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Can Your Tax Client (or You) Tax advisers should be aware of what actions are criminal and how crimes are prosecuted. Part II of this two-part article discusses Federal criminal procedure, sentencing rules and steps a CPA can take to guard against prosecution. Arlene M. Hibschweiler, Esq.,
J.D., MBA For more information about this article contact Ms. Hibschweiler at ah33@buffalo.edu.
Executive Summary
This two-part article highlights the most common substantive and procedural issues a CPA needs to know about crimes under the Internal Revenue Code. Part I, in the April 2006 issue, described the basic elements and consequences of these crimes. Part II, below, discusses current Federal criminal procedure and sentencing rules, and steps CPAs can take to protect against criminal investigation or prosecution. Overview of Criminal Procedure When considering the possibility of a criminal prosecution against a client or even a CPA, it is helpful to understand, at least on a rudimentary level, the process leading to a criminal conviction. For example, under Sec. 6531, the statute of limitations for tax evasion, failing to file or pay, filing false or fraudulent returns or other documents, and assisting in filing false returns, generally is six years from when the offense was committed. When a false return is involved, the six-year period starts on the later of the date the return was filed or its due date. 61 Constitutionality of Federal Sentencing Guidelines Criminal cases can be resolved through a trial or plea agreement. In either situation, a defendant convicted of tax crimes is likely to be affected by the Federal Sentencing Guidelines (Guidelines).62 The Guidelines provide a range of punishment, which generally depends on a defendant’s past criminal history and, in tax cases, the loss involved in the scheme. The Guidelines were declared unconstitutional in Booker,63 a 2005 Supreme Court decision. In the case, a fractured Court majority pointed to the Sixth Amendment right to a jury trial, meaning that the statutory maximum sentence must be based solely on facts as reflected in a jury’s verdict or admitted to by a defendant. The Court found this requirement was violated by the Guidelines’ scheme under which a defendant’s punishment can be enhanced for “relevant conduct.” In Booker, the defendant was convicted at trial of possessing 92.5 grams of cocaine base, commonly referred to as “crack.” However, his punishment was enhanced under the Guidelines, due to a post-trial sentencing proceeding conducted without a jury, during which the trial judge found Booker had actually possessed far more crack and also had obstructed justice. This mandated a sentence of 360 months to life. However, based on the jury’s verdict alone Booker faced a term of between 210 and 262 months in prison.64 The effect of Booker remains unclear. In its ruling, the Supreme Court found the Guidelines would satisfy Constitutional requirements if they were merely advisory, rather than mandatory in nature. As a result, the majority deleted the statutory language requiring judges to follow the Guidelines. It ruled that sentencing courts should consider the Guidelines’ ranges, but also take into account other factors when determining punishments to be meted out to defendants.65 Discussions have erupted in Congress and elsewhere about a legislative fix that would reinstate a system to reduce judicial discretion and disparity in sentencing across the country.66 It is not clear whether any Congressional action will ever result however. Application of Guidelines Even though they are now advisory only, the Guidelines continue to be relevant to taxpayers facing potential criminal action. Example: A taxpayer with no prior criminal history was convicted after a trial of tax evasion, based on a scheme that caused a tax loss of $45,000. According to Sec. 7201, evasion is punishable by a fine of up to $100,000, a maximum of five years in prison or both. However, the Sentencing Guidelines result would be 15 to 21 months,67 plus a fine that also would be determined per the Guidelines’ calculations. 68 The result could be further reduced in some cases, depending on the facts. For example, under Section 3E1.1 of the Guidelines, in pleading guilty to a crime, defendants are generally entitled to a reduction in the severity of their sentence because they have “accepted responsibility” for their criminal actions.69 Whatever the result, under Booker the sentencing judge now must consider the Guidelines’ calculation along with “other statutory concerns,” including deterrence, protection of the public and restitution.70 What Should a CPA Do? Whether a criminal matter is a certainty or only a possibility, accountants can take a variety of steps and measures to assist their client, which will enable them to fulfill their own professional responsibilities and avoid malpractice. SSTSs A CPA who suspects a tax client of any criminal activity in connection with filing returns, reporting income, paying taxes, etc., needs to consult and carefully consider the guidance offered in the Statements on Standards for Tax Services (SSTSs), available through the AICPA website.71 These statements, which are mandatory, apply to all members of the AICPA and can be the basis for professional discipline by the Institute, including loss of membership. In addition, the courts, the IRS and state accountancy boards all have been influenced by the SSTSs or their predecessors, the Statements on Responsibilities in Tax Practice.72 This means that even tax practitioners who are not AICPA members may be subject to standards similar to those found in the SSTSs. For example, the