How does criminal employment tax fraud happen?

This blog entry explores some of the more recent prosecutions of employers for payroll tax crimes that made the IRS’s “convicted” list:

http://www.irs.gov/compliance/enforcement/article/0,,id=246531,00.html  

Florida: 

On February 22, 2012, in Miami, Fla., Osvaldo Martinez, was sentenced to 24 months in prison. He withheld employee payroll taxes from his employees’ salaries, but he failed to pay $1,781,294 to the IRS.

New York:

On February 21, 2012, in Rochester, N.Y., Jeffrey Sykes, was sentenced to 96 months in prison, three years of supervised release, and ordered to pay $3,714,649. Sykes owned a payroll company, and he failed to use his some 1,100 clients’ funds to pay the employment taxes. He also didn’t submit the required 941 Forms, and then lied to his clients that he did file the Forms and pay the taxes.

Pennsylvania:

On February 3, 2012, in Pittsburgh, Pa., Richard Swartz and Richard J. Connell were sentenced to 15 months in prison, three years of supervised release and must pay a $30,000 fine. They had an auto-parts store, and they obstructed the IRS from collecting income and employment taxes, and they also filed false tax returns.

New Jersey:

On January 26, 2012, in Camden, N.J., Channavel “Danny” Kong was sentenced to 24 months in prison, three years of supervised release and is required to pay New Jersey $15,000, and the IRS his back taxes. He made illegal cash payments ($55,000), bribe money,  to an investigator of the State of New Jersey. His goal was to convince the investigator not to conduct audits or inspections, including into his payroll taxes.

Missouri:

On January 24, 2012, in Springfield, Mo., Robert Landis was sentenced to 37 months in prison and ordered to pay $6.26 million. He failed to pay employment taxes; he took deductions from his employees’ pay between 2005 and 2009, but he did  not account for, nor pay, the IRS the tax.

Virginia:

On January 20, 2012, in Alexandria, Va., Russell Fournier was sentenced to 25 months in prison and three years of supervised release for failing to pay more than $700,000 in employment taxes from 2000 to 2008. For about 10 years, he failed to file his company’s tax returns and pay to the employment tax. Instead, he used company funds to buy for himself and his family luxury cars and trips abroad.

New York:

On November 15, 2011, in Manhattan, N.Y., Michael Mahoney was sentenced to 24 months home confinement, two years of supervised release; he must also pay $306,765 to the IRS. He “took checks that represented receipts of [his company] and, rather than depositing them in the corporate bank accounts, cashed them at a check-cashing establishment in New York City.” He used the funds to pay all or some of his employee’s wages, instead of the taxes.

Florida:

On November 3, 2011, in Miami, Fla., Braynert Marquez, of Miami, Fla., was sentenced to 30 months in prison, one year of supervised release and is required to pay $280,362. He aided and assisted in preparing a false employment tax return. The return underreported wages, tips, and other compensation paid to employees. From 2004 through 2007, Marquez paid his employees “off-the-books,” which he failed to report to the IRS on the quarterly employment tax returns; and he failed to withhold and pay over employment taxes on the wages.

If you have intentionally or unintentionally committed one of the above offenses, or something like it, you need to retain competent legal counsel to best defend your future. We can help. Our Office specializes in this niche area of the intersection of criminal law and tax fraud.

http://www.klasing-associates.com/  

For more on tax fraud, generally:

http://www.klasing-associates.com/Tax-Law/Tax-Evasion-Fraud-Representation.shtml  

Tax Preparers: Who May Be Liable, and For How Much

This is an informative blog on tax preparer liability, sketching the conditions under which a tax preparer may be liable for his or her errors, and the correlative penalties. For more on this topic, see:

http://www.klasing-associates.com/Tax-Law/Tax-Preparer-Fraud.shtml

In the past, a tax preparer was not liable for gift (Form 709) and estate and generation-skipping (Form 706) tax returns. But a tax preparer was liable for income tax returns. Thus, for example, if a tax preparer committed an error—intentionally or unintentionally—on Forms 1040, 1040A, 1040EZ, 1041s, or 1065 (partnership) and 1041 (grantor trusts), the preparer was liable.

