Criminal Tax Audit Methods

IRS tax fraud investigations, whether they lean towards civil or criminal tax case, share commonalities in their inception but differ significantly in their process, particularly in the burden of proof required for criminal tax case. Initiation and execution of tax fraud investigations by the Internal Revenue Service (IRS) and the methodologies employed in these often complex tax audits are crucial in defending taxpayers’ rights throughout the potential criminal tax process.

I. Origination of Tax Fraud Investigations

Tax fraud investigations typically begin during routine tax audits where revenue agents uncover discrepancies that hint at fraudulent tax activity. If the suspicion of fraud is substantial, the agent compiles a detailed memorandum, and forwards it to the Criminal Investigation Division. This division then assesses whether there’s sufficient grounds to suspect criminal tax offenses, potentially leading to a preliminary investigation by IRS special agent. This agent might engage with the taxpayer or their financial representatives to gather more evidence to prosecute the case.

Should this preliminary tax investigation confirm the possibility of criminal tax fraud with a likelihood of proving it, the case transitions into a formal investigation known as a “jacketed” case. This investigation becomes a collaborative effort between IRS civil and criminal division:

Joint Investigation: A special agent, focusing on criminal evidence, teams up with a revenue agent from the Audit Division, who aims to establish civil tax deficiencies and penalties. This dual approach not only broadens the scope of the investigation but also ensures that both criminal and civil aspects are thoroughly explored.

Apart from internal audit discoveries, tax fraud investigations can also originate from:

IRS Whistleblower: Individuals might report suspected fraud, often driven by the prospect of receiving a reward, which can be over 10% of the recovered taxes and fines.

Agency Cooperation: Information can be shared between different government bodies like the FBI or state tax departments, expanding the IRS’s investigative reach.
Public Scrutiny: Media reports or public awareness of suspicious wealth accumulation or large cash discoveries can also prompt investigations.

II. Course and Scope of Tax Fraud Investigation

1. In General:

The duration of an income tax fraud investigation can be quite variable, potentially spanning from a few months to several years. The timeline largely depends on the taxpayer’s cooperation. A cooperative taxpayer who allows access to records and provides statements can lead to a swift investigation. However, the detailed nature of these investigations, necessitated by the need for undeniable evidence (beyond reasonable doubt) in criminal tax cases, usually makes them lengthier and more exhaustive than standard tax audits.

2. Investigative Tools of IRS:

a. Types of Audits:

Net Worth Investigations: This method reconstructs income by analyzing changes in net worth over time. It involves a meticulous accounting of assets, liabilities, and expenditures to estimate unreported income.
Bank Deposit Analysis: When bank deposits seem disproportionate to reported income, agents investigate these discrepancies, a task that becomes significantly harder without access to bank records.
Circularization: Directly contacting the taxpayer’s clients or customers to confirm transactions through documentation like canceled checks.

b. Administrative Summons:

The IRS uses administrative summons as a critical tool to obtain testimony or documents. These summons provide at least ten days’ notice for appearance and can require production of records. However, they are rarely used against the taxpayer in criminal cases due to self-incrimination rights, focusing instead on third parties or the taxpayer’s corporate roles.

c. Administrative Summons and Barred Years:

Even for years barred by the statute of limitations, a IRS tax summons can be issued if justified, but any reassessment of tax without proper notification might be nullified.

d. Privileged Communications with Attorney
IRS will often make attempts to issue an administrative summons to the taxpayer’s attorney requiring him to produce whatever records of the taxpayer he may under his control. An attorney may claim his client’s privileges of the fifth amendment against self-incrimination and further raise objections based on confidential communications between himself and the client. The attorney-client privilege of confidential communications also extends to documents that have been prepared by an accountant hired by the attorney in defending the client.

An accountant cannot claim the privilege of confidential communications. Nevertheless, a taxpayer needs to force the accountant to protect these work papers an claim privilege against self-incrimination and instruct the accountant to refuse turnover of this information to the government. The accountant’s attorney needs to assert this privilege on his behalf.

In certain situations, an attorney is required to testify about fees paid by the client during any given year that is the subject of tax investigation. Financial transactions may not be deemed confidential communications, however, an attorney may refuse to disclose the identity of the client.

e. Voluntary Statements by Taxpayer
During the course of a criminal tax investigation the special agent will always try to coax taxpayers to make a statement which often leads to self incrimination. IRS will often not give the taxpayer a fifth amendment warning as the questions are often made in public or situations where the taxpayer has not been arrested or under custody.

In the course of any conversations with IRS agents, the inquiry usually focuses on personal history of the taxpayer, education level, and business sophistication. Special Agents will try to gain information related to the suspected tax fraud which not only secures the taxpayer’s explanation or defenses but shows taxpayer’s understanding of tax rules. If the taxpayer gives such a statement, success of the criminal prosecution of the case are usually enhanced.

Most taxpayers are not aware of the implications of the questions by the IRS agents and often are under the mistaken belief that he can outsmart the agent. These conversations never help the taxpayer. For example, an agent may casually ask the taxpayer about his net worth. Many taxpayers believe that minimizing the actual amount is to his advantage. However, in reality, the larger net worth response could have been a defense to the smaller income reported for the period. In addition, false statement to IRS Special Agent also could bring about a separate felony charge.

If you are notified of an audit or have been contacted by a special agent about your case, it is critical to speak with a tax lawyer before having any conversations with the IRS or even speaking with your own accountant because your own accountant will be interviewed by IRS special agents, and they may become a witness against you. Keep in mind that other than your tax attorney, there is no attorney client privilege which would prevent an accountant or CPA from testifying against you. Our criminal tax lawyers in Los Angeles, California, aggressively defend taxpayers in all tax crime cases. Speak with one of our tax attorneys so that you know how to protect yourself.