regulations issued under Sec. 6694 are similar to the language of SSTS No. 1, “Tax Return Positions.” Sec. 6694 penalizes income tax preparers when an understatement of tax or refund claim is due to a position that has no realistic possibility of being sustained on the merits. All of the SSTSs are important and must be consulted as an authority by CPAs who are involved in a tax matter that could turn criminal. The Exhibit summarizes the SSTSs. For example, SSTS No. 4, “Use of Estimates,” permits estimates in tax returns if obtaining the precise data is impractical and the estimates are reasonable based on known facts and circumstances.73 If this standard is met, a CPA who used fraudulent taxpayer-provided estimates would not be convicted of aiding and assisting in the filing of a false return, under Sec. 7206(2). To convict under this section, the government must show willfulness, which involves proving a defendant acted knowingly.74 When an estimate is reasonable, CPAs would presumably not have had the knowledge required to support a conviction. SSTS No. 1—“Tax Return Positions” A CPA who satisfies SSTS No. 1 and can document such compliance will not be treated as having acted willfully for prosecution purposes. SSTS No. 1 prohibits AICPA members from recommending a tax return position unless they have a good-faith belief that the position has a realistic possibility of being sustained on the merits.75 This means the CPA must have a good-faith belief the position is supported by existing law or a good-faith argument for the extension, modification or reversal of such law.76 The belief can be based on reasonable interpretations of the statute at issue, pronouncements generated by applicable taxing authority, well-reasoned treatises or articles77 and also other reference tools commonly used by tax advisers and preparers.78 A member may recommend a tax return position that does not meet the realistic possibility standard, as long as the position is not frivolous and the CPA advises the taxpayer to make adequate disclosure.79 Again, this should be sufficient to preclude a finding of willfulness.80 A frivolous position is “one that is knowingly advanced in bad faith and is patently improper.”81 The SSTS requires CPAs, when appropriate, to advise taxpayers of potential penalties that may apply to a position, and the opportunity, if any, to avoid those penalties through disclosure.82 Positions are not to be adopted based on the audit selection process or for bargaining purposes.83 SSTS No. 3—“Certain Procedural Aspects of Preparing Returns” Clients and employers supply information that CPAs use in preparing tax returns or other tax documents. When the information is fraudulent, the supplier may face criminal responsibility, as Leona Helmsley can attest to.84 However, under the SSTSs, AICPA members are permitted to rely in good faith on information provided by a taxpayer or third parties, although this reliance cannot be blind. Members cannot ignore the implications of the information they received and they must make reasonable inquiries when the facts appear incorrect, incomplete or inconsistent, either on their face or due to other information known to the CPA.85 When a condition calls in to question the tax treatment of an item (e.g., whether records substantiate a deduction), members should determine whether the condition has been met. 86 Withdrawal The possibility that CPAs may need to withdraw from a specific engagement or terminate their professional relationship with a client is recognized in SSTSs No. 6 and No. 7. These statements address the treatment of errors. Under SSTS No. 6,87 AICPA members who become aware of an error on a previous return or of a failure to file a required return should inform the taxpayer promptly and recommend corrective measures. They are under no duty to disclose the information to the government and cannot do so without the taxpayer’s consent, unless required by law.88 If the taxpayer does not take corrective action, CPAs should consider whether to continue preparing the return, and also whether to continue the relationship.89 The situation may create a conflict of interest between members and their clients, as potential violations of confidentiality, tax law or privilege may arise. Under such circumstances, CPAs should consult their own legal counsel.90 SSTS No. 791 offers similar guidance when a member becomes aware of an error in the course of an administrative proceeding. The term “administrative proceeding” expressly excludes criminal matters. The statement recognizes that special issues may arise when a CPA is retained by an attorney rather than by the taxpayer to assist in the lawyer’s legal representation. Under both statements, an error is defined as a position, omission or accounting method that fails to meet the standards of SSTS No. 1 and can include positions no longer meeting the standard due to retroactive changes in the law.92 Errors do not include items that have an insignificant effect on a taxpayer’s liability.93 The SSTSs do not dictate withdrawal in instances when a member suspects a client or employer of committing tax crimes. However, even if withdrawing is not mandatory, the CPA needs to decide very carefully whether to continue a professional relationship. In most cases, the chances of obtaining a criminal conviction against the CPA would be remote.94 Still, even a criminal prosecution could have an enormous impact on a CPA’s reputation and practice. Plus, there is the potential for civil liability if a CPA firm also provides audit services. Warning signs of criminal intent could include a client’s failure to turn over material information, and also the use of unorthodox accounting