what to do when tax preparer learned client lied after return is filed

Your client just called and left the following message: "I answered the door at my habitation today, and an agent who said he was from the IRS Criminal Investigation Segmentation wanted to inquire me some questions. What should I do?"

While yous may never get a call from a client exactly like this, it is important to know that taxpayers may achieve out to their adviser, such as a CPA, during the initial stages of an IRS investigation that could upshot 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.

Equally a practicing CPA, yous should exist alert to a taxpayer's possible exposure to allegations of fraud or other criminal misconduct. The consequences to the taxpayer from conviction are mostly imprisonment and substantial monetary penalties. While CPAs may provide valuable advice concerning tax liability and IRS administrative procedures, once a client'due south actions appear potentially to constitute fraud or another offense (see sidebar, "How the IRS Defines and Prosecutes Tax Fraud," below) CPAs should refer that customer to an attorney experienced and skilled in this surface area. If the CPA is not also an attorney, he or she must avoid acting in a fashion that could exist considered practicing law. However, knowing criminal revenue enhancement fraud legal definitions and IRS investigative procedures can assist CPAs avoid inadvertently complicating or hampering legal representation of the client.

SOURCES OF CRIMINAL INVESTIGATIONS

Investigations conducted by the IRS' Criminal Investigation Sectionalization (CI) are generated from various sources, but the largest source is IRS ceremonious examinations. Because the IRS cannot criminally prosecute every taxpayer suspected of having a willful intent to violate the IRC, other factors are oft evaluated in deciding whether to pursue a criminal prosecution. Generally, unmarried instances of wrongdoing will not upshot in criminal prosecution; rather, the government looks for multiple years of ongoing wrongful beliefs before it charges a taxpayer with a crime, as opposed to civil penalties. Office 25 of the Internal Revenue Manual (IRM) gives examples of indicators of fraud that, if uncovered during an exam, can trigger a criminal investigation or the assertion of a civil fraud penalisation. They include:

• Omissions of unabridged sources of income.

• Substantial unexplained increases in net worth, peculiarly over a menses of years.

• Substantial amounts of personal expenditures claimed as business expenses.

• Keeping two sets of books or no books.

• Amounts on render not in understanding with amounts in books.

• Backdating of applications and related documents.

• Assets placed in others' names.

Because an IRS field agent conducting a civil examination is under no obligation to inform a taxpayer when a case has been referred for criminal investigation, the commencement indication that a taxpayer is nether criminal investigation may come when an IRS special amanuensis requests an interview with the taxpayer. A taxpayer who is interviewed before he or she has obtained representation past a criminal attorney may make incriminating statements that can after exist used confronting him or her in a criminal prosecution.

Once a special amanuensis has been assigned to the customer'southward instance, the CPA should cease representation of the taxpayer. Representing a taxpayer in a criminal tax investigation requires specific knowledge and expertise that most tax advisers do non possess. Moreover, the revenue enhancement adviser may be considered a witness in the criminal investigation and be subpoenaed to testify against the taxpayer.

ACCOUNTANT-CLIENT PRIVILEGE Limited TO NONCRIMINAL MATTERS

Department 7525 extends the common-law attorney-client privilege to taxation advice furnished past a federally authorized taxation practitioner; however, it may exist asserted just in noncriminal tax matters. The IRS takes the position that the accountant privilege does not comprehend communications that took identify in the context of a civil proceeding that later becomes a criminal matter.

Furthermore, at least ane court has held that statements made by taxpayers during a civil test can afterward be admitted as evidence in a criminal case, even where IRS agents neglect to follow the IRM's instructions to suspend the examination and refer the case to the criminal division once a firm indication of fraud has surfaced. In U.S. 5. Rutherford, docket no. 06- 20207, E.D. Mich. (2007), rev'd and remanded, 555 F.3d 190 (sixth Cir. 2009), a ceremonious examination into a nonprofit's tax-exempt status quickly turned into an investigation of potential revenue enhancement fraud by the nonprofit's officers. Although the court agreed that the IRS civil agents probably should accept made a criminal referral sooner (which would have had the effect of putting the defendants on notice that the investigation was at present a criminal one), information technology did not bar the use of interview statements the defendants fabricated after that point but earlier it officially became a criminal investigation. The defendants were represented past a CPA when the interviews were conducted.

