Procedure & Administration

Tax Practice and the Federal Criminal Code

Although criminal prosecutions of taxpayers and practitioners are relatively rare, it is important for practitioners to be aware of the basic criminal offenses that can apply in tax cases. This article discusses elements of these offenses and provides examples from cases of the types of activities to which they apply.

Arlene M. Hibschweiler, MBA, J.D.
Lecturer
University at Buffalo
Buffalo, NY

For more information about this article, contact Ms. Hibschweiler at ah33@buffalo.edu.

EXECUTIVE SUMMARY

Only a small percentage of the taxpayers who file returns or conduct other business with the IRS ever face criminal prosecution. For example, in fiscal year 2007, only 1,780 criminal investigations were initiated across the entire country.1 Nevertheless, because the consequences of a criminal tax action can be so severe, basic knowledge of the crimes that can apply in tax cases is important for any practitioner. This requires an understanding not only of the criminal parts of the Internal Revenue Code but also of some sections of Title 18 of the U.S. Code.

Title 18 covers federal penal law and includes, among others, sections targeting false claims, false statements, and conspiracies. Case law makes it more than clear that taxpayers, and also accountants doing tax work, can be prosecuted and convicted under these provisions.2 In some cases, such as perjury (18 USC Section 1621) and filing a false tax return (Sec. 7206(1)), for example, acts punished by Title 18 are similar to behavior made criminal by the Internal Revenue Code. However, in other situations, Title 18 provisions considerably expand the reach of prosecutors.3 All of this means that tax practitioners concerned about a potential criminal matter need to know federal tax law and federal penal law.

This article examines some of the Title 18 sections particularly relevant to tax practice. It describes the conduct the section punishes and discusses cases involving taxpayers and accountants. The article includes a description of some warning signs designed to help practitioners recognize criminal law issues and offers advice for CPAs, including comments on the Statements on Standards for Tax Services (SSTS).4 While not a guarantee, compliance with the statements can help practitioners reach decisions that are both professionally responsible and legally correct.

False Claims Against the Government (18 USC Section 287)

Under federal law, a person who makes a false claim against any agency or department of the U.S. government has committed a felony. The maximum sentence under 18 USC Section 287 is a fine and five years in prison, although the actual punishment is likely to be affected by the federal sentencing guidelines.5 Section 287 targets false, fictitious, or fraudulent claims, but in tax cases it has been used even where there was no proof that the return was technically inaccurate. In Kercher, for example, a defendant was convicted when he filed returns without the authorization of the taxpayers.6 The court held that the documents were false because the defendant did not have permission to submit the returns in question.7

To obtain a conviction under Section 287, the government must show that the defendant knowingly made a claim against the U.S. government or one of its agencies or departments, with knowledge at the time of submission that the claim was false, fictitious, or fraudulent.

Submission of a Claim Against the United States

Case law has defined a “claim” as a demand for money or transfer of public property.8 Submitting a claim includes cashing a tax refund check obtained fraudulently.9 This provision has been used to target not only the actual taxpayers who have submitted false information to the IRS10 but also accountants involved in fraudulent tax schemes. For example, in Rappaport,11 an accountant was convicted after masterminding a plan by which he and others obtained tax refunds amounting to approximately $813,400. The refunds were paid in connection with 81 separate returns that reported fictitious employment and tax withholding information.

Courts have upheld convictions under Section 287 in cases in which defendants were indirectly involved in the submission of a claim. This would apply, for example, where an individual presented information to an intermediary who in turn submitted a claim to the federal government. Jury instructions for this theory discuss the rules for aiding and abetting, under which a defendant who willfully causes another to perform an illegal act is punishable as a principal.12 In Tilford,13 for instance, an accountant pled guilty to an aiding and abetting charge under Section 287. Tilford engaged in various tax fraud schemes, including creating false documents and helping persons file false tax returns electronically. The tax documents were used to obtain refund anticipation bank loans, the proceeds of which were divided between Tilford and the person named on the return.

