Washington IRS more likely to audit millionaires
There's at least one advantage to not being a millionaire -- less chance of being audited by the Internal Revenue Service.
The tax agency said Thursday that in the 2007 budget year it audited one out of every 11 with incomes of $1 million or more. Among those with incomes of $100,000 or less, 99 out of every 100 escaped further IRS scrutiny...There were 31,382 audits of those with $1 million incomes, up 84 percent from the 17,015 audited in 2006.
For complete article click link above.
Showing posts with label irs. Show all posts
Showing posts with label irs. Show all posts
Tuesday, January 22, 2008
Friday, November 30, 2007
Unreported Income: Voluntary Disclosure
A tax crime is complete on the day the false return was filed.
Between 1945 and 1952, the IRS had a "voluntary disclosure" policy under which a taxpayer who failed to file a return or declare his full income and pay the tax due could escape criminal prosecution through voluntary disclosure of the deficiency, (so long as the voluntary disclosure was made before an investigation was started).
If the IRS determined that a voluntary disclosure had been made, no recommendation for criminal prosecution would be made to the Department of Justice.
Under current IRS practice, the review includes whether there was a true "voluntary disclosure" along with other factors in determining whether or not to recommend prosecution to the Department of Justice. (IRM, Chief Counsel Directive Manual (31) 330 (Dec. 11, 1989) (Voluntary Disclosure).
IRM 9781, Special Agents Handbook § 342.14, MT 9781-125 (Apr. 10, 1990) (Voluntary Disclosure). (although prosecution after voluntary disclosure is not precluded, the "IRS will carefully consider and weigh the voluntary disclosure, along with all other facts and circumstances, in deciding whether or not to recommend prosecution"). See also IRM 9131(1), MT 9-329 (Mar. 24, 1989). (Prosecution Guidelines).
IRS administrative practice recognizes that a taxpayer may still avoid prosecution by voluntarily disclosing a tax violation, provided that there is a qualifying disclosure that is (1) timely and (2) voluntary. A disclosure within the meaning of the practice means a communication that is truthful and complete, and the taxpayer cooperates with IRS personnel in determining the correct tax liability. Cooperation also includes making good faith arrangements to pay the unpaid tax and penalties "to the extent of the taxpayer's actual ability to pay."
A disclosure is timely if it is received before the IRS has begun an inquiry that is (1) "likely to lead to the taxpayer" and (2) the taxpayer is reasonably thought to be aware" of that inquiry; or the disclosure is received before some triggering or prompting event has occurred (1) that is known by the taxpayer and (2) that triggering event is likely to cause an audit into the taxpayer's liabilities.
Voluntariness is tested by the following factors: (1) how far the IRS has gone in determining the tax investigation potential of the taxpayer; (2) the extent of the taxpayer's knowledge or awareness of the Service's interest; and (3) what part the triggering event played in prompting the disclosure (where the disclosure is prompted by fear of a triggering event, it is not truly a voluntary disclosure).
No voluntary disclosure can be made by a taxpayer if an investigation by the Service has already begun. Therefore, once a taxpayer has been contacted by any Service function (whether it be the Service center, office examiner, revenue agent, or a special agent), the taxpayer cannot make a qualifying voluntary disclosure under IRS practice.
A voluntary disclosure can be made even if the taxpayer does not know that the Service has selected the return for examination or investigation may be too restrictive. Consequently, if there is no indication that the Service has started an examination or investigation, Tax Counsel may send a letter to the Service stating that tax returns of the taxpayer have been found to be incorrect and that amended returns will be filed as soon as they can be accurately and correctly prepared. This approach has the advantage of putting the taxpayer on record as making a voluntary disclosure at a time when no known investigation is pending. However, neither the taxpayer nor the lawyer can be completely certain that the voluntary disclosure will prevent the recommendation of criminal prosecution.
Where no IRS examination or investigation is pending a taxpayer’s alternative is the preparation and filing of delinquent or amended returns. The advantage of filing delinquent or amended returns without a communication drawing attention to them is that the returns may not even be examined after being received at the Service center. In such an event, the taxpayer not only will have made a voluntary disclosure but will have avoided an examination as well. The disadvantage is that during the time the returns are being prepared, the taxpayer may be contacted by the Service and a voluntary disclosure prevented.
If a taxpayer who cannot make a qualifying voluntary disclosure nevertheless files amended or delinquent tax returns, these returns (1) constitute an admission that the correct income and tax were not reported and (2) if incorrect, may serve as an independent attempt to evade or as a separate false statement.
No formula exists, and a taxpayer must endure the uncertainty of the risk that a voluntary disclosure will not be considered truly voluntary by the Service. If so, an investigation that has already started but has lagged may be pursued more overtly and aggressively as a result of the disclosure.
Between 1945 and 1952, the IRS had a "voluntary disclosure" policy under which a taxpayer who failed to file a return or declare his full income and pay the tax due could escape criminal prosecution through voluntary disclosure of the deficiency, (so long as the voluntary disclosure was made before an investigation was started).
If the IRS determined that a voluntary disclosure had been made, no recommendation for criminal prosecution would be made to the Department of Justice.
Under current IRS practice, the review includes whether there was a true "voluntary disclosure" along with other factors in determining whether or not to recommend prosecution to the Department of Justice. (IRM, Chief Counsel Directive Manual (31) 330 (Dec. 11, 1989) (Voluntary Disclosure).
IRM 9781, Special Agents Handbook § 342.14, MT 9781-125 (Apr. 10, 1990) (Voluntary Disclosure). (although prosecution after voluntary disclosure is not precluded, the "IRS will carefully consider and weigh the voluntary disclosure, along with all other facts and circumstances, in deciding whether or not to recommend prosecution"). See also IRM 9131(1), MT 9-329 (Mar. 24, 1989). (Prosecution Guidelines).
IRS administrative practice recognizes that a taxpayer may still avoid prosecution by voluntarily disclosing a tax violation, provided that there is a qualifying disclosure that is (1) timely and (2) voluntary. A disclosure within the meaning of the practice means a communication that is truthful and complete, and the taxpayer cooperates with IRS personnel in determining the correct tax liability. Cooperation also includes making good faith arrangements to pay the unpaid tax and penalties "to the extent of the taxpayer's actual ability to pay."
A disclosure is timely if it is received before the IRS has begun an inquiry that is (1) "likely to lead to the taxpayer" and (2) the taxpayer is reasonably thought to be aware" of that inquiry; or the disclosure is received before some triggering or prompting event has occurred (1) that is known by the taxpayer and (2) that triggering event is likely to cause an audit into the taxpayer's liabilities.
Voluntariness is tested by the following factors: (1) how far the IRS has gone in determining the tax investigation potential of the taxpayer; (2) the extent of the taxpayer's knowledge or awareness of the Service's interest; and (3) what part the triggering event played in prompting the disclosure (where the disclosure is prompted by fear of a triggering event, it is not truly a voluntary disclosure).
No voluntary disclosure can be made by a taxpayer if an investigation by the Service has already begun. Therefore, once a taxpayer has been contacted by any Service function (whether it be the Service center, office examiner, revenue agent, or a special agent), the taxpayer cannot make a qualifying voluntary disclosure under IRS practice.
A voluntary disclosure can be made even if the taxpayer does not know that the Service has selected the return for examination or investigation may be too restrictive. Consequently, if there is no indication that the Service has started an examination or investigation, Tax Counsel may send a letter to the Service stating that tax returns of the taxpayer have been found to be incorrect and that amended returns will be filed as soon as they can be accurately and correctly prepared. This approach has the advantage of putting the taxpayer on record as making a voluntary disclosure at a time when no known investigation is pending. However, neither the taxpayer nor the lawyer can be completely certain that the voluntary disclosure will prevent the recommendation of criminal prosecution.
Where no IRS examination or investigation is pending a taxpayer’s alternative is the preparation and filing of delinquent or amended returns. The advantage of filing delinquent or amended returns without a communication drawing attention to them is that the returns may not even be examined after being received at the Service center. In such an event, the taxpayer not only will have made a voluntary disclosure but will have avoided an examination as well. The disadvantage is that during the time the returns are being prepared, the taxpayer may be contacted by the Service and a voluntary disclosure prevented.
If a taxpayer who cannot make a qualifying voluntary disclosure nevertheless files amended or delinquent tax returns, these returns (1) constitute an admission that the correct income and tax were not reported and (2) if incorrect, may serve as an independent attempt to evade or as a separate false statement.
No formula exists, and a taxpayer must endure the uncertainty of the risk that a voluntary disclosure will not be considered truly voluntary by the Service. If so, an investigation that has already started but has lagged may be pursued more overtly and aggressively as a result of the disclosure.
Thursday, November 29, 2007
Unreported Income: Jeopardy Assessment
Under a jeopardy assessment, Taxpayers who have unreported income may be subject to immediate IRS seizure of assets. If the IRS determines that tax collection is at risk, the IRS may immediately seize taxpayer assets without prior notice.
The IRS must have made a determination that a deficiency existed and that tax collection would be jeopardized if the IRS were to follow normal assessment and collection procedures. (IRC § 6861(a)).
In the event of a jeopardy assessment, the IRS is permitted to send a notice and demand for payment immediately. (IRC § 6861(a)).
Normally, the IRS assertion of an income tax deficiency is made after the taxpayer’s year closes and the tax return is filed. However, if the IRS determines that a Taxpayer (who received significant income) may prejudice tax collection (e.g., leave the country, place assets beyond IRS reach) the IRS may issue a jeopardy assessment (levy on Taxpayer’s property without prior notice (IRC § 6861(a)).