Today, since 2007, a tax preparer will be liable for errors committed on any return. This is because the Internal Revenue Code (IRC) §6694 was modified—broadened, really—replacing “an income tax return preparer” with “a tax return preparer.” Thus, a tax preparer may be liable for all federal tax returns and claims for refund.

Who is a “tax return preparer”?

There are two types of tax return preparers: (1) Those licensed to practice under state law and before the IRS. These include your CPAs, attorneys, enrolled agents, enrolled actuaries, appraisers, and the like. (2) Those who are not licensed (called “unenrolled” tax preparers), who are permitted to prepare returns but disallowed from practicing before the IRS.

IRC § 7701(1)(36)(A) defines a “preparer” as “any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return of tax imposed . . . or any claim of refund.” Thus, a preparer does not include someone who did a tax return without receiving compensation. However, case law includes within the definition of a preparer one who did other services for the client, even though, strictly speaking, no compensation was received for preparing the return itself.

What are the penalties?

Under IRC § 6694, the IRS imposes a penalty on a tax return preparer that understates a taxpayer’s liability, and that is determined by whether he made any part of the understatement due to taking an “unreasonable position” that he knew (or reasonably should have known) of the position, or if he made any part of the understatement due to “willful or reckless conduct.” A penalty of $1,000 or 50% of the income (to be) derived may occur for each error on a return or claim for refund. However, if the preparer had reasonable cause for the understatement, and he acted in good faith, then IRC 6694(a)(3) exempts these penalties. A good tax attorney should be able to inform you whether a preparer had a “reasonable cause” for the understatement.

If the preparer made an understatement with “willful or reckless conduct” he shall pay a penalty on each return (or claim for refund) of $5,000 or 50% of the income derived. What’s “willful or reckless conduct”? It is defined as any willful attempt in any way to understate a tax liability, or a reckless or intentional disregard of the tax law. IRC 6694(b)(2).

In addition to the monetary penalties, there are non-monetary penalties, like an “injunction,” which is a basically a court order saying the preparer cannot practice in her professional capacity for a certain period of time. This can be far more devastating than the monetary penalties, because she would likely lose many clients. Moreover, the preparer may be required to re-open every like and non-like return that she prepared for the years falling within the statute of limitations. Finally, a preparer may also lose his license if found liable for tax preparer fraud.

Tax law is notoriously complex, so it is understandable that mistakes occur. The IRS, however, is not so forgiving. That is why if you are tax preparer who has reason to believe that you have intentionally or unintentionally committed one of the above offenses, you need competent legal counsel. Due to the complexity of the intersection of taxation and criminal law, few attorneys are competent to handle this sort of controversy. The Tax Law Office of David W. Klasing, however, specializes in this area of law; we can help you navigate through your legal options.

http://www.klasing-associates.com/

“419 Plans”: Employers and Promoters Face Serious Problems with the IRS

The bottom line.

If you’re the owner of a small business with a “419 plan” for your employees, you may be in serious trouble with the IRS, either now or in the near future. And the same is true if you’ve sold one of these plans to a business. This blog post explains the details. This post is a bit technical, but so is tax law.

The typical scenario.

Here is the typical situation. A closely held business is sold, along with other employers, a welfare benefit plan—an “IRC 419 Plan”—and is told by the plan promoter that the employer’s contributions to the multiple employer welfare benefit fund are tax deductible when paid. In almost every case, this is mistaken.

An employer’s contributions to certain §§ 419 and 419A plans are deductible, but that is the exception, not the general rule. What is happening is that the promoters of most § 419 plans tell the employer’s they sell the plans to that contributions to the plan meet that exception but, again, most of the time that is mistaken.

The Details.

Tax Law —

A “welfare benefit plan” is a plan that provides certain benefits, like medical or death benefits, to employees or their beneficiaries. 

The general rule is that an employer’s contributions to a welfare benefit plan are deductible when paid only if (1) they qualify for an “ordinary and necessary” business expense (which must meet a certain definition set by 26 U.S.C. §162 and underlying regulations), and (2) only to the extent it’s allowed under 26 U.S.C. §§419 and 419A, which place some rather strict limits on the amount an employer may deduct.