Filing a false tax return that fraudulently shows the taxpayer is entitled to a refund has been treated as making a claim against the United States.14 However, merely filing a false return that underreports a defendant’s tax liability apparently is not sufficient to trigger prosecution under this provision.15

False, Fictitious, or Fraudulent Claims

To obtain a conviction under Section 287, the government also must show that the claim filed by the defendant was “false, fictitious, or fraudulent.” There is a difference of opinion among courts on the interpretation of these terms. Some courts have held that a claim is “false” if it is untrue when made, while a “fictitious” claim is one that is not real or does not correspond to what actually occurred.16 However, other courts use “false” and “fictitious” interchangeably and hold that the government only must prove the claim was untrue when made or used.17 In any case, in order to be convicted, defendants must have acted “knowingly.” This means that they acted voluntarily and intentionally, and not by mistake or carelessness.18 It is not necessary to show that defendants knew their actions were criminal, as long as they were aware at the time that the claim being made was false or fictitious.19

In prosecuting a fraudulent claim, the government must show that the defendant had a specific intent to deceive20 in order to obtain money or property from the United States or one of its agencies or departments.21 Preparation of false documentation to support a claim for a tax refund has been treated as fraudulent. It is not necessary to show that the government actually relied on the material the defendant submitted.22

Courts have reached conflicting results when considering whether a false, fictitious, or fraudulent claim being prosecuted under Section 287 must be proven to be material.23 The issue has not yet been considered by the Supreme Court. Where materiality is required, the statement must be shown to relate to an important fact or must have the potential to affect or influence a government function. Actual reliance on the statement need not be proven.24

Conspiracy (18 USC Section 371)

The conspiracy statute is frequently used to prosecute tax professionals, including CPAs, involved in evasion or other fraudulent tax schemes.25 A conviction carries a maximum sentence of five years, plus a fine, although the punishment will be less where the object of the conspiracy was to commit a crime classified as a misdemeanor rather than a felony.26 A conspiracy charge involving an attempt to evade or defeat taxes is subject to a six-year statute of limitation. This means the prosecution must begin within six years of the last affirmative act taken by the conspirators to accomplish their goal.27

A conspiracy can be thought of as a “partnership in crime.”28 More specifically, it involves an agreement between two or more persons either to commit an offense against the United States or to defraud the federal government.29 Both theories have been used in prosecutions involving tax cases. For example, in Johnson,30 the defendants were moonshiners who sold untaxed whiskey to federal agents masquerading as liquor buyers. Johnson, his wife, and three others were convicted of various charges including conspiring to violate federal alcohol tax laws. By comparison, the prosecution in Larson31 relied on a conspiracy-to-defraud theory. Larson, an accountant, was part of a scheme that sought to avoid reporting income by hiding assets in sham trusts. Although Larson’s clients retained full control over trust assets, they nonetheless failed to report the income that those assets generated, in violation of the grantor trust rules. Larson prepared false tax returns, opened accounts, set up trusts, and was involved in recruiting clients. The plan ultimately resulted in a tax loss to the federal government of at least $2.6 million.32

To obtain a conspiracy conviction, the government must prove that two or more persons entered into an unlawful agreement that the defendant knowingly and willfully joined. It must also be shown that one of the conspirators knowingly committed an overt act that in some way furthered one of the conspiracy’s goals.33 A conspiracy charge is separate from the substantive crime the agreement was designed to commit.34 In other words, in a tax scheme a defendant may be charged with both evasion and conspiring to evade. Acquittal on one of the counts does not bar conviction on the other.35 For example, in Klein,36 defendants were convicted of conspiring to obstruct the Treasury Department’s collection of revenue, although at trial the judge directed verdicts of acquittal on the separate charges of evasion.

Existence of an Agreement

No formal agreement is necessary for a conspiracy; it is enough for the government to show that some sort of mutual understanding existed between two or more parties.37 A defendant cannot be convicted where the only other person in the scheme was a federal agent.38 However, some courts have held that a conspiracy charge is proper in a case involving a corporation conspiring with one or more of its officers.39 A defendant need not be aware of every detail or phase of a plan in order to be found to have participated in an unlawful agreement.40 Nonetheless, the existence of an understanding, at some time during the course of the criminal conduct, is critical. Otherwise a defendant who assists in unlawful activity is more properly charged with aiding and abetting.41

