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?

Kerik indictment would wreak havoc for Giuliani

Kerik indictment would wreak havoc for Giuliani

"Kerik faces 14 charges, including criminal conspiracy, tax evasion and making false statements to White House officials considering him for Homeland Security secretary.

In return for Kerik's support, the indictment said, the New Jersey company paid for more than $250,000 in improvements to his apartment in the Bronx. Among the renovations were new bathrooms with a Jacuzzi, the marble entrance and a new kitchen.

The indictment said Kerik concealed this income -- as well as rent payments a New York real estate developer made on an Upper East Side apartment -- from the IRS.

Kerik's fame led to a contract to write a book and, according to the indictment, he failed to report more than $75,000 in income from that project."

Please click title above for complete article

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.

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.

PE shops escape tax man this year, but he’s coming

PE shops escape tax man this year, but he’s coming.

"Rangel’s $1 trillion ‘mother of all tax reform bills’ is close to seeing light of day so that long battle for next year can begin.

All indications are that a controversial bill to tax private equity carried interest as regular income will have to wait until 2008. But for lawmakers and corporate governance watchdogs, carried interest is just the start of a campaign to make life miserable—or at least more expensive—for the private equity crowd.

The bill would increase the current 15% tax on carried interest to as much as 35% for private equity firms, venture capitalists, real estate trusts, hedge funds and numerous oil, gas and commodity investment vehicles."

See link above for complete article.

IRS Looks at Mortgage Securities

The Internal Revenue Service is checking out dozens of participants in a financial arrangement to see if they are reaping illegal tax benefits by underreporting income on mortgage-backed securities, which make up the bulk of the multitrillion-dollar market for asset-backed securities.

The inquiry, which an I.R.S. official said yesterday was in its early stages, concerns the use of arcane but powerful investment entities known as real estate mortgage investment conduits.

Complete article found here
IRS Looks at Mortgage Securities

IRS Moves to Reduce Tax Evasion

Starting in October, hundreds of Americans will be getting "Dear Taxpayer" letters telling them they've been selected for a special audit by the Internal Revenue Service.

The 13,000 chosen at random this year -- and similar numbers in subsequent years -- are part of the tax agency's National Research Program, which is designed to give the IRS a better understanding of how accurately income and deductions are reported and to reduce the so-called tax gap.

"...the greatest problem, responsible for about 80 percent of the tax gap, comes from underreporting."

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IRS Moves to Reduce Tax Evasion