When a Tax Case Turns Criminal.

Within the context of federal law, there is a distinct difference between lawful tax avoidance and willful tax evasion. Tax avoidance involves legitimately minimizing the amount of taxes owed under the Internal Revenue Code. Tax evasion, however, is the intentional and illegal nonpayment of taxes.

Under 26 U.S.C. § 7201, tax evasion is a federal felony. An individual or business convicted of tax evasion may face substantial monetary fines and up to five years of federal imprisonment for each count.

Is an Underpayment to the IRS per Se Criminal?

No. With this exception, the distinction between a civil and a criminal tax matter depends on the taxpayer’s state of mind. A mistake by the taxpayer does not generally constitute tax evasion.

The amount underpaid to the IRS does not, by itself, establish criminal tax evasion or support criminal tax fraud charges. For example, if a taxpayer makes an honest computational mistake, then, ordinarily, the IRS will address the underpayment through a civil tax proceeding rather than pursuing criminal prosecution.

How Often Do Taxpayer Mistakes Lead to Criminal Prosecution?

The IRS will take a taxpayer’s intent and history into consideration when deciding how to address suspected tax underpayment. For example, if a taxpayer has a clean record, is paying taxes on time, and makes an inadvertent mistake, the IRS will often resolve the issue through a civil assessment. The IRS will also consider whether the taxpayer has sought to avoid civil assessment.

Generally, the IRS will seek criminal tax prosecution in cases involving substantial underpayment, attempts to conceal evidence from the IRS, evidence of fraud, intentional or planned concealment of income, or involvement in illegal schemes.

Can Parallel Civil and Criminal Tax Proceedings Occur?

Yes. The U.S. Department of Justice (DOJ) or a U.S. Attorney’s Office can prosecute federal criminal tax cases in federal court while a related civil tax matter is pending. Conversely, a civil tax proceeding can occur while a criminal case is pending.

Does a Civil Tax Loss Bar Prosecution?

A civil tax loss is not always a bar to criminal prosecution. For example, even if the civil tax assessment is eventually discharged in bankruptcy, the government can still pursue criminal prosecution if it had the ability to recover its tax loss.

What makes an unpaid tax case criminal?

What Requirements Establish a Felony Tax Evasion Charge Under Section 7201?

To pursue a felony tax evasion charge under 26 U.S.C. § 7201, federal prosecutors must prove a taxpayer’s willfulness beyond a reasonable doubt. As discussed below, taxpayers can avoid liability for willfulness by demonstrating a lack of awareness of their tax obligations or that they made a good-faith effort to comply.

In addition to willfulness, prosecutors must also prove a tax deficiency and an affirmative evasive act. While some evidence of willful conduct may suggest a failure to pay taxes, this is not sufficient to establish criminal tax evasion.

How Does Federal Tax Fraud Differ from Felony Tax Evasion?

While civil fraud involves willfulness, it does not impose the same burdensome rules as felony tax evasion. In civil tax cases, the government’s burden of proof is lower than in criminal cases. In a criminal case, prosecutors must prove the defendant’s guilt beyond a reasonable doubt. In a civil case, the government need only prove a preponderance of the evidence, which means that more than 50 percent of the evidence supports the government’s claim.

When Do Federal Prosecutors Charge Taxpayer Errors as Felony Tax Evasion?

While many tax errors will not justify civil tax fraud charges, even fewer will warrant criminal tax fraud charges. The government will not generally seek criminal prosecution in cases involving:

• Honest mistakes,
• Good-faith efforts to determine tax liability and avoid underpayment,
• Passive tax avoidance or failure to pay taxes, and,
• Minor mistakes where the government’s loss is small.

What Is “Willfulness” in a Federal Tax Evasion Case?

Willfulness is the most complex element of a Section 7201 charge. Specifically, “willfulness” requires the government to prove that the taxpayer acted with the specific intent to evade his or her tax liabilities, that is, that the taxpayer knowingly and intentionally violated a legal duty he or she knew existed (i.e., the taxpayer did not have a bona fide belief that he or she did not owe taxes to the federal government). The U.S. Supreme Court has taken an unusually open approach to the concept of willfulness, notably holding that “a genuine misunderstanding of the law may nonetheless preclude a finding of willfulness,” and that this includes “a good faith misunderstanding of the law.” This exception allows taxpayers to assert their lack of tax knowledge as an effective defense to criminal tax fraud charges. While taxpayers’ confessions of willful evasion do happen, prosecutors can generally prove willfulness through the circumstantial evidence at hand.

Do Federal Prosecutors Treat Failure to Pay as Felony Tax Evasion?

Even when willfulness is present, federal prosecutors must still prove a tax deficiency and an affirmative evasive act. An affirmative evasive act is more than passive conduct. The U.S.When an individual or entity fails to pay taxes to the IRS, this alone does not constitute a positive act of evasion.

