This is a continuation of the blog entitled, “Tips for Surviving the Dreaded Eggshell Audit.” It focuses on spotting and solving some of the issues raised in an eggshell audit. This hypothetical comes from the creative genius of Jack Townsend and his book, “Tax Crimes.”
You are the tax preparer for the Cashcows, owners of the Golden Cow restaurant. The Cashcows’ 2004 income tax return was selected for civil examination by the IRS. Assume these facts:
“Revenue Agent Diligent Dan, an IRS civil examiner, conducted the examination. In addition to reviewing the cash register tapes, the bank accounts, and all of your files, Agent Dan met with Mr. and Mrs. Cashcow several times during the period that he examined the Cashcow’s income tax returns.
In the initial interview with Mr. and Mrs. Cashcow, Agent Dan confirmed that “no income was deposited into other bank accounts.” Within two months of that interview, Agent Dan conducted a second interview with Mr. and Mrs. Cashcow.
According to Agent Dan’s notes, the second interview was requested “after it was discovered that the Cashcows were depositing business money to an undisclosed bank account.” In the second interview, Mr. and Mrs. Cashcow again told Agent Dan that the restaurant checking account was the only account that they had and that no income had been deposited into any other accounts.
After that interview, Agent Dan met with his group manager to discuss the fact that he had found significant deposits into a securities account at a brokerage firm. Both Dan and his manager decided to expand the examination to include tax year 2006, to obtain documents from both the bank and the brokerage firm, and to track the case for fraud.
You represented Mr. and Mrs. Cashcow during the first 12 months of the civil examination. You even made yourself available for an interview with Agent Dan. During the interview, you denied knowing about any Golden Cow income beyond the deposits to the checking account and the dividends and interest from the brokerage firm.
After several meetings with the fraud coordinator to review the information obtained during the examination, Agent Dan scheduled one final interview with Mr. and Mrs. Cachcow. During that interview, Agent Dan confronted the Cashcows with account statements obtained from the brokerage firm revealing the skimmed cash deposits. Mr. and Mrs. Cashcow broke down and admitted that the money deposited into that account was skimmed from the restaurant.
Based on the documents and the confessions, Agent Dan referred the case to Criminal Investigation. Shortly thereafter, Mr. and Mrs. Cashcow hired a criminal tax attorney. During the criminal investigation, Mr. and Mrs. Cashcow were subpoenaed, but they claimed their Fifth Amendment privilege and gave no further statements to the special agents.
After another year of review, the matter was referred to the Department of Justice Tax Division. Despite the best efforts of their lawyer to convince the IRS and the Tax Division that there was no proof of anything but a mix-up in the preparation of the returns, the Tax Division transferred the case to the U.S. Attorney’s office. The U.S. Attorney’s Office obtained a grand jury indictment against Mr. and Mrs. Cashcow, charging them with income tax evasion for tax years 2004 and 2005.”
[“Tax Crimes,” Townsend, Jack, Adjunct Professor, University of Houston Law Center; Campagna, Larry, Adjunct Professor, University of Houston Law Center; Johnson, Steve, E.L. Wiegand Professor of Law, University of Nevada, Las Vegas, William S. Boyd School of Law; Schumacher, Scott, Assistant Professor of Law, Director, Federal Tax Clinic & Acting Director, Clinical Law Program, University of Washington School of Law; LexisNexis, 2008.]
Questions
1. Assuming that within the first two months of the civil examination Agent Dan found numerous “firm indications of fraud,” what type of motion would you consider filing to argue that Agent Dan violated Mr. and Mrs. Cashcow’s constitutional rights?
a. The IRM says that once the revenue agent has firm indications of fraud, the revenue agent must discontinue working the case civilly (or at least once the case is transferred to CI, that shouldn’t happen).
b. Here, the revenue agent had clear indications that this case could be fraudulent. Yet he continued to work it in order to develop information that could be turned over to CI and used as part of the prosecution. That’s potentially a Tweel situation.
c. If a defense attorney has these kinds of facts, he should make two motions – a motion to suppress and if successful, a motion to dismiss, based on Tweel. Argument: The defendant’s constitutional rights were violated by the deception of the revenue agent.
d. Mechanically, how would you make such a motion?