However, a narrow exemption (found in § 419A(f)(6)) to the general rule of §§419 and 419A is carved out, permitting deductions beyond the limitations of (2), above. It is the exemption that the promoters of certain “419 plans” claim is satisfied by their plan; most of the time, however, it is not.

Generally, to qualify for the exemption, an employer must be (i) contributing to a welfare benefit fund that is part of a 10 or more employer plan, (ii) is precluded from contributing more than 10% of the total contributions to the plan, and (iii) the plan is not experience related with respect to certain employers.

The Problematic 419 Plans —

The problematic 419 plans usually involve investing in variable life or universal life insurance policies  (placed in a trust) that insure the owner or key employees, where the employer makes significant contributions beyond what is required for the cost of the term insurance, and the trust administrator is permitted by the contract to withdrawal the insurance policies’ cash value. Further, the insurance proceeds are distributed to participants when the plan is terminated. Business owners are wrongly being told that their contributions to the plan that is used to pay insurance premiums are deductible as qualified costs without a corresponding inclusion in the employer's income.

More specifically, the trustee uses the employer's contributions to the trust to buy life insurance policies: cash value policies on the lives of the owners of the business, and term life policies on the employees’ lives. Then, down the line, when the plan terminates, the cash value and other property in the trust is distributed to the then-existing employees. Due to the termination timing and trust allocations, it’s expected that a small amount of trust proceeds will go to the employees, while most of it will go to the business owners and key employees.

The IRS doesn’t like these plans. That is why these sorts of arrangements typically do not satisfy the requirements of 26 USC § 419A(f)(6), and thus are not permitted tax deductions that the plan promoters claim business owners are entitled to.

Why not? IRS Notice 95-34 (http://www.irs.gov/pub/irs-tege/n-95-34.pdf) provides some of the reasons:

(1)     The arrangement is actually providing deferred compensation. An employer’s contributions to a non-qualified plan of deferred compensation are governed by §405(a)(5), which says that a deduction is permitted when the associated amount is included in the employer’s gross income.

(2)     The plan arrangements are, based on the facts, separate plans, which thus doe not satisfy the “10-or-more employer plan” exemption of 419A(f)(6).

(3)     The plan qualifies for § 419A(f)(6), but the employer’s contributions are deemed a non-deductible prepaid expense under a different IRC section.

A business owner with a so-called “419 plan” is subject to certain disclosure requirements found in 26 USC § 6111, and may also be subject to tax penalties.

Conclusion.

Recently, the IRS has specifically identified certain §419 and §419A plans that are prohibited. Competent legal counsel will be able to instruct you whether: (1) your plan is prohibited or permits deductions for employer contributions, and (2) whether you will be subject to penalties, and (3) the disclosure requirements.

If your business uses one of these plans, or you have sold one of these plans, due diligence should compel you to seek legal counsel. The Tax Law Office of David W. Klasing can help in this regard; this is what we do. http://www.klasing-associates.com/  

Civil Audits vs. Criminal Investigations

The IRS divides its responsibility of enforcing the tax laws into two divisions: the Civil Examination Division (CED) and the Criminal Investigation Division (CID). This post explores the differences between these.

The CED is the civil division, and its chief responsibility is to conduct civil audits, which are performed by revenue agents. The goal of their inquiry is to decide whether taxpayers have reported the correct tax liability. Revenue agents are mostly number crunchers, and they do most of their work in their office, but sometimes a civil audit will require field exams to the taxpayer’s office or home.

Revenue agents commence a field exam by contacting the taxpayer, giving her notice that she is under internal investigation. The agent has broad authority to compel document production and if the taxpayer refuses to furnish the requested documents, she may be served a summons ordering her to do so. A revenue agent does not carry a firearm, nor do they provide the taxpayer with a Miranda-like warning (i.e. telling them they have a right to silence, an attorney, etc.).

If the agent, during the civil audit process, discovers a “firm indication of fraud,” he may refer the case to the IRS’s criminal division for investigation. Generally, if the agent believes the taxpayer knowingly violated the law, he is required to cease the civil audit and refer the case to the CID.

