Inside a Criminal Tax Investigation (Part Two)
In part one of this post, we mapped out CID’s role in a criminal tax investigation. In this post, we will review DOJ Tax’s role once CID has completed their inquiry. Later, we will look at an alternative track for developing and prosecuting criminal tax cases. As always, we will highlight some important ancillary issues along the way.
Injection of the Criminal Enforcement Section of DOJ Tax
DOJ Tax’s mission is to ensure the tax laws are being enforced uniformly and fairly across all fifty states. This mission was created in direct response to a few realities: 1) tax violations provide low hanging fruit for use in political or inappropriately motivated prosecutions and 2) disparate treatment of tax payers will occur if prosecution is left solely to local Assistant United States Attorneys. DOJ’s stance makes a ton of sense. Companies and individual taxpayers should not be subjected to criminal prosecution based on the location of their business. Companies in California should receive the same prosecutorial standards as those in Texas or New York.
In the pursuit of uniformity, the Criminal Enforcement Section (CES) is involved in every criminal tax prosecution. The nature of their involvement is largely dictated by the prosecutorial path chosen. However, CES will provide assistance through oversight or lead prosecution in all instances.
Once the special agent has completed evidence collection and drafted the special agent’s report (SAR), CID will decide whether to recommend prosecution to DOJ or the United States Attorney’s Office. If they recommend prosecution, the case will take one of two paths: 1) referral to CES for review of the evidence and recommendation or 2) referral to the local United States Attorney’s Office for further investigation through a grand jury. If the second path is chosen, a prosecutor with DOJ Tax will oversee the grand jury process. CES will ultimately make the decision on whether to move forward.
Once CID closes their investigation, the criminal tax attorney should immediately request a conference with DOJ Tax. These tax conferences are invaluable to the client as they provide the best opportunity to stop the criminal process, and alternatively, provide unique insight into the nuts and bolts of the charges. The government normally grants a conference after the CES referral is made, but that offer disappears once the grand jury begins their investigation (under DOJ policy). The attorney should request the conference regardless of the path chosen above. However, the government will frequently ignore the conference request once the grand jury is involved in developing evidence.
If CES recommends prosecution (initially or after a grand jury investigation), they will hand the case off to the local United States Attorney’s Office for prosecution. Most criminal tax cases are prosecuted with a local lead prosecutor and oversight from DOJ Tax. The local prosecutor will obtain the indictment, and ultimately, try the case if necessary.
The attorney’s final chance to impact charging occurs after the local prosecutor has taken over the case. Any negotiations with the local prosecutor are overseen by DOJ Tax. Any agreements that are made must receive DOJ Tax’s stamp of approval. The local prosecutors are normally open to working these cases out through plea agreements. However, all negotiations are handcuffed by the everlasting presence of DOJ Tax. Negotiations at this stage are often constricted to charging decisions and ultimate tax loss. While these negotiations can provide tangible benefits to the client, the likelihood of sidestepping charges altogether remains small. Absent a creative and airtight legal defense, DOJ Tax will not entertain a resolution short of some criminal action.
One major mistake made by taxpayers under CID investigation comes from a lack of urgency. We often receive phone calls from clients wanting to retain our services late in the investigation. Once CES has reviewed the case and recommended prosecution, the best opportunities to affect the investigation have passed. And considerable time and effort has been spent preparing the case for trial. At these later stages, it is difficult to stop the train that has likely been in motion for years. It is imperative that the taxpayer find competent counsel the moment they become aware of a criminal investigation. If a taxpayer chooses to let the investigation run its course, they will likely be stuck with CES’ decision regardless of a meritorious defense.
The Unusual Route
Most of our criminal tax cases proceed along the route outlined above. However, there is nothing that prevents DOJ Tax and the United States Attorney’s Office from deviating from the common procedure. In recent years, we have noticed a larger number of cases taking an alternative route to prosecution.
In these cases, CES will decide to skip the long, protracted CID investigation and move to the grand jury from the outset of the case. The grand jury supplants the investigative role of CID. Instead of CID summonses, or a knock on the door from a special agent, the first sign of a criminal complaint is the emergence of grand jury subpoenas. These subpoenas will often request documents from the taxpayer’s business and accountant and request the appearance of employees to appear for testimony.