e. It would be brought under Fed. R. Crim. Proc. 12(b)(3), taking the form of a motion to suppress evidence. And it would come before trial.
f. What does the defense want to suppress? Information given to the revenue agent by the Cashcows after the revenue agent had “firm indications of fraud.”
g. Key issue: At what point in time did the revenue agent have firm indications of fraud?
i. The earlier in the process the revenue agent developed firm indications of fraud, the better it is for the Cashcows because incriminating information gathered by the revenue agent during a “civil exam” will be suppressed. The later in the process the revenue agent develops firm indications of fraud, the better it is for the government because potentially all incriminating information gathered by the revenue agent up to that point would be admissible.
ii. Time line of civil examination
1. The agent began an audit by reviewing cash register tapes, bank accounts, and Sam’s files.
2. The agent conducted an initial interview with the Cashcows. Cashcows said, “No income was deposited into other bank accounts.”
3. The agent conducted a second interview with the Cashcows. The Cashcows told the agent that the restaurant checking account was the only checking account they had and that no income had been deposited into any other account.
4. The agent issued a summons for bank records from the Cashcows’ brokerage account
5. The agent interviewed the Cashcows’ return preparer. He denied knowing about any Golden Cow income beyond the deposits to the checking account and the dividends and interest from the brokerage firm.
6. The agent conducted a final interview with the Cashcows, in which he confronted them with documents from the brokerage firm showing skimmed cash deposits. The Cashcows admitted that the amounts deposited into that bank account were cash skimmed from the restaurant.
7. The agent referred the case to CI.
iii. The Cashcows will argue that the revenue agent found clear indications of fraud early on in the civil examination, right after he reviewed the cash register tapes and bank accounts. Therefore, all of the information given to the agent after that point must be suppressed because it was being gathered by the agent for the criminal case without the Cashcows being advised of such.
iv. The government will argue that the agent did not find clear indications of fraud until after he conducted the final interview with the Cashcows, where he confronted them with documents from the brokerage firm showing skimmed cash deposits and the Cashcows confessed. Therefore, any information obtained up to and including the final interview was used to develop evidence of fraud and is admissible.
h. The case law is far from clear as to the current status of Tweel. Whether it remains good law is probably not well-established. Nevertheless, the defense attorney must make the argument.
i. IMPORTANT POINT: This motion would come in two parts:
i. First, defense counsel would attempt to suppress information that had been gathered by the revenue agent from the Cashcows after the agent had firm indications of fraud. “That’s a violation of defendant’s constitutional rights. The information so obtained should be suppressed.”
ii. Second, if the defense wins the motion to suppress, then defense counsel should file a motion to dismiss. If the government doesn’t have enough evidence to meet its prima facie burden without the evidence that has just been suppressed, then defense counsel should argue that the case should be dismissed on the ground of insufficiency of evidence. That’s a matter for the judge to decide.
iii. Defense counsel should have a minimum objective and a maximum objective. The minimum objective is to get the evidence suppressed. The maximum objective is an outright dismissal.
2. Are Mr. and Mrs. Cashcow likely to succeed if they blame you, their tax preparer?
a. It might be that the strategy of blaming the tax preparer could work or it might be that the strategy of bringing the tax preparer into the tent – i.e., cooperating with him instead of blaming him – might be the best option.
b. What are the downsides to blaming the tax preparer?
i. The tax preparer’s emotions:
1. The tax preparer’s professional pride is injured.
2. The tax preparer fears that the Cashcows are going to pursue a malpractice action against him.
ii. The tax preparer might retaliate. What will that consist of?
