IRS Criminal Investigation Process

The most frightening thing the IRS can do to you is open up a criminal investigation. The Internal Revenue Service Criminal Investigation Division (CID) conducts criminal investigations of individuals and firms under suspicion of committing tax fraud or other serious financial crimes. The CID looks for violations of the Internal Revenue Code, the Bank Secrecy Act, or for significant discrepancies in tax returns that constitute tax fraud. Examples such as deliberately under reporting income or intentionally failing to file a tax return can spark an IRS investigation.

Although only a handful of the millions of taxpayers undergo investigation, those who do are usually convicted and face devastating consequences. According to the IRS website, 3,853 criminal investigations were initiated in 2015 with 2,879 convictions and 80.8% of those investigated sent to prison. Alongside incarceration, a criminal investigation can result in huge fines, the loss of licenses, and the closure of businesses.

It’s important to understand that an investigation by the CID is very different and much more dangerous than an audit. Whereas the IRS during an audit seeks to find errors in a return in order to collect funds for the agency, the CID seeks not to collect money but only to prosecute you.

Warning Signs

More often than not, you will not be notified immediately when the investigation begins. If you are being audited, warning signs that the audit has turned into a criminal investigation include:

  • The IRS auditor who has been conducting your audit suddenly stops contacting you and will not return your calls for days or weeks at a time. This is not luck and no, they did not decide to just let you off easy. Your case may have been referred to a Special Agent in the CID. The auditor reviewing your return is no longer is in control of your case and ceases contact with you in order to prevent any obstruction to prosecution.
  • Your bank informs you that the CID using a summons or the local U.S Attorney’s Office using a grand jury subpoena are collecting copies of your bank records. Hiring representation will allow you to follow the IRS investigation and acquire the same records the IRS collects.
  • Your accountant is contacted by the CID or is subpoenaed to appear before a grand jury and hand over your tax records. Unfortunately, you are not given the same confidentiality guarantees with your accountant that you are with your lawyer. Not only does the accountant have to bring forward your records but they may also be called to testify, using any conversations you’ve had with them against you. While there is such a thing as accountant-client privilege, it does not apply in criminal investigations.
  • You are in the middle of an audit and the IRS informs you that a different year’s return has also been selected for examination.

How it’s Initiated

Criminal investigations usually begin when the auditor finds suspicious or significant errors in your tax return and refer your case to the CID. Investigations can also be based off of information given by other law enforcement agencies such as the FBI or the United States Attorney’s office. It is important to note that if the auditor finds indications of fraud, they are required to suspend your audit without telling you. It is illegal for the IRS to conduct a criminal investigation while you think it is an audit, but they will not tell you that your case has been given to the Criminal Investigation Division.

When your case is referred to the CID, it is given to a Special Agent. Like other agencies, IRS Special Agents are highly trained and armed  federal law enforcement officers conducting the investigation. The investigation begins with what is called the “primary investigation” which is a preliminary evaluation of your financial records, tax return, etc. The special agent analyzes your information to determine if fraud or other financial crimes are present. The agent has to acquire approvals before he can contact your bank/employer and needs special authorization before they can ask the grand jury to use its subpoena power to collect certain documentation. Once the special agent concludes his preliminary examination, they hand it to their front line supervisor who will then determine if there is significant evidence to approve investigation. Upon approval, the special agent is given permission to conduct a “subject criminal investigation.”

The special agent may appear at your home unannounced. If you didn’t know you were under criminal investigation by now, this is your wake up call. The agent is required to identify themselves and give a warning. The purpose of this visit is to catch you off guard without representation in order to interrogate you. Without counsel, it is very likely you will incriminate yourself in attempt to explain your mistake. Absolutely do not speak with the Special Agent without representation. You are not required to and it is in your best interest that you wait until you have professional help.

Once the criminal investigation has officially begun, the special agent will begin collecting evidence against you through a variety of means such as conducting surveillance, acquiring search warrants, collecting bank records and other financial documentation, and interviewing third parties such as employers, coworkers, and landlords.

The Investigation Process

To summarize, the IRS criminal investigation proceeds as follows:

  1. The IRS agent auditing your return finds evidence of fraud and refers your case to the Criminal Investigation Division.
  2. The special agent in the CID reviews your case and begins the primary investigation, reviewing your case for potential fraud.
  3. The special agent obtains authorization to collect information, issue a summons for records, ask the grand jury to subpoena documents, and to interview third parties.
  4. Once the special agent has collected sufficient evidence to bring the criminal case to court, they will document their findings in a Special Agent Report (SAR). This report features the agent’s conclusions of the criminal investigation and possible federal charges you can face. The agent then refers this report to the Department of Justice in order to prosecute and indict you. The referral, prosecution, and indictment must first be approved by a higher-up in the IRS.
  5. Once the IRS collectively approves the special agent’s referral, the IRS must seek approval from the local United States Attorney and from the Tax Division of the Department of Justice. You have the right to meet with anyone involved in the approval process to potentially stop the prosecution before it even begins.
  6. Once the IRS, United States Attorney, and the Tax Division of the Department of Justice all approve the referral, they must finally seek authorization from the grand jury to indict you.
  7. When the grand jury decides to indict you, your case has officially been brought to court. You must appear in court for a bail hearing and an arraignment where you will either plea guilty or not guilty. It is absolutely crucial that you have legal counsel by this time.
  8. It is your right to meet with your district federal judge and convince them to have the indictment dismissed before it goes to court. If they do not dismiss it, your case will appear before a jury.
  9. The jury will then determine whether you are guilty and not guilty. You have the right to appeal, but if your appeal does not succeed, jail time and other harsh penalties will follow.

