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What If…



What if Adam and Eve had admitted that they ate from the Tree of Knowledge of Good and Evil, instead of pointing the finger at anyone else, and anything else, that happened to be there at the time? Would they still be lounging in the Garden of Eden today, munching on pomegranates instead of apples and perusing through YouTube videos on their iPads?

What if a small team of British commandos had been unable to disable Nazi Germany’s deuterium oxide factory in Vermork in 1943, after several prior attempts had failed? Would Hitler have gained the final component he needed for an atomic bomb, and attached these weapons to the V-2 rockets falling from the sky onto London?

What if that Star Destroyer captain had blown R2-D2’s escape pod to smithereens in the opening act of Star Wars Episode IV, instead of ordering the gunner to “hold your fire…there are no life-forms aboard”? Without the stolen plans, would the Death Star have reduced the Rebel’s hidden fortress to ashes, and the Galaxy’s last hope for freedom along with it?

What if an IRS auditor feels that a referral to the Criminal Investigation (CI) division is warranted, but still wants to “talk things out” with the taxpayer to try and achieve a resolution, and the taxpayer spills the beans in the interview? If the taxpayer is later indicted, would a motion to dismiss the indictment be successful?

Admittedly, that fourth hypothetical doesn’t quite have the gravitas of the previous three. But since this is a tax law blog, that’s the one we’ll examine.

The Facts

In United States v. Hee, the government charged Mr. Hee, who is a communications mogul in Hawaii, with various counts of filing false tax returns and corrupt interference with an IRS investigation. In early 2008, the Service began looking at some tax returns from Waimana Enterprises, Clearcom, Inc., and Sandwich Isles Communications, Inc. According to Form 2797, the dreaded Examiner’s Office Activity Record, there was about a $325,000 difference between the amount Sandwich Isles reported as a payment and Waimana reported as income.

It turns out that different accounting procedures caused the discrepancy, but the intrepid IRS auditor was undeterred. The Service began looking into Mr. Hee’s personal returns, and specifically the lack of documentation. In November, a Waimana CPA admitted that Mr. Hee “close[d] deals with handshakes” and preferred to “play the odds” of being audited instead of maintaining troublesome records. Although these statements certainly did nothing to advance Mr. Hee’s cause, a judge would later rule that they did not amount to firm indicators of fraud. More on that later.

In August 2009, Crystal Cary, the agent, had a conversation with Alan Yee, one of Mr. Hee’s representatives, and she did not drop an f-bomb (“fraud”). Instead, according to the record, she told him that “things look bad, and that we should try to solve as many things at my level as possible.” Mr. Yee grudgingly confirmed her account.

Now, things get really interesting. In late September, Ms. Cary met with a supervisor, who told her to write it up. She cancelled a meeting with Mr. Hee’s representative, completed Form 2797, and submitted it. In November, Ms. Cary left a very evasive voicemail in response to Mr. Hee’s questions about the audit:

“Hi Danielle, this is Crystal Cary from the IRS, returning your earlier phone call regarding Waimana Enterprises and Clearcom. In regard to time frames, my manager has asked me to work on another time sensitive matter, and I will have to get back in contact with you at a later date regarding resolution of the Waimana and Clearcom exams.”

The Law

The jousting match between Mr. Hee and the IRS is a classic Tweel problem. The government cannot use an audit to obtain evidence for a criminal investigation, no matter how well-intentioned and helpful the agent appears to be.

The other bit of law is IRM 25.1.3.2, Preparation of Form 2797 – Referral Report of Potential Criminal Fraud Cases (May 27, 2014). If, after consultation with the Fraud Technical Advisor (FTA), it is determined that a potential criminal case has firm indications of fraud/willfulness, the agent must immediately suspend the examination/collection activities without telling the taxpayer or the taxpayer’s representative why they are walking out. Prior cases suggest that these kinds of responses are appropriate:

• The refusal to answer any questions about criminal potential, or
• A generalized response that every time there are firm indicators of fraud, there must be a CI referral.
• The agents cannot say anything deceitful or misleading, and can definitely not use the f-word.

There are Constitutional issues as well. Agents violate the Fourth Amendment if they obtain any information by “deceit, trickery or misrepresentation.” Being less than forthcoming about the status of a criminal investigation, even if the statements are technically correct, certainly falls into this category.

More recent case law seems to back away from this position. According to a 2008 case from the Ninth Circuit, the government must affirmatively mislead the taxpayer and the civil investigation must be a mere pretext for a subsequent criminal proceeding. That case – United States v. Springer – involved an SEC investigation, but its analysis may apply in other parallel proceedings, such as the ones at the IRS.

The Holding

Not surprisingly, Mr. Hee’s lawyers claim that Ms. Cary intended to use anything she learned in a civil audit as ammunition in a criminal proceeding, and capped it off by deliberately lying in November 2009.