1. First, when he’s called to testify, the preparer might shade his testimony less favorably towards the Cashcows than he otherwise would; or
2. Second, the preparer might suddenly remember something that he did not previously remember. For example, the preparer might remember, regardless of whether it actually happened, that he asked the Cashcows whether they had any other accounts and they affirmatively said, “no.”
c. If the defense wants to shift blame, what would the defense attorney argue?
i. Whenever the defense can establish that the taxpayer provided or made available all of the information to the accountant, the defense has a good shot at negating willfulness. The argument would go something like this: “Everything that the preparer needed, we provided or we put him on notice of. The problem was his bad preparation of returns.”
ii. The facts reveal that the Cashcows rang up their receipts at the register. The Cashcows skimmed some money.
iii. The facts aren’t clear as to how the skimming occurred:
1. Did the skimming occur by not ringing up certain sales?
a. Even if the cash sales were not rung up on the register so that the register receipts matched the bank deposits, the fact remains that the preparer was still aware of the dividends and interest earned on the brokerage account.
b. Being aware of the dividends and interest, it seems obvious that the preparer should have asked the Cashcows where they got the cash to deposit into the brokerage account in the first place. The preparer could not have seen any transfers from the checking account to the brokerage account because there weren’t any. At the very least, however, the preparer must have known that deposits into the brokerage account came from somewhere other than the checking account. Moreover, the Cashcows did not have any additional income outside of the restaurant business. This was enough to at least arouse suspicion that the brokerage account was funded exclusively from diverted funds. Sam should have noticed this but didn’t.
c. How is that helpful to the defense? It allows the defense to make the following argument: “All of the information that the preparer needed to prepare an accurate return was provided. The problem was that he didn’t ask enough questions.”
2. Or did the skimming occur by ringing up sales and then taking cash out of the register?
If sales were properly rung up on the register but the cash was taken out (i.e., “half for the cash register, half for the brokerage account”), the preparer should have seen that the cash register receipts didn’t match the bank deposits. Any skimmed money was deposited into the brokerage account, not the checking account. Sam should have seen a discrepancy between the cash register totals, on the one hand, and the bank deposits, on the other. And he should have asked about that.
d. Alternatively, the defense might try to bring the preparer into the tent.
i. The defense attorney must convince the preparer that the Cashcows are not gunning for him: “We’re not going to file a malpractice suit against you. We think that you behaved well. The problem was simply one of miscommunication.
ii. The preparer might then be more magnanimous towards the Cashcows in the way that he testifies.
iii. The tax preparer should be interviewed, but not by the defense attorney. Instead, the defense attorney should arrange to have a private investigator interview the preparer so that he can’t be accused of attempting to obstruct the administration of justice.
iv. If the preparer has good things to say, his statement should be memorialized in an affidavit. Maybe the preparer will acknowledge that the Cashcows always provided him with everything that he asked for and that he never thought to reconcile the brokerage statements with the lack of cash transfers from the checking account. Assuming that the preparer makes such a representation, the defense has a good shot of getting an acquittal.
e. Could the government argue that the Cashcows have a nondelegable duty to ensure the accuracy of their tax returns or at least to report all of their taxable income?
i. When an accountant prepares returns, he gives them back to the taxpayer to review and to confirm for purposes of accuracy. If the taxpayer fails to review them or does but doesn’t notice any errors, the government can argue that the taxpayer was negligent for failing to live up to his duty to ensure the accuracy of his returns.
ii. But there is a critical distinction. This argument might work in the civil context. In the civil context, the government will argue that the Cashcows are liable for the deficiency, the interest, and the 20% negligence penalty. Negligence, however, is the standard in the civil context. In the criminal context, the standard is willfulness. The two are not the same. Negligence leads to penalties. Willfulness leads to jail and penalties. Therefore, if your client avoids jail at the expense of paying a civil penalty, he has dodged the bigger bullet.
3. Assume that you have a long list of clients who have been the targets of civil examinations and criminal investigations by the IRS. In virtually every one of these cases, the IRS found a separate bank account where the taxpayers had deposited income that was never reported on the returns that you prepared. What special discovery would the Cashcows need in order to make use of this information in their defense?
a. Does it matter? Would the defense want to have this information?
i. Yes. If the preparer really had lots of clients like this, that would suggest two things: (a) first, that he was very sloppy and (b) second, that other taxpayers, not just the Cashcows, reasonably interpreted the preparer’s words and remarks as suggesting that this kind of practice was acceptable. If the preparer gave the Cashcows and other taxpayers alike the impression that this was kosher – and that it didn’t violate the law – then the defense is in good shape on the willfulness issue. It might even suggest that the preparer is the culprit. Therefore, it is material.
