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Protect Clients from Providing Incriminating Information in an IRS audit

by David Jacquot

In many cases, a taxpayer with an IRS audit may have exposure to potential criminal charges in addition to potential increased tax liability, penalties and interest. Cases that have potential criminal exposure are often referred to as “eggshell” or “sensitive issue” audits.

Criminal Tax Matters. There are a broad number of potential actions that can get a taxpayer in criminal trouble. Some common tax related crimes are:

Tax Evasion Failure to Collect Taxes Failure to Pay Over Taxes Collected to the IRS Failure to File a Return Failure to Supply Information to the IRS Failure to Pay Tax Owed False Returns Submitting False Documents Attempts to Interfere with Administration of Internal Revenue Laws False Statements False Claims Perjury Mail Fraud Money Laundering Conspiracy to Commit Any of the Above Aiding and Abetting the Commission of Any of the Above

Tax Practitioners that are not attorneys need to be extremely careful in representing clients in “eggshell” audits. Statements made by the taxpayer to the representative in the course of the audit may be subject to forced disclosure to the government. Many practitioners are aware that some communications by the taxpayer to the representative are protected from disclosure. Specifically, the Internal Revenue Service Restructuring and Reform Act of 1998 (P.L.105-206) added a “tax practitioner-client privilege”. In summary this privilege applies when:

Tax advice is sought, from a federally authorized tax practitioner in his/her capacity as such, and the communications relate to that purpose. Further the communications must be made in confidence by the client. These communications are then permanently protected (at the client’s insistence) from disclosure by the client or by the federally authorized tax practitioner, unless the protection is waived.

However, this privilege only applies to "TAX" matters and does not apply to "CRIMINAL" matters. Therefore if the “eggshell” audit turns into a criminal investigation, the taxpayer’s representative could be required to disclose all communications that he or she had with the taxpayer. In short, the tax practitioner could become the government’s star witness against the tax payer. On the other hand, tax practitioners that are attorneys do have an attorney-client privilege that extends to criminal matters. Additionally, the tax practitioner privilege likely does not apply in civil suits or non-tax administrative hearings. Again this puts the practitioner in the undesirable position to adversely testify against his or her client. Obviously, a taxpayer is not going to be happy about is representative testifying against him. But can a taxpayer sue a tax practitioner for not taking steps to protect them in an “eggshell” audit? How can a tax practitioner tell when a taxpayer may have potential criminal exposure? What can a tax practitioner do to protect themselves? The remaining parts of this article will explore these questions.

Can a Tax Practitioner be Sued for Failure to Taking Steps to Protect the Client?

In general, all professionals owe a duty to provide services at a level expected of a reasonably competent professional of their type. If a client suffers injury as a result for failure to render such services, they may be liable for damages. This is the standard that is imposed on doctors, lawyers, accountants, engineers, etc. Likewise it could apply to tax practitioners. The question then becomes does a reasonably competent tax practitioner have a duty to prevent a client from disclosing potentially damaging information to them? Recent changes to IRS Circular 230 seem to indicate yes. IRS Circular 230 governs who can represent taxpayers before the IRS and governs the activities of such persons. IRS Circular 230 was recently modified with new provisions effective 20 June 2005. Many of these modifications were meant to deal with abuses in opinion letters and tax shelters. However, some changes may also create duties that would allow tax representatives to be sued when a client is injured due to the representative’s failure to take steps to protect the client when criminal exposure is present. Circular 230 provides in Section 10.33 certain “Best Practices for Tax Advisors”. This section provides that:

Tax advisors should provide clients with the highest quality representation concerning Federal tax issues by adhering to best practices in providing advice and in preparing or assisting in the preparation of a submission to the Internal Revenue Service… best practices include the following:

(1) Communicating clearly with the client regarding the terms of the engagement. For example, the advisor should determine the client’s expected purpose for and use of the advice and should have a clear understanding with the client regarding the form and scope of the advice or assistance to be rendered…

(2) Establishing the facts, determining which facts are relevant, evaluating the reasonableness of any assumptions or representations, relating the applicable law (including potentially applicable judicial doctrines) to the relevant facts, and arriving at a conclusion supported by the law and the facts.