Generally, the government’s case will fail unless the defendant took a proactive measure to prevent tax payment or evade taxes, such as filing a return that purposefully understated income.

Is Failing to File a Tax Return Per Se Felony Tax Evasion?

Generally, the federal crime of felony tax evasion requires affirmative acts. In the case of, or failure to file a return, this does not per se amount to tax evasion, because filing a fraudulent tax return is the proactive effort. A person or entity that fails to file can still face prosecution in some circumstances, and the law also imposes misdemeanor penalties for failure to file a tax return in some cases.

Is There a Minimum Dollar Amount for Felony Tax Evasion Charges?

There is no published minimum dollar amount that the government uses for assessing criminal tax evasion under Section 7201. That being said, generally, only larger sums will support pursuing felony charges.

How does an IRS audit become a criminal case?

How Does the IRS Evaluate Potential Criminal Tax Liability?

Many taxpayers have been surprised to learn that the Internal Revenue Service (IRS) is one of the largest law enforcement agencies in the United States. As of fiscal year 2017, the IRS’s Criminal Investigation division employed roughly 2,200 special agents.

The IRS has a division known as the Office of Chief Counsel, which employs federal attorneys to counsel Revenue Agents, Revenue Officers, and Special Agents, to enforce federal tax laws, and to prosecute tax fraud cases.

What is an IRS Tax Examination?

A tax examination, also known as an IRS audit, is when IRS Revenue Agents examine a taxpayer’s returns in order to check for underpayment or fraud. While the IRS has an enforcement division that investigates potential crimes, Revenue Agents examine taxpayers’ returns in order to determine how much (if any) taxes the taxpayer owes, or if a civil penalty is warranted.

When Does an IRS Audit Become a Criminal Investigation?

IRS Special Agents conduct examinations of taxpayers suspected of committing federal criminal tax fraud. Most criminal tax investigations follow a civil examination. While civil examinations are often completed in a single meeting, they can last for months when fraud is a concern.

Revenue Agents can refer a taxpayer to the IRS’s Criminal Investigation division when “there is a firm indication” that the taxpayer has committed tax fraud, and the case also meets Criminal Investigation’s criminal criteria, which weigh the additional tax due to fraud, the flagrancy and significance of the conduct, public interest, and deterrent effect. Revenue Agents can consult with an IRS Fraud Technical Advisor if they are unsure whether to refer a taxpayer’s case to the IRS’s Criminal Investigation division.

IRS Form 2797 is the referral form that Revenue Agents use when they refer cases to Criminal Investigation. It specifies whether the taxpayers in question are individuals, businesses, or both, and provides details on the suspected offenses, including amounts underpaid.

If there are firm fraud indicators, a Revenue Agent may suspend a taxpayer’s civil examination and refer the case to the IRS’s Criminal Investigation division. The Special Agent who accepts the case will continue the investigation with a focus on proving criminal tax evasion charges.

Special Agents may also initiate tax fraud investigations when they receive allegations of federal criminal tax fraud from whistleblowers or when they become aware of criminal tax fraud through information about money laundering, drug trafficking, or other offenses.

What Happens When an IRS Special Agent Recommends Prosecution?

IRS Special Agents conduct thorough investigations, and it is not uncommon for a taxpayer’s case to take a year or longer to examine. If a Special Agent recommends prosecution, the Special Agent’s case file then goes to the IRS’s Office of Chief Counsel for a second level of review. If the Office of Chief Counsel concurs, then the case is then referred to the U.S. Department of Justice (DOJ) Tax Division.

IRS recommends prosecution to the Department of Justice Tax Division in Washington, D.C., which then reviews the referral. While prosecutors in Washington, D.C. usually refer cases involving federal criminal tax fraud to the appropriate U.S. Attorney’s Office for prosecution, the DOJ Tax Division can directly oversee prosecution when cases are unusually complex or high-profile.

Can I Use a Grand Jury Strategy for My Tax Defense?

A federal grand jury will determine whether there is probable cause to indict a taxpayer when criminal prosecutors in federal court seek an indictment. Prosecutors will present a summary of the government’s evidence to the grand jury. Unlike a trial, a grand jury is not adversarial in nature. In most cases, the prosecution will be the only side to present evidence to the grand jury. However, at the U.S. Attorney’s Office, prosecutors will usually ask defense counsel for an interview. If the defense counsel can convince the prosecutor that he or she has reason to doubt the prosecutor’s case, prosecutors can sometimes drop the case before reaching the grand jury.

What civil penalties can follow suspected tax fraud?

What Is “Clear and Convincing Evidence”?