The CID’s chief responsibility is the investigation of criminal violations under the Internal Revenue Code (“IRC”). Criminal investigations are generally thought to serve two related purposes: (1) to inspire the public’s confidence in the government’s enforcement of criminal tax laws, and (2) encourage a taxpayer’s voluntary compliance (voluntary disclosures). For more on voluntary disclosures, read “The Solution” on this page:

http://www.klasing-associates.com/Tax-Law/Tax-Evasion-Fraud-Representation.shtml  

A criminal tax case differs from a criminal non-tax case (e.g. a homicide case, or a robbery). In the criminal non-tax case, the crime is known (e.g. there was a murder or items were stolen) but the perpetrator is not. Much of the efforts of the government in these cases is spent on identifying the perpetrator of the crime.

In a criminal tax case, however, it is the reverse: the taxpayer (i.e. the perpetrator) is known, thus the IRS’s entire time is spent collecting evidence against you. How do they get the evidence against you? Typically it is from those conducing financial business with the taxpayer: her accountant, bankers, etc. It is a scary prospect that one’s accountant can be compelled by the IRS to disclosure information you thought was protected by the so-called “accountant-client privilege.” However, the truth is that the "accountant-client privilege" does not protect you in a criminal case. By contrast, conversations with one's attorney are protected, and insulated by the attorney-client privilege. See:

http://www.klasing-associates.com/Tax-Law/IRS-Criminal-Investigations.shtml

And, for more on the attorney-client privilege, see:

http://www.klasing-associates.com/Attorney-Client-Privilege-Discussion.shtml

The CID uses “special agents” to operate its affairs. Special agents are involved in detecting criminal violations and deciding whether to recommend a criminal prosecution. Their job is to amass a case against you for failing to file, filing of a false return, for engaging in tax evasion, or money-laundering.

Typically, a special agent will not provide a warning or notice before showing up to your residence. His goal is to catch you by surprise, so that when he interviews you he can collect much evidence from you.

Unlike revenue agents, special agents carry a gun and a badge, and are required by the internal revenue manual (IRM) to issue Miranda warnings. However the Supreme Court has said they are not required by the Constitution to issue a Miranda warning. Beckwith v. United States, 425 U.S. 341, 345-46 (1976) (Miranda warnings are not required when interviewing taxpayer under investigation if questioning does not deprive person of his freedom of action in any significant way). Often a taxpayer will speak freely with a special agent, not knowing that he is offering potentially incriminating evidence against him for a subsequent trial.

A revenue agent’s referral of a civil audit is the most common way a tax case turns from civil to criminal. During a routine audit, a revenue agent examines the taxpayer’s books and records, and often unearths evidence of fraudulent reporting. When the agent discovers evidence of fraud during the civil audit, he may be required to cease his investigation.

“If, during an examination, an examiner [i.e., revenue agent] uncovers a potentially fraudulent situation caused by the taxpayer and or the preparer, the examiner shall discuss the case at the earliest possible convenience with his/her group manager.... Once there is a firm indication of criminal fraud all examination activity shall be suspended.”

United States v. McKee, 192 F.3d 535, 541-42 (6th Cir. 1999)(quoting old Internal Revenue Manual § 4565.21(1) (August 1, 1996)).

Moreover, the revenue officer is not permitted to tell the taxpayer that the case has been transferred to the Criminal Investigation Division:

“The revenue officer should inform the taxpayer that they are conducting a civil investigation, and that the information obtained can be shared with CI. Under no circumstances should the revenue officer inform the taxpayer that the case has been referred to CI. This is CI's responsibility. The revenue officer should immediately notify the special agent of the contact with the taxpayer.”

IRM 5.1.5 (emphasis added).

http://www.irs.gov/irm/part5/irm_05-001-005.html#d0e909

However, the agent is encouraged not to cease the civil investigation “too soon” because he is to wait until there is a “firm indication of fraud”—which is a seemingly vague line. For this reason, if you are under a civil investigation by the IRS, you should retain legal counsel.