Conviction

The goal of the CID is not to collect money owed to the federal government but to put tax evaders behind bars. Penalties can be severe, generally resulting in fines up to $250,000 for individuals, $500,000 for businesses, and up to 5 years in prison. If you find that you are being criminally investigated by the IRS, contact an attorney immediately. Alone, you won’t stand a chance against the IRS. With professional help from the experienced attorneys at the Law Offices of Jef Henninger, we’ll keep you out of jail and assure you the best possible outcome from a criminal investigation.

Tax Fraud

What is tax fraud?

Tax fraud is a general term for when a person or firm intentionally defrauds the government in order to avoid paying taxes. Major examples of fraud include failure to file a tax return, intentional failure to pay taxes, intentional under-reporting of income, preparation of false files, filing a false tax return, and using a fake Social Security number. Tax fraud is a serious offense with brutal consequences. Along with jail time, individuals convicted of tax fraud can be fined up to $250,000 and businesses can be fined up to $500,000.

The key component to fraud is that the taxpayer’s actions are intentional. Taxpayers are legally bound to accurately report income and expenses on their tax return. Withholding or falsifying information on a return is illegal and can result in either civil or criminal charges. If the auditor reviewing your return finds evidence or sufficient suspicion of tax fraud, your return may end up in the hands of the IRS Criminal Investigation Unit.

It is important to note that, while the IRS usually has 3 years to conduct an audit, there is no statute of limitations if they find evidence of fraud in your tax return. The IRS can investigate a fraudulent return for however long they require and can open up returns from previous years, so don’t try to wait them out.

If you intentionally commit tax fraud, the IRS will find out. The IRS combines both trained auditors and computer systems to detect discrepancies within your return. The auditors are trained to find fraud within a return, however most of the errors they find are honest mistakes. So what distinguishes fraud and mistake to the IRS?

Fraud or Negligence?

The IRS can tell the difference between honest mistakes and fraudulent actions. If you did not intentionally falsify your tax return, you don’t have anything to worry about. Honest mistakes do happen, though. The IRS knows that the tax code is complicated and most people are unaware of how it works. When errors are found in a return, the IRS generally gives the taxpayer the benefit of the doubt and assumes the mistake was out of negligence. Intent is the key difference between fraud and negligence. Common intentional actions that serve as red flags to the IRS include:

  • Overstatement of deductions and exemptions
  • Falsification of documents
  • Concealing income
  • Keeping two sets of books
  • Falsifying personal expenses as business expenses
  • Using a false Social Security number
  • Claiming an exemption for a nonexistent dependent, such as a child

A 20% penalty can be placed on you for negligent actions such as failing to keep adequate records. This means that if you owe $10,000 in taxes and are given a 20% penalty, the penalty will amount to $2,000 for a total of $12,000 plus interest. This is an honest mistake and is much better for you than the 75% penalty placed on you for civil fraud. Negligence isn’t illegal, but you can still pay for it. Be careful to keep records and to file your return accurately. The IRS is trained to tell the difference between fraud and negligence, but you don’t want to give them any reason to take a closer look at your finances.

The chances of you being charged criminally for fraud are extremely low. The IRS Criminal Investigation Unit only investigates about 2% of taxpayers, only 20% of that actually face charges. When an auditor spots an error in a return, they usually just place civil penalties to avoid extra paperwork. The IRS unofficially only conducts criminal investigations on cases with at least $70,000 in unpaid taxes. Considering most people don’t even make that in a year, the average American shouldn’t worry about being accused of tax fraud.

How the IRS Proves Fraud

The IRS relies on four indirect methods for determining fraud. They examine specific items, bank deposits, expenditures, and net worth to determine if you have committed tax fraud.

Specific items, such as checks given in payment to a company that are pocketed by the company owner, are useful in an investigation but there must be enough specific items to prove fraud. Unless a single check is pocketed for a significant amount of money, anywhere between 15 to 20 specific items are needed to prove fraud.

Bank deposits are the easiest way for the IRS to prove fraud because the auditor only has to find the sum of all of your deposits and compare it to your reported income. If your deposits exceed your reported income, you will be accused of fraud.

As with bank deposits, the IRS will calculate the sum of all your expenditures such as written checks, living expenses, and estimated cash expenses. The auditor can even use statistics on the cost of living in your area. If the sum of all of your expenditures exceeds your reported income, the IRS will be suspicious of tax fraud. The auditor will want you to fill out IRS Form 4822 which lists your living expenses. Do not do this. There is no punishment for refusing to fill it out and it only makes it easier for them to incriminate you.