This tract creates a disadvantage for the taxpayer. The CID special agent is no longer heading the investigation, but rather, assisting the grand jury in the process. This creates obstacles to the open dialogue needed to assist the client in the early stages. Second, the client’s access to the conference process at CES is normally not available once the grand jury investigation has begun. These two factors frustrate the criminal tax lawyer’s ability to steer the criminal investigation back under the civil umbrella. The attorney’s main contact is the local prosecutor heading the investigation. Like the late stages above, that prosecutor is being overseen by CES and further constricted by the secrecy of grand jury proceedings.
We are unsure if this route is being more commonly used, or if our practice just happens to be getting more of these cases lately. However, it seems clear that CES is quite comfortable with this less common route in preparing and prosecuting criminal tax cases.
Tax Loss – the Swiss Army Knife
Tax loss plays a central role in all criminal tax prosecutions. Specifically, the tax loss serves as a central component of charging decisions and the ultimate sentence after conviction. Attorneys must understand the importance of tax loss to effectively represent their clients throughout the process.
Most criminal tax indictments are going to include criminal counts for each taxable year at issue. Often, these multiple counts will be accompanied by a count for conspiracy if two or more persons are involved or a false statement count if the government believes they were misled during the investigation.
For sentencing purposes, the number of counts makes little difference. The sentencing guidelines operate solely off the total tax loss involved in the scheme. If a taxpayer is found guilty of nine counts of tax evasion, and the tax loss for those nine counts is $1,600,000, the guidelines would recommend a sentencing range of 41-51 months. If the taxpayer is convicted on one count of tax evasion, and the entire scheme involved $1,600,000, the guidelines would recommend the same sentence of 41-51 months. A detailed review of the tax loss’ role in sentencing can be found in a prior post.
The number of counts plays no role in the base offense level. Whether they are charged with one-hundred counts or one, the tax loss will decide the offense level for sentencing purposes. And that tax loss figure includes all relevant conduct, including amounts tied to counts where the client is found not guilty (if the government can prove by preponderance of the evidence that the loss is tied to criminal activity at sentencing).
This understanding is imperative when an attorney is trying to work a case out prior to trial. The government may agree to drop all counts except the one for which the client pleads guilty. The reality is that plea deal offers a felony conviction and a guideline sentence based on all the relevant conduct, including the conduct in the dismissed charges. The two things the attorney is trying to avoid are a lengthy prison sentence and a felony conviction. Both are alive and well under that standard plea deal.
Criminal tax attorneys should not be persuaded by the dismissal of numerous counts in exchange for a guilty plea. Instead, the negotiations should revolve around three important considerations: 1) a three-point reduction for acceptance of responsibility, 2) the final tax loss, and 3) the aggravating factors that may support an increase in the offense level. If the client appears to have no chance at trial, there is a way to limit the damage during this stage of the criminal process.
Acceptance of Responsibility
When a client pleads guilty early in the process, they will receive a two-point reduction for acceptance of responsibility. If the government agrees the client’s acceptance has saved resources by preventing trial preparation, they can agree to an extra point reduction. The lawyer should ensure that this extra point reduction is a part of any plea deal negotiated with the government.
Agreements to Tax Loss
The tax loss can have the greatest impact on the final sentence for the client. As discussed above, the base offense level (or starting point) for all guideline recommendations is the tax loss. If this number is not negotiated in the plea agreement, the District Court will decide the ultimate tax loss at the sentencing hearing. The attorney will have a chance to argue for a reduction in tax loss at the hearing based on their investigations and final numbers. However, this is a dangerous game that relies on an advantageous ruling in the final hours of the case.
The best practice is to contain the tax loss prior to sentencing. This can be done through negotiations with the local prosecutor when drafting the plea agreement. We have seen tax loss agreements presented in two ways: 1) a cap is placed on the potential tax loss or 2) an exact tax loss figure is agreed to by the client and government. At this stage, the attorney should have put together their own tax loss figures with expert assistance. These figures need to be persuasively presented to the local prosecutor. If the government agrees the points are valid, they may reduce the tax loss that is purported in the SAR. A successful argument early can have a huge impact on the final sentence.