The standard of proof for civil tax fraud is “clear and convincing evidence.” This is higher than the standard used in a civil tax assessment case, but lower than the standard used in a criminal case. Clear and convincing evidence is more than a preponderance of the evidence but less than proof beyond a reasonable doubt. The standard is met when “the evidence is strongly persuasive.”

In other words, while proving “clear and convincing evidence” is more difficult than proving “a preponderance of the evidence,” it is significantly less demanding than proving “beyond a reasonable doubt.”

What Are the Civil Penalties for Tax Fraud?

There are numerous civil penalties under the Internal Revenue Code that can apply in a tax fraud case, but the most common civil fraud penalty is the Section 6663 fraud penalty. A Section 6663 penalty is imposed on underpayments of tax that the IRS determines resulted from civil tax fraud.

If a penalty under Section 6663 is imposed, then the tax amount will include the unpaid tax amount, interest, and the Section 6663 fraud penalty. The Section 6663 fraud penalty is equal to “75 percent of the underpayment attributable to fraud.”

It is important to note that Section 6663 only applies to the “underpayment attributable to fraud.” If a taxpayer has liability that the IRS determines is attributable to something other than fraud, Section 6663 does not apply.

Are There Other Penalties That Can Apply?

Yes. When the IRS determines that any tax underpayment is attributable to negligence or a substantial understatement of income, the IRS may also impose a Section 6662 penalty. The amount of the Section 6662 penalty is “equal to 20 percent of the underpayment amount.”

What Is the Difference Between a Criminal Tax Penalty and a Civil Tax Penalty?

The primary difference between a criminal tax penalty and a civil tax penalty is that criminal tax penalties include the possibility of imprisonment. Civil tax penalties generally are monetary penalties that do not carry any likelihood of imprisonment.

While criminal punishment and civil liability can both result from the same conduct, the most significant difference is that an IRS civil tax assessment does not result in the loss of a taxpayer’s right to freedom.

When Do Taxpayers Face Civil Tax Liability?

Taxpayers generally face civil tax liability if the IRS determines that their underpayment was attributable to civil tax fraud or a substantial understatement of their tax liability.

How Is Civil Tax Fraud Proven?

Under 26 U.S.C. § 7454(a), the burden of proving fraud rests on the Secretary, and the courts require that fraud be proven by clear and convincing evidence. This means that for the IRS to successfully impose a civil fraud penalty, the government must prove the taxpayer’s underpayment resulted from civil tax fraud.

Under Section 6663(b), however, if the IRS provides evidence of “fraud upon any portion of an underpayment,” then “the taxpayer shall have the burden of proof by a preponderance of the evidence to show that the underpayment does not include an amount attributable to fraud.”

This is the point at which most people call a lawyer. Spodek Law Group takes federal criminal defense cases nationwide from its New York and Los Angeles offices.

What are the Penalties for Federal Tax Evasion?

The penalties for federal tax evasion depend on the charges that are brought against a taxpayer. If a taxpayer faces criminal tax fraud charges under 26 U.S.C. § 7201, the potential penalties include both monetary fines and federal imprisonment.

Under 26 U.S.C. § 7201, individuals found to be guilty of tax evasion may face a fine of “up to $100,000, or both.” 26 U.S.C. § 3571 provides for an individual felony fine of “not more than $250,000.” However, taxpayers found to be guilty of corporate tax fraud under Section 7201 can be fined “up to $500,000.”

In addition to fines and other financial penalties, individuals found to be guilty of criminal tax evasion can face a prison sentence of “up to five years for each count” of tax evasion.

How Often Do Taxpayers Serve the Five-Year Sentence for Criminal Tax Evasion?

While 26 U.S.C. § 7201 imposes a prison sentence of “up to five years” for federal criminal tax evasion, this is the statutory maximum, not the average sentence.

The actual prison sentence imposed in federal criminal tax fraud cases will depend on the factors considered when calculating the taxpayer’s federal sentencing guidelines sentence. One material factor is the amount of tax underpayment that resulted from the fraud. The Guidelines provide for longer sentences as the tax-loss amount increases.

The sentencing guidelines calculations are separate from the statutory maximum punishments. Additionally, other facts can both increase and decrease a taxpayer’s sentencing guidelines sentence. While federal sentencing guidelines calculations provide sentencing recommendations for each offense, these recommendations also take into account a taxpayer’s other federal crimes, if any, and previous criminal record. Thus, even if a taxpayer’s relevant tax conduct is limited to a single year, a sentencing guidelines calculation may involve aggregating other crimes, each of which can lead to a statutory maximum prison sentence.

Can a Taxpayer Face a Sentence to Prison or Incarceration for 26 U.S.C. § 7203 Charges?

26 U.S.C. § 7203 is a misdemeanor, and individuals who plead guilty to or are found to be guilty of this charge can face the possibility of imprisonment as well. In cases in which federal criminal prosecutors pursue a taxpayer under Section 7203 for fraud, criminal prosecution typically involves a sentence of up to one year.