IRS jeopardy assessment requirements:
1. The Taxpayer’s year is completed;
2. The due date of the tax return (with extensions) has passed;
3. Either:
a. Taxpayer did not file tax return or;
b. Tax liability on the filed return is understated, and;
c. Tax collection is jeopardized.
Treas. Reg. Sections 301.6861 – 1(a)
IRS general levy requirements (IRC § 6330, 6331) do not apply if the IRS finds that tax collection is in jeopardy.
Under IRC § 6330(f), the IRS is entitled to levy on taxpayer’s property, without prior notice to Taxpayer.
To justify a jeopardy levy, the IRS must be able to show:
1. The Taxpayer is (or appears to be) designing to quickly depart from the U.S.;
2. The Taxpayer is (or appears to be) designing to quickly place their assets beyond the reach of the IRS by:
a. Removing assets from the U.S.;
b. Concealing assets;
c. Dissipating assets;
d. Transferring assets to third parties; or
3. The Taxpayer is in danger of becoming insolvent (bankruptcy or receivership, alone is not sufficient evidence to establish financial insolvency for jeopardy purposes).
The IRS procedures for a jeopardy levy, (as stated in the Internal Revenue Manual):
1. IRS chief counsel must personally give prior written approval to a jeopardy levy (IRC § 7429(a));
2. Thereafter, the IRS must provide Taxpayer with a written statement, within five days, of the information upon which the IRS relied in making its jeopardy levy (IRC § 7429(a)(1)(B));
3. IRM 5.11, Notice of Levy Handbook section 3.5(5) instructs the IRS to try to give Taxpayer notice in person, or certified mail (last known address);
4. IRS notice should include:
a. Reason for jeopardy levy;
b. Taxpayer’s rights to administrative and judicial review (IRC § 7429);
c. Notice of Taxpayer’s rights to administrative and judicial review within a reasonable period of time (under IRC § 6330).
The jeopardy assessment may be made either:
1. Before or after a notice of tax deficiency is issued, and;
2. Also, either before or after a Tax Court petition is filed (IRC § 6861(a), Treas. Reg. Section 301.6861 – 1(a).
IRS notice and demand for payment gives the Taxpayer ten days to pay the tax in full or post a bond to stay collection (Treas. Reg. Section 301.6861 – 1(d).
If tax collection is determined to be in jeopardy, the IRS may immediately levy on Taxpayer’s assets (without 30 day notice of intent to levy) (IRC § 6331(d)(3)), subject to IRS chief counsel personally approving the levy in writing (IRC § 7429(a)(1)(A)).
The IRS must send a formal notice of deficiency within 60 days after making the jeopardy assessment (IRC § 6861(b)). Upon receipt of notice of deficiency, the Taxpayer may file a Tax Court petition for redetermination of the deficiency amount (IRC § 6213(a)).
Under IRC § 6213(a), the Tax Court petition stops additional IRS assessments until the Tax Court decision is finalized. However, upon receipt of the notice of deficiency, payment (of the tax assessed), or a bond is required, within ten days, to stay collection (IRC § 6863(a)).
Under a jeopardy assessment, any amount collected by the IRS, in excess of the amount determined by the Tax Court, (as the final assessment), is refunded (IRC § 6861(f)).
The IRS must have made a determination that a deficiency existed and that tax collection would be jeopardized if the IRS were to follow normal assessment and collection procedures. (IRC § 6861(a)).
In the event of a jeopardy assessment, the IRS is permitted to send a notice and demand for payment immediately. (IRC § 6861(a)).
Normally, the IRS assertion of an income tax deficiency is made after the taxpayer’s year closes and the tax return is filed. However, if the IRS determines that a Taxpayer (who received significant income) may prejudice tax collection (e.g., leave the country, place assets beyond IRS reach) the IRS may issue a jeopardy assessment (levy on Taxpayer’s property without prior notice (IRC § 6861(a)).
IRS jeopardy assessment requirements:
1. The Taxpayer’s year is completed;
2. The due date of the tax return (with extensions) has passed;
3. Either:
a. Taxpayer did not file tax return or;
b. Tax liability on the filed return is understated, and;
c. Tax collection is jeopardized.
Treas. Reg. Sections 301.6861 – 1(a)
IRS general levy requirements (IRC § 6330, 6331) do not apply if the IRS finds that tax collection is in jeopardy.
Under IRC § 6330(f), the IRS is entitled to levy on taxpayer’s property, without prior notice to Taxpayer.
To justify a jeopardy levy, the IRS must be able to show:
1. The Taxpayer is (or appears to be) designing to quickly depart from the U.S.;
2. The Taxpayer is (or appears to be) designing to quickly place their assets beyond the reach of the IRS by:
a. Removing assets from the U.S.;
b. Concealing assets;
c. Dissipating assets;
d. Transferring assets to third parties; or
3. The Taxpayer is in danger of becoming insolvent (bankruptcy or receivership, alone is not sufficient evidence to establish financial insolvency for jeopardy purposes).
The IRS procedures for a jeopardy levy, (as stated in the Internal Revenue Manual):
1. IRS chief counsel must personally give prior written approval to a jeopardy levy (IRC § 7429(a));
2. Thereafter, the IRS must provide Taxpayer with a written statement, within five days, of the information upon which the IRS relied in making its jeopardy levy (IRC § 7429(a)(1)(B));
3. IRM 5.11, Notice of Levy Handbook section 3.5(5) instructs the IRS to try to give Taxpayer notice in person, or certified mail (last known address);
4. IRS notice should include:
a. Reason for jeopardy levy;
b. Taxpayer’s rights to administrative and judicial review (IRC § 7429);
c. Notice of Taxpayer’s rights to administrative and judicial review within a reasonable period of time (under IRC § 6330).
The jeopardy assessment may be made either:
1. Before or after a notice of tax deficiency is issued, and;
2. Also, either before or after a Tax Court petition is filed (IRC § 6861(a), Treas. Reg. Section 301.6861 – 1(a).
IRS notice and demand for payment gives the Taxpayer ten days to pay the tax in full or post a bond to stay collection (Treas. Reg. Section 301.6861 – 1(d).
If tax collection is determined to be in jeopardy, the IRS may immediately levy on Taxpayer’s assets (without 30 day notice of intent to levy) (IRC § 6331(d)(3)), subject to IRS chief counsel personally approving the levy in writing (IRC § 7429(a)(1)(A)).
The IRS must send a formal notice of deficiency within 60 days after making the jeopardy assessment (IRC § 6861(b)). Upon receipt of notice of deficiency, the Taxpayer may file a Tax Court petition for redetermination of the deficiency amount (IRC § 6213(a)).
Under IRC § 6213(a), the Tax Court petition stops additional IRS assessments until the Tax Court decision is finalized. However, upon receipt of the notice of deficiency, payment (of the tax assessed), or a bond is required, within ten days, to stay collection (IRC § 6863(a)).
Under a jeopardy assessment, any amount collected by the IRS, in excess of the amount determined by the Tax Court, (as the final assessment), is refunded (IRC § 6861(f)).
Wednesday, November 28, 2007
Unreported Income: Understatement of Tax Liability (Tax Preparer Penalties)
1. Tax Understatement Penalty (Pre 5/26/07)
For income tax returns prepared prior to May 26, 2007, a preparer is subject to a $250 penalty (for each understatement of tax liability on a tax return or refund claim he prepared) if the understatement:
a. Was caused by a position that did not have a realistic possibility of being sustained on its merits,
b. The preparer knew or should have known of the position, and
c. The position was not disclosed or was frivolous (IRC § 6694, prior to amendment by Pub.L. 110-28, the Small Business and Work Opportunity Act of 2007, Section 8246(b)).
2. Tax Understatement Penalty (Post 5/25/07) IRC § 6694
Under IRC § 6694, effective after May 25, 2007, a tax preparer may be subject to a penalty for each understatement of tax liability on a tax return (or refund claim) he prepares if the understatement results from a tax return position in which the preparer did not have a reasonable belief the tax treatment was more likely than not the proper treatment.
If the preparer can not meet the more likely than not standard but has at least a reasonable belief for the position, the preparer may avoid the penalty for an understatement of tax by specifically disclosing the position taken on the tax return.
If the preparer cannot demonstrate at least a reasonable basis for the position, specific disclosure of that position will not insulate the preparer from the understatement penalties. (IRC § 6694(a)(2))
Penalty ($1,000/50% Income)
The amount of the penalty is the greater of:
a. $1,000 or
b. 50% of the income derived from the preparation of the tax return (the penalty is not imposed if the understatement is due to reasonable cause)
3. Willful Tax Understatement
Penalty ($5,000/50% Income)
a. Willfully understates liability for a return (or refund claim), or
b. The understatement is caused by the preparer’s reckless or intentional disregard of rules or regulations,
c. For willful or reckless conduct the penalty is equal to the greater of $5,000, or 50% of the income derived by the tax return preparer from the preparation of the return or claim with respect to which the penalty is imposed (IRC § 6694(b)(1))
Both tax understatement penalties: $1,000 or $5,000 cannot be imposed with respect to the same tax return (or refund claim) (IRC § 6694(b)(3))
An understatement of liability for the purpose of these penalties is any understatement of the net amount of tax payable or any overstatement of the net amount of such taxes that may be credited or refunded.
Any understatement is not reduced by any carryback. (Treas. Reg. Section 1.6694-1(c)).
The preparer generally may rely in good faith without verification upon information furnished by the taxpayer. The preparer does not have to audit, examine or review books and records, business operations, or documents or other evidence to verify independently the taxpayer’s information. The preparer must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete. The preparer must inquire to determine whether a claimed deduction is supported by any facts and circumstances that the tax laws require as a condition to claiming the deduction. (Treas. Reg. Section 1.6694-1(e)).
