Although the odds of being the target of a criminal IRS investigation are small, the penalties can be high. The document discusses that intent or willfulness is the key factor that differentiates a civil tax adjustment from criminal prosecution. It also outlines the investigative techniques IRS special agents use to gather evidence of unreported income and document a taxpayer's willful intent to evade taxes, such as analyzing financial records, conducting surveillance and interviews, and using indirect methods to calculate unreported income. It stresses that anyone under criminal tax investigation should seek legal counsel from an attorney with experience in criminal tax law.

2. D
Although the odds of being the target of an IRScriminalInvestigation are small, the
potential penalty can be quite high, so Investigation targets should obtain expert advice.
ANNE MARIE MINOGUE
any attorneys and accoun-
tants are concerned that
one of their clients, without
their knowledge, could have
done something that could
cause the client to become the subject of a crim-
inal tax investigation. In this regard, trepidation
is avery real element of tax compliance. In fact,
the IRS relies on the fear factor as an incentive
for most people to file accurate returns.
When should a tax advisor be concerned that
a client could be the subject of a probe by the
Criminal Investigation (CI) division of the IRS?
The answer lies within the client, because the
single most differentiating characteristic
between a civil tax adjustment and a criminal
prosecution recommendation is intent or will-
fulness. Willfulness generally involves a vol-
untary, intentional violation of a known legal
duty. While IRS special agents are well trained
in tax, accounting, and law enforcement tech-
niques, they are not trained in mind reading.
Consequently, absent an admission from a tar-
ANNE MARIE MINOGUE is an associate director in the Busi-
ness Risk Consulting Practice of Protiviti Inc. in New York.
She formerly served as assistant special agent in charge. New
York Field Office and interim special agent in charge, Den-
ver Field Office and New Jersey Field Offices of the Crim-
inaiinvestigation Division of the Internal Revenue Service.
Anne Marie is experienced in leading and conducting in-
depth financial investigations focused on tax violations,
money laundering. currency crimes, and asset forfeiture.
36 PRACTICALTAX STRATEGIES JULY2009
get of an investigation that he or she willfully
intended not to pay taxes,the IRSspecial agents
must indirectly prove willfulness by gathering
and documenting circumstantial evidence of
the taxpayer's intent. To this end, special
agents will ferret out affirmative acts done by
the taxpayer before, during, and after the fil-
ing of a return, which demonstrate that the
intent was to defeat the payment of taxes.
How taxpayers handle their recordkeeping
is often indicative of their intentions regard-
ing the reporting of income. Taxevaders often
keep duplicate sets of books and records (i.e.,
one containing the true income and one
recording the income they intend to report to
the IRS). Needless to say,the discovery of two
sets of records would go a long way in satis-
fying the government's requirement to estab-
lish the element of willfulness. Similarly, false
or altered entries in the books, and the destruc-
tion of records also could be used as circum-
stantial evidence of the criminal intent of the
taxpayer.
The act of concealment isalso an indication
of the taxpayer's intent to evade paying taxes.
Concealment of sources of income could be in
the form of a different handling of certain trans-
actions to avoid detection or the setting up of
separate bank accounts to avoid linkages to the
funds. Lies and false statements to IRS agents
or accountants also are indicative of the tax-
I
1
I"="

3. payer's intent to deceive. Assets are often
placed in the name of a nominee to avoid detec-
tion. Therefore, documentation of acts of
concealment also is used to prove willfulness.
Consistent patterns of behavior also may
demonstrate that the taxpayer sought to
deceive the IRS.Repeated omissions of income
would indicate a deliberate attempt to evade
paying taxes. Likewise,a steady pattern of over-
stating deductions also may indicate that the
taxpayer did so with a calculated purpose.
Documentingwilfulness
CI special agents employ many overt and
covert investigative techniques to document
willfulness. The most common technique is
interviewing. Special agents will attempt to
interview partners, colleagues, and associates
in an attempt to document admissions and
knowledge of the taxpayer. Key among inter-
views is the tax return preparer interview in
which the special agent will attempt to estab-
lish whether the taxpayer withheld informa-
tion from the return preparer, which resulted
in the understatement, or if the return preparer
had knowledge of the unreported income or
fictitious deductions.
Special agents also will seek to interview the
taxpayer who is under investigation. The tax-
payer has the right to refuse to submit to this
interview. If, however, the taxpayer agrees to
answer questions, this interview can be
extremely grueling and can last several hours.
During the interview,the special agent will seek
to identify all income, assets, liabilities, and
expenses of the taxpayer for the periods
before, during, and subsequent to the inves-
tigativeyears.The special agentswillseekadmis-
sions and confessions, and they will document
lies and misstatements. In addition:
Corporate records and bank records are
subpoenaed and analyzed in an attempt
to document selective handling or record
alterations.
Surveillance may be conducted to iden-
tify hidden assets.
