Overview of Criminal Tax Fraud Indictment by IRS Investigation

Overview of Criminal Tax Fraud Indictment by IRS Investigation

With any conversation involving IRS tax crimes arising, two of the most common tax crimes that are usually mentioned in the same breath are tax fraud and tax evasion. Unlike tax evasion, which is only a crime — and a felony, tax fraud can be either civil and/or criminal. In order to go from a tax fraud investigation to an indictment, there is a long and often winding road. And, because a criminal tax fraud case involves a crime, the US government is required to prove its case beyond a reasonable doubt. While the IRS and DOJ do not pursue many criminal tax fraud cases each year, they are on the rise — and especially when it involves enforcement priorities such as cryptocurrency, offshore compliance, syndicated conservation easements, and abusive trust schemes. Let’s travel down the road have a criminal tax fraud case from investigation to indictment by using an example.

26 U.S. Code § 7206 – Fraud and False Statements

• Any person who—

  • • (1) Declaration under penalties of perjury Willfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter; or

    • (2) Aid or assistance Willfully aids or assists in, or procures, counsels, or advises the preparation or presentation under, or in connection with any matter arising under, the internal revenue laws, of a return, affidavit, claim, or other document, which is fraudulent or is false as to any material matter, whether or not such falsity or fraud is with the knowledge or consent of the person authorized or required to present such return, affidavit, claim, or document; or

    • (3) Fraudulent bonds, permits, and entries Simulates or falsely or fraudulently executes or signs any bond, permit, entry, or other document required by the provisions of the internal revenue laws, or by any regulation made in pursuance thereof, or procures the same to be falsely or fraudulently executed, or advises, aids in, or connives at such execution thereof; or

    • (4) Removal or concealment with intent to defraud Removes, deposits, or conceals, or is concerned in removing, depositing, or concealing, any goods or commodities for or in respect whereof any tax is or shall be imposed, or any property upon which levy is authorized by section 6331, with intent to evade or defeat the assessment or collection of any tax imposed by this title; or

    • (5) Compromises and closing agreements In connection with any compromise under section 7122, or offer of such compromise, or in connection with any closing agreement under section 7121, or offer to enter into any such agreement, willfully—

    • (A) Concealment of property Conceals from any officer or employee of the United States any property belonging to the estate of a taxpayer or other person liable in respect of the tax, or

    • (B) Withholding, falsifying, and destroying rec­ords Receives, withholds, destroys, mutilates, or falsifies any book, document, or record, or makes any false statement, relating to the estate or financial condition of the taxpayer or other person liable in respect of the tax; shall be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 3 years, or both, together with the costs of prosecution.

Taxpayer has Foreign Accounts and Income

Dean is a US citizen who is originally from a foreign country. In prior years and up until about five years ago, Dean had reported all of his foreign income along with his foreign bank account to the IRS — as he was aware of the annual FBAR reporting requirements. Thus, Dean was fully in compliance with all his domestic and overseas income and reporting. Then, Dean started making significantly more money from foreign sources and decided he does not want to report this money to the US government. Going forward, Dean decides to intentionally limit the amount of foreign income he reports on his US tax return and asks for his foreign customers to pay him in cash and other untraceable currency — his goal is to artificially reduce his US tax liability.

Taxpayer has High-Balance Foreign Accounts

Initially, Dean had only one foreign bank account. But, the account balance was getting too high for Dean’s liking and he was concerned about the bank reporting him, despite the fact that he had a great relationship with the foreign bank and they told him that they would not report him. To accomplish this, the bank had Dean transfer his account to a numbered account — to only be identified by a number and a dummy foreign entity associated with that number (and not Dean personally).

He Intentionally Splits the Money Into Several Foreign Accounts

In order to avoid detection, Dean structures and smurfs the larger account into several smaller accounts at various institutions, under different names, and across different foreign jurisdictions in order to avoid the foreign equivalent of CTR (Currency Transaction Reports) and SAR (Suspicious Activity Reports). He does not identify that he is a US person to any of the foreign jurisdictions.

Taxpayer Intentionally Does Not Report the Accounts Nor File FBAR

For the past five (5) years, Dean has been intentionally reducing the amount of income on his US tax return as well as intentionally not filing the annual FBAR, Form 8938, and Form 8621 for the passive investments he maintains overseas. In addition, Dean stopped filing Schedule B, because he was under the misimpression that by not filing Schedule B, he would not be making any affirmative misrepresentation about the FBAR (or lack of filing) — but this is incorrect.