The understatement penalty is an assessable penalty that is due after notice and demand from the IRS. However, unless the statute of limitations may expire without adequate opportunity for assessment, the IRS will send, before assessment the penalty, a 30-day letter to the preparer notifying the preparer of the proposed penalty and the opportunity of the preparer to request a review of the proposed assessment by IRS Appeals. (Treas. Reg. Section 1.6694-4(a)(1)).
The penalty may not be challenged in Tax Court prior to payment of the penalty because the deficiency procedures do not apply. (IRC § 6696(b)). However, a special procedure allows preparers to sue for a refund of an understatement penalty without having to pay the full amount of the penalty. A preparer may, within 30 days after the day that the IRS demands payment of the penalty, pay at least 15 percent of the penalty and file a refund claim for the amount paid. (IRC § 6694(c)(1)).
If the refund claim is denied, the preparer may, within 30 days after the denial file a refund suit. The suit may also be filed within 30 days of after six months have passed since the filing of the claim if the claim has not been denied by that time. (IRC § 6694(c)(2)).
The IRS can counterclaim for the remainder of the penalty in the refund suit. The IRS cannot levy or begin a court proceeding to collect the remainder of the penalty until the final resolution of the refund suit.
A court may enjoin the IRS from levying or beginning a collection proceeding during this period. (IRC § 6694(c)(1)). If the preparer does not begin a refund suit within the time allowed, the restrictions on IRS collection action expire on the day after the last day that the suit could have been filed. (IRC § 6694 (c)(2)). The running of the period of limitations for collecting the penalty is suspended for the period that the IRS is prohibited from collecting the penalty. (IRC § 6694(c)(3)).
For income tax returns prepared prior to May 26, 2007, a preparer is subject to a $250 penalty (for each understatement of tax liability on a tax return or refund claim he prepared) if the understatement:
a. Was caused by a position that did not have a realistic possibility of being sustained on its merits,
b. The preparer knew or should have known of the position, and
c. The position was not disclosed or was frivolous (IRC § 6694, prior to amendment by Pub.L. 110-28, the Small Business and Work Opportunity Act of 2007, Section 8246(b)).
2. Tax Understatement Penalty (Post 5/25/07) IRC § 6694
Under IRC § 6694, effective after May 25, 2007, a tax preparer may be subject to a penalty for each understatement of tax liability on a tax return (or refund claim) he prepares if the understatement results from a tax return position in which the preparer did not have a reasonable belief the tax treatment was more likely than not the proper treatment.
If the preparer can not meet the more likely than not standard but has at least a reasonable belief for the position, the preparer may avoid the penalty for an understatement of tax by specifically disclosing the position taken on the tax return.
If the preparer cannot demonstrate at least a reasonable basis for the position, specific disclosure of that position will not insulate the preparer from the understatement penalties. (IRC § 6694(a)(2))
Penalty ($1,000/50% Income)
The amount of the penalty is the greater of:
a. $1,000 or
b. 50% of the income derived from the preparation of the tax return (the penalty is not imposed if the understatement is due to reasonable cause)
3. Willful Tax Understatement
Penalty ($5,000/50% Income)
a. Willfully understates liability for a return (or refund claim), or
b. The understatement is caused by the preparer’s reckless or intentional disregard of rules or regulations,
c. For willful or reckless conduct the penalty is equal to the greater of $5,000, or 50% of the income derived by the tax return preparer from the preparation of the return or claim with respect to which the penalty is imposed (IRC § 6694(b)(1))
Both tax understatement penalties: $1,000 or $5,000 cannot be imposed with respect to the same tax return (or refund claim) (IRC § 6694(b)(3))
An understatement of liability for the purpose of these penalties is any understatement of the net amount of tax payable or any overstatement of the net amount of such taxes that may be credited or refunded.
Any understatement is not reduced by any carryback. (Treas. Reg. Section 1.6694-1(c)).
The preparer generally may rely in good faith without verification upon information furnished by the taxpayer. The preparer does not have to audit, examine or review books and records, business operations, or documents or other evidence to verify independently the taxpayer’s information. The preparer must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete. The preparer must inquire to determine whether a claimed deduction is supported by any facts and circumstances that the tax laws require as a condition to claiming the deduction. (Treas. Reg. Section 1.6694-1(e)).
The understatement penalty is an assessable penalty that is due after notice and demand from the IRS. However, unless the statute of limitations may expire without adequate opportunity for assessment, the IRS will send, before assessment the penalty, a 30-day letter to the preparer notifying the preparer of the proposed penalty and the opportunity of the preparer to request a review of the proposed assessment by IRS Appeals. (Treas. Reg. Section 1.6694-4(a)(1)).
The penalty may not be challenged in Tax Court prior to payment of the penalty because the deficiency procedures do not apply. (IRC § 6696(b)). However, a special procedure allows preparers to sue for a refund of an understatement penalty without having to pay the full amount of the penalty. A preparer may, within 30 days after the day that the IRS demands payment of the penalty, pay at least 15 percent of the penalty and file a refund claim for the amount paid. (IRC § 6694(c)(1)).
If the refund claim is denied, the preparer may, within 30 days after the denial file a refund suit. The suit may also be filed within 30 days of after six months have passed since the filing of the claim if the claim has not been denied by that time. (IRC § 6694(c)(2)).
The IRS can counterclaim for the remainder of the penalty in the refund suit. The IRS cannot levy or begin a court proceeding to collect the remainder of the penalty until the final resolution of the refund suit.
A court may enjoin the IRS from levying or beginning a collection proceeding during this period. (IRC § 6694(c)(1)). If the preparer does not begin a refund suit within the time allowed, the restrictions on IRS collection action expire on the day after the last day that the suit could have been filed. (IRC § 6694 (c)(2)). The running of the period of limitations for collecting the penalty is suspended for the period that the IRS is prohibited from collecting the penalty. (IRC § 6694(c)(3)).
Tuesday, November 27, 2007
Unreported Income: Aiding & Abetting Understatements (Tax Preparer Penalties)
1. Aiding and Abetting Tax Understatements (Penalty)
Any person who aids or assists in, or gives advice concerning, the preparation or presentation of any portion of a return, affidavit, claim, with the knowledge that the portion, if submitted, will create an understatement of the tax liability of another person must pay a penalty for each document that the person helps in preparing. (IRC § 6701(a)).
The penalty applies when a person orders a subordinate to act in a manner that violates this provision (or when a person knows that a subordinate will violate this provision and does not attempt to prevent the violation). (IRC § 6701(a), (c)).
A person who provides only mechanical assistance for a document, such as typing or photocopying, does not aid or assist in the preparation of the document. (IRC § 6701(e)).
The penalty applies regardless of whether the taxpayer was aware of, or consented to, the document that causes the understatement. (IRC § 6701(d)).
The penalty is $1,000 per violation with regard to a return or document concerning a taxpayer other than a corporation, and $10,000 with regard to a return or other document concerning the tax liability of a corporation.
The penalty applies only once for assistance given to a taxpayer for a specific tax period regardless of the number of documents prepared that case an understatement for that tax period. (IRC § 6701(b)). The penalty is generally in addition to any other penalty provided by law.
2. IRS: Burden of Proof
The burden of proof involving the issue of whether any person is liable for the penalty is on the IRS. (IRC § 6703(a)). (The government must prove its case by a preponderance of the evidence.)
3. Contest Penalty
The penalty is an assessable penalty. (IRC § 6703(b)). Accordingly, it is due after notice and demand from the IRS. (IRC § 6671(a)). It can not be challenged in the Tax Court prior to payment of the penalty because the deficiency procedures do not apply. (IRC § 6703(b)).
IRC § 6703(c) provides an alternative method for contesting assessment. The alternative method applies if, within 30 days after notice and demand for the penalty, the preparer pays not less than 15 percent of the asserted penalty and files a claim for refund of the amount paid. The IRS may file a counterclaim for the unpaid remainder of the penalty in such a proceeding. (IRC § 6703(c)(1)).
If the requirements as to timely payment of the 15 percent amount and as to filing of a refund claim are satisfied, then the IRS is prohibited from further collection activities with respect to the penalty until completion of the preparer’s challenge to the penalty. (IRC § 6703(c)(1)). The next step in the process occurs if the IRS denies the refund claim or fails to act on the claim within six months of filing, at which time the preparer has 30 days within which to initiate a refund suit in the United States district court to determine liability for the IRC § 6701 penalty.
During the pendency of the refund suit, the statute of limitations on collection is suspended. (IRC § 6703(c)(3)). The IRS may not make, begin, or prosecute a levy or proceeding in court for collection of the unpaid remainder of the penalty until final resolution of the refund suit. Final resolution of the proceeding includes any settlement between the IRS and the preparer, and any final determination by the court (for which the period of appeal has expired).
Any person who aids or assists in, or gives advice concerning, the preparation or presentation of any portion of a return, affidavit, claim, with the knowledge that the portion, if submitted, will create an understatement of the tax liability of another person must pay a penalty for each document that the person helps in preparing. (IRC § 6701(a)).
The penalty applies when a person orders a subordinate to act in a manner that violates this provision (or when a person knows that a subordinate will violate this provision and does not attempt to prevent the violation). (IRC § 6701(a), (c)).
A person who provides only mechanical assistance for a document, such as typing or photocopying, does not aid or assist in the preparation of the document. (IRC § 6701(e)).
The penalty applies regardless of whether the taxpayer was aware of, or consented to, the document that causes the understatement. (IRC § 6701(d)).
The penalty is $1,000 per violation with regard to a return or document concerning a taxpayer other than a corporation, and $10,000 with regard to a return or other document concerning the tax liability of a corporation.
The penalty applies only once for assistance given to a taxpayer for a specific tax period regardless of the number of documents prepared that case an understatement for that tax period. (IRC § 6701(b)). The penalty is generally in addition to any other penalty provided by law.
