[authors: Michael A. Gillen and Stanley V. Todd]
Originally published in The Legal Intelligencer
Danger is lurking in the world of Internal Revenue Service audits, namely, parallel investigations. Parallel investigations by the IRS are simultaneous civil and criminal investigations of an individual or business entity, which means that taxpayers can be under investigation for criminal tax matters at the same time a civil audit is being conducted.
A parallel investigation is not a joint, but rather two separate, yet simultaneous investigations being conducted by the criminal investigation and civil examination divisions of the IRS. Although the two divisions may coordinate, they do not direct each other's actions during the investigation.
Recent changes to IRS policies direct IRS personnel not to inform the taxpayer when a criminal investigation is taking place, nor is the civil investigation required to stop when a criminal investigation commences. Therefore, it is essential for taxpayers and their advisers to be aware of the dangers lurking in the shadows of civil examination activities and audits, and the possibility that those activities may be used to gather information for a criminal investigation.
Prior to 1977 there was a free flow of information between agents conducting both civil and criminal investigations since there were no procedures for conducting parallel investigations. In fact, agents conducting criminal investigations often solicited the help of agents conducting civil examinations to obtain documents and records that added value to the criminal case. That all changed with the U.S. Court of Appeals for the Fifth Circuit's decision in U.S. v. Tweel, 550 F. 2d. 297 (1977).
In Tweell, the IRS agent continued an investigation of a taxpayer after evidence was obtained through the IRS agent's deception of the taxpayer's representative as to the criminal nature of the investigation. The court suppressed the evidence even though the taxpayer's accountant had voluntarily turned over records to the IRS agent. The Tweel case compelled the IRS to implement procedures directing its agents who discovered firm indications of fraud during an audit to cease the civil examination and refer the case to the criminal investigation division. Thus, parallel investigations were no longer a concern for taxpayers subject to a civil audit, even if fraud was evident, after the Tweel case.
Current Procedures and Related Perils
Quietly, in August 2009 and 2010, the IRS changed its procedures with respect to parallel investigations, and, pursuant to Internal Revenue Manual (IRM) Section 126.96.36.199, parallel investigations are now permissible. The IRM contains policies, procedures, guidelines and instructions directing the operation and administration of the service. The change is based in large part on the ability of other federal agencies, such as the Securities and Exchange Commission and the Justice Department, to operate similarly in the conduct of parallel investigations.
The SEC and DOJ have both had great success utilizing parallel investigations in the financial fraud arena. The change to IRM Section 188.8.131.52 came soon after several cases were settled in the favor of the government allowing parallel investigations for the SEC and the DOJ. In one of the cases, U.S. v. Stringer, 521 F.3d 1189 (9th Cir. 2008), the decision stated that the government may not affirmatively mislead defendants to hide the existence of a criminal investigation. The government is under no obligation to inform targets about a criminal investigation as long as the defendants are generally aware that prosecution can take place. Finally, where a civil investigation was initiated prior to a criminal investigation, the criminal investigation agencies may use and help guide the civil investigation to assist in developing evidence in the criminal case.
Although Tweel is still good case law, the IRS is now relying on a Supreme Court case, U.S. v. Kordel , 397 U.S. 1 (1970), that permits parallel investigations so long as the government does not proceed in bad faith. The Kordel case is the case that is being used by other federal agencies in their parallel investigations. In Kordel, the federal Food and Drug Administration requested information as part of a civil investigation, which was used later for criminal prosecution. The Supreme Court ruled that there was no violation of due process in using this information for criminal purposes. The key to avoiding the limitations of Tweel and properly employing parallel investigations is that the IRS must act in good faith.
Despite the IRS's reliance on Kordel , several district court opinions have been critical of the government's conduct in parallel investigations, including U.S. v. Scrushy , 366 F. Supp. 2d 1134 (DC Ala. 2005). In Scrushy, the court held that the DOJ was involved in a behind-the-scenes orchestration of the SEC's deposition of the defendant. This led the court to suppress the deposition testimony and dismiss the perjury charges against the defendant. The court concluded in Scrushy that the government had "depart[ed] from the proper administration of justice" by its actions in directing the SEC deposition.
Under theScrushy decision, if it can be shown the criminal investigators directed the civil investigators to gather information for the criminal case, there is a possibility that the courts will suppress evidence presented in the criminal case. The avoidance of taxpayer deception is the apparent process by which the courts will allow evidence gathered during parallel investigations to stand.
The Internal Revenue Code (IRC) contains both civil and criminal provisions addressing fraud. When fraud is suspected during a civil audit, it is now possible that a parallel investigation will commence, as the civil agent may share evidence of fraud with the criminal investigations division. Criminal investigation special agents, although not permitted to influence the investigations of other divisions, may now conduct criminal investigations before, during and after civil investigations of the same taxpayer or entity.