Limit the Aggravating Factors
The tax loss will determine the base offense level for sentencing. This base offense level is then adjusted by mitigating factors (acceptance of responsibility and others) and aggravating factors. The final offense level, and resulting guideline range, will only be determined after these factors are considered. In the criminal tax arena, there are some common aggravating factors that will move the offense level up. One of them is “sophisticated means.” If the offense involved “sophisticated means”, the offense level should be increased by two. Sophisticated means (under tax evasion) is defined as complex or intricate offense conduct relating to the concealment of assets. Put simply, any complicated scheme to hide assets will result in a two level increase to the offense level.
The government may be open to disposing of various enhancement in the plea deal. The attorney can ask for an agreement that the offense did not involve sophisticated means. If agreed to, the probation department is unlikely to include the two level enhancement in the final guideline range. If they do, the client has a great argument for removal based on the prior agreement.
Difference in Sentence
Let’s look at an example that highlights the importance of the three pronged attack above. Let’s assume a client is charged with six counts of tax evasion. The tax evasion scheme involved sophisticated conduct and a tax loss of $2.9 million.
The first client pleads guilty to one count of tax evasion in exchange for a dismissal of five other counts. No other agreements are made prior to sentencing. That client’s recommended sentence would likely be as follows:
Base Offense Level ($2.9 million tax loss) of 22 / 2-point reduction for acceptance of responsibility / 2-point increase for sophisticated means = Final Offense Level of 22 with a recommended guideline range of 41-51 months.
The second client pleads guilty to one count of tax evasion in exchange for 1) dismissal of five other counts, 2) agreed tax loss of under $1.5 million, 3) the extra point for acceptance of responsibility, and 4) non-sophisticated conduct. That client’s recommended sentence would be as follows:
Base Offense Level (under $1.5 million) of 20 / three point reduction for acceptance of responsibility = Final Offense Level of 17 with a recommended guideline range of 24-30 months. This latter plea deal may result in a 50% reduction in the final sentence for the client.
The idea behind this section is to offer thoughts on proper negotiation parameters, but more importantly, to highlight the importance of tax loss throughout the entire criminal process. It is the one tool that will assist the client at every single stage of litigation. The necessity of an early parallel investigation cannot be overstated. This investigation should include creative and legitimate explanations for the tax due and owing. A valid argument for a lower tax loss will assist the client in 1) negotiating a civil resolution with CID and CES, 2) negotiating a reasonable offer with the local prosecutor, and 3) determining the appropriate guideline range at sentencing.
Most Criminal Tax Cases Require Further Interaction with the IRS
Our number one job is to steer these criminal tax investigations back to the civil division of the IRS. If we are successful, the biggest gorilla on the island (jail time and felony conviction) vanishes. However, it is important to note that a successful resolution criminally does not restrain the IRS’ civil division. Our “win” often results in a long journey where the taxpayer will be subjected to more attorney’s fees, penalties, interest, and other financial drain.
The same outcome is true if a criminal case results in conviction through a plea or trial. During sentencing, the District Court is likely to order restitution to the government in the amount of tax loss under the guidelines. To most clients, this order would seem to end the fight over back taxes. However, nothing in the criminal case will handcuff the civil division from continuing their inquiry. This is true for tax years inside or outside the indictment. Having said that, prompt payment of criminal restitution can have a chilling effect on the IRS’ willingness to expend resources in civil litigation. But the IRS can, and often will, continue to work out civil fines and penalties after the resolution of the criminal case.
The world of criminal tax is unique in our justice system. Representing a client under CID investigation requires knowledge of the investigation process, the opportunities for negotiation, the interplay between the civil division and CID, and the crucial role of tax loss in determining the taxpayer’s fate. There are ample opportunities to obtain a great result for the client. It is up to the attorney to take advantage of those opportunities by thoroughly building the taxpayer’s case early.