Membership in the Conspiracy

Membership in a conspiracy means a defendant knowingly, willfully, and voluntarily participated in the scheme, with knowledge of its unlawful purpose and a specific intent to further its objectives.42 A financial interest in the plan is not required but can be considered as evidence of a defendant’s membership. A defendant need not know every other co-conspirator or be aware of all their activities.43 Further, the degree of  participation is irrelevant—meaning, for example, that a defendant who plays a minor role in a tax evasion scheme by preparing several false documents still could be convicted of conspiracy.44 However, mere knowledge of a plan is not enough for a conviction; actual participation is required.45

Sometimes prosecutors in conspiracy cases rely on a theory of “conscious avoidance” to prove knowledge. For example, in Gurary,46 the defendants were charged in connection with a scheme to sell false invoices to corporations, which used the documents to reduce taxable income by inflating the cost of goods sold. On appeal, the defendants argued that they had no reason to believe the false invoices were being purchased in order to commit tax crimes, since they claimed that such documents are used in the garment industry routinely for other purposes. However, this argument was rejected on appeal. The court noted that the depth of the scheme, which encompassed an eight-year period and involved over $136 million in invoices, served as indirect evidence that the defendants knew their plan would result in the filing of false tax returns.47

Courts have held that reliance on the advice of counsel does not preclude a finding of willfulness sufficient to support a conspiracy conviction. In other words, a defendant aware that a plan is illegal cannot avoid prosecution simply by getting a favorable legal opinion.48 However, the advice of a professional can be considered in determining if a defendant acted willfully.49 This raises the prospect of a client attempting to defeat a conspiracy charge by claiming to have relied on a CPA’s advice. For example, in Meneilly,50 a taxpayer was convicted of conspiracy and tax crimes despite arguing that he had relied on the advice of his accountant. The court found that the claims were not supported by the evidence, basing its conclusion in part on the accountant’s testimony to the effect that he did no more than use the data the taxpayer supplied.51

Caution: All of this points to the importance of careful record keeping by CPAs when giving advice or performing tax services of any kind.

Commission of an Overt Act in Furtherance of the Agreement

The charge of conspiracy requires commission of at least one overt act by at least one of the conspirators.52 A defendant who did not personally commit the act alleged in the indictment still can be convicted as long as one member of the conspiracy knowingly performed the action in question.53 This is true even if the action was taken outside the defendant’s presence and without his knowledge.54 An act can be used against a defendant even though it occurred before she became a party to the illegal agreement.55 However, the action must have been performed while the conspiracy still existed.56

The overt act required for conspiracy purposes need not be illegal. Common and otherwise innocent activities such as meetings and conversations can be sufficient.57 However, the action must have been knowingly and willfully performed in order to advance some purpose of the agreement.58 In tax cases, the overt act may consist of filing or preparing false returns or documentation. It is not necessary to show that the conspiracy caused a financial loss to the government.59

Defenses

Impossibility is not a defense to a conspiracy charge. This means that defendants still can be convicted of conspiracy even though it was not possible for them to execute their plan successfully.60 Withdrawal is a defense, since it negates membership in the agreement. However, affirmative action to renounce the conspiracy or defeat its purpose is required in order to make this argument; otherwise a defendant is presumed to belong to the conspiracy until its last overt act is committed.61 In Nowak,62 for example, the Seventh Circuit ruled that an attorney’s actions in terminating his legal representation were insufficient to constitute withdrawal from a conspiracy. In order to be effective, withdrawal must occur before the purpose of the conspiracy has been accomplished.63

Merely stopping activity, as where a tax adviser resigns his or her employment, does not constitute withdrawal.64 Good faith is also required in order to raise this claim. For example, in Ingredient Technology Corp.,65 a withdrawal argument was held to be unwarranted where the taxpayers dropped their plan only after being discovered by auditors.

Perjury (18 USC Section 1621)

Commonly thought of as “lying under oath,” perjury includes not only giving false testimony but also submitting documents that contain materially false information. Perjury is a felony, punishable by a fine and up to five years in prison.66 A person who files a false tax return could be prosecuted under this section of the criminal law or under Sec. 7206(1). The maximum prison sentence for a conviction under Sec. 7206 is only three years, instead of the five applicable to perjurious conduct under Section 1621. However, the rules of evidence allow only certain tax cases to be prosecuted under Section 1621.67

Oath

To establish perjury, the government must show that the defendant either took an oath to testify truthfully or submitted written information under penalty of perjury that was subscribed as true.68 The fact that the testimony or submission may have been compelled by law or subpoena is irrelevant because the Fifth Amendment privilege against self-incrimination allows a person to remain silent but does not protect those who provide false information.69 All U.S. tax returns are submitted under penalty of perjury.70