One of the dangers to taxpayers with respect to parallel investigations is that disclosure to a taxpayer by the IRS is not required during a civil examination when evidence presents itself that fraud may have occurred and that, as a result, a criminal investigation is commencing or ongoing at the same time. An agent, during an ongoing parallel investigation, is now permitted, but not required, by recent policy to disclose to a taxpayer or representative that a criminal investigation is taking place, and the agent may share with the criminal investigation division any information obtained during the civil examination. When the IRS decides to conduct a parallel investigation, the criminal investigation special agent is required to meet and discuss the case with the noncriminal agent on a regular basis. IRM Section 184.108.40.206.11.1 states:
"Civil and criminal special agents, and IRS attorneys should regularly coordinate their efforts through regular status meetings held at least quarterly until the collection activities are complete. These coordination meetings will facilitate sharing important case developments."
Therefore, an unsuspecting taxpayer subject to a civil examination may unknowingly provide the IRS ammunition for or during a parallel criminal investigation. While the IRM clearly provides that the special agents "will not direct the actions" in the civil case, they can greatly influence the civil examination. The IRS also requires the civil agent to inform the criminal investigation special agent of all meetings with the taxpayer in advance of any meeting. Unstated in these rules is that the special agent can suggest that the civil agent gather documents that the civil agent would not collect as part of the normal civil examination.
Impact to You and Your Clients
The change in IRS policy that we have now started to see creates a progressively more challenging IRS audit process. While conducting a civil audit an agent can now, and likely will, gather information to assist in the criminal investigation. It is common for agents in a civil investigation to request information that may or may not be helpful in resolving the examination. Frequently, agents decide, without taxpayer or representative involvement or knowledge, on the nature and extent of information document requests based on a multitude of factors.
In representing a client in a civil examination, it is important to ascertain if a criminal investigation is also taking place. How should you reach this determination? Ask the revenue agent? "No," is the general answer.
Asking if your client is under a criminal investigation or if the revenue agent is contemplating a referral to the criminal investigation division may suggest to the revenue agent that criminal behavior has or may have occurred. A better approach may be to ask what records they are seeking. While the civil agent is now permitted to disclose the existence of a parallel investigation, the agent's response should be documented. The agent's statement, especially if the agent denies the existence of a parallel criminal investigation, may be used for the purpose of suppressing evidence in the criminal trial.
A tax practitioner whose client is undergoing a civil examination or collection action should seek to resolve the civil matter while preserving the taxpayer's rights by making every effort to determine if, in fact, a criminal investigation may be lurking in the shadows. Civil agents may engage in certain activities that can be indicative of a simultaneous criminal, or parallel, investigation, including, but not limited to:
A more extensive review of aggressive transactions than might otherwise be conducted during a civil investigation.
Making repeated requests to interview the taxpayer.
An unusual focus by the agent on taxpayer intent, as opposed to transaction structure.
An intent to provide documents to the criminal investigation division, by requesting copies rather than a review of originals.
If there is any chance that the IRS may be building a criminal case, the taxpayer may not wish to provide copies of select records and source documents to the agent. These documents would still be available for the agent to review in the taxpayer's or representative's office, but copies would not be provided for the civil agent to share with the criminal agents. Taxpayers should be cautioned not to provide any information to the IRS without the involvement of tax counsel.
A New Era
In this new era of IRS expanded and enhanced parallel investigations, it is essential for taxpayers to immediately contact their tax advisers in the event of an audit. It is also advisable for tax practitioners representing clients before the examination or collections divisions of the IRS to be extremely sensitive to the new devious investigations policy.
Otherwise, a tax practitioner may find himself or herself a defendant in a lawsuit filed by the taxpaying client for wrongfully producing records to the IRS. IRS representation is an art, not a science, and a taxpayer's rights must be protected at all times. It is particularly vital in cases of audits of taxpayers with questionable, aggressive or perhaps nondisclosed tax positions, where the risk of a parallel investigation is much greater, that the audit be managed with extreme care. Lawyers and accountants advising clients on tax matters should be well versed in IRS audit procedure in order to protect their client's rights.
Michael A. Gillen is the director of the Tax Accounting Group of Duane Morris, a group of certified public accountants providing tax, accounting and consulting services as an ancillary business of the firm.
Stanley Todd is a senior manager in the Tax Accounting Group of Duane Morris. He has more than 25 years of experience in many facets of federal, state and local income taxation, with particular emphasis on corporation and partnership income tax compliance and planning.