Mail covers are used to identify unknown
bank accounts. A mail cover is a request
made to the U.S. Postal Inspector by a law
enforcement agent to monitor the mail
received by a person who is the target of
a felony investigation. In response to the
mail cover request, the U.S. Postal
Inspector will send to the law enforce-
CRIMINAL INVESTIGATION
ment officer a list of all mail received by
the target of the investigation during a
30-day period.
"Dumpster diving:' a term used to
describe the retrieval of trash for analy-
sis, may be employed to retrieve docu-
mentation that has been discarded.
Computer forensics may be conducted to
locate deleted documents.
When traditional investigative techniques
are not realistic, financial search warrants
maybe employed for IRSspecial agentsto locate
concealed records and executed to seize the sec-
ond set of books and records or receipts
reflecting unreported income. Co-conspirators
may be convinced to cooperate and wear elec-
tronic monitoring devices to document admis-
sion. Undercover operations are sometimes
initiated to locate evidence and document
admissions of knowledge and willfulness.
Documentingunreportedincome
CI special agents document evidence of unre-
ported income directly or indirectly. In the spe-
cific items method, direct evidence is obtained
by identifying specific items of unreported
income and obtaining testimony from the
source of the income. The special agent then
demonstrates which specificitemswere reported
on the income tax returns, and which items were
not reported on the tax returns.
Three indirect methods of documenting
income may be used:
1. Net worth method.
2. Bank deposits method.
3. Expenditures method.
In the net worth method, the taxpayer's net
worth is calculated at the beginning of the
period and at the end of each tax year. An
increase in net worth, less any nontaxable
sources of funds, iscalculated as income. Inthe
computation of income via the bank deposits
method of proof, unreported income is doc-
umented through illustration of the extent to
which the taxpayer's bank deposits exceeded
his or her reported income. Similarly, in the
expenditures method, the special agent deter-
mines unreported income by demonstrating
that the taxpayer spent more than he or she
earned.
JULY2009 PRACTICALTAX STRATEGIES
DTHE SPECIAL
AGENT WILL
AnEMPT TO
ESTABUSH
WHETHER THE
TAXPAYER
WITHHELD
INFORMATION
FROM THE RETURN
PREPARER.
37

4. DIT IS ESSENTIAL
THAT THE SUB.JECT
OF AN
INVESTIGATION BE
REPRESENTED BY
AN ATTORNEY. NOT
AN ACCOUNTANT.
SO THAT
COMMUNICATIONS
ARE PROTECTED
UNDER THE
ATTORNEY-CLIENT
PRMLEGE.
38
Targetsof investigation
Virtually anyone who files an income tax
return or anyone who fails to file an income
tax return could find himself or herself the tar-
get of a criminal tax investigation. CI classi-
fies its investigations into programs and
emphasis areas of fraud. Program areas include:
Abusive return preparer enforcement.
Abusive tax schemes.
General tax fraud.
Money laundering.
Narcotics-related investigations.
Non-filer enforcement.
Questionable refunds.
Areas of emphasis include the following:
Telemarketing fraud.
Bankruptcy fraud.
Corporate fraud.
Employment tax enforcement.
Excise tax enforcement.
Financial institution fraud.
Gaming.
Health care fraud.
Insurance fraud.
Public corruption.
Often otherwise-law-abiding citizens are
lured into tax crimes by unscrupulous tax return
preparers or promoters of abusive tax schemes.
The IRS often warns, "If it sounds too
good to be true, it probably is." That is good
advice in these times. Also, it is essential that
every taxpayer carefully review and understand
every item on their returns. Even if willfulness
isestablished and the taxpayer isnot prosecuted,
he or she could be subject to hefty fines, inter-
est, and penalties.
Although most criminal tax investigations
target individuals, increasingly corporations
as well as the responsible individuals are pros-
ecuted for evasion of corporate taxes. However,
the elements of proof are the same. Evenin large
corporations, fictitious books, false state-
ments, and concealment are what demon-
strate the willfulness that supports a criminal
prosecution.
Likelihood of becoming the target. The IRS
encourages individuals to inform on those that
they know to be tax cheaters. In fact, legisla-
tion signed into law on 12/20/06 by President
Bush authorized the IRS to pay higher rewards
to many informants in cases involving large
amounts of money. Rewards could be as much
as 30% of what the IRS collects.'
Lawmakers hope this and other incentives
in the legislation will encourage more people
PRACTICALTAX STRATEGIES JULY2009
to step forward with valuable tips that will help
the IRScollect additional revenue. Taxcheaters
have a much greater chance of being detected
and investigated if others are awareof their non-
compliance with the lawand are enticed to come
forward by the hefty reward.
Still, tax prosecutions must be recom-
mended by CI special agents of the IRS. The
IRS employs approximately 2,600 special
agents nationwide. Only 3,794 investigations
were initiated and 2,785 prosecution recom-
mendations were made by IRS special agents
during fiscal year 2008 (10/1/07-9/30/08).