*Had Dean never filed Schedule B because he was unaware of the form, then it generally would have worked out better for him on the FBAR penalty front than if he knew about the Schedule B and either filed it incorrectly or simply did not file the FBAR – See Hughes Case for Willful and Non-Willful Violations.

IRS Learns of Taxpayer’s Noncompliance

Unfortunately for Dean, one of the foreign financial institutions where Dean maintains several of his foreign bank accounts realized that Dean was a US Person — because many years ago it turns out Dean had opened an account at that institution and while the account primarily had a zero balance and remained dormant most of the time, the bank’s system shows Dean as a US Citizen. Therefore, the foreign financial institution includes Dean in their exchange of information for US person account holders to the US government. The US government then decides it is going to audit Dean, as they also learn that Dean failed to include a significant amount of underreported income.

Reverse Eggshell Audit, Special Agents, and Criminal Prosecution

As is commonplace with many human beings in general — they tend to be too smart for their own good. Dean was almost sure that the IRS was bluffing so when he went into the audit, he doubled down and confirmed that he had no foreign accounts nor any unreported foreign income. This is referred to as a reverse eggshell audit because the IRS already has the information at the time of audit.

As a result, the IRS Agent referred the matter to the IRS Special Agents. After an extensive investigation into Dean’s finances, they came to the conclusion that based on the numerous intentional misrepresentations about his foreign account balances along with intentionally failing to report the FBAR and filing false returns (an affirmative act), Dean has crossed over from a civil willful violation into criminal FBAR noncompliance and tax evasion. Thus, marked the beginning of the end for Dean.

How the Investigation to Indictment Process Works

As provided by the IRS

Sources of Criminal Investigations for IRS Special Agents

Criminal Investigations can be initiated from information obtained from within the IRS when a revenue agent (auditor) or revenue officer (collection) detects possible fraud. Information is also routinely received from the public as well as from ongoing investigations underway by other law enforcement agencies or by United States Attorneys offices across the country.

Preliminary Analysis and Investigation Approvals

Special agents analyze information to determine if criminal tax fraud or some other financial crime may have occurred. Relevant information is evaluated. This preliminary process is called a “primary investigation.” The special agent’s front line supervisor reviews the preliminary information and makes the determination to approve or decline the further development of the information. If the supervisor approves, approval is obtained from the head of the office, the special agent in charge, to initiate a “subject criminal investigation.” At this point, at least two layers of CI management have reviewed the ‘primary investigation’ material and determined there is sufficient evidence to initiate a subject criminal investigation.

Conducting a Criminal Investigation

Once an investigation is opened, the special agent obtains the facts and evidence needed to establish the elements of criminal activity. Various investigative techniques are used to obtain evidence, including interviews of third party witnesses, conducting surveillance, executing search warrants, subpoenaing bank records, and reviewing financial data.

The special agent works closely with IRS Chief Counsel Criminal Tax Attorneys during the course of the criminal investigation. This process ensures all legal aspects of the investigation and prosecution recommendation are correctly addressed.

Prosecution Recommendations by the Special Agent

After all the evidence is gathered and analyzed, the special agent and his or her supervisor either make the determination that evidence does not substantiate criminal activity, in which case the investigation is ‘discontinued,’ or the evidence is sufficient to support the recommendation of prosecution, in which case the agent proceeds with the preparation of a written report detailing the findings of violation of the law and recommending prosecution. This report is called a “special agent report” and it is reviewed by numerous officials, including:

1. 1. 1. The agent’s front line supervisor, called the supervisory special agent;

      2. A criminal investigation quality review team, Centralized Case Review;

      3. CI assistant special agent in charge;

      4. CI special agent in charge.

If CI determines the investigation should be criminally prosecuted, a prosecution recommendation is forwarded to:

1. 1. 1. The Department of Justice, Tax Division, (if it is a tax investigation) or

      2. The United States Attorney for all other investigations.

Each level of review may determine that evidence does not substantiate criminal charges and the investigation should not be prosecuted.

Prosecution

If the Department of Justice or the United States Attorney accepts the investigation for prosecution, the IRS special agent will be asked by the prosecutors to assist in preparation for trial. However, once a special agent report is referred to for prosecution, the investigation is managed by the prosecutors.

Conviction

The ultimate goal of an IRS Criminal Investigation prosecution recommendation is to obtain a conviction – either by a guilty verdict or plea. Approximately 3,000 criminal prosecutions per year provide a deterrent effect and signals to our compliant taxpayers that fraud will not be tolerated.

Golding & Golding: International Tax Lawyers Representing Clients Worldwide

Our International Tax Lawyer team specializes exclusively in international tax, and specifically IRS offshore disclosure, including representation in VDP matters for Taxpayers who are willful.

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