(3) Advising the client regarding the import of the conclusions reached, including, for example, whether a taxpayer may avoid accuracy-related penalties under the Internal Revenue Code if a taxpayer acts in reliance on the advice

Circular 230 goes on in Section §10.51 to describe acts of incompetence that can result in discipline. It reads:

Incompetence…for which a practitioner may be censured, suspended or disbarred from practice before the Internal Revenue Service includes, but is not limited to-- (l) Giving a false opinion, knowingly, recklessly, or through gross incompetence, including an opinion which is intentionally or recklessly misleading, or engaging in a pattern of providing incompetent opinions on questions arising under the Federal tax laws… False opinions described in this paragraph (l) include … concealing matters required by law to be revealed,…For purposes of this paragraph (l), reckless conduct is a highly unreasonable omission or misrepresentation involving an extreme departure from the standards of ordinary care that a practitioner should observe under the circumstances. A pattern of conduct is a factor that will be taken into account in determining whether a practitioner acted knowingly, recklessly, or through gross incompetence. Gross incompetence includes conduct that reflects gross indifference…

Circular 230 imposes a duty on practitioners to establish with a client a “clear understanding with the client regarding the form and scope of the advice or assistance to be rendered.” This clear understanding should include that the client should not disclose to the practitioner any information that may tend to incriminate the client. This is because Circular 230 also imposes a duty on the practitioner to “establish the facts” of the situation and relate “the applicable law (including potentially applicable judicial doctrines)” to these facts. Potentially applicable judicial doctrines would include the Constitutional right against self incrimination.

Breach of this duty could be considered common law negligence and lead to liability.

Moreover, Circular 230 in Section 10.51 provides that “concealing matters that are required by law to be revealed” is giving a “false opinion.” Since Section 10.33 imposes a duty to establish a clear understanding of applicable judicial doctrines (as described above), failing to do so would be deemed a “false opinion”. Section 10.51 goes on to say that “incompetence” is defined as giving a “false opinion” either knowingly, recklessly or through gross incompetence. Thus, failure to disclose that if the client provides incriminating information to the tax practitioner, such information can be used against them, appears to meet the definition of “incompetence.”

Based on the analysis of the provisions of Circular 230, it seems quite clear that a tax practitioner has at a minimum, a duty to warn clients that information conveyed to the practitioner can be used against them in criminal proceedings and probably in civil or administrative proceedings as well. But is merely providing a warning sufficient?

The specific examples of Circular 230 are not intended to be a definitive guide to what is “best practices” or “incompetence”. Both Sections 10.33 and 10.51 clearly indicate that the subparagraphs listed are included as examples but are not exhaustive lists. Section 10.33 imposes the duty to provide the “highest quality representation concerning Federal tax issues by adhering to best practices.” Section 10.51 imposes the duty to not provide “incompetent” services. It is hard to see how merely warning that disclosures can have adverse consequences would be the “highest quality services”, especially when simple additional actions can prevent the harm. As described in Part two of this article, there is a simple process that would facilitate the prevention of the harm rather than merely warning against it. If prevention is so easy, wouldn’t be the “best practice” to prevent the harm? If prevention is easy, wouldn’t be “incompetent” not to prevent the harm?

Lets look at this in an analogous context:

You go to the doctor. The doctor knows that many people in your circumstances face an easily preventable yet very serious health problem. The doctor warns you that you could be at risk and that this problem could be serious. Has this doctor performed the “best practices” or has this doctor acted “incompetently”?. Shouldn’t this doctor tell you what can be done to prevent this harm?

Assume the doctor discloses the potential health risk and then tells you that there is a shot that can prevent the problem? Isn’t this better?

Assume the doctor discloses the potential health risk, tells you that the shot is available and offers the shot to you? Isn’t this better yet? Isn’t this “competent” service and the “best practice?”

As described in Part Three of this article there is a simple “shot” that tax practitioners can give their clients that can prevent this serious problem.

How Can a Tax Practitioner Tell When a Case Contains Criminal Exposure?

