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What Turns an IRS Revenue Agent's Civil Examination into a Criminal Case?

Tax professionals, such as CPAs, often confront IRS examinations into their clients’ income tax returns. Such examinations cost the client professional fees and may result in additional taxes, interest, and civil penalties. These costs may not be the worst result of an IRS examination. A more serious outcome may arise if the Revenue Agent believes the taxpayer committed fraud and refers the matter to the IRS Criminal Investigation Division.

It is the practice of the IRS to not tell the taxpayer that the Revenue Agent suspects fraud and is gathering information for referral to Criminal Investigators.

This blog considers some of the factors that cause a referral from the civil side of the IRS to the criminal side of the IRS.

The Criminal Investigation Division is the branch of the Internal Revenue Service whose function is to enforce criminal statutes of the tax code. Tax crimes include tax evasion, failure to file tax returns, and false statements on tax returns, to name a few. Criminal investigations can begin from various sources including: 1) a whistleblower, usually an employee of the taxpayer, who has knowledge of a business owner skimming or otherwise committing tax fraud; 2) a husband or wife reporting on his or her spouse, usually as a result of a bitter divorce; 3) the filing by financial institutions of numerous Suspicious Activity Reports concerning deposits of cash less than $10,000 or Currency Transaction Reports for multiple deposits over $10,000; 4) IRS programs which target certain types of businesses or professions; and 5) disclosure of offshore financial accounts from financial institutions reporting U.S. account holders to the IRS, because of treaty with the U.S. or for other reasons.

Most referrals to the Criminal Investigation Division traditionally stem from the Civil Compliance Officers, such as Revenue Agents, who conduct civil examinations and audits of tax returns, and from Collection Officers who discover efforts to evade the payment of tax through hiding assets. The subject of this blog will be limited to criminal referrals which result from the Revenue Agent’s audits of tax returns.

A Revenue Agent, in preparation for an examination of the taxpayer, will review the tax returns, the nature of the taxpayer’s business, industry data and various other items. It must be remembered that Revenue Agents are trained and experienced in analyzing tax returns of individuals and businesses. The experience a Revenue Agent brings to the examination will vary based upon years of service and types of returns routinely handled. The Revenue Agent is trained to recognize factors which are indicative of fraud. While the Agent may suspect fraud, that suspicion may be incorrect. The incorrect suspicion is, however, enough to cause the Agent to vigorously examine for fraud.

The Revenue Agent, while not a Criminal Investigator, is familiar with fraud and can impose a civil fraud penalty. In addition, the Revenue Agent can call upon a Fraud Technical Advisor within the Civil Division for consultation, analysis, and assistance in preparing the criminal fraud referral. If the Revenue Agent suspects fraud, the Agent will discuss the matter with his or her supervisor and the Fraud Technical Advisor will be called in. The participation of a Fraud Technical Advisor is not revealed by the Revenue Agent during the course of the examination. Likewise, the Revenue Agent will not advise that he or she suspects fraud.

Items that can cause a suspicion of fraud on the part of the taxpayer are varied and numerous. A few examples include: 1) a lifestyle that is inconsistent with reported income; 2) existence of foreign bank accounts; 3) unreported income; 4) businesses that involve cash; 5) production of documentation that appears false or fabricated to support deductions; and 6) accounting inconsistencies such as reported gross receipts that do not match up with bank deposits, or deductions inconsistent with business expenses. These are just a few of the ways in which tax fraud manifests itself to an experienced Revenue Agent.

A Revenue Agent is prohibited from disclosing to the taxpayer or his representative that a referral to the Criminal Investigation Division will be or has been made. Likewise, the Revenue Agent will not disclose that he is working with the Fraud Technical Advisor. One reason that the Revenue Agent will not disclose the suspicion of fraud is that such a disclosure may cause the taxpayer to hire an experienced attorney and thereby prevent the Agent from obtaining evidence to establish fraud. The IRS knows that most experienced attorneys will not allow interviews of the taxpayer when there is a suspicion of fraud.

An accountant representing the taxpayer needs to be alert to the existence of information which may be perceived by the Revenue Agent as indicative of fraud. If the accountant believes that the client did not engage in tax fraud, there still may be a problem if the facts can be perceived by the Revenue Agent in a fashion that raises the suspicion of fraud. An accountant should be alert to any changes in the Revenue Agent’s demeanor as well as the types of information and documents being requested. It should also be remembered that criminal referrals will typically involve multiple tax years. So, the expansion of the examination into multiple years is a factor to be considered by the representative.

In addition, other actions by the Revenue Agent may reveal a fraud investigation. These include: 1) requesting financial statements; 2) contacting third parties such as business employees, customers, past employees, vendors, and other business suppliers; and 3) the issuance of an IRS summons to obtain records from the taxpayer as well as from banks, brokerage firms, and other financial businesses for records including accounts, loans, loan applications, credit card records, and stock trading.