PROTECTING DOCUMENTS AND OTHER MATERIALS

A CPA should accept steps to protect any materials related to services rendered with respect to a client with a potential criminal matter. The taxpayer's attorney volition discover information technology helpful to know what documents have already been provided to the IRS, equally well equally the substance of any interviews. If the CPA has a document retention policy that calls for disposal of materials related to the matter, the CPA should consider extending the retentivity period for the materials. To the extent the CPA is performing services for the client through a Kovel organization, the CPA should expect to the chaser who has engaged him or her for direction regarding maintaining and retaining any materials related to the potential criminal matter. In a Kovel arrangement (named for U.Due south. 5. Kovel, 296 F.2d 918 (second Cir. 1961)) an auditor works direct for an attorney, profitable the chaser equally an interpreter of technical tax bug, enabling the attorney'due south rendering of legal advice (see "Attorney-Customer Privilege: CPAs and the East-Borderland," JofA, April 2004, folio 64).

ENCOUNTERING POTENTIAL FRAUD

Having effective client credence policies and procedures is an important office of the CPA's practice management. These policies and procedures should include that, when a CPA screens a new client, if any potentially criminal matters come up to light, the CPA should request that the prospective client engage the services of advisable legal counsel before commencement the engagement. Screening of a customer may include procedures such equally background checks and other data searches that would bring to the attention of the CPA relevant information concerning the prospective client'south business and personal affairs. To the extent the prospective client is unwilling to engage the services of legal counsel, the CPA should consider whether establishing the business concern human relationship is appropriate.

AICPA Argument on Standards for Tax Services (SSTS) no. 6, Cognition of Fault: Render Grooming and Authoritative Proceedings, provides that if a CPA believes a taxpayer could be charged with fraud or criminal misconduct, the CPA should advise him or her to consult with an attorney earlier the taxpayer takes whatsoever activeness. Additionally, you may need to consider whether to withdraw from the functioning of farther tax (or other) services for the customer and whether to continue a professional person or employment relationship with the client. The client should be enlightened of the demand to retain legal counsel and the potential lack of protection that is provided with respect to communications between you and the client. When you lot propose the client of the need to engage legal counsel, you lot should be aware that whatsoever advice made between you and the customer could be field of study to an investigative summons or 1000 jury subpoena.

A CPA may become enlightened of circumstances such as an mistake on a previously filed tax return of the client or of the customer'due south failure to file a required tax render. Such circumstances or others (see the indicators of fraud in the IRM) can arouse the suspicion of examining agents. Under SSTS no. vi, in these circumstances, a CPA should inform the client of the error or failure to file and recommend that cosmetic measures be taken. If the CPA believes the customer could face up possible exposure to allegations of fraud or other criminal misconduct, the CPA should suggest the client to consult legal counsel earlier taking any other activity.

A client who has committed tax fraud may be able to avert criminal liability past making a voluntary disclosure before the IRS has discovered the fraud. However, such a disclosure should be approached with caution and after obtaining the advice of legal counsel, since it can backlash and atomic number 82 to criminal prosecution (run across "Voluntary Disclosure to the IRS: A Viable Choice," JofA, March 2008, folio twoscore). The CPA may non inform the taxing authority of the error or failure to file without the taxpayer'due south permission, except when required by constabulary. If the client does non correct the fault, the CPA should consider whether to go on a professional person relationship with that client. If the CPA decides to maintain the client relationship and prepare a return for a twelvemonth subsequent to that in which the error occurred, the CPA should have reasonable steps to ensure the error is not repeated. If the subsequent year's return cannot be prepared without perpetuating the error, the CPA should consider withdrawing from the return preparation.

CPA LEGAL LIABILITY

Generally speaking, when a CPA is providing advice on behalf of a client with respect to a potential criminal matter, the CPA would not necessarily demand his or her own legal representation. In some instances, notwithstanding, based on the nature of the services the CPA previously performed for the client, it may be advisable for the CPA to engage separate legal counsel. The CPA should analyze the services that have been performed, along with understanding the provisions of the organisation with the client likewise as other concern arrangements, such as insurance coverage the CPA may have, when considering seeking the communication of legal counsel.

Editor'due south note: Portions of this commodity are adapted from Client Criminal Matters and the CPA: Practice Guide, developed by the author for the AICPA Tax Division, January 2011. The full guide is gratis to members of the AICPA Revenue enhancement Department.

How the IRS Defines and Prosecutes Tax Fraud

The most familiar tax offense is tax evasion under IRC § 7201. Taxation evasion is a felony, with a maximum sentence of five years in prison. The elements of revenue enhancement evasion are (1) a deficiency in tax, (2) an affirmative act or attempted act of evasion, and (iii) willfulness. An affirmative act of evasion means something more than a failure to perform a duty, such as file a render. An affirmative human action of evasion is conduct that has the probable effect of misleading or concealing wrongdoing. Willfulness requires the intentional violation of a known legal duty, every bit opposed to a careless condone for the truth or negligence. The test for willfulness in tax evasion is subjective rather than objective, and good faith reliance on the advice of a tax practitioner (subsequently complete factual disclosure to the practitioner) is a defense to the crime.