Even the IRS admits in a Memo that the line is a vague one, for “revenue agents … must walk a fine line between vigorous investigation and overzealous, and even unconstitutional, investigations.”

http://www.irs.gov/pub/lanoa/pmta01123_7321.pdf   

Lessons From Another’s Tax Fraud Conviction? Or Another Lesson on Voluntary Disclosures

Recently, a California resident, William Nurick, was found guilty for engaging in tax fraud. For Irvine, Calif. residents, it’s a very local story because it was the IRS’s Criminal Investigation Division (“CID”) in Laguna Nigel, Calif. that investigated the case.

His fraud was committed 10 years ago, and the IRS’s CID patiently waited until the evidence came full circle before they obtained a conviction against him.

Between 1994 and 2002, Nurick concealed the receipt of nearly $1.1 million from an account known as the Genesis Fund, which apparently involved foreign currency trading. Nurick used eight different financial entities to disguise his ownership over his monies, real property, and other financial assets.

The trial court uncovered evidence that Nurick filed an amended return for his 1995 taxes, which had an approximate $100,000 tax liability. But, to avoid paying his liability, he attempted to conceal monies by transferring them from one offshore account to a friend’s offshore account. Nurick also provided the IRS with a false “Offer in Compromise,” an agreement alleging that the IRS permitted him to pay a mere tenth of his tax liability, and also understated his income, omitting the receipt of $200,000 that were eventually placed in his Costa Rica bank account.

Well, it’s no surprise, his plans backfired. Nurick was sentenced to spend 60 months in prison and to pay a sum of roughly $300,000. The complaint, filed in the U.S. District Court situated in Los Angeles, alleged (1) conspiracy, (2) mail fraud, (3) wire fraud, (4) money laundering, and (5) engaging in unlawful monetary transactions. The full complained may conveniently be accessed here:

http://www.justice.gov/tax/GenesisIndictment.pdf

For someone who has committed tax evasion, even long in the past, the IRS’s patience—that it will prosecute in its own time—is a scary prospect.

What’s the lesson is to be learned from this? Possibly, it’s this: Mr. Nurick might have been better off had he made a “voluntary disclosure” of his fraud to the IRS; doing so would most likely have eliminated his jail time. For more on voluntary disclosures, 

The fines are bad, the jail time is worse, and to top it off, the government makes it all public. The IRS decided to make an example of him, listing his case on IRS website on its “Examples of Abusive Tax Schemes - Fiscal Year 2012” page:

http://www.irs.gov/compliance/enforcement/article/0,,id=246525,00.html

And the Department of Justice (DOJ) explained the story more fully here:

http://www.justice.gov/opa/pr/2011/September/11-tax-1190.html

Please avail yourself of these additional resources if you have committed purely domestic income tax evasion:

http://www.klasing-associates.com/Tax-Law/Tax-Evasion-Fraud-Representation.shtml

Foreign income tax evasion including foreign accounts or foreign income producing assets:

http://www.klasing-associates.com/Tax-Law/FBAR-Compliance-and-Disclosure.shtml

Other tax crimes and general information:

http://www.klasing-associates.com/Criminal-Tax-Representation-FAQ/

Voluntary Disclosures Program & Swiss Accounts

In an earlier post we wrote about the IRS’s voluntary disclosure program for those hiding assets in bank accounts overseas. This is a follow up post to that one, discussing some recent developments that have been going on in the courts. It will be of particular interest to those tempted to hide assets in a Swiss account.

Recall that the IRS’s voluntary disclosure program for foreign accounts that was reopened this year, allowing taxpayers to come forward on their own before the IRS finds them. The upshot is that the consequences of a voluntary disclosure are far less severe than the sometimes draconian measures exacted by the IRS when it discovers one’s tax evasion or tax fraud. For more on the IRS’s Offshore Voluntary Disclosure Initiative (OVDI) Program, visit:

http://www.klasing-associates.com/Tax-Law/FBAR-Compliance-and-Disclosure.shtml

Recently this month, on Feb. 2, 2012, Switzerland’s oldest bank, Wegelin & Co. (“Wegelin”), founded in 1741, found itself entangled in a U.S. federal court in Manhattan. Wegelin manages something in the neighborhood of $25 billion in assets, and was alleged to have “conspired against the U.S. in the amount of $1.2 billion” in taxes, according to the indictment, courtesy of the Wall Street Journal:

http://online.wsj.com/public/resources/documents/indictment02022012.pdf

Basically, Wegelin was accused of helping people evade U.S. income tax. The hearing date was Feb. 11, 2012, but Wegelin did not appear.