2. IRS: Burden of Proof
The burden of proof involving the issue of whether any person is liable for the penalty is on the IRS. (IRC § 6703(a)). (The government must prove its case by a preponderance of the evidence.)
3. Contest Penalty
The penalty is an assessable penalty. (IRC § 6703(b)). Accordingly, it is due after notice and demand from the IRS. (IRC § 6671(a)). It can not be challenged in the Tax Court prior to payment of the penalty because the deficiency procedures do not apply. (IRC § 6703(b)).
IRC § 6703(c) provides an alternative method for contesting assessment. The alternative method applies if, within 30 days after notice and demand for the penalty, the preparer pays not less than 15 percent of the asserted penalty and files a claim for refund of the amount paid. The IRS may file a counterclaim for the unpaid remainder of the penalty in such a proceeding. (IRC § 6703(c)(1)).
If the requirements as to timely payment of the 15 percent amount and as to filing of a refund claim are satisfied, then the IRS is prohibited from further collection activities with respect to the penalty until completion of the preparer’s challenge to the penalty. (IRC § 6703(c)(1)). The next step in the process occurs if the IRS denies the refund claim or fails to act on the claim within six months of filing, at which time the preparer has 30 days within which to initiate a refund suit in the United States district court to determine liability for the IRC § 6701 penalty.
During the pendency of the refund suit, the statute of limitations on collection is suspended. (IRC § 6703(c)(3)). The IRS may not make, begin, or prosecute a levy or proceeding in court for collection of the unpaid remainder of the penalty until final resolution of the refund suit. Final resolution of the proceeding includes any settlement between the IRS and the preparer, and any final determination by the court (for which the period of appeal has expired).
Monday, November 26, 2007
Unreported Income - Attorney Client Privilege
Attorney Client Privilege - US v Kovel
If retained by an attorney, client accountants may receive the benefits of Attorney-Client privilege. In United States v. Kovel, 296 F.2d 918 (2d Cir. 1961), the Attorney-Client privilege was extended to accountants retained to assist the attorney in understanding taxpayer’s financial records.
The IRS Restructuring & Reform Act of 1998 extended Attorney-Client privilege to communications with federally authorized practitioners with respect to tax advice. (IRC § 7525)
IRC § 7525 applies to:
1. Any non-criminal matter before the IRS, or in Federal Court brought by or against the U.S.
2. IRC § 7525(b) provides the privilege will not apply to representation of a corporation involved in the promotion or the direct or indirect participation of any such corporation in any tax shelter.
3. The IRC § 7525 privilege does not extend to criminal tax investigations.
A federally authorized tax practitioner is any individual who is authorized under federal law to practice before the IRS. This includes attorneys, CPAs, and enrolled agents. IRC § 7525(a).
Tax advice is advice given by an individual on a matter for which he is authorized to practice before the IRS. IRC § 7525(a). In general, the privilege, like the common-law privilege, applies to the content of the advice, not the identity of the person seeking the advice.
For communications made on or after October 22, 2004, the privilege does not apply to written communications concerning tax shelters. Thus, the privilege does not apply to any written communication between a tax practitioner and any person, director, officer, employee, agent, or representative of a person, or any other person holding a capital or profits interest in a person, in connection with the promotion of the direct or indirect participation of the person in any tax shelter. IRC § 7525(b).
A tax shelter is a partnership or other entity, an investment plan or arrangement, or any other plan or arrangement, if a significant purpose of the partnership, entity, plan, or arrangement is the avoidance or evasion of federal income tax. IRC § 6662(d)(2)(C). (This exception was limited to communications concerning corporate tax shelters, IRC § 7525(b), prior to amendment by Pub. L. 108-357, American Jobs Creation Act of 2004, Section 813.)
The IRS's position is that the Attorney-Client privilege also does not apply to tax accrual workpapers (tax accrual and other financial audit workpapers relating to the tax reserve for deferred tax liabilities and to footnotes disclosing contingent tax liabilities appearing on audited financial statements).
These workpapers are not generated in connection with seeking legal or tax advice, but are developed to evaluate a taxpayer's deferred or contingent tax liabilities in connection with a taxpayer's disclosure to third parties of the taxpayer's financial condition. IRS Announcement 2002-63, 2002-2 C.B. 72.
The crime-fraud exception may be asserted to defeat the claim of tax practitioner privilege for communications that were made for the purpose of getting advice for the commission of crime or fraud. This prevents a party from seeking advice to commit a crime or fraud and then claiming that the communication is privileged.
To assert the crime-fraud exception, (1) there must be a prima facie showing of a crime or fraud, and (2) the communications in question must be in furtherance of the misconduct. U.S. v. BDO Seidman, 368 F.Supp. 2d 858 (N.D. Ill. 2005). If the IRS shows sufficient evidence that the communication was made in furtherance of a crime or fraud, then the taxpayer may respond by providing an explanation that would rebut the IRS's evidence. The crime-fraud exception will apply only if the court finds the taxpayer's explanation unsatisfactory. U.S. v. BDO Seidman, No. 02 C 4822 (N.D. Ill. May 17, 2005), aff’d on this issue and vacated and remanded on other grounds, No. 05-3260 & 05-3518 (7th Cir. July 2, 2007).
If retained by an attorney, client accountants may receive the benefits of Attorney-Client privilege. In United States v. Kovel, 296 F.2d 918 (2d Cir. 1961), the Attorney-Client privilege was extended to accountants retained to assist the attorney in understanding taxpayer’s financial records.
The IRS Restructuring & Reform Act of 1998 extended Attorney-Client privilege to communications with federally authorized practitioners with respect to tax advice. (IRC § 7525)
IRC § 7525 applies to:
1. Any non-criminal matter before the IRS, or in Federal Court brought by or against the U.S.
2. IRC § 7525(b) provides the privilege will not apply to representation of a corporation involved in the promotion or the direct or indirect participation of any such corporation in any tax shelter.
3. The IRC § 7525 privilege does not extend to criminal tax investigations.
A federally authorized tax practitioner is any individual who is authorized under federal law to practice before the IRS. This includes attorneys, CPAs, and enrolled agents. IRC § 7525(a).
Tax advice is advice given by an individual on a matter for which he is authorized to practice before the IRS. IRC § 7525(a). In general, the privilege, like the common-law privilege, applies to the content of the advice, not the identity of the person seeking the advice.
For communications made on or after October 22, 2004, the privilege does not apply to written communications concerning tax shelters. Thus, the privilege does not apply to any written communication between a tax practitioner and any person, director, officer, employee, agent, or representative of a person, or any other person holding a capital or profits interest in a person, in connection with the promotion of the direct or indirect participation of the person in any tax shelter. IRC § 7525(b).
A tax shelter is a partnership or other entity, an investment plan or arrangement, or any other plan or arrangement, if a significant purpose of the partnership, entity, plan, or arrangement is the avoidance or evasion of federal income tax. IRC § 6662(d)(2)(C). (This exception was limited to communications concerning corporate tax shelters, IRC § 7525(b), prior to amendment by Pub. L. 108-357, American Jobs Creation Act of 2004, Section 813.)
The IRS's position is that the Attorney-Client privilege also does not apply to tax accrual workpapers (tax accrual and other financial audit workpapers relating to the tax reserve for deferred tax liabilities and to footnotes disclosing contingent tax liabilities appearing on audited financial statements).
These workpapers are not generated in connection with seeking legal or tax advice, but are developed to evaluate a taxpayer's deferred or contingent tax liabilities in connection with a taxpayer's disclosure to third parties of the taxpayer's financial condition. IRS Announcement 2002-63, 2002-2 C.B. 72.
The crime-fraud exception may be asserted to defeat the claim of tax practitioner privilege for communications that were made for the purpose of getting advice for the commission of crime or fraud. This prevents a party from seeking advice to commit a crime or fraud and then claiming that the communication is privileged.
To assert the crime-fraud exception, (1) there must be a prima facie showing of a crime or fraud, and (2) the communications in question must be in furtherance of the misconduct. U.S. v. BDO Seidman, 368 F.Supp. 2d 858 (N.D. Ill. 2005). If the IRS shows sufficient evidence that the communication was made in furtherance of a crime or fraud, then the taxpayer may respond by providing an explanation that would rebut the IRS's evidence. The crime-fraud exception will apply only if the court finds the taxpayer's explanation unsatisfactory. U.S. v. BDO Seidman, No. 02 C 4822 (N.D. Ill. May 17, 2005), aff’d on this issue and vacated and remanded on other grounds, No. 05-3260 & 05-3518 (7th Cir. July 2, 2007).
Tuesday, November 20, 2007
Unreported Income: Fraudulent Failure to File Tax Returns
In order to avoid the 75% penalty for fraudulent failure to file tax returns the tax payer must establish:
1) The delinquent filing is due to reasonable cause.
2) The delinquent filing is not due to willful neglect.
If both elements are established the failure to file penalty does not apply.
Penalty: Failure to file tax return
To establish that the penalty does not apply, the taxpayer must furnish the IRS a written statement setting out the grounds of the claim. The statement must contain a declaration that it is signed under penalty of perjury. Treas. Reg. Section 301.6651-1(c)(1). The written statement must be filed with the IRS office where the late return is filed.
If the IRS determines that the delinquency was due to reasonable cause and not due to willful neglect, the penalty is not assessed.
If a taxpayer exercised ordinary business care and prudence and was nevertheless unable to file a return, the delay is due to reasonable cause. Treas. Reg. Section 301.6651-1(c)(1).
