IRS Criminal Investigation

IRS Criminal Investigation

IRS Criminal Investigation

IRS Criminal Investigation: When it comes to tax law (and especially international tax law), the chances of being criminally investigated by the IRS are pretty rare. Usually, when a person is being investigated or under examination by the Internal Revenue Service, it is for civil-related matters. Even in situations involving tax fraud or international offshore penalties for willfulness — it is still primarily a civil matter. But, the IRS does refer thousands of cases each year for prosecution (generally between 3,000 to 5,000).  The Service generally reserves criminal prosecution referrals for matters where they are nearly certain the Taxpayer has committed a crime. When criminal tax is at issue, it may result in more than just monetary fines and penalties — it may result in criminal prosecution by the Department of Justice or other government agencies. The IRS itself does not prosecute you. Oftentimes, the criminal investigation is sparked from a civil audit — otherwise referred to as a reverse eggshell audit. Let’s walk through an example.

How a Reverse Eggshell Audit Leads to an IRS Criminal Investigation

When a Taxpayer is in an audit and has information they know is damaging to their own case, it is referred to as an eggshell audit. The idea is that the Taxpayer is walking on eggshells in order to avoid making any representation that can be used against them — while at the same time not making any false misrepresentations or omissions.

On the flip side, a reverse eggshell audit is when the Internal Revenue Service Agent is aware of information about the Taxpayer that the Taxpayer may not know the Agent is aware of.

Example: Fred and the Reverse Eggshell Audit

Here is a common example of how an IRS criminal investigation works:

Unreported Foreign Accounts

Fred is a US citizen who has business in several foreign countries. Fred decides to open various bank accounts in these foreign countries because it is just easier to operate in local currency.

Willful Failure to Report Foreign Accounts

Fred was aware that the account should be reported on the FBAR, but Fred intentionally did not report the information to his CPA or on the FBAR.

IRS Commences a Tax Audit

Fred is being audited for matters involving business deductions he took for his consulting firm. The IRS believes that some of these deductions were personal in nature and not deductible to the business. Fred is a smart guy and he doesn’t see the need for a lawyer for a simple tax audit. He decides to go into the audit by himself.

Fred is unaware that the IRS agent has information regarding his foreign accounts. The reason the IRS has this information is that one of Fred’s foreign banks reported the account in accordance with FATCA.  During the audit, the Agent pulls out Fred’s Schedule B and reviews it with him. The Agent asks Fred if it is accurate that Fred does not have foreign accounts. Fred confirms that he does not have foreign accounts.

Since many of Fred’s accounts are high-dollar accounts, he earns a significant amount of passive income from these accounts. The Agent is also aware that Fred earns this money and since the foreign financial institution knows Fred is a US Citizen, they sent Fred a 1099 equivalent each year.

During the audit, the IRS Agent asks Fred if he has any foreign income that has not been reported. Fred denies having any unreported foreign income.

The IRS Agent somewhat abruptly ends the audit. Since the audit is wrapped up quickly, Fred believes he has successfully convinced the Agent that he does not have foreign accounts or foreign income.

Why Did the Agent Stop the Audit Mid-Way?

The reason the IRS Agent stopped the audit is that the Agent believes that Fred may have acted criminally. In fact, Fred has now made intentional misrepresentations to the IRS Agent. Since Fred is not under arrest and has not been read his rights, an IRS agent is unable to pursue a criminal investigation. Technically, the Agent is not supposed to ask any questions relating to any possible criminal violation — since an IRS audit is not a criminal examination.

Referral to the IRS Special Agents for IRS Criminal Investigation

Generally what happens in this type of situation is that the Agent will then summarize the matter for their manager or supervisor. After reviewing the facts and circumstances, the manager or supervisor will then prepare their own summary and forward it over to CI (Criminal Investigations) for a referral to the Special Agents. The Special Agents represent the criminal faction of the IRS and they can pursue a criminal investigation to determine whether Fred should be criminally indicted or if a criminal complaint should be filed against Fred.

Special Agents Find Fred

Several months have passed since the audit ended. Fred, being the self-assured slickster that he is, is convinced that he has beaten the IRS. He cannot figure out why any of these other taxpayers are concerned about these IRS audits when he was able to wrap up the matter in under 30 minutes. Fred has long forgotten about the IRS audit and the IRS is the last thing on Fred’s mind. Fred finishes up lunch with some friends and heads back to his car where he unexpectedly meets two Special Agents. They tell Fred they want to interview him about his foreign money. 

Fred immediately realizes what’s going on and instead of speaking with the Special Agents, he asks for their business cards so that he can contact an attorney. The Special Agents try to goad Fred on a bit and get him to speak but Fred (finally) knows better. He realizes he is in over his head. 

Special Agent Interview and IRS Criminal Investigation

Fred will appear at the interview with his lawyer and answer questions regarding the foreign money. This will be a crucial meeting because the IRS Special Agents will determine whether or not the case should be referred for criminal prosecution. After the Special Agents meet with Fred, they will report back to their manager or supervisor who will then make the final decision as to whether the matter should be referred to the Department of Justice or another government agency for prosecution.

In conclusion, when a Taxpayer intentionally evades U.S. tax and reporting and the IRS believes the Taxpayer acted willfully, they may become subject to an IRS criminal investigation. Generally, the IRS does not inform Taxpayers that they are under criminal investigation. Rather, they learn about it when they are first met by the IRS Special Agents. Therefore, it is important that the Taxpayer take all audits seriously and always consider some form of representation from the outset. In this situation, Fred would have been better off if he had a lawyer from the beginning. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure and international criminal tax investigations.

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