But the fact is that the agent did nothing with regard to the civil audit after the decision to “write it up” in September 2009, the rather cryptic voicemail notwithstanding. And though the “handshake” comments certainly caused the Service to release the bloodhounds, in a legal sense, they were not badges of fraud. So, the judge denied the motion to dismiss the indictment.

The Application

Let’s go back to the example we introduced at the beginning, one that comes from the creative genius of Jack Townsend, author of the Federal Tax Crimes Blog. The IRS is conducting a civil audit of Tommy Taxpayer. During the audit, the examiner discovers some irregularities that are not badges of fraud in and of themselves, but are enough to arouse suspicion on the part of the examiner that Tommy may have engaged in, let us say, some “tax hanky-panky.”

However, the examiner believes that the irregularities could just as easily have been caused by something completely innocuous (it’s probably no accident that the “TurboTax” logo just flashed through my mind). For example, they could have been caused by a clerical error, or perhaps, by something that would erase any doubt in the examiner’s mind that Tommy was playing “fast and loose.”

In an effort to achieve a resolution, the examiner decides to continue to work with Tommy and formally invites him to sit down and discuss the matter over tea and trinkets, so that Tommy may explain his side of the story.

Tommy’s accountant is no dummy. He has a “nose for these things” and can pick up the scent of a rotting fish from more than a thousand feet away. He senses that there may be something underhanded going on and that allowing Tommy to sit down with the examiner would be like a shepherd standing by while his sheep is being led to the slaughter.

Eventually, he and the agent have The Talk. The accountant asks, “Has a referral to Criminal Investigation been made?” The agent answers, “No.” Tommy’s accountant balances the risk of sending Tommy into the “lion’s den” with the benefits. He knows that Tommy could make a bad situation that much worse by making incriminating statements during the interview. The latter could seal Tommy’s fate for good.

At the same time, Tommy’s accountant is painfully aware of the fact that the case still has the potential to be referred to CI and that if Tommy does not agree to sit down for a “fireside chat” with the agent, then the agent will view this as a “failure to cooperate.” This may increase the odds of the agent referring the case to CI. Satisfied with the agent’s answer that the case has not been referred to CI, Tommy’s accountant gives Tommy the “green light” to sit down and explain his side of the story to the agent.

In textbook fashion, Tommy misleads the examiner (or tells the damaging truth) – pick your poison. Faster than the IRS can cash a taxpayer’s check, the examiner refers the case to CI. No sooner does that happen that Tommy is indicted. All of this can be summarized by the expression made famous by the wise philosopher, Homer Simpson: “D’oh!”

We’ll examine this question in classic law school exam style:

• Would Tommy win a motion to suppress based on these facts?

Possibly so, because the agent has definitely been deceptive. If there is evidence of maliciousness or ill-will on behalf of the Service, the “possibly” becomes a “probably.”

Assume that the agent had completed an initial draft of the write-up, but had not submitted it for approval. Would Tommy win a motion to suppress based on these facts?

Roughly the same logic applies, but the results are more slanted towards Tommy. The presence of Form 2797 changes the tenor of the proceedings, and any civil audit work is arguably a pretext for a supplement to the write-up.

Assume the accountant asked, “Do you have a firm indication of fraud?” instead of “Has a referral to Criminal Investigation been made?” Would Tommy win a motion to suppress based on these facts?

If the agent answers “no” and files a 2797 any time in the near future, perhaps within a few weeks, a judge may well conclude that the agent was lying through her teeth.

As a side note, if Tommy does not receive any Miranda-esque warnings in these situations, place another mark in his column. Why, you ask? Very simply, IRS guidelines require a special agent from CI who is interviewing a taxpayer to issue Miranda warnings – albeit a slightly watered-down version – at the start of any interview.

While these facts present a dilemma regardless of whether the taxpayer is represented by an accountant or an attorney, the fact remains that a seasoned tax attorney has the knowledge, skill, and expertise to help the taxpayer navigate these choppy waters. In other words, this is not as risky when the taxpayer is represented by a seasoned tax attorney. However, it can be a serious problem if the taxpayer is not so represented. All of this is to say that the tax practitioner and taxpayer would be wise to consider retaining a tax attorney during what might appropriately be called, an “eggshell audit”. Don’t risk it!  Connect with me on TaxConnections.

Original Post By:  Michael DeBlis

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As a former public defender, Michael has defended the poor, the forgotten, and the damned against a gov. that has seemingly unlimited resources to investigate and prosecute crimes. He has spent the last six years cutting his teeth on some of the most serious felony cases, obtaining favorable results for his clients. He knows what it’s like to go toe to toe with the government. In an adversarial environment that is akin to trench warfare, Michael has developed a reputation as a fearless litigator.

Michael graduated from the Thomas M. Cooley Law School. He then earned his LLM in International Tax. Michael’s unique background in tax law puts him into an elite category of criminal defense attorneys who specialize in criminal tax defense. His extensive trial experience and solid grounding in all major areas of taxation make him uniquely qualified to handle any white-collar case.