How Long Can Federal Tax Exposure Remain Open?

Under Section 6501 of the Internal Revenue Code, IRS Revenue Agents generally cannot go back more than three years to seek an additional tax assessment. However, if a taxpayer files a “false or fraudulent return with intent to evade or defeat tax,” then the IRS is permitted to seek the underpayment “at any time.” When a taxpayer does not file a return, Section 6501(c)(3) provides that “the limitation period does not apply.”

What Are the Limitations Period Rules for Criminal Tax Evasion?

For criminal tax fraud offenses, Section 6531 applies. For federal criminal tax evasion prosecution to proceed, prosecutors must prove that the offense occurred within the six-year statute of limitations period. The expiration of the statute of limitations period for criminal tax fraud does not automatically eliminate a taxpayer’s unpaid federal tax liability or eliminate civil tax fraud exposure.

While criminal tax fraud prosecution is generally time-limited, civil tax liability from underpayment and potential civil tax fraud prosecution remain possible for longer periods.

What Is the IRS Collection Period?

Under Section 6502, the IRS generally has ten years after making a tax assessment to pursue collection for unpaid federal taxes.

What Are the Limitations Period Rules for Evasion of Payment?

Federal prosecutors can seek criminal prosecution for attempts to evade the government’s collection of already-assessed tax liability. Because evasion of payment is a continuing offense, the limitation period runs from “the date of the last affirmative evasive act.”

When is Tolling Allowed?

Section 6502(b) provides that tolling agreements and extensions to statutes of limitations are permitted. However, tolling generally applies to civil assessments, while extensions generally only apply to individuals who are filing for an extension at the time of filing.

Toll the six-year criminal statute of limitations can only be used to extend the government’s window for pursuing criminal prosecution if:

• The suspected fraud occurred outside the United States,
• The suspect is a fugitive or fleeing prosecution, or,
• The suspect is actively evading prosecution.

Notably, the statute of limitations period does not apply to the offense of federal criminal tax fraud if the conduct falls outside the federal criminal statute of limitations period.

What should I do if criminal exposure is possible?

Q: Should I Attempt a “Voluntary Disclosure” with the IRS?

If you suspect that you may be facing federal criminal tax fraud prosecution, you may have the option of attempting to voluntarily disclose your tax fraud to the Internal Revenue Service (IRS). At the IRS, voluntary disclosure is the process of approaching the government before the government determines that you may have committed a federal criminal tax fraud offense. When you approach the government through an IRS voluntary disclosure, you run the risk of the government not providing immunity. With that being said, you also run the risk of IRS Special Agents reaching out to you and initiating an investigation. As a result, if you are considering attempting a voluntary disclosure, it is important to discuss this option with an experienced federal tax evasion defense attorney before you do so.

Q: Can I Assert My Fifth Amendment Privilege Against the IRS?

If you are in custody, your Fifth Amendment privilege against self-incrimination generally applies. This privilege also applies if you are questioned by the IRS. With that being said, if you are facing questioning by the IRS, you will need to assert your Fifth Amendment privilege question-by-question. You cannot invoke your Fifth Amendment privilege and then voluntarily provide answers to some of the questions you are asked.

While the Fifth Amendment protects your right to refrain from providing truthful testimony, it is important to note that this is very different from compelling you to produce preexisting records. Federal courts have long held that the Fifth Amendment does not protect you against being compelled to produce records that were produced and kept independently of the government’s request.

Q: Is there a Privilege Against the IRS for Communications Between a Taxpayer and His or Her CPA?

Generally, no. Communications with a CPA who serves as a tax preparer do not fall under the attorney-client privilege, and they do not fall under a privilege for the CPA’s status as a licensed professional. While Section 7525 of the Internal Revenue Code contains a privilege that generally prohibits the IRS from disclosing communications between a taxpayer and their tax return preparer in civil tax matters, the provision does not apply in cases where federal criminal prosecution is pursued.

Q: Can I Invoke the Privilege for Communications Between a Taxpayer and Tax Preparer in Criminal Tax Fraud Cases?

No. Under Section 7525, taxpayers cannot rely on a privilege to protect communications with their tax return preparer in cases involving federal criminal tax fraud. The purpose of Section 7525 is to preserve the confidentiality of tax return preparers’ records in civil tax matters. However, in criminal tax fraud cases, the government is entitled to seek and use communications between taxpayers and their tax preparers.

Contact a Federal Criminal Defense Attorney

Nothing here is legal advice, and the details of your case matter. Todd Spodek and Spodek Law Group take federal criminal and white collar cases nationwide, from offices in New York, Brooklyn, Queens and Los Angeles. You can reach the firm at 212-300-5196.