Inside a Criminal Tax Investigation – CID to Indictment (Part One)
Criminal tax cases are truly unique within the federal justice system. It is one of the few criminal categories that follows a well-maintained structure from investigation to prosecution. Further, it is one of the few crimes where involvement from the Department of Justice is required before prosecution can move forward. Attorneys handling these cases must be familiar with this structure to effectively represent clients in the pre-indictment phase. Understanding the general road map allows practitioners to take advantage of the various opportunities to steer these cases back to the civil division. For any criminal tax attorney, this is the ultimate goal and the best possible result for the client.
This two-part post will provide the general road map for a criminal tax prosecution. We will review the steps taken by the government from the initial inquiry to indictment. Along the way, we will point out ancillary points that will be useful to both taxpayers and attorneys. This initial post will cover the CID investigation process. A subsequent post will outline the procedure through the Criminal Enforcement Section of DOJ Tax (CES).
The Usual Route
Criminal tax investigations normally follow one of two routes from initial inquiry to indictment. We will discuss the most common route first, and later, a less common path.
Under the standard investigation route, there are two overarching phases: 1) the IRS investigation performed by CID and 2) investigation and eventual prosecution by the Criminal Enforcement Section of DOJ tax and the local United States Attorney’s Office.
CID Investigation
The initial CID investigation involves a massive effort to collect documents and testimony to support criminal charges. Their goal is to compile as much information as possible before putting together a report outlining the potential criminal violations and the suspected tax loss to the government. The main tool for evidence collection is the CID summons.
The special agent will use summonses to obtain record evidence and testimony from key witnesses. The common record evidence includes bank records, business records, property records, prior tax returns, and other documents relevant to the probe. Key witnesses often include the target of the investigation, employees of the target, family of the target, the target’s accountant, and any other person who may have knowledge of the target’s business/accounting practices.
A CID summons reads and looks like a grand jury subpoena. The summons will provide a time for the person/entity to meet with the special agent and request documents in the latter pages. Under some summonses, the special agent merely wants documents from the person or entity. In others, their goal is to obtain a statement during a face to face meeting.
Sources for a CID Investigation
CID investigations start with a criminal referral. The most likely source for a referral is the civil division of the IRS. If the civil division notices badges of fraud during a routine audit, they will make a referral to CID for further investigation. It is important to note that under IRS policy the civil inquiry should halt after a referral to CID. The IRS adopted this policy to make the nature of the inquiry clear to the taxpayer. At times, this line can be blurred as the transition is made. It is always the best practice to confirm with any civil agent that a CID referral has not been made prior to an interview. The advice to the client changes quickly if/when the audit turns criminal.
Other sources for CID referrals include disgruntled peers including the target’s wife, business partner, or former clients.
Navigating The CID Investigation
How an attorney should handle a summons is largely dependent on their client’s role in the underlying criminal offense and the nature of the request. During a CID investigation, and most other federal investigations, the government is going to place the client into one of three categories: 1) target of the investigation, 2) subject of the investigation, or 3) potential witness. It is imperative the attorney determine how the government views their client as it will dictate the steps moving forward. Luckily, most special agents will provide this information if asked.
If the client is a target or subject of the investigation, they have potential criminal liability. The government carves out these two classes, but the only real difference between a target and subject is where the person is likely to appear on the indictment. For example, let’s assume a taxpayer filed false returns for three separate tax years. These false returns underreported substantial income, and the false statement was made with the knowledge of the CPA filer. The taxpayer would be the target. The CPA would be a subject. However, their potential liability is the same. The representation should be handled with that understanding.
If the client is deemed a witness, the government does not currently plan to charge the person/entity. Absent a huge change in factual circumstances, a witness should remain a witness with proper cooperation.
Based on the client’s role in the alleged criminal scheme, the attorney will have to strategically answer summonses and decide whether to subject their client to an interview. As an overarching rule, we do not allow clients with potential liability to sit down with CID special agents. The unknowns of the investigation make it nearly impossible to prepare for an interview with any assurance the client will not make a detrimental statement. If we believe we can clarify central issues, and potentially steer the investigation back to the civil division, we will sit down with the special agent (without our client) for a presentation. We have conducted this step with success on numerous cases over the years.
If the client is viewed as a witness, it is likely in their best interest to meet with the special agent. The government is unlikely to pursue charges after the attorney has been notified of their client’s minor/non-existent role in the criminal conduct. If the client cooperates with CID, it is highly unlikely the government will pursue criminal charges in the future. Of course, there are caveats to every bright line rule, and the attorney must assess any potential liability before making strategic decisions.
Need for Parallel Defense Investigation
While CID is compiling their evidence, the defense should be running a parallel investigation. Most times, the nature of the potential criminal charges can be ascertained through discussions with the special agent and the client. Once the scope of the potential charges is obtained, it is necessary to start building a defensive theory in hopes of gaining leverage prior to indictment. The following steps may benefit the client during the investigation:
- Retaining a forensic accountant to reconstruct the client’s taxes for the years in question. This person can be used as an expert later in the case, if necessary.
- Meeting with employees, spouses, accountants, or other persons with relevant knowledge of business and accounting practices.
- Looking for alternative tax practices that may offset the tax loss.
- Obtaining all documentary evidence requested by CID, including bank records, business records, property records, and notes from the filing accountant.
- Obtaining any other relevant documentation/testimony to build the narrative.
Prior to indictment, there is always a chance to discuss the criminal charges with an attorney at DOJ tax or the US Attorney’s Office. It is not always easy to determine whether CID is early in the investigation or close to making a recommendation. The special agent, DOJ tax attorney, and Assistant United States Attorney all provide opportunities to discuss factual and legal issues with the case. It is important to get the defensive theory in place early to take advantage of every opportunity to avoid criminal charges. The older a case gets, and the more work CID puts into the allegations, the more difficult it becomes to steer the investigation back to the civil division.
In our practice, there are two main issues that provide the foundation for thwarting the criminal process. The first is an argument under Cheek (the ignorance defense is discussed in a pervious article). The second is a drastic reduction in the tax loss. If the government believes they have a tax fraud with a $1.9 million loss to the government, they are going to move forward. However, if a legitimate accounting practice or misunderstanding of the numbers brings that loss under $100,000, the government may lose interest in using resources for criminal prosecution. Under those circumstances, the government may prefer to allow the civil division to collect the back taxes with penalties and interest.
It may seem unlikely that a client will be able to argue for a huge reduction in tax loss. However, it happens with some regularity. In many cases, we have a legitimate argument that CID’s tax loss numbers are inaccurate. In some of those cases, the loss reduction is massive.
In 2019, our firm represented a client who was under CID investigation. The client had millions of dollars entering his bank account over four years. The tax returns showed minimal income. With the assistance of a forensic accountant, we were able to convince the special agent that none of the money entering his account was taxable income. CID closed the case and sent the issue back to the civil division of the IRS.
In the second post, we will discuss the end of the CID investigation and the transfer of the case to the Criminal Enforcement Section of DOJ Tax. That post will navigate the investigative steps from CES transfer to indictment. In addition, we will outline an unusual route to criminal prosecution that cuts against the known procedures.