Falsity

To obtain a conviction, the government must show that a statement made by a defendant, or the written information he or she submitted, was false.71 A determination of truth or falsity is based on the facts as they existed at the time the offense allegedly occurred.72 Where several statements or items are being considered, a jury must unanimously conclude that at least one particular piece of information is false.73 In other words, a perjury conviction based on an individual tax return would be improper where some jurors felt that a medical deduction was overstated while others found instead that income had been underreported.74  Information that is literally true cannot be the basis for a perjury conviction, even if it is unresponsive to what was requested or intentionally misleading.75

A “two-witness” rule applies to perjury prosecutions under Section 1621. This means that the falsity of the statement made or document submitted must be established by two witnesses or by one witness and other corroborating, independent evidence.76 In a tax case, the testimony of a bookkeeper familiar with a defendant’s business, in combination with independent accounting records, could be sufficient to support a conviction. The two-witness rule does not apply, however, where the accusations concern statements made by the defendant about her own state of mind.77 This would be the case, for example, where the government is trying to show that a taxpayer who claimed under oath that she could not recall a specific business transaction in fact did remember the details about which she was being questioned.

Materiality

A defendant can be convicted for false testimony or a false document only if the matter giving rise to the allegation was material.78 A statement is material if it has a tendency to influence or is capable of influencing an agency or court’s decision. Proof that the statement actually had an effect is not required.79 In tax cases, it is also not necessary to show the false information related to the defendant’s own return. For example, in Eckhardt,80 a tax shelter promoter who made false statements both in a deposition and before the Tax Court was charged with perjury. Eckhardt had accepted money from clients in connection with a tax shelter involving cattle, whereby loans to purchase livestock were to be taken out in the names of investors, with the animals serving as collateral. However, Eckhardt actually used the funds for other purposes. He then went to considerable lengths to hide the deception after his clients filed a case in Tax Court contesting the IRS’s decision to deny the farm losses and investment credits they had claimed.

Willfulness

Finally, to obtain a perjury conviction the government must show that the false statements or false documents were provided willfully.81 This has been interpreted to require proof that the defendant knew the information was false. Evidence of an evil motive is not necessary.82Important to tax cases, which may involve defendants attempting to navigate laws with which they are unfamiliar, willfulness does not include information provided because of a mistake or faulty memory.83 Circumstances surrounding a defendant’s acts, as well as possible motives, can be considered as evidence of willful intent.84

False Statements (18 USC Section 1001)

18 USC Section 1001 applies where a defendant knowingly and willfully makes false statements to the federal government or submits false documents. Unlike perjury, it is not necessary to show that the material was provided under oath. This means that false information provided to IRS agents in the course of a tax investigation could be prosecuted.85 A defendant who makes false statements in response to government questions, where truthful answers would be incriminating, is not protected under the Constitution.86 In Brogan, the Supreme Court ruled that Section 1001 applies to any false statement, including a denial.87 The majority held that the Fifth Amendment does not confer a privilege to lie to federal officials.88

A taxpayer can be pursued under Section 1001 in addition to being charged with a tax crime under the Internal Revenue Code. For example, in Secor,89 a defendant was convicted for attempting to evade taxes, in violation of Sec. 7201, and also for making false statements, because of answers she gave in response to IRS inquiries.A fraudulent tax return could be prosecuted as a false statement under Section 100190 or under Sec. 7206(1), which is applicable to false statements filed under penalty of perjury. Although Section 1001 provides for a longer maximum prison sentence,91 it is subject to a five-year statute of limitation.92 The period of time within which a Sec. 7206(1) prosecution must be brought is six years.93

False Statement or Document; Concealment

A defendant who makes a material statement that is false or fraudulent has violated 18 USC Section 1001, assuming the other elements of the statute are satisfied. The representation, which need not be written,94 is false if it was untrue when made.95 “Fraudulent” means a defendant intended to deceive; it is not necessary to prove the existence of a plan to deprive the government of money or property.96 In either case, materiality must be established.97 This has been defined by the courts to mean that the statement naturally tended to influence or was capable of influencing the government’s actions.98

The false statements provision also applies where a material fact is concealed. Concealment means a defendant took affirmative steps to hide information he or she was required to disclose.99Use of some sort of trick or scheme is required, as where a taxpayer deliberately structures a currency transaction to avoid reporting requirements applicable to cash transfers of $10,000 or more.100 Mere nondisclosure of information required to be reported does not constitute a violation of this provision.