Thus, statistically,the odds are small that a client
would become the subject of a criminal inves-
tigation. Yet,the penalty is stiff if a client is one
of the select few who become the subject of a
criminal tax investigation. During fiscal year
2008,81 % percent of those recommended for
prosecution received jail time.2
Whattodoifa clientistargeted
Prior to agreeing to be interviewed by CI spe-
cial agents, the target of an investigation is
strongly encouraged to seek the advice of an
attorney. He or she should obtain a criminal
defense attorney who specializesin representing
individuals in U.S. district court and who has
experience in defending individuals accused
of criminal tax violations. Attorneys experi-
enced in defending criminal tax allegations are
familiar with the unique methods employed in
criminal tax investigations and are well
equipped to navigate the bureaucracy of the
IRS, Department ofJustice Tax Division, U.S.
Attorney's Office, and federal judicial system.
Experienced criminal tax defense attorneys
are also knowledgeable of the sufficiency of evi-
dence necessary to prove income and willful-
ness. The proper legal representation can
protect the individual's legal rights, and ensure
that the individual does not provide false
information or submit a confession. A good
defense counsel can assist the individual in
preparing the best possible defense. It is essen-
tial that the subject of an investigation be rep-
resented by an attorney, not an accountant, so
that communications are protected under the
attorney-client privilege.
The attorney may also enlist the services of
a forensicaccountantlfinancial investigator who
is experienced in fraud investigations and
criminal tax investigations. If the forensic
accountant/financial investigator is engaged
L-
CRIMINAL INVESTIGATION

5. through the defense attorney or through a
"Kovelletter" communications with the foren-
sic expert and his or her work products will be
protected under the attorney-client privilege.
A Kovelletter is a form letter that is used by
lawfirmsto placean accountant under the attor-
ney-client privilege. It stems from the landmark
case, Kovel,3in which a former IRS agent and
accountant had been hired by a lawfirm to help
advise its clients. Kovelmet with and received
information from a client under IRS investi-
gation for tax fraud. When subpoenaed by a
grand jury, Kovelrefused to answer questions
about the client and was sentenced to a year
in prison for contempt of court. The Second
Circuit reversed the contempt citation. It
ruled there was no reason in the case to
exclude accountants from the list of those who
assist lawyers in providing legal services.
The forensic accountant/financial investi-
gator can gather financial documents and
predict the findings of the special agents. He
or she can uncover defenses and gather the nec-
essary evidence to support them. This can be
invaluable in interactions with the government
and in the overall defense strategy.
Becausethe person who prepared a taxpayer's
returns also may become the target of an
investigation,it isnot in the taxpayer'sbest inter-
estto enlistthe assistance of the accountant who
prepared the returns when the taxpayer is the
subject of a criminal investigation. The accoun-
tant also may have exposure to criminal
charges. He or she may have given poor advice
to the taxpayer and will have a vested interest
in protecting himself or herself rather than the
taxpayer.
Finally,a taxpayer must be extremely patient
if he or she is under a criminal investigation
by the IRS. Investigations may last up to two
years and probe every cent spent by the tax-
payer.
Avoidbecominga CI subject
A tax advisor whose client believes he or she
may have committed a tax violation may want
to consider advising the client to make a vol-
untary disclosure. Prior to making a voluntary
disclosure, a taxpayer should consult with an
CRIMINAL INVESTIGATION
attorney and, if he or she decides to go forward
with a voluntary disclosure, it should be made
through an attorney.
The IRS CI division has established proce-
dures for the handling of voluntary disclosures
that are designed to encourage individuals to
come forward and pay their tax liabilities. A
voluntary disclosure will be considered by the
IRS, along with all other factors in the inves-
tigation, in determining whether to recommend
criminal prosecution. Although avoluntary dis-
closure will not guarantee immunity from pros-
ecution, it may result in prosecution not being
recommended. This practice does not apply to
taxpayers with illegal-source income.
A disclosure is only considered voluntary
by the IRS if it truthful, timely, complete, and
when the taxpayer shows a willingness to
cooperate (and does in fact cooperate) with the
IRS in determining his or her correct tax lia-
bility. The taxpayer also must make good-faith
arrangements with the IRS to pay in full the
tax, interest, and any penalties determined by
the IRS to be applicable.
Adisclosureistimelyif itis receivedbefore
the IRS has initiated or obtained information
that would lead to a civil examination or
criminal investigation of the taxpayer, or has
notified the taxpayer that it intends to com-
mence such an examination or investigation.
In addition, to be considered timely, the IRS
must not havereceived information from a third
party (e.g., informant, other governmental
agency, or the media) alerting the IRS to the
specific taxpayer's noncompliance.
Most clients will not become the target of
a criminal investigation by the IRS, as long as
they do not willfullyevade the payment of taxes.
However, should they receive a visit by CI spe-
cial agents, it is in their best interest to obtain
advice, counsel, and assistance from criminal
defense attorneys and forensic experts who have
experience in the area of criminal tax law..
39
NOTES
1 Section 7623(b).
2 Statistics taken from the IRS CID website at
http://www. irs. gov Icom p Iia n cel en fo rc e men tl art ic Ie/.
3 296 F.2d 918. 9 AFTR2d 366 (CA-2. 1961).
JULY2009 PRACTICALTAX STRATEGIES