TO FILE OR NOT TO FILE AN AMENDED RETURN TO CORRECT AN ORIGINAL RETURN THAT HAS CRIMINAL TAX DIMENSIONS – THAT IS THE QUESTION

Your client has filed a fraudulent return underreporting his tax liability. He now has misgivings. He comes to you and expresses great concern. What should you do?

The crime of tax evasion is complete upon filing the return. There are two possible exceptions. First, if the taxpayer filed the return before the normal due date (April 15 for an individual taxpayer and March 15 for a calendar year corporation), the taxpayer can purge the fraud by filing a non-fraudulent amended return on or before the normal due date. This opportunity also applies if a superseding return purges the fraud during an applicable extension period.

More times than not, the taxpayer cannot qualify for these exceptions and the question becomes one of damage control. Is it wise to file an amended tax return – after the due date – to correct an original return that has criminal tax dimensions? There are two schools of thought. First are those practitioners that oppose filing an amended return to correct an original return that contains an understatement of tax liability. They rely on the common-sense argument that doing so will establish one of the key elements of tax evasion: tax due and owing. Thus, making such an admission does nothing more than bring the taxpayer one step closer to conviction and his attorney one step closer to an ineffective assistance of counsel claim, having assisted the government in proving its case against his client.

A second-school of thought recognizes the dangers of filing a delinquent tax return. At the same time, it recognizes that an exception exists to that bright-line rule. What is the exception? The opportunity for the taxpayer to avoid prosecution under the voluntary disclosure program.

What is the voluntary disclosure program? It is a policy-based program, the essence of which is that a taxpayer will not be prosecuted if he voluntarily discloses his misconduct before the IRS or DOJ is hot on his trail. As with all policies, voluntary disclosure involves a balancing of interests. On the one hand, there is a huge tax gap. Those taxpayers contributing to the gap – whether they are non-filers or evaders – must be encouraged to come back into the system. This militates strongly in favor of the policy. If no such policy existed or if it was narrowly construed such that only few taxpayers benefited, the government would lose revenue because taxpayers would have no incentive to come into compliance.

In addition to the revenue effect, a taxpayer who voluntarily discloses makes it harder for the government to prove its case. How? By making it less likely that the taxpayer acted willfully. To be sure, a delinquent return is proof of the original failure to file. And an amended return reporting the taxes evaded is proof – at the very least – of the “substantial tax due” element for tax evasion.

But the government still has to prove willfulness. A jury might be less inclined to find that the taxpayer-defendant acted willfully – and more inclined to find that he just acted negligently – if it knows that the taxpayer voluntarily came forward to correct his return before it had been selected by the IRS for audit. In short, a jury may want to acquit someone who has voluntarily done the right thing before being discovered and has then promptly paid or made good faith arrangements to pay all taxes, penalties, and interest. Even though it might not be relevant in a legal sense (since the criminal conduct is the failure to file or the filing of the false return), it might nevertheless resonate in the hearts of sympathetic jurors. Thus, the policy is also based upon the practical reality that with so many other fish to fry, why should the government expend and risk limited resources after a voluntary disclosure?

Before viewing the voluntary disclosure policy as the silver-lining or the panacea to all of your client’s problems, you must determine whether he qualifies for the program in the first place. The two main aspects of voluntary disclosure, the cornerstones if you will, are timeliness and taxpayer cooperation. Questions that must be asked and answered before picking up the phone to call the revenue officer are: (1) Will the disclosure be timely and complete? (2) Will the taxpayer be able to cooperate with any examination of the tax returns? (3) Will he be able to pay or make arrangements to pay?

If the facts fit the IRS policy, a voluntary disclosure might avoid criminal problems for your client. However, you should advise your client that there are no guarantees. Why? The voluntary disclosure policy is just that – a policy. It is not law. If that is not enough to convince you to proceed with caution, then this will. The IRM provides the following disclaimer: “A voluntary disclosure will not automatically guarantee immunity from prosecution …” Moreover, the taxpayer’s ability to force the IRS to apply the policy is limited.

While most practitioners feel that the IRS will honor the policy, you must always ask the question: Is there some other fact that might persuade the IRS to refer this case to the Department of Justice despite an honest effort by my client to disclose? For example, is your client a politician? Or is he a well-known figure that would make the publicity surrounding the prosecution so tantalizing to the IRS that they cannot afford to turn a blind eye to prosecution? If so, voluntary disclosure must begin with an anonymous call to the Special Agent In Charge in order to receive assurance that the IRS will not pursue a criminal case if disclosure is made.

Assuming that you discuss the case on a “no-names” basis with CI, you must make sure that the facts are fully and accurately presented. Otherwise, any assurance received from CI will not be binding. If you decide to simply send in an amended return without considering all of these variables, you heighten your client’s risk of prosecution. Of course, the decision to take that risk is the client’s and the client’s alone after a full discussion of the pros and cons.

EGGSHELL AUDITS: KEEPING THE SHELL OF THE EGG FROM CRACKING WHEN THERE ARE CRIMINAL TAX ISSUES – See Part 2 posted on October 3, 2013.

In accordance with Circular 230 Disclosure