Knowing and Willful Conduct

The false statement statute applies only where a defendant’s conduct in making a statement, concealing information, or another similar action was knowing and willful.101 Similar to Section 287, prohibiting false claims, the courts have defined the term “knowing” under Section 1001 to mean an action was done purposefully and voluntarily. In other words, it was not the result of a mistake or accident. An act is willful if done with the intent to do something the law forbids, or with a bad purpose to disobey legal requirements.102 In concealment cases, the government must show that the defendant had a specific intent to not do what the law required to be done.   

Reliance on the advice of an expert is often raised to refute the government’s proof of the necessary intent. In order to use this argument, a defendant must show that she disclosed all relevant facts to the expert and relied in good faith on the advice received.103 In Smith,104 a defendant charged under Section 1001 in connection with a Medicare scheme claimed that he depended on his CPA when signing the documents at issue. However, the court found that the defendant knew the forms were inaccurate and therefore could not have relied in good faith on the accountant’s work. Claimed negligence on the part of the CPA in failing to discover the irregularities was not relevant to whether Smith acted willfully and with knowledge.

Jurisdiction of the Federal Government

Section 1001 applies only to matters involving the federal government. For example, a taxpayer who submits false information to a state in order to avoid paying a sales or use tax would not be prosecuted under this provision.105 Statements or documents provided to the IRS are considered to fall under federal jurisdiction.106 However, practitioners should bear in mind that false statements made to a state are generally punishable under state law.

Mail and Wire Fraud (18 USC Sections 1341, 1343)

Although property crimes often are thought of as involving state law, the federal government can prosecute persons who commit frauds using the mail, an interstate carrier, or interstate wires, such as the telephone system. Under 18 USC Section 1341, a person who receives or sends mail as part of a scheme to defraud or obtain assets by means of false statements and similar actions is guilty of a felony and subject to a fine and up to 20 years imprisonment.107 A similar rule applies to plans involving the use of interstate wire, radio, or television communication.108 Both mail and wire fraud can be raised in tax cases. For example, among other charges, the late Leona Helmsley was convicted of 10 counts of mail fraud for underreporting New York state tax liabilities.109 Helmsley’s troubles stemmed from a scheme devised to charge personal expenses to business entities she or her husband owned or controlled.110

Plan to defraud: Both mail and wire fraud require proof of a scheme to defraud through materially false statements. This has been defined as the use of a plan to obtain money or property through false or fraudulent pretenses.111 A false representation includes one that was known to be untrue when made,112 while a fraudulent statement is made falsely with intent to deceive.113 The failure to disclose information, where a defendant is under a legal or professional duty to speak, also can be treated as fraudulent.114 In all cases, the misrepresented information must be material, meaning something expected to be of concern to a reasonable and prudent person.115

Mail and wire fraud both are prem-ised on the intent to deprive the victim of property or money.116 In Czubinski,117 the defendant’s conviction on nine counts of wire fraud was reversed on appeal. Czubinski was an IRS employee who used his access to Treasury computers to investigate personal friends and acquaintances, including browsing the tax return of a woman he had dated.118 The court held that merely accessing confidential information, without more, did not deprive the IRS of property for purposes of wire fraud.119 However,  governments do have a property interest in uncollected revenue, meaning that the mail and wire fraud statutes are applicable where federal or state taxes are unpaid because of fraudulent schemes.120

Intent

Intent under the mail and wire fraud provisions is defined in much the same way as in other criminal statutes. Courts require that a defendant act knowingly, meaning voluntarily and deliberately.121 In addition, the government must prove the defendant acted willfully, defined as purposely and with a bad intent to disobey or disregard the law. This does not mean that proof is required that the defendant intended to commit a crime. For example, in Porcelli,122 the defendant’s mail fraud convictions were premised on a scheme involving fraudulent state sales tax returns. The convictions were upheld even though the state imposed only civil and not criminal sanctions for the violations at issue.