What makes this case unique is that it is the first time a foreign bank was indicted by the U.S. for helping people engage in tax fraud. In the past, the practice was that the IRS would compel the bank to disclose a client’s account data. Precedent appears to be changing.

The takeaway lesson from this appears to be that while, on the one hand, the IRS has gone “soft” with allowing people to make voluntary disclosures and (likely) avoid steep penalties, it has, on the other, also become more vigorous in its prosecution of tax evaders, breaking new precedent. For more on the IRS’s actual practice of how it treats taxpayers making a voluntary disclosure, read further at “The Solution” here:

http://www.klasing-associates.com/Tax-Law/Tax-Evasion-Fraud-Representation.shtml

From a policy standpoint, the idea of the government balancing out its leniency with its uncompromising litigious spirit is quite sagacious. From the taxpayer’s point of view, this will further incentivize him to make a voluntary disclosure of his tax fraud.  

For more on this story:

http://online.wsj.com/article/SB10001424052970203889904577199483877439236.html

Will the IRS Prosecute Someone After Making a Voluntary Disclosure of Tax Fraud?

There’s a lot of confusion out there whether the IRS will prosecute someone after making a voluntary disclosure of his/her tax fraud. I’ll try to set the record straight in this post. For more on this topic, see:
http://www.klasing-associates.com/Tax-Law/Tax-Evasion-Fraud-Representation.shtml


In addition, our FAQ section contains answers to questions related to criminal tax, more generally:
http://www.klasing-associates.com/Criminal-Tax-Representation-FAQ/

The short answer is that, technically, the official language of the Internal Revenue Manual provides that the IRS retains the right to prosecute a taxpayer who has engaged in tax fraud, even if she made a voluntary disclosure to the IRS. IRM § 9.5.11.9 (12-02-2009)( http://www.irs.gov/irm/part9/irm_09-005-011-cont01.html ). BUT! the IRS’s actual practice has, for the most part, not been to exercise this right. In other words, the practice of the IRS has not been to pursue prosecution after a taxpayer makes a voluntary disclosure — which is fantastic news to the taxpayer wanting to come clean.

A number of tax experts concur with this conclusion: “[T]he practice of the IRS has been that it will not prosecute taxpayers who satisfy all of the requirements of the voluntary disclosure program because, if it did initiate such prosecutions, no taxpayers ever would be willing to make a voluntary disclosure in the future.” New York University Annual Institute on Federal Taxation § 27.06 (2010).

I’m often asked, why would IRS not be willing to put in writing its “unofficial” practice of refraining from prosecuting taxpayer’s that make timely accurate and complete voluntary disclosures? I think the one motivation for not doing so is that the IRS does not want to enable taxpayers to cheat on their income taxes during hard economic times taxes knowing there is a sure fire way to correct the behavior later on when its more convenient to pay income taxes. The IRS cannot put in writing, as part of its official policy that it will not pursue criminal prosecution because it would tempt people too much to cheat on taxes and repent later. The IRS wants to avoid this sort of “cheap grace” solution. But, on the other hand, the IRS wants to encourage people to make voluntary disclosures, and to better achieve that they have decided not to exact criminal prosecution on most taxpayers making voluntary disclosures. It’s a very understandable strategy, since it attempts to strike a balance between governmental “sticks” and “carrots.”

Generally speaking, a taxpayer will be able to avail him or herself of the benefits of the IRS’s practice of non-prosecution only if she is completely truthful, discloses all previous non-compliance with federal tax law, and only if his or her disclosure is timely (made before the IRS discovers the fraud on its own).
Special rules apply for voluntary disclosures where a foreign account is involved. See here for more on that:
http://www.klasing-associates.com/FBAR-Compliance-and-Disclosure-FAQ/

Our office has successfully represented many clients wanting to make a voluntary disclosure. If you find yourself in a similar situation, our office can help. http://www.klasing-associates.com/