The Internal Revenue Manual lists the following circumstances under which reasonable cause may exist:
(1) the delinquency was due to the death or serious illness of the taxpayer or a member of the taxpayer's immediate family (for a corporation, estate, trust, etc., the delinquency was due to the death of the individual responsible for filing or a death in the immediate family of such individual);
(2) the taxpayer is unable to obtain records;
(3) reliance on erroneous advice from the IRS;
(4) reliance on a tax adviser; and
(5) failure to file resulting from a fire, casualty, natural disaster, or other disturbance.
Penalty: Failure to pay tax shown on return
Treas Reg Section 6652(a)(2) penalizes the failure to pay the amount shown as tax on the taxpayer’s return unless the delinquency in payment is due to reasonable cause and not due to willful neglect.
The penalty period starts with the date prescribed for payment (generally the due date of the related return, but determined with regard to extensions) and ends with payment of the tax. The penalty is one-half percent for each month (or part of a month) up to a maximum of 25 percent. However, the one-half percent rate is increased to 1 percent if the taxpayer fails to pay after the IRS notifies the taxpayer.
The appropriate penalty rate is applied to the amount of tax shown on the return, which is the net amount of tax due. The net amount due is the total amount shown as tax reduced by the sum of (1) any part of the tax that is paid on or before the beginning of the month and (2) the amount of any credit against the tax that may be claimed on the return. If the amount of tax required to be shown on the return is less than the amount shown on the return, the lesser amount is used for computing the penalty. Treas. Reg. Section 6651(c)(2).
1) The delinquent filing is due to reasonable cause.
2) The delinquent filing is not due to willful neglect.
If both elements are established the failure to file penalty does not apply.
Penalty: Failure to file tax return
To establish that the penalty does not apply, the taxpayer must furnish the IRS a written statement setting out the grounds of the claim. The statement must contain a declaration that it is signed under penalty of perjury. Treas. Reg. Section 301.6651-1(c)(1). The written statement must be filed with the IRS office where the late return is filed.
If the IRS determines that the delinquency was due to reasonable cause and not due to willful neglect, the penalty is not assessed.
If a taxpayer exercised ordinary business care and prudence and was nevertheless unable to file a return, the delay is due to reasonable cause. Treas. Reg. Section 301.6651-1(c)(1).
The Internal Revenue Manual lists the following circumstances under which reasonable cause may exist:
(1) the delinquency was due to the death or serious illness of the taxpayer or a member of the taxpayer's immediate family (for a corporation, estate, trust, etc., the delinquency was due to the death of the individual responsible for filing or a death in the immediate family of such individual);
(2) the taxpayer is unable to obtain records;
(3) reliance on erroneous advice from the IRS;
(4) reliance on a tax adviser; and
(5) failure to file resulting from a fire, casualty, natural disaster, or other disturbance.
Penalty: Failure to pay tax shown on return
Treas Reg Section 6652(a)(2) penalizes the failure to pay the amount shown as tax on the taxpayer’s return unless the delinquency in payment is due to reasonable cause and not due to willful neglect.
The penalty period starts with the date prescribed for payment (generally the due date of the related return, but determined with regard to extensions) and ends with payment of the tax. The penalty is one-half percent for each month (or part of a month) up to a maximum of 25 percent. However, the one-half percent rate is increased to 1 percent if the taxpayer fails to pay after the IRS notifies the taxpayer.
The appropriate penalty rate is applied to the amount of tax shown on the return, which is the net amount of tax due. The net amount due is the total amount shown as tax reduced by the sum of (1) any part of the tax that is paid on or before the beginning of the month and (2) the amount of any credit against the tax that may be claimed on the return. If the amount of tax required to be shown on the return is less than the amount shown on the return, the lesser amount is used for computing the penalty. Treas. Reg. Section 6651(c)(2).
Monday, November 19, 2007
Unreported Income: Criminal Penalties: Tax Preparers
Clients, with unreported income, may subject tax preparers to criminal penalties, fines, costs of prosecution and up to 10 years imprisonment (2 felonies, 2 misdemeanors):
1. Any person who willfully attempts in any manner to evade or defeat any tax or payment of any tax imposed by the Code is guilty of a felony.
A person convicted of tax evasion may be fined up to $100,000 ($500,000 for a corporation) or imprisoned not more than five years or both, together with the costs of prosecution. This penalty is in addition to any other penalties provided by law. (IRS § 7201.)
2. Any person required by the Code or regulations to file a return, keep any records or supply any information who willfully fails to file the return, keep the records or supply the information is guilty of a misdemeanor.
A person convicted of this offense may be fined up to $25,000 ($100,000 for a corporation) or imprisoned not more than one year or both, together with the costs of prosecution. This penalty is in addition to any other penalties provided by law. (IRC § 7203.)
3. Any person who willfully aids or assists in, or procures, counsels, or advises the preparation or presentation of a return, affidavit, claim, or other document under the tax laws that is fraudulent or false as to any material matter is guilty of a felony. This provision applies regardless of whether or not the taxpayer knows or consents to the falsity or fraud.
A person convicted of this offense may be fined up to $100,000 ($500,000 for a corporation) or imprisoned not more than three years or both, together with the costs of prosecution. (IRC § 7206.)
4. Any person who fails to comply with a summons issued under the Code that calls for testimony or for the production of books or documents and neglects to appear or to produce the books or documents has committed a crime.
A person convicted of this offense may be fined not more than $1,000 or imprisoned not more than one year or both, together with costs of prosecution. (IRC § 7210.)
1. Any person who willfully attempts in any manner to evade or defeat any tax or payment of any tax imposed by the Code is guilty of a felony.
A person convicted of tax evasion may be fined up to $100,000 ($500,000 for a corporation) or imprisoned not more than five years or both, together with the costs of prosecution. This penalty is in addition to any other penalties provided by law. (IRS § 7201.)
2. Any person required by the Code or regulations to file a return, keep any records or supply any information who willfully fails to file the return, keep the records or supply the information is guilty of a misdemeanor.
A person convicted of this offense may be fined up to $25,000 ($100,000 for a corporation) or imprisoned not more than one year or both, together with the costs of prosecution. This penalty is in addition to any other penalties provided by law. (IRC § 7203.)
3. Any person who willfully aids or assists in, or procures, counsels, or advises the preparation or presentation of a return, affidavit, claim, or other document under the tax laws that is fraudulent or false as to any material matter is guilty of a felony. This provision applies regardless of whether or not the taxpayer knows or consents to the falsity or fraud.
A person convicted of this offense may be fined up to $100,000 ($500,000 for a corporation) or imprisoned not more than three years or both, together with the costs of prosecution. (IRC § 7206.)
4. Any person who fails to comply with a summons issued under the Code that calls for testimony or for the production of books or documents and neglects to appear or to produce the books or documents has committed a crime.
A person convicted of this offense may be fined not more than $1,000 or imprisoned not more than one year or both, together with costs of prosecution. (IRC § 7210.)
Thursday, November 15, 2007
IRS Blinks on Stance Against Circ. 230 Fees
IRS Blinks on Stance Against Circ. 230 fees
"The Internal Revenue Service has softened its opposition to contingent fees charged by Circular 230 practitioners. Originally, the IRS proposed permitting a contingent fee only in connection with an IRS examination or the challenge of an original return, or an amended return filed before a notice of examination was received.
Under the final rules, a tax practitioner will be allowed to charge a contingent fee for services rendered in connection with the IRS examination of, or challenge to, an original return, or an amended return or claim for refund or credit where it was filed within 120 days of the taxpayer receiving a written notice of the examination, or a written challenge to the original return."
Clcik title above for complete article
"The Internal Revenue Service has softened its opposition to contingent fees charged by Circular 230 practitioners. Originally, the IRS proposed permitting a contingent fee only in connection with an IRS examination or the challenge of an original return, or an amended return filed before a notice of examination was received.
Under the final rules, a tax practitioner will be allowed to charge a contingent fee for services rendered in connection with the IRS examination of, or challenge to, an original return, or an amended return or claim for refund or credit where it was filed within 120 days of the taxpayer receiving a written notice of the examination, or a written challenge to the original return."
Clcik title above for complete article
Wednesday, November 14, 2007
Unreported Income (IRS): CPA Liability
The IRS has a new method for identifying returns with a high probability for unreported income (i.e., Unreported Income Discriminate Index Function (UI DIF)). Unreported income is both civil tax fraud and criminal tax evasion.
Taxpayers who have unreported income may be subject to up to 6 years in prison, 100% penalties and fines, and expose their accountants to civil and criminal liability.
1. Statutes of Limitations
a. Civil Tax Fraud: No statute of limitations on assessment (tax can be assessed at any time)
b. Criminal Tax Evasion: For crimes, the statute of limitations is either 3, 5 or 6 years, only on the prosecution of the crime (i.e., tax evasion, not the assessment of tax owed)
2. Burdens of Proof
a. Civil Tax Fraud: “Clear and Convincing Evidence”
b. Criminal Tax Evasion: “Beyond a Reasonable Doubt”
3. Penalties/Fines
a. Civil Tax Fraud
i. Fraudulent Failure to File Tax Return: (IRC §6651(f))
ii. Fraudulent Tax Return Filed: (IRC §6663(a))
Maximum Penalty: 75% of tax due
iii. Failure to Pay Tax:
Shown on Return (IRC §6651(a)(2)),
Not Shown on Return (IRC §6651(a)(3))
Maximum Penalty: 25% of tax due
b. Criminal Tax Evasion
i. IRC §7201: Evade Tax
Fine: $100,000 (individual) $500,000 (corporate)
Imprisonment: not more than 5 years (or both fine and imprisonment)
ii. IRC §7203: Failure to File or Pay Tax
Fine: $25,000 (individual) $100,000 (corporate)
Imprisonment: up to one year (or both fine and imprisonment)
As a tax preparer, if a client has unreported income:
1. What is your liability re: IRC §6694 preparer penalties?
2. If you advise the client to report the income, do you prepare the tax return, or advise the client to engage an attorney to hire a CPA to prepare the tax return (for attorney-client privilege)?