Net worth is calculated by the IRS by finding the sum of all your liabilities and subtracts it from the sum of all of your assets from the start and end of the year under audit. If there is an increase of net worth without an increase of income from the previous year, the IRS will suspect you of tax fraud.

The IRS has additionally compiled a list of “badges of fraud” which are specific indicators that fraud is present. The badges are various but generally fall under the categories of understated income, insufficient books and records, failure to file tax returns, inconsistent or unlikely financial behavior, concealing assets, and failure to cooperate with the IRS.

No one of these badges are enough to prove fraud on their own. Multiple indicators are necessary for the IRS to conduct a criminal investigation.

A Clear Example of Tax Fraud

It is fairly easy for a self-employed person to fall into fraudulent habits. Since they keep track of their own books and records, it is easy for them to write off personal or fictitious expenses as business related. This would give them tax benefits they are not actually entitled to.

Say you own a restaurant and you decide to write off personal expenses such as vacations, personal travel expenses, or your phone and internet bill as business you can amount large illegal deductions that hide the actual amount of money you owe the IRS. This is an example of intentionally fraudulent behavior that can result in criminal consequences.

It is the IRS’s responsibility to prove that you intentionally committed fraudulent actions. Regardless, it is vital that you cease contact with the IRS and get legal representation such as the Law Offices of Jef Henninger as soon as you discover you are being investigated for fraud.

What kind of penalties can an audit result in?

How likely am I to go through an audit without owing any money to the IRS?

The IRS doesn’t audit someone if they don’t think there’s money to be made. Other than to ensure that taxpayers are abiding to the U.S. tax code, the main purpose of an audit is to provide funds to the IRS through penalties and interest. That being said, your chances of getting away scot-free or even receiving a refund are slim. Less than 25% of taxpayers audited by the IRS end up owing nothing to the IRS. There are a variety of reasons why you can be audited, but whatever reason it may be you will likely have to fork over a large sum of cash to the IRS.

It’s important to file your taxes accurately on and time. The penalties the IRS can place on you plus interest rates pile up quickly and can lead to you owing substantial amounts of money.

There are a variety of penalties you can face depending on the nature and severity of the error on the tax return.

Accuracy Related Penalties

If your tax return is inaccurate, the IRS can impose a penalty of 20% on the total tax understatement. If your taxes are severely understated, this penalty can double to a massive 40%. The following are the types of inaccuracies that can result in penalties.

  • Negligence or Disregard of Regulations: You can face penalty if you do not conform to the Internal Revenue Code, such as not submitting a tax return or not keeping records.
  • Substantially Understating Your Taxes: If you under-reported your income by more than 10% or $5,000, whichever is greater, you will face penalties.
  • Substantially Misstating the Value of Property: Penalties are placed on you if you substantially overvalue property donated or you substantially undervalue property that is depreciating.
  • Substantially Overstating Pension Liabilities: You will face penalty if you overstate pension liabilities by 200% or more.
  • Substantially Understating a Gift or Estate:  You will be fined if you undervalue property claimed on an estate or gift tax return by 65% or less resulting in an understatement of tax of $5,000 or more.
  • Understatements Related to Reportable Transactions: If you understate tax liabilities due to a reportable or listed transaction you can be fined.

Failure to Pay Penalty

If you file your tax return on time but you do not pay all the taxes due, you will have to pay a penalty for late payment. This penalty is 0.5% for each month that increases each month up to a maximum of 25%. This penalty covers all unpaid tax from the date the return was due until the penalty is fully paid.

Failure to File Penalty

If you do not file your tax return on time, the IRS places a penalty of 5% of the tax owed for each month that your return is late, up until a maximum of 25%. If you file your tax return over 60 days late, there is an additional penalty of $205 or 100% of the tax owed, whichever is less. This can be avoided if you can prove that you had reasonable cause for filing late.

Civil Fraud Penalty

If during the audit the IRS determines that any part of the underpayment is fraudulent, the entire underpayment will be treated as fraudulent and a 75% penalty will be imposed. It is the burden of the taxpayer to prove the return is not fraudulent.

Fraudulently Failing To File a Federal Tax Return

If the IRS determines that you intentionally filed your tax return late in order to evade taxes, you will be subject to a penalty of 75%.

Criminal Penalties

If the IRS finds that you intentionally commit tax evasion, tax fraud, fail to pay your taxes in general, and/or not keep records for your business, you can be charged criminally. Depending on the severity of the crime, punishments range from misdemeanors to felonies. You can face fines up to $100,000 and up to 5 years in prison for tax fraud according to the Internal Revenue Code. If you are being investigated by the IRS, it is absolutely crucial that you contact an attorney immediately.  Here at the Law Offices of Jef Henninger, Esq., we combine professional experience with unwavering determination to produce the best possible outcome for our clients.