayer has an affiliation is not the subject of an examination or investigation.

F. Cooperation with the IRS

The requirement of cooperating with the IRS includes paying, or making a bona fide arrangement with the IRS to pay, any outstanding tax liabilities. In United States v. Tenzer, 127 F.3d 222 (2d Cir. 1999) (Tenzer I), the court held that the taxpayer did not meet all of the requirements of the voluntary disclosure policy because he had failed to pay, or make an arrangement to pay, tax liabilities of almost $1,300,000. The court found it significant that, although a civil IRS agent advised that any offer in compromise filed by the taxpayer should be in the $600,000 range, the taxpayer, with the assistance of tax counsel, offered only $250,000, which offer the district court deemed "laughable."2 Moreover, after the IRS returned the inadequate offer, Tenzer indicated not that he would offer more, but, instead, that "he planned to resubmit the same offer with a more detailed explanation attached." 127 F.3d at 228. In addition, although the IRS revenue agent advised Tenzer that, if he wished the IRS to consider his offer-in-compromise he would have to become current on his accruing taxes and make all estimated payments, Tenzer failed to make estimated payments or pay any of his current year’s taxes. Finally, Tenzer disregarded the revenue agent’s advice that he divest certain assets and begin making monthly tax payments of $7,000. Given the foregoing, the Second Circuit concluded that Tenzer "had ample opportunity" to comply with the policy’s requirement to make an arrangement to pay, but failed to do so.

G. Sentencing

Following Tenzer I, U.S.D.J. Judge Charles Brieant sentenced Tenzer to a year and a day in prison, rejecting Tenzer’s request for a departure based on the IRS’s conduct in the case. Judge Brieant’s holding in this regard was premised on his belief that the mandate in Tenzer I precluded him from considering Tenzer’s attempts to qualify for the voluntary disclosure policy, or the IRS’s conduct, as a basis to depart. United States v. Tenzer, 213 F.3d 34, 41 (2d Cir. 2000) (Tenzer II). On appeal, the Second Circuit remanded for re sentencing, finding that its opinion in Tenzer I did not preclude the District Court, in the first instance, from considering whether Tenzer’s attempts to qualify for the voluntary disclosure program, and the IRS’s conduct, were sufficiently exceptional factors to take Tenzer’s case out of the heartland and justify a downward departure. Id. at 43 44. The Tenzer II panel emphasized, however, that it was not deciding whether those factors, individually or together, constitute an appropriate basis for departure; rather, it held that such a consideration was not precluded by the mandate of Tenzer I, and the District Court was in the best position to make such an assessment in the first instance.

Following Tenzer II, the case was reassigned to U.S.D.J. Judge Colleen McMahon, who rejected Tenzer’s departure motion and sentenced Tenzer to the same year-and-a-day sentence previously imposed by Judge Brieant. In so doing, Judge McMahon cited, among other factors, Tenzer’s position as a tax attorney and advisor, and his "de minimus offers of back tax payments."

H. Procedure

The attorney's task is to put policy and theory into practice. Although the Internal Revenue Service Manual provisions set forth a procedure for making a formal voluntary disclosure directly with the Criminal Investigation Division, some practitioners advocate making a voluntary disclosure directly with the Internal Revenue Service Center by filing delinquent or amended returns with a remittance for tax and interest. Although the taxpayer will not get oral or written absolution that, assuming truthful, timely, complete, and cooperation (payment of the tax and interest), as well as the absence of any triggering events, he or she will not be criminally investigated, by causing these filings to be made at the Service Center, counsel may accomplish the same result by getting to the Internal Revenue Service before it gets to the client. In such cases, it is highly likely that, other than a bill for interest and perhaps a delinquency penalty in a failure to file situation, the taxpayer may never be contacted by an Internal Revenue Service employee concerning the years for which the delinquent or amended filings were made. Additionally, dealing directly with the Service Center may limit the number of tax years your client's disclosure has to address. Many clients prefer this "informal" method of voluntary disclosure because of the fear of the type of Criminal Investigation scrutiny that accompanies a formal voluntary disclosure. That scrutiny includes an inquiry as to timeliness, detailed scrutiny of the accuracy of the amended returns and often an imposition of the 75% civil fraud penalty.

There are issues in addition to formal/informal disclosure, i.e, is the disclosure truly voluntary? Counsel must exercise great care in his or her factual inquiry to determine no entity examination or investigation is underway.

When considering a voluntary disclosure, it bears repeating that it is important to distinguish between failure to file cases and fraudulent return cases. Generally, practitioners feel more comfortable in their ability to prevent criminal investigations by making voluntary disclosures in failure to file cases rather than fraudulently-filed return cases. Some of the issues raised include: starting a new statute of limitation for criminal purposes (by filing false amended returns not including all previously undisclosed items), making admissions of understatements of income (which amended returns essentially constitute), and do the amended returns contain all of the income attributable to your taxpayer client?

The issue of the anonymity of the taxpayer at the hypothetical stage is now receiving considerable discussion. Does the lawyer practice in a district where he or she can proffer facts, amounts, lack of triggering events, and other factors and receive a comment "if everything you say is confirmed by an investigation of your client, once you reveal his identity and tender the returns, your client will be in the clear" or will the Internal Revenue Service official require you to state the identity of your taxpayer at the inception of the process? If that is a requirement, can you safely proceed in that manner?