The taxpayer’s representative may inquire of the Revenue Agent as to whether the Agent has conferred with anyone in addition to his or her supervisor. The Agent should be asked whether he or she has consulted with a Fraud Technical Advisor if the Revenue Agent’s conduct indicates a possible suspicion of fraud. The Revenue Agent is not authorized to provide a false answer to this question, therefore a failure to answer may in itself provide the answer. If the Agent lies and it is later determined that there was a Fraud Technical Advisor working on the matter, the consequences of the false statement may be useful to an experienced criminal defense attorney.

Procedures involved in referring a case to the Criminal Investigation Division are time-consuming. Before such a referral can be made, the Revenue Agent will consult with his or her supervisor and the Fraud Technical Advisor. The consultation will result in advice to the Revenue Agent on how to conduct the examination so as to gather information to support the opening of a criminal fraud investigation.

The referral to the Criminal Investigation Division requires the approval of the Revenue Agent’s supervisor as well as the Technical Fraud Adviser’s supervisor. With this necessary approval, a formal referral entitled “Report of Potential Criminal Fraud Cases”, Form 2797, is prepared and submitted to the Criminal Investigation Division. A Special Agent of the Criminal Investigation Division is then assigned the matter and according to regulation has 10 days from the receipt of Form 2797 to consult with the Revenue Agent, the Agent’s supervisor, and the Fraud Technical Advisor.

The purpose of this conference is to discuss the tax returns, the evidence gathered to support proof of the criminal offense, the criminal tax figures which can be different than the civil tax liability, and other matters related to the investigation. There follows a Primary Investigation and if the Criminal Investigation Division supervisor believes fraud is present, an investigation of the taxpayer is opened. This investigation is called a “Subject Criminal Investigation”. No one wants to be the “Subject” of an IRS criminal investigation.

At the time that the Subject Criminal Investigation is opened, the Criminal Investigation Division Special Agent coordinates with the Revenue Agent to assist in the investigation. While the regulations state that a period of 30 days is allotted for the Criminal Division to decide whether to open a Subject Criminal Investigation, in practice, the time is usually much greater. It is not uncommon for 3 or 4 months to elapse from the referral to Criminal Investigation Division to the opening of the Subject Criminal Investigation.

When the initial Report of Potential Criminal Fraud Cases is submitted to the Criminal Investigation Division, the Revenue Agent is not supposed to have any contact with the taxpayer or the taxpayer’s representative, while the matter is being considered by the Criminal Investigation Division. Therefore, the taxpayer’s representative should be on alert when all communication with the Revenue Agent ceases for an extended period of time. During this time, the Criminal Investigation Division is deciding whether to open a formal investigation. If the decision is to proceed, the Special Agent will conduct a more thorough investigation to develop a criminal case and take control of the IRS efforts.

If the Criminal Investigation Division does not open an investigation, the case is returned to the Revenue Agent who will not volunteer that the referral was made. It is still possible that a criminal referral will be made, especially if the Revenue Agent obtains from the taxpayer an admission of fraud or false documents.

Special care should be taken to recognize the potential of a criminal investigation before the taxpayer and his representative are confronted with the unpleasant experience of meeting with the Revenue Agent and being introduced to a Special Agent of the Criminal Investigation Division. This usually happens at an appointment arranged by the Revenue Agent who unexpectedly shows up with the Criminal Investigator.

A criminal tax investigation will involve efforts by the IRS Special Agents to prove criminal intent on the part of the taxpayer. An interview often provides the evidence of intent necessary for a successful prosecution. Unfortunately, the evidence of the interview is filtered through the Special Agent’s recitation of the interview. It is not the practice of the Internal Revenue Service Special Agents to tape-record interviews of the potential defendant. The end result of not having a recording is that the information attributed to the defendant and presented to a jury in a trial several years later may be incorrect or false. The risks in talking to the Special Agent include: 1) the Agent does not understand the taxpayer’s answers; 2) the Agent makes mistakes when he prepares a memorandum of the interview days or weeks or months after the discussion; 3) the Agent ignores statements by the potential defendant which are inconsistent with the Agent’s theory of guilt; 4) the Agent intentionally attributes false or incorrect comments to the defendant; and 5) the Agent’s memory of the interview is in error due to the passage of time and reliance upon his or her memory and the written memorandum which may be inaccurate or intentionally false.

The taxpayer’s representative, whether it be an enrolled agent, accountant, or CPA should be vigilant to the potential of a criminal investigation. The earlier an experienced criminal tax defense attorney is retained, the better.