Client Tax Fraud and the CPA: Take the Right Steps to Advise Your Client and to Protect Yourself during a Tax Fraud Investigation
EXECUTIVE SUMMARY * Taxpayers may be subject to criminal prosecution for felonies including tax evasion under IRC [section] 7201 and filing false returns under section 7906. CPAs with clients with a possible exposure to criminal fraud allegations require appropriate advising and consultation, usually including a referral to an attorney experienced in such matters. * In addition to criminal investigation, the IRS may also pursue civil penalties, including the section 6663 fraud penalty. The penalty amount is 75% of the portion of a tax understatement attributable to fraud, with the taxpayer bearing the burden of proving that any part of an underpayment is not attributable to fraud. * Criminal cases are typically investigated by the IRS' Criminal Investigation Division. Cases are reviewed by the Department of Justice's Tax Division, which may authorize a prosecution by a local U.S. attorney's office or grand jury investigation. * Criminal investigations often begin as civil examinations in which omission of sources of income or substantial personal expenditures claimed as business expenses are "red flags" that may trigger a criminal referral. IRS field agents conducting a civil examination are not obligated to inform the taxpayer when a case has been referred for criminal investigation, and incriminating statements from a civil examination can be used in a criminal prosecution. * The tax practitioner privilege of client confidentiality does not extend to criminal matters, and at least one court has held admissible in a criminal case taxpayer statements made before a civil examination became a criminal investigation, even though examiners should have made the criminal referral sooner. * CPAs should have a document retention policy to preserve evidence helpful to a criminal defense. CPAs may also assist an attorney representing a client through a Kovel arrangement, interpreting technical tax issues to better inform the attorney's legal advice. * Through their client acceptance policies and procedures, CPAs should screen new clients for any possibility of criminal exposure. The AICPA Statements on Standards for Tax Services provide guidance for AICPA members in such situations. In some situations, the CPA may also need legal representation. ********** [ILLUSTRATION OMITTED] Your client just called and left the following message: "I answered the door at my home today, and an agent who said he was from the IRS Criminal Investigation Division wanted to ask me some questions. What should I do?" While you may never get a call from a client exactly like this, it is important to know that taxpayers may reach out to their adviser, such as a CPA, during the initial stages of an IRS investigation that could result in allegations of criminal misconduct. How you handle this call and other situations like it is important in providing your client with quality service and defining your role in a tax fraud investigation. As a practicing CPA, you should be alert to a taxpayer's possible exposure to allegations of fraud or other criminal misconduct. The consequences to the taxpayer from conviction are generally imprisonment and substantial monetary penalties. While CPAs may provide valuable advice concerning tax liability and IRS administrative procedures, once a client's actions appear potentially to constitute fraud or another crime (see sidebar, "How the IRS Defines and Prosecutes Tax Fraud") CPAs should refer that client to an attorney experienced and skilled in this area. If the CPA is not also an attorney, he or she must avoid acting in a way that could be considered practicing law. However, knowing criminal tax fraud legal definitions and IRS investigative procedures can help CPAs avoid inadvertently complicating or hampering legal representation of the client. SOURCES OF CRIMINAL INVESTIGATIONS Investigations conducted by the IRS' Criminal Investigation Division (CI) are generated from various sources, but the largest source is IRS civil examinations. …