The issues of formal or informal, delinquent or amended, the presence of some triggering event, causing a new statute of limitations to begin if amended returns are filed, and anonymity must be addressed individually and collectively in advising a client whether and how to make a voluntary disclosure. Painstakingly detailed interview of clients must take place. A Kovel accountant should be retained to prepare delinquent or amended returns in order to determine if the taxpayer has the means to pay the tax, interest and perhaps civil penalty and if so, whether he or she wants to pay or continue to assume the risk of discovery

An additional problem facing practitioners in jurisdictions which have state income taxes is to determine what impact the federal filing will have on federal/state return information sharing agreements and should a simultaneous voluntary disclosure be attempted, if such a procedure exists in that state, with the state taxing authorities?

The December 11, 2002 Manual provisions make it clear that voluntary disclosure is only available to legal source income. In some districts, elected officials are disqualified from making voluntary disclosures as are taxpayers who are considered environmental polluters.

For further discussions of how to make a voluntary disclosure, see, e.g., Saltzman, ¶ 12.07[3][d], at 12 51 54. See also, testimony of IRS Attorney Robert Marino in United States v. Tenzer, 95 Cr. 1016 (S.D.N.Y.) (CLB), explaining practice of IRS District Counsel in handling voluntary disclosures.

I. Current Returns

There is no legal obligation for a taxpayer to file delinquent returns or, in the case of previously filed false returns, amended returns. However, as each year passes, a new return comes due, which must be filed in a timely, accurate and complete manner. A practitioner should always advise a client seeking advice about a potential voluntary disclosure that the client must comply with the next filing requirement. Any suggestion to the contrary by the practitioner could subject him or her to potential criminal liability, i.e., aiding or assisting in the failure to file a return or the filing of a false return. This precept becomes important because many clients express a fear that a current filing may trigger scrutiny of their prior conduct, and some change their minds about making a voluntary disclosure prior to actually filing. Thus, the practitioner should always advise the client of the legal requirements for the current filing season and memorialize in the file that such advice was given.

J. Other Forms

1. It is important to note that the IRS Manual provision that governs voluntary disclosures does not apply to non-IRS forms, such as Treas. Form 90-22.1, the Report of Foreign Bank and Financial Account (FBAR). In some cases, a taxpayer will want to make a voluntary disclosure to report a previously undisclosed foreign bank account, including any income earned on such account and the fact that the taxpayer was a signator on such account. An amended tax return can report the additional income, and it can also change the answer to the foreign bank account question on Schedule B. But an affirmative answer to that question also requires the taxpayer to file an FBAR, and the FBAR is under the jurisdiction of the Financial Crimes Enforcement Network, which has no published voluntary disclosure policy.

2. However, most practitioners advise their clients making a voluntary disclosure about a previously concealed foreign bank account to file FBARs for the years in issue. In at least one case of which the authors are aware, FINCEN declined to impose civil penalties on a taxpayer in a similar case on the ground that the taxpayer had made a voluntary disclosure.

3. However, because the Form 8300 is an IRS form, the Manual provisions on voluntary disclosures should and do apply to taxpayers who wish to make a voluntary disclosure regarding previously unreported cash transactions that should have been reported pursuant to § 6050I.

1 See also Crystal v. United States, 172 F.3d 1141, 1151 (9th Cir. 1999) (“if completing a voluntary disclosure does not immunize taxpayers from prosecution, a fortiori initiating a voluntary disclosure cannot immunize them from investigation”); United States v. Knottnerus, 139 F.3d 558, 560, 561 n.5 (7th Cir.) (concluding that defendant seeking to preclude tax evasion prosecution failed to make a timely voluntary disclosure, but noting that even if he had, “his due process claim would be highly dubious”), cert. denied, 119 S. Ct. 146 (1998); Bateman v. United States, 212 F.2d 61, 65 n.2 (9th Cir. 1954) (“In 1952 the Treasury Department announced that voluntary disclosure would no longer prevent recommendation for prosecution”); United States v. J.R. Watkins Co., 127 F. Supp. 97, 105 (D. Minn. 1954) (taxpayers who make voluntary disclosure after 1952 act at their own risk, since “prosecution might well be recommended”).

2  Despite this finding, the District Court had concluded that Tenzer had made a bona fide arrangement to pay, and ultimately dismissed the information charging Tenzer with four courts of failure-to-file. 950 F. Supp. 554 (S.D.N.Y. 1996). The District court also had held that Tenzer’s disclosure was timely, despite the fact that the IRS was investigating the clients of Tenzer’s accounting firm and had served Tenzer with a grand jury subpoena for client documents, which had led Tenzer to question whether he himself was under investigation. Because the Second Circuit’s holding on the “arrangement to pay” issue resulted in reinstatement of the charges, the Court did not address the Government’s additional contentions on appeal that Tenzer’s disclosures were untimely and that, in any event, Tenzer’s case was sufficiently egregious that prosecution was appropriate notwithstanding compliance with the voluntary disclosure policy. 126 F.3d at 226.

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