ii. Recognize that the Cashcows cannot secure an acquittal by arguing, “Our accountant told us that we could get away with something we knew to be illegal.” But if the Cashcows did not know that the conduct they were engaging in was illegal, that suggests that they were merely pawns.
b. How can the defense get this information?
i. The defense needs to make a motion under Brady and Giglio.
ii. Brady/Giglio: Information that is exculpatory or that would be useful in impeaching government witnesses must be turned over to the defense if it’s material.
iii. Analysis: This is potentially exculpatory material, or at least material that would help the defense impeach the preparer if he were called as a witness by the government. Therefore, it’s both helpful to the defense and material.
iv. If the government opposes the defense’s Brady motion, what arguments would it rely upon in refusing to turn over this information?
1. The government will resist materiality on the combination of relevance and privacy grounds:
a. Not material: The mere fact that lots of the preparer’s clients were violating the law doesn’t change the fact that these defendants were violating the law.
b. Private: S. 6103 of the IRC contains strong confidentiality provisions when it comes to the privacy of taxpayer information (returns and return information). “The defense asks that that policy be violated. If the defense needs to get this information for fair trial purposes, that’s one thing. But as you are evaluating if this information is relevant, take into account the fact that what the defense seeks violates a strong policy in the IRC.”
v. At the end of the day, the judge will likely agree with the defense on materiality grounds.
vi. The prosecutor has an obligation to turn this material over to the defense when it sees it in the file, even if the defense doesn’t ask. Failure by the government to turn over such information could result in reversal of a conviction.
vii. Defense counsel should not rely upon the prosecutor to turn over Brady/Giglio material but instead ask the prosecutor informally whether there is any Brady material. And then defense counsel should make a Brady motion for production as part of the pre-trial process. Presumably, it would be in response to the government’s objection to its pre-trial motion that the defense would argue that the material is relevant.
4. Mr. and Mrs. Cashcow learned during the IRS examination that Agent Dan was once investigated for an alleged bribe received from one of the taxpayers that he was examining. What type of motion could the Cashcows bring to gather information about that potential bribe?
a. This is a Henthorn situation. In Henthorn, the ninth circuit court of appeals held that the defense must ask. If the defense asks, there is an obligation on the agency to review the files of those government employees that will testify to see if there is anything material that might be useful to the defense for impeachment purposes.
b. If the IRS finds something relevant on Dan, it must tell the AUSA and the AUSA must tell the defense. If the AUSA isn’t sure whether it’s relevant, the AUSA should ask the court to review the file in camera, with respect to materiality.
c. The defense must file a Henthorn motion to obtain this information.
d. Presumably, the government would resist turning over this information on the grounds of relevance. It would argue: (a) nobody has argued that Agent Dan has taken a bribe in this case specifically, so whether he took a bribe in another case isn’t relevant and (b) Agent Dan was only investigated, not prosecuted. Why drag Agent Dan’s reputation through the mud for an investigation that did not result in prosecution? The government would argue that there is no materiality – that the defense is not entitled to this information.
e. If the government was really concerned, it could avoid turning over this information simply by agreeing not to call Dan as a witness at trial. However, by not calling Dan, it would lose some potentially strong evidence (i.e., Cashcows’ admission that the amounts deposited into the brokerage account were cash skimmed from the restaurant). In the problem, the Cashcows told Dan that they did not have any other bank accounts. Since that was a false statement, the governmentt would want to introduce it at trial. And the only way for them to do so would be by calling Dan to testify that the statement was made. Otherwise, it’s hearsay.
f. The defense could counter that. This was a brokerage account. When the Cashcows told Dan that they didn’t have any other bank accounts, they might be able to explain that by saying (a) that the statement was literally true because a brokerage house is not a bank or (b) even if a brokerage house is a bank, they thought that there was a difference. It’s not unreasonable to think that a bank account refers only to a checking and savings account. In this way, the Cashcows can argue that their statement wasn’t false.
g. If the prosecutor thinks that the statement is equivocal and that its evidentiary value is limited, then to avoid the Henthorn mess, he might just decide not to call the revenue agent. It’s a strategy decision. At the end of the day, the revenue agent is simply too important of a witness not to be called. So the government will probably call Dan and when the defense makes its’ Henthorn motion, resist these arguments on the grounds that they are not relevant.