3. If you advise your client to file or amend a tax return, is it a voluntary disclosure with no criminal liability? Is there any criminal liability for you?
Taxpayers who have unreported income may be subject to up to 6 years in prison, 100% penalties and fines, and expose their accountants to civil and criminal liability.
1. Statutes of Limitations
a. Civil Tax Fraud: No statute of limitations on assessment (tax can be assessed at any time)
b. Criminal Tax Evasion: For crimes, the statute of limitations is either 3, 5 or 6 years, only on the prosecution of the crime (i.e., tax evasion, not the assessment of tax owed)
2. Burdens of Proof
a. Civil Tax Fraud: “Clear and Convincing Evidence”
b. Criminal Tax Evasion: “Beyond a Reasonable Doubt”
3. Penalties/Fines
a. Civil Tax Fraud
i. Fraudulent Failure to File Tax Return: (IRC §6651(f))
ii. Fraudulent Tax Return Filed: (IRC §6663(a))
Maximum Penalty: 75% of tax due
iii. Failure to Pay Tax:
Shown on Return (IRC §6651(a)(2)),
Not Shown on Return (IRC §6651(a)(3))
Maximum Penalty: 25% of tax due
b. Criminal Tax Evasion
i. IRC §7201: Evade Tax
Fine: $100,000 (individual) $500,000 (corporate)
Imprisonment: not more than 5 years (or both fine and imprisonment)
ii. IRC §7203: Failure to File or Pay Tax
Fine: $25,000 (individual) $100,000 (corporate)
Imprisonment: up to one year (or both fine and imprisonment)
As a tax preparer, if a client has unreported income:
1. What is your liability re: IRC §6694 preparer penalties?
2. If you advise the client to report the income, do you prepare the tax return, or advise the client to engage an attorney to hire a CPA to prepare the tax return (for attorney-client privilege)?
3. If you advise your client to file or amend a tax return, is it a voluntary disclosure with no criminal liability? Is there any criminal liability for you?
Monday, November 5, 2007
Unreported Income: IRS Civil Tax Fraud and Criminal Tax Evasion
The IRS will often pursue a Taxpayer first, on criminal tax evasion, and then, civil tax fraud (otherwise, the taxpayer could assert, during the civil investigation, his Fifth Amendment privilege against self-incrimination).
If the IRS pursues civil tax fraud first and wins, they may collect civil penalties, tax and obtain discovery information, and then pursue criminal proceedings (and use the civil file to prosecute).
Civil Tax Fraud, and Criminal Tax Evasion cases have different:
I. Burdens of Proof
II. Statutes of Limitations (Unreported Income)
III. Penalties
IV. Collateral Estoppel (Civil/Criminal Issues)
I. Burdens of Proof
(Evidentiary Standard)
a. Civil Tax Fraud: “Clear and Convincing Evidence” (a.k.a. Preponderance of the Evidence)
b. Criminal Tax Evasion: “Beyond a Reasonable Doubt” (Higher Standard)
II. Statutes of Limitations
a. Civil Tax Fraud: No statute of limitations (tax can be assessed at any time).
b. Criminal Tax Fraud (Evasion): The criminal statute of limitations is only on the prosecution of the crime i.e. tax evasion (not the assessment of tax owed).
Generally, 3 years after the offense is committed.
Six (6) years for specified offenses (including: unreported income) (IRC §6531)
Under Federal Criminal Code (Title 18 U.S.C.A.) 5 years after the commission of a crime.
The statute begins to run when the last of the acts constituting the tax evasion is committed.
III. Penalties (Unreported Income)
(a) Civil Tax Fraud
(1) Fraudulent Failure to File Tax Return (IRC §6651(f))
15% of net amount of tax due for each month, (up to a maximum of 5 months), for a maximum penalty of 75% (of unpaid tax) (IRC §6651(f)). This is the only penalty imposed for failure to file.
(2) Fraudulent Tax Return (Unreported Income) (IRC §6663(d))
If any part of an underpayment of tax (required to be shown on a tax return) is due to fraud, a penalty equal to 75% of the portion of the underpayment.
(3) Accuracy – Related Penalty (IRC §6662(b)(1)-(5))
A penalty at a flat rate of 20% on portion of underpayment of tax.
The fraud penalty and accuracy-related penalty apply only for filed tax returns.
(4) Spousal Liability (IRC §6663(c))
For a joint tax return, both spouses are subject to joint and several liability for the entire tax liability.
The civil fraud penalty applies only to the spouse responsible for the underpayment that is attributable to fraud.
(5) Failure to Pay Tax
The penalty applies to the amount of unpaid tax due:
Unpaid tax shown as due on a tax return (IRC §6651(a)(2))
½ percent (of unpaid tax) for each month, up to a maximum of 25% (of unpaid tax)
Unpaid tax not shown as due on a return (i.e., unreported income (IRC §6651(a)(3))
½ percent (of unpaid tax) for each month up to a maximum of 25% (of unpaid tax)
OFFSETTING PENALTIES (IRC §6651(c)(1))
If taxpayer is liable for more than one of the delinquency penalties with respect to any tax return, the amount of the penalty for failure to file, is reduced by the amount of the penalty for failure to pay (the amount shown on a return for any month for which both penalties apply )
There is no offset for the penalty for failure to pay tax (IRC §6651(a)(3)) not shown as due on a return (i.e., unreported income).
No credit is allowed against the civil fraud penalty for any criminal fines paid for income tax evasion and conspiracy to defraud the U.S.
(b) Criminal Tax Evasion (Unreported Income)
(1) IRC §7201: Criminal penalty for willful attempt by any person to evade or defeat any tax or the payment of any tax
Conviction, punishable:
Fine: $100,000 (individual)
$500,000 (corporation)
Imprisonment: Not more than 5 years (or both fine and imprisonment)
(2) IRC §7203: Criminal Failure to File or Pay Taxes
Willful failure to pay tax, file a return, keep required records, or supply required information
Fine: $25,000 (individual)
$100,000 (corporation)
Imprisonment: Up to one year (or both fine and imprisonment)
IV. Collateral Estoppel
When criminal proceedings are followed by civil proceedings, the legal doctrine of collateral estoppel may apply. This doctrine provides that an issue necessarily decided in a previous proceeding (the 1st proceeding) will determine the issue in a subsequent proceeding (the 2nd proceeding), but only as to matters in the 2nd proceeding that were actually presented and determined in the 1st proceeding.
a. Conviction for criminal tax evasion collaterally estops the taxpayer from contesting the existence of fraud for purposes of the civil fraud penalty because a finding of criminal fraud (beyond a reasonable doubt) establishes proof of civil fraud (by clear and convincing evidence).
b. Acquittal of criminal tax evasion does not collaterally estop the government from proving civil fraud (by clear and convincing evidence). The acquittal established that proof of fraud did not exist beyond reasonable doubt, but that does not mean that proof of fraud by clear and convincing evidence does not exist.
If the IRS pursues civil tax fraud first and wins, they may collect civil penalties, tax and obtain discovery information, and then pursue criminal proceedings (and use the civil file to prosecute).
Civil Tax Fraud, and Criminal Tax Evasion cases have different:
I. Burdens of Proof
II. Statutes of Limitations (Unreported Income)
III. Penalties
IV. Collateral Estoppel (Civil/Criminal Issues)
I. Burdens of Proof
(Evidentiary Standard)
a. Civil Tax Fraud: “Clear and Convincing Evidence” (a.k.a. Preponderance of the Evidence)
b. Criminal Tax Evasion: “Beyond a Reasonable Doubt” (Higher Standard)
II. Statutes of Limitations
a. Civil Tax Fraud: No statute of limitations (tax can be assessed at any time).
b. Criminal Tax Fraud (Evasion): The criminal statute of limitations is only on the prosecution of the crime i.e. tax evasion (not the assessment of tax owed).
Generally, 3 years after the offense is committed.
Six (6) years for specified offenses (including: unreported income) (IRC §6531)
Under Federal Criminal Code (Title 18 U.S.C.A.) 5 years after the commission of a crime.
The statute begins to run when the last of the acts constituting the tax evasion is committed.
III. Penalties (Unreported Income)
(a) Civil Tax Fraud
(1) Fraudulent Failure to File Tax Return (IRC §6651(f))
15% of net amount of tax due for each month, (up to a maximum of 5 months), for a maximum penalty of 75% (of unpaid tax) (IRC §6651(f)). This is the only penalty imposed for failure to file.
(2) Fraudulent Tax Return (Unreported Income) (IRC §6663(d))
If any part of an underpayment of tax (required to be shown on a tax return) is due to fraud, a penalty equal to 75% of the portion of the underpayment.
(3) Accuracy – Related Penalty (IRC §6662(b)(1)-(5))
A penalty at a flat rate of 20% on portion of underpayment of tax.
The fraud penalty and accuracy-related penalty apply only for filed tax returns.
(4) Spousal Liability (IRC §6663(c))
For a joint tax return, both spouses are subject to joint and several liability for the entire tax liability.
The civil fraud penalty applies only to the spouse responsible for the underpayment that is attributable to fraud.
(5) Failure to Pay Tax
The penalty applies to the amount of unpaid tax due:
Unpaid tax shown as due on a tax return (IRC §6651(a)(2))
½ percent (of unpaid tax) for each month, up to a maximum of 25% (of unpaid tax)
Unpaid tax not shown as due on a return (i.e., unreported income (IRC §6651(a)(3))
½ percent (of unpaid tax) for each month up to a maximum of 25% (of unpaid tax)
OFFSETTING PENALTIES (IRC §6651(c)(1))
If taxpayer is liable for more than one of the delinquency penalties with respect to any tax return, the amount of the penalty for failure to file, is reduced by the amount of the penalty for failure to pay (the amount shown on a return for any month for which both penalties apply )
There is no offset for the penalty for failure to pay tax (IRC §6651(a)(3)) not shown as due on a return (i.e., unreported income).