practices. Documentation The potential criminal prosecution of clients regrettably underscores the need for CPAs to keep good records. Not surprisingly, taxpayers may react to criminal allegations by blaming their CPAs, claiming, for example, that the CPA failed to take into account information the client provided or prepared the tax return improperly. This was the case in Mounkes,95 when the taxpayer testified that he did not recall being advised by his CPA to separate business and personal accounts. The taxpayer’s strategy backfired; he was convicted despite his efforts, and his punishment was increased under the Guidelines. In part, this was due to the court’s finding that Mounkes’ testimony about his CPA was false.96 Mounkes exemplifies the importance of good recordkeeping. At the very least, a CPA’s files should reflect what advice was given, when it was given and why it was given (meaning the authority supporting the CPA’s opinion), as well as information the client supplied, as it relates to the specific advice rendered. When CPAs issue an opinion that reflects the results of tax planning, their files should document compliance with Interpretation No. 1-2, “Tax Planning,” of SSTS No. 1. That means the files should contain a summary of the facts and an assessment of the reasonableness of any assumptions or representations. The file also should show how the relevant tax authorities were applied and it should include consideration of the business purpose or economic substance of the transaction, if relevant to its tax consequences. Finally, the CPA’s records should document the conclusion that was reached.97 Oral communication with a client regarding the results of tax planning is permissible.98 However, advice regarding complex, significant or unusual transactions should be written.99 Checking IRS Calculations CPAs whose client has been targeted for criminal prosecution can provide an important service by checking IRS calculations. For example, in a failure-to-pay case, if they can show that the IRS determination was inaccurate and no additional tax was due, the client cannot be convicted under Sec. 7203. Even when CPAs can only reduce, but not eliminate, the tax deficiency, their clients have still received a valuable service because, under the Guidelines, the severity of the sentence generally depends on the amount of tax dollars involved.100 In other words, a taxpayer who has evaded a large amount of taxes might receive a stiffer sentence than someone convicted of evasion on a much lesser sum, depending on how a sentencing judge weighs the Guidelines with other factors to be considered under Booker.101 Legal Counsel If a client facing criminal investigation asks a CPA for help, the CPA should recommend an attorney with experience in criminal tax matters. This is consistent with both SSTSs No. 6 and No. 7, which relate to errors in the context of return preparation and administrative proceedings, respectively.102 It is important that this be done promptly, so that neither the client nor the CPA makes any strategic missteps. This could happen, for example, when clients consent to an IRS interview and wind up voluntarily making damaging statements in response to questions that they could have refused to answer, based on the Fifth Amendment right against self-incrimination. Privilege: Another reason why clients should hire a lawyer is because of the need to protect work done in preparation for a possible trial from having to be disclosed to the IRS. The Federal courts do not recognize a general accountant-client privilege.103 The privilege created by the IRS Reform Act of 1998 under Sec. 7525(a), for communications between a taxpayer and a “federally-authorized tax practitioner,” is not applicable to criminal proceedings. Thus, the work a CPA does to assist a client in preparing for a criminal tax matter can be obtained by the IRS. However, courts have held that the attorney-client privilege applies if the CPA was hired to assist in the lawyer’s legal representation of the client.104 In other words, if a criminal tax investigation is anticipated, the client’s attorney—not the client—should hire the CPA who will assist in preparing for the proceedings; all documentation among the parties, including retainer letters, bills, etc., should reflect this arrangement. Communication with attorney: It is important for a CPA to communicate carefully and precisely with any attorney who is retained by the client. In Bender,105 a worksheet prepared by the taxpayer’s accountant was used as part of the government’s proof in a prosecution for tax evasion. The worksheet was surrendered by the taxpayer’s lawyer, who thought the document would explain the deficiencies that appeared on the tax return. Presumably, thorough communication between a CPA and the attorney will help to prevent the inadvertent surrender of damaging material that might otherwise be protected from disclosure through privilege or on other grounds. Conclusion Although most CPAs are unlikely to have many, if any, clients with tax problems that could lead to criminal punishment, it is still important to be aware of how clients could be prosecuted and which actions could be viewed as criminal. Also, CPAs should know which actions on their own part could lead to criminal prosecutions of the CPA and possible punishment or professional discipline. A CPA whose client is facing criminal tax action can play an important role, such as checking IRS calculations of the tax amount allegedly due. Whether a client or the CPA is facing the criminal justice system, however, it is important to get the advice of an attorney experienced in criminal tax matters before trying to resolve the matter with the IRS. |