Where it may be difficult to prove the chemical element of a revenue enhancement deficiency beyond a reasonable dubiousness, the regime will ofttimes bring charges under section 7206(ane), for willfully making and subscribing to a false return, statement or other certificate, which also is a felony. Department 7206(i) sets along the post-obit elements for this law-breaking: (1) the willful making and subscribing to a render, statement or other document under penalties of perjury and (2) not believing it to be true and correct with respect to every material matter. The IRS likewise has authorization to investigate crimes arising under Championship eighteen of the U.S. Code, sections 1956 and 1957, which deal with money laundering, and Title 31 U.S.C. sections 5311 and following, the Bank Secrecy Deed.

To successfully prosecute a criminal taxation case, the authorities must prove its case beyond a reasonable doubt, whereas in a civil case, the IRS has to testify the instance only by articulate and convincing prove. From a factual proof standpoint, the chemical element of willfulness can exist the hardest to establish.

Ceremonious penalties. Notwithstanding, civil penalties may also arise from a instance that is investigated equally potential fraud, specially the fraud penalty of section 6663. The penalty amount is 75% of the portion of an understatement of tax attributable to fraud, but note that if any part of an underpayment of tax is due to fraud, the entire underpayment is presumptively owing to fraud, and the taxpayer bears the burden of proving otherwise (section 6663(b)).

Criminal investigations. The IRS' Criminal Investigation Division (CI) conducts an investigation and may recommend a case for prosecution. The example is then reviewed by the Tax Division of the Department of Justice (DOJ). If the Taxation Division authorizes prosecution, the prosecution will usually exist handled by the local U.S. attorney'due south office. In one case the example is referred to the Tax Partition, the IRS may non effect or enforce an administrative summons with respect to the taxpayer for the same tax and the same taxable catamenia. In circumstances where CI either cannot consummate its investigation or otherwise determines that information technology cannot effectively gather information through the administrative process, information technology may request that the Taxation Division authorize a k jury investigation.

EXECUTIVE SUMMARY

  Taxpayers may be subject to criminal prosecution for felonies including tax evasion under IRC § 7201 and filing false returns under section 7206. 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 department 6663 fraud punishment. The punishment amount is 75% of the portion of a revenue enhancement understatement attributable to fraud, with the taxpayer bearing the burden of proving that any part of an underpayment is non owing to fraud.

  Criminal cases are typically investigated past the IRS' Criminal Investigation Division. Cases are reviewed by the Department of Justice's Taxation Division, which may authorize a prosecution past a local U.S. attorney'south function or 1000 jury investigation.

  Criminal investigations oftentimes brainstorm as civil examinations in which omission of sources of income or substantial personal expenditures claimed as business expenses are "cherry flags" that may trigger a criminal referral. IRS field agents conducting a civil examination are not obligated to inform the taxpayer when a example has been referred for criminal investigation, and incriminating statements from a ceremonious exam tin can be used in a criminal prosecution.

  The tax practitioner privilege of customer confidentiality does not extend to criminal matters, and at least 1 court has held open-door in a criminal instance taxpayer statements made before a civil examination became a criminal investigation, even though examiners should accept made the criminal referral sooner.

  CPAs should have a certificate memory policy to preserve evidence helpful to a criminal defence. CPAs may also assist an chaser representing a client through a Kovel arrangement, interpreting technical tax problems 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 Taxation Services provide guidance for AICPA members in such situations. In some situations, the CPA may too need legal representation.

James H. Schlesser (jaschlesser@deloitte.com) is managing manager of Deloitte'southward U.South. India tax practise and a former member of the AICPA Tax Practice Responsibilities Commission.

To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at pbonner@aicpa.org or 919-402-4434.

AICPA Resource

JofA article

"Voluntary Disclosure to the IRS: A Viable Option," March 2008, page 40

Employ journalofaccountancy.com to discover past manufactures. In the search box, click "Open Advanced Search" and then search by title.

CPE self-study

Tips and Traps for Dealing With the IRS: From Offset to Stop (#753442)

Briefing

National Tax Conference, November. 7–8, Washington

Software

TaxInterest (#016566HS, unmarried user, #016571HS, multiuser)

For more information or to make a purchase or register, go to cpa2biz.com or call the Institute at 888-777-7077.

AICPA Revenue enhancement Eye

Statements on Standards for Tax Services, tinyurl.com/28oo7uh

The Tax Adviser and Tax Section

The Revenue enhancement Adviser is available at a reduced subscription price to members of the Taxation Section, which provides tools, technologies and peer interaction to CPAs with tax practices. More than 23,000 CPAs are Tax Section members. The Department keeps members up to date on tax legislative and regulatory developments. Visit the Taxation Center at aicpa.org/revenue enhancement. The current issue of The Tax Adviser is available at aicpa.org/pubs/taxadv.

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