No credit is allowed against the civil fraud penalty for any criminal fines paid for income tax evasion and conspiracy to defraud the U.S.
(b) Criminal Tax Evasion (Unreported Income)
(1) IRC §7201: Criminal penalty for willful attempt by any person to evade or defeat any tax or the payment of any tax
Conviction, punishable:
Fine: $100,000 (individual)
$500,000 (corporation)
Imprisonment: Not more than 5 years (or both fine and imprisonment)
(2) IRC §7203: Criminal Failure to File or Pay Taxes
Willful failure to pay tax, file a return, keep required records, or supply required information
Fine: $25,000 (individual)
$100,000 (corporation)
Imprisonment: Up to one year (or both fine and imprisonment)
IV. Collateral Estoppel
When criminal proceedings are followed by civil proceedings, the legal doctrine of collateral estoppel may apply. This doctrine provides that an issue necessarily decided in a previous proceeding (the 1st proceeding) will determine the issue in a subsequent proceeding (the 2nd proceeding), but only as to matters in the 2nd proceeding that were actually presented and determined in the 1st proceeding.
a. Conviction for criminal tax evasion collaterally estops the taxpayer from contesting the existence of fraud for purposes of the civil fraud penalty because a finding of criminal fraud (beyond a reasonable doubt) establishes proof of civil fraud (by clear and convincing evidence).
b. Acquittal of criminal tax evasion does not collaterally estop the government from proving civil fraud (by clear and convincing evidence). The acquittal established that proof of fraud did not exist beyond reasonable doubt, but that does not mean that proof of fraud by clear and convincing evidence does not exist.
Monday, October 29, 2007
Unreported Income: IRS Criminal and Civil Tax Issues - Part 1
UNREPORTED INCOME (IRS Criminal Tax Issues)
1. IRC § 7201: Acts to Evade or Defeat Collection of Tax
“It is a crime to evade or defeat any tax” (it is a felony to willfully attempt in any manner to evade or defeat the collection of a federal tax).
2. IRC § 7206: False Statements/Aid or Assist
“It is a crime to make false statements to the IRS,” or to “aid or assist” in defeating the tax process.
3. IRC § 7212: Obstructing or Impeding
“It is a felony to obstruct or impede the due administration of the federal Internal Revenue Code, including the collection of tax owed” (U.S. v. Reeves 752 F.2d 995, 998, 5th Cir. Cert denied 474 U.S.834 (1985)).
4. “A person may be charged with conspiracy to impede collection of a federal tax as well as with a separate charge of impeding.” (18 U.S.C. 371)
ATTORNEY’S ETHICAL DUTIES (ABA)
ABA Model Rules of Professional Conduct Rules 1.2 and 1.6:
Model Rules of Professional Conduct Rule 1.2 – Scope of Representation
(d) A lawyer shall not counsel a client to engage, or assist a client in conduct the lawyer knows is criminal or fraudulent
Model Rules of Professional Conduct Rule 1.6 – Declining or Terminating Representation
(a) Except as stated in paragraph (c) [court orders lawyer to continue representation], a lawyer shall not represent a client or, where representation has commenced, shall withdraw from the representation of a client if:
(1) The representation will result in violation of the rules of professional conduct or other law. . .
CRIMINAL TAX FRAUD
1. Penalties
IRC §7201 imposes criminal penalties on “any person who willfully attempts in any matter to evade or defeat any tax . . . .” A violation of Section 7201 is a felony and conviction under this provision invokes a maximum fine of $100,000 for individuals and $500,000 for a corporation, or a maximum imprisonment of five years, or both, and the payment of prosecution costs.
A “willful attempt” requires more than just the failure to file a tax return or report taxable income. Such an attempt requires a positive, voluntary act designed to mislead the Service or conceal income. [U.S. v. Meek, 998 F.2d 776 (10th Cir. 1993)] Essentially, there must be an intent to avoid tax and the performance of some affirmative act to further the intent. [U.S. v. Jannuzzio, 184 F. Supp. 460 9D. Del. 1960)]
2. Burden of Proof: (Civil Fraud cf. Criminal Fraud)
Criminal fraud requires a higher standard of proof than civil fraud. The government must prove “beyond a reasonable doubt” that the defendant is guilty of criminal fraud, whereas in civil fraud, the burden of proof required is preponderance of the evidence (also termed as “by clear and convincing evidence”).
A criminal decision of a court or jury will bind a civil decision, but a civil decision does not bind a criminal decision.
3. Statute of Limitations: (Civil and Criminal Proceedings)
For civil tax fraud (i.e. unreported income), there is no statute of limitations (the tax can be assessed at any time).
For criminal tax evasion (i.e. unreported income), the criminal statute of limitations is only on the prosecution of the crime i.e. tax evasion (not the assessment of tax owed).
When the prosecution is for the offense of willfully attempting in any manner to evade or defeat any tax, the limitation is six years (i.e., unreported income). The Federal Criminal Code contains a general limitations period for prosecutions under Title 18, U.S.C.A., of five years after the commission of the crime.
Other offenses arising under the Internal Revenue laws generally have a three-year period of limitation for prosecution. [IRC §6531(1)]
The government may first, collect civil penalties and tax, get discovery information via civil proceedings that would be illegal under criminal proceedings (Fifth Amendment), then begin criminal proceedings, and use the civil file to prosecute.
Attorney-Client Privilege
Attorney-client privilege does not protect participation in future crimes or frauds.
The Attorney-Client privilege does not include advice that assists the Client in the commission of a crime.
The subject matter of the privilege does not include advice that assists the client in the commission of a crime. A crime/fraud exception to the attorney-client privilege is recognized. A two-pronged test is applied to decide whether this exception exists: (1) Is there prima facie evidence showing that the client was engaged in criminal or fraudulent conduct when he sought the advice, that he was planning such conduct when he sought the advice, or that he committed a crime or fraud after receiving the benefit of counsel’s advice and (2) is there evidence that the attorney’s assistance was obtained in furtherance of the criminal or fraudulent conduct or that it was closely related to it?
Under this exception, no privilege applies where the desired advice refers not only to prior wrongdoing, but to future wrongdoing – i.e., to further either the crime charged in an indictment or future illegality.
Attorney-Client privilege legal issues:
Confidential communication between an attorney and a client for the purpose of obtaining or giving legal advice is generally protected from disclosure. Courts carefully examine whether the attorney produced the document in their role as legal counsel as opposed to some other advisory role.
The privilege extends to subordinates working for the attorney providing legal advise, such as an accountant hired by an attorney to interpret financial data. The privilege does not extend to non-legal experts hired independently by the client, but does include in-house counsel when giving legal advice. The privilege does not generally extend to the mere identity of legal clients and their fee arrangements.
The attorney-client privilege is recognized in tax-fraud cases, but it is not absolute. Although direct communication between an attorney and client is shielded, peripheral matters are not. The attorney may be required to disclose such things as the name of his or her client, the client’s financial status and tax payments, when and where matters were discussed, fee arrangements, involvement in litigation, and types of services, such as tax advice, rendered. (See In re Grand Jury Subpoena Duces Tecum [11th Cir. 1985]; Frank E. Haddad, 527 F.2d 537 [1976].)
In addition, the attorney-client privilege applies only if the attorney is acting in the capacity of an attorney.
The attorney-client privilege belongs to the client rather than the attorney. This distinction is important when the taxpayer’s business is subsequently controlled by a legal successor, such as a trustee in bankruptcy.
The party claiming attorney-client privilege must specifically asset the privilege at an early opportunity. Failure to assert the privilege may be considered waiver, as is disclosure to a non-privileged third party. Waiver is interpreted broadly. If a taxpayer waives privilege as to one document, it may be waived as to all other documents relating to that particular matter. Material provided to assist in the preparation of tax returns is deemed to be intended for disclosure, and thus the privilege is waived. Privilege may also be waived by court filings, SEC filings, or by allowing the IRS to review files.
Indirect testimonial use of an opinion to avoid penalties has also been held to waive privilege. Courts occasionally order in camera review of allegedly privileged documents, but this review alone should not operate to waive privilege. Production of documents to a state or foreign government, however, may waive the privilege.
In opposing an attorney-client privilege claim on grounds of the crime/fraud exception, the IRS may request that the district court conduct an in-camera review of allegedly confidential communications to determine whether these communications fall within the crime/fraud exception. However, before the request can be granted, the Supreme Court in United States v. Zolin (109 S.Ct. 2619 (1989)) stated that the party seeking in-camera review “must present evidence sufficient to support a reasonable belief that in camera review may yield evidence that establishes the exception’s applicability.”
The purpose of the privilege “is to encourage clients to make full disclosure to their attorneys.” Thus, it protects communications by the client to the lawyer in both oral and written form – that is, the client may make the communication orally or in writing to the lawyer. However, preexisting records do not become confidential communications by their mere delivery to an attorney. The status of the records in the lawyer’s hands depends on their status in the taxpayer-client’s hands.
In Fisher v. United States, (425 U.S. 391 (1976)), the Supreme Court distinguished between a document that already had independent existence, the information in which is communicated to a lawyer, and physical possession of a preexisting document. The preexisting document is not covered by the privilege unless it is otherwise confidential in the hands of the taxpayer-client. For this reason, a taxpayer’s attorney may be compelled to produce an accountant’s workpapers because such workpapers would not have been privileged from production in the hands of the taxpayer-client.