For mail and wire fraud convictions, there must also be proof of specific intent to commit fraud. A defendant who acted in good faith, with an honest belief as to the truthfulness of the representations he or she made, cannot be convicted.123 Consulting an expert, such as a CPA in a tax case, can be viewed as evidence of good faith.124

Use of the Mails or Wires

In a mail fraud case, it must be shown that material was sent through the U.S. Postal Service or by a private or commercial interstate carrier in furtherance of the scheme. The mailed item does not itself have to be fraudulent as long as it advances the plan. In addition, the government need not show that one of the defendants involved in the scheme personally mailed the item at issue.125 For example, in Mangan,126 an IRS agent and his brother filed false income tax returns on behalf of other taxpayers as part of a plan to obtain improper refunds. The appellants challenged their convictions under 18 USC Section 1341, in part based on the lack of evidence at trial that they used the mails to file the tax forms in question. However, the court found sufficient evidence that the refund checks were mailed and that this mailing was caused by the fictitious returns the scheme generated. Mailings mandated by law also satisfy this element of the statute. In Helmsley,127 the appellate court rejected the argument that required tax mailings cannot serve as the basis of a mail fraud conviction.

Similar principles apply to wire fraud cases. However, Section 1343 expressly requires evidence that the wire communication passed between two states or between the United States and a foreign country. Wire communication can include telephone calls, a wire transfer of funds, or use of the internet. 128

Advice for the CPA

In almost all situations, CPAs themselves will not face prosecution under Title 18 in connection with tax services offered to clients.129 This is because most of the statutes require some showing of knowledge or a deliberate intent to commit wrongdoing. Where CPAs are following professional guidance in their tax services, such as by observing the principles contained in the SSTS, the required intent almost certainly will be lacking. For example, under SSTS No.1, Tax Return Positions, a CPA can recommend a position on a tax return if he or she has a good-faith belief that the position has a realistic possibility of being sustained on the merits. A position not meeting this standard can still be recommended if it is not frivolous and the CPA recommends appropriate disclosure. Adherence to these principles would preclude a finding that the accountant intended to use the mails in a tax fraud scheme—for example, as would be required for a prosecution for mail fraud.

Although conviction of the CPA may not be likely, involvement with clients who may be engaged in criminal matters is risky for many reasons. For example, federal investigators almost certainly will examine the CPA’s conduct, even where it ultimately is shown that the accountant was unaware of the illegal scheme a client used to avoid tax payments. This may mean that the CPA will be required to retain legal counsel and spend time responding to investigator requests. Prosecution of a client for criminal tax violations is likely to generate unfavorable publicity for the CPA’s practice and may mean that he or she will be required to testify in court, an experience most accountants would prefer to avoid. In addition, a criminal action may jeopardize a client’s ability to pay the CPA for services, as courts are authorized to impose fines under all the statutes discussed in this article and the client is likely to be incurring significant legal and other expenses.

CPAs should therefore be very careful when providing tax services to clients whose conduct raises doubts in the accountant’s mind. Warning signals that may indicate potential trouble include transactions that do not appear to make good business sense or situations in which the documentation does not support what the client is reporting to the accountant.130 Other signs include the use of cash where checks or other forms of payment that would create a paper trail would be expected or complex transactions that the accountant does not fully understand. In these cases, CPAs should observe all the guidance of the SSTS. It is extremely important for them to thoroughly document what they know regarding client transactions and the basis, including statutory and other authority, on which they give advice.

Finally, a CPA must consider withdrawal under SSTS Nos. 6, Knowledge of Error: Return Preparation, and 7, Knowledge of Error: Administrative Proceedings. Both of these statements require a CPA to consider withdrawing from an engagement in which a taxpayer who has been advised of the problem refuses to take corrective measures. Although the pressures of maintaining a practice may make it difficult to surrender a client, the decision to sever the relationship may ultimately be to the CPA’s advantage both professionally and financially.

Conclusion

Although perhaps not common, prosecutions under Title 18 can have serious consequences, including fines, prison, and, for a CPA, loss of license.131 Familiarity with the statutes discussed in this article is therefore important both for practitioners themselves and for their clients. Although adherence to SSTS guidance is extremely useful, a tax accountant also should be mindful of the Title 18 provisions. A criminal prosecution of a client, while not likely to be as devastating as an action against the CPA, can also be damaging to the practitioner.

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