Just because a client doesn't think that they have committed a crime does not mean that the IRS will not institute a criminal investigation. Many people charged with tax crimes don't believe they have done anything wrong. Furthermore, many people charged with tax crimes are found to be not guilty. Therefore, even if a client believes that you have done nothing wrong, practitioners need to be on the look-out for signs of a criminal investigation. Some situations that should raise concern about the possibility of a criminal investigation are:

1. The client, the practitioner or anyone the client knows are visited by an IRS Special agent, FBI Agent, or other law enforcement officer. These individuals are likely investigating a tax crime. No matter what they say, they are likely NOT part of any routine audit.

2. The practitioner discovers evidence that indicates that the return contains false or fraudulent information. This is especially true if the practitioner has evidence that the client knew the return information was false. IRS auditors are trained to refer cases to Criminal Investigation Division (CID) when they discover false or fraudulent information on a return.

3. The client has not been filing returns. This is true even if the client believes that they have paid the all the tax owed through withholding by an employer or otherwise. Willful failure to file a return is a criminal offense.

4. A grand jury subpoena is served on the practitioner, or the client’s accountant, bank, employer, employee, customers, or any other person which seeks information related to the client. A grand jury’s sole purpose is to determine whether sufficient evidence exists to indict a someone for a crime. If a grand jury is seeking information about a client, a client’s tax return, or a client’s financial affairs, the client is likely a target of a criminal investigation.

5. The client has had trouble with state tax authorities. Often the IRS and state tax authorities have information sharing agreements. Therefore, if a client has had trouble with state tax authorities, it is likely that the IRS is aware of the situation and will likely look into the matter.

6. A CID summons is served on the practitioner or the client’s accountant, bank, employer, employee, customers, or any other person which seeks information related to you. The CID’s sole purpose is to gather evidence related to a crime. If the CID is seeking information about the client, the client’s tax return, or the client’s financial affairs, the client is likely a target of a criminal investigation.

7. The client has any indication of a non-tax criminal investigation that involves money or property. Many criminal tax cases begin as investigations into some other criminal matter, especially cases that involve money, drugs, or property. Since taxpayers owe taxes on all their income, both legal and illegal, tax cases often evolve from these other types of criminal investigations. In fact, often it is often easier to prove the tax case than the underlying crime.

What Can a Tax Practitioner Do to Protect Themselves?

There are some simple actions that a practitioner can do to limit exposure to liability. These are:

Disclose. All practitioners should disclose the limits of the tax practitioner privilege to all of their clients. A good way to do this is to include it in your written engagement agreement. This matter should also be discussed with the client at the onset of the engagement and at any time during the engagement that the practitioner suspects there may be a potential criminal investigation. In addition to disclosing the limits of the privilege, it is likely that “best practices” would require the practitioner to disclose one or both of the following potential remedies to the limitations of the tax practitioner privilege.

Associate. Tax practitioners in “eggshell audits” should consider associating with an attorney. If this arrangement is done properly, all communications should be protected by the attorney-client privilege. See United States v. Kovel, 296 F.2d 918 (2d Cir. 1961). This arrangement is often more beneficial to the client than an outright referral (see below). This arrangement allows the practitioner to continue in the case often at a lower rate than the attorney. For this arrangement to be effective, the attorney should engage the practitioner via written agreement. This engagement agreement should indicate that:

1. The tax practitioner is acting under the direction of counsel in connection with counsel's rendering of legal services to the client;

2. Communications between the practitioner and the client are confidential and are made solely for purposes of enabling counsel to provide legal advice;

3. The practitioner's work papers are held solely for counsel's use and convenience and subject to counsel's right to demand their return; and

4. The practitioner is to segregate their work papers, correspondence and other documents gathered during the course of the engagement and designate such documents as property of counsel.

Refer. The last remedy is for the tax practitioner to step out of the situation and simply refer the client to appropriate tax/criminal counsel.

What Type of Attorney Should the Practitioner Associate With or Refer To?

Clients facing an IRS criminal investigation or charged with a tax crime need an attorney with specialized skills. This attorney needs to be competent in both tax issues and criminal issues. A tax lawyer won't do and a criminal lawyer won't do. They need a lawyer that has experience in BOTH criminal trials and tax law.

About the Author

Tax Attorney David Jacquot, JD, LLM provides aggressive representation NATIONWIDE to businesses and individuals with tax problems or facing criminal tax investigations and trials. A description of his education and experience can be found at http://www.4taxhero.com

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