The IRS is requesting tax accrual and other financial audit work papers from taxpayers under certain limited circumstances. In Announcement 2002-63, 2002-2 C.B. 72, the IRS has put practitioners on notice that it will request and summon, if necessary, tax accrual workpapers when it examines tax returns that claim any of the “listed transactions” that have been identified by the IRS as tax-avoidance or abusive-tax transactions.
These work papers are compiled by clients’ accountants to determine the extent of reserves necessary to cover potential tax liability. They often disclose questionable transactions and positions taken by the client.
The announcement affects tax returns filed on or after July 1, 2002. The IRS has determined that neither the attorney-client privilege nor Section 7525 (dealing with tax practitioner privilege) protects these work papers. However, the IRS will use restraint, as has been its policy in the past, with regard to requests for this information in areas other than listed transactions.
The IRS maintains agreements with most states and cities to share audit information. States also provide refund information to the IRS) When the IRS has audited a return that should require a state tax change, many states provide that their assessment statutes for such changes do not close until notification of the change is given by the taxpayer to the state tax authority.
1. IRC § 7201: Acts to Evade or Defeat Collection of Tax
“It is a crime to evade or defeat any tax” (it is a felony to willfully attempt in any manner to evade or defeat the collection of a federal tax).
2. IRC § 7206: False Statements/Aid or Assist
“It is a crime to make false statements to the IRS,” or to “aid or assist” in defeating the tax process.
3. IRC § 7212: Obstructing or Impeding
“It is a felony to obstruct or impede the due administration of the federal Internal Revenue Code, including the collection of tax owed” (U.S. v. Reeves 752 F.2d 995, 998, 5th Cir. Cert denied 474 U.S.834 (1985)).
4. “A person may be charged with conspiracy to impede collection of a federal tax as well as with a separate charge of impeding.” (18 U.S.C. 371)
ATTORNEY’S ETHICAL DUTIES (ABA)
ABA Model Rules of Professional Conduct Rules 1.2 and 1.6:
Model Rules of Professional Conduct Rule 1.2 – Scope of Representation
(d) A lawyer shall not counsel a client to engage, or assist a client in conduct the lawyer knows is criminal or fraudulent
Model Rules of Professional Conduct Rule 1.6 – Declining or Terminating Representation
(a) Except as stated in paragraph (c) [court orders lawyer to continue representation], a lawyer shall not represent a client or, where representation has commenced, shall withdraw from the representation of a client if:
(1) The representation will result in violation of the rules of professional conduct or other law. . .
CRIMINAL TAX FRAUD
1. Penalties
IRC §7201 imposes criminal penalties on “any person who willfully attempts in any matter to evade or defeat any tax . . . .” A violation of Section 7201 is a felony and conviction under this provision invokes a maximum fine of $100,000 for individuals and $500,000 for a corporation, or a maximum imprisonment of five years, or both, and the payment of prosecution costs.
A “willful attempt” requires more than just the failure to file a tax return or report taxable income. Such an attempt requires a positive, voluntary act designed to mislead the Service or conceal income. [U.S. v. Meek, 998 F.2d 776 (10th Cir. 1993)] Essentially, there must be an intent to avoid tax and the performance of some affirmative act to further the intent. [U.S. v. Jannuzzio, 184 F. Supp. 460 9D. Del. 1960)]
2. Burden of Proof: (Civil Fraud cf. Criminal Fraud)
Criminal fraud requires a higher standard of proof than civil fraud. The government must prove “beyond a reasonable doubt” that the defendant is guilty of criminal fraud, whereas in civil fraud, the burden of proof required is preponderance of the evidence (also termed as “by clear and convincing evidence”).
A criminal decision of a court or jury will bind a civil decision, but a civil decision does not bind a criminal decision.
3. Statute of Limitations: (Civil and Criminal Proceedings)
For civil tax fraud (i.e. unreported income), there is no statute of limitations (the tax can be assessed at any time).
For criminal tax evasion (i.e. unreported income), the criminal statute of limitations is only on the prosecution of the crime i.e. tax evasion (not the assessment of tax owed).
When the prosecution is for the offense of willfully attempting in any manner to evade or defeat any tax, the limitation is six years (i.e., unreported income). The Federal Criminal Code contains a general limitations period for prosecutions under Title 18, U.S.C.A., of five years after the commission of the crime.
Other offenses arising under the Internal Revenue laws generally have a three-year period of limitation for prosecution. [IRC §6531(1)]
The government may first, collect civil penalties and tax, get discovery information via civil proceedings that would be illegal under criminal proceedings (Fifth Amendment), then begin criminal proceedings, and use the civil file to prosecute.
Attorney-Client Privilege
Attorney-client privilege does not protect participation in future crimes or frauds.
The Attorney-Client privilege does not include advice that assists the Client in the commission of a crime.
The subject matter of the privilege does not include advice that assists the client in the commission of a crime. A crime/fraud exception to the attorney-client privilege is recognized. A two-pronged test is applied to decide whether this exception exists: (1) Is there prima facie evidence showing that the client was engaged in criminal or fraudulent conduct when he sought the advice, that he was planning such conduct when he sought the advice, or that he committed a crime or fraud after receiving the benefit of counsel’s advice and (2) is there evidence that the attorney’s assistance was obtained in furtherance of the criminal or fraudulent conduct or that it was closely related to it?
Under this exception, no privilege applies where the desired advice refers not only to prior wrongdoing, but to future wrongdoing – i.e., to further either the crime charged in an indictment or future illegality.
Attorney-Client privilege legal issues:
Confidential communication between an attorney and a client for the purpose of obtaining or giving legal advice is generally protected from disclosure. Courts carefully examine whether the attorney produced the document in their role as legal counsel as opposed to some other advisory role.
The privilege extends to subordinates working for the attorney providing legal advise, such as an accountant hired by an attorney to interpret financial data. The privilege does not extend to non-legal experts hired independently by the client, but does include in-house counsel when giving legal advice. The privilege does not generally extend to the mere identity of legal clients and their fee arrangements.
The attorney-client privilege is recognized in tax-fraud cases, but it is not absolute. Although direct communication between an attorney and client is shielded, peripheral matters are not. The attorney may be required to disclose such things as the name of his or her client, the client’s financial status and tax payments, when and where matters were discussed, fee arrangements, involvement in litigation, and types of services, such as tax advice, rendered. (See In re Grand Jury Subpoena Duces Tecum [11th Cir. 1985]; Frank E. Haddad, 527 F.2d 537 [1976].)
In addition, the attorney-client privilege applies only if the attorney is acting in the capacity of an attorney.
The attorney-client privilege belongs to the client rather than the attorney. This distinction is important when the taxpayer’s business is subsequently controlled by a legal successor, such as a trustee in bankruptcy.
The party claiming attorney-client privilege must specifically asset the privilege at an early opportunity. Failure to assert the privilege may be considered waiver, as is disclosure to a non-privileged third party. Waiver is interpreted broadly. If a taxpayer waives privilege as to one document, it may be waived as to all other documents relating to that particular matter. Material provided to assist in the preparation of tax returns is deemed to be intended for disclosure, and thus the privilege is waived. Privilege may also be waived by court filings, SEC filings, or by allowing the IRS to review files.
Indirect testimonial use of an opinion to avoid penalties has also been held to waive privilege. Courts occasionally order in camera review of allegedly privileged documents, but this review alone should not operate to waive privilege. Production of documents to a state or foreign government, however, may waive the privilege.
In opposing an attorney-client privilege claim on grounds of the crime/fraud exception, the IRS may request that the district court conduct an in-camera review of allegedly confidential communications to determine whether these communications fall within the crime/fraud exception. However, before the request can be granted, the Supreme Court in United States v. Zolin (109 S.Ct. 2619 (1989)) stated that the party seeking in-camera review “must present evidence sufficient to support a reasonable belief that in camera review may yield evidence that establishes the exception’s applicability.”
The purpose of the privilege “is to encourage clients to make full disclosure to their attorneys.” Thus, it protects communications by the client to the lawyer in both oral and written form – that is, the client may make the communication orally or in writing to the lawyer. However, preexisting records do not become confidential communications by their mere delivery to an attorney. The status of the records in the lawyer’s hands depends on their status in the taxpayer-client’s hands.
In Fisher v. United States, (425 U.S. 391 (1976)), the Supreme Court distinguished between a document that already had independent existence, the information in which is communicated to a lawyer, and physical possession of a preexisting document. The preexisting document is not covered by the privilege unless it is otherwise confidential in the hands of the taxpayer-client. For this reason, a taxpayer’s attorney may be compelled to produce an accountant’s workpapers because such workpapers would not have been privileged from production in the hands of the taxpayer-client.
The IRS is requesting tax accrual and other financial audit work papers from taxpayers under certain limited circumstances. In Announcement 2002-63, 2002-2 C.B. 72, the IRS has put practitioners on notice that it will request and summon, if necessary, tax accrual workpapers when it examines tax returns that claim any of the “listed transactions” that have been identified by the IRS as tax-avoidance or abusive-tax transactions.
These work papers are compiled by clients’ accountants to determine the extent of reserves necessary to cover potential tax liability. They often disclose questionable transactions and positions taken by the client.
The announcement affects tax returns filed on or after July 1, 2002. The IRS has determined that neither the attorney-client privilege nor Section 7525 (dealing with tax practitioner privilege) protects these work papers. However, the IRS will use restraint, as has been its policy in the past, with regard to requests for this information in areas other than listed transactions.
The IRS maintains agreements with most states and cities to share audit information. States also provide refund information to the IRS) When the IRS has audited a return that should require a state tax change, many states provide that their assessment statutes for such changes do not close until notification of the change is given by the taxpayer to the state tax authority.
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