Using Accountants to Deflect and Defend Criminal Tax Investigations and Prosecutions

For the uninitiated, tax cases are often thought of as binary in nature – either taxes were filed correctly and paid, or they were not. In actuality, they are much more complex. Serious criminal tax investigations and prosecutions cases are not often borne from mere failures to pay or file tax returns. They are often centered upon more complicated issues such as the classification of a company’s workers as employees or independent contractors, failing to remit employment tax withholdings, the fair calculation of net-income, complex international tax issues, and other topics that are not typically within the ken of a lay juror. These concepts are usually best explained by expert accountants.

The Internal Revenue Service (“IRS”) agents investigating these cases will have the benefit of their own in-house experts, and many of the same investigating IRS agents can and do testify as experts themselves. In order to level the playing field, it is important for targets of investigations to employ expert accountants to attempt to deflect investigations before the criminal authorities become involved. If a case proceeds to a criminal trial, defendants can and should set forth their own expert analysis of the tax issues to combat the government’s witnesses. The government often calls at least two IRS agents to testify at trial: one as an expert witness and another as a “summary” witness. Whether the forum is a mid-investigation presentation to the government or at a criminal trial, tax cases can involve thousands of transactions and various tax code provisions which are often best explained by qualified accountants.

Criminal Tax Statutes

There are a number of criminal tax statutes that a taxpayer could be prosecuted under for evading, failing to pay or providing false information. The most common criminal statutes are 26 U.S.C. § 7201 (attempt to evade or defeat tax), 26 U.S.C. § 7202 (willful failure to collect or pay over tax), 26 U.S.C. § 7203 (willful failure to file return, supply information, or pay tax), 26 U.S.C. § 7206(1) (fraud and false statements), 26 U.S.C. § 7206(2) (fraud and false statements), 26 U.S.C. § 7212(a)(attempts to interfere with administration of Internal Revenue laws) and 18 U.S.C. § 371 (conspiracy to commit offense or to defraud the United States). Each offense carries its own elements and penalties. At the heart of many of these statutes, the government must prove a willingness to violate the tax code. It is the central issue of whether a violation actually occurred where a expert accountant can be of significant aid.

Tips and Pitfalls in Kovel Arrangements with Accountants

With tax cases and investigations, one of the first steps defense counsel will take is to retain an accountant to work under his direction. However, counsel must tread carefully in retaining the accountant to ensure that the attorney-client privilege covers the accountant.

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In United States v. Kovel, the Second Circuit recognized that accountants are critical for the defense in criminal tax investigations. In Kovel, an accountant employed by a law firm to help their client in a criminal tax investigation was first sentenced to prison for refusing to testify about the client, but the Court overturned the conviction because the accountant was covered by the attorney-client privilege. The Court identified the necessary role that accountants play in criminal tax investigations and prosecutions:

“Accounting concepts are a foreign language to some lawyers in almost all cases, and to almost all lawyers in some cases. Hence the presence of an accountant, whether hired by the lawyer or by the client, while the client is relating a complicated tax story to the lawyer, ought not destroy the privilege . . . the presence of the accountant is necessary, or at least highly useful, for the effective consultation between the client and the lawyer which the privilege is designed to permit.”

This privilege is not absolute. It is only privileged to the extent that the disclosures made by the tax payer to the accountant is “made in confidence for the purpose of obtaining legal advice from the lawyer.” In a comprehensive article written by Jeremy H. Temkin for the New York Law Journal he describes the scope of the Kovel privilege and writes:

“the privilege will attach to analysis performed by an accountant to determine, for example, the extent of income generated in the client’s previously undisclosed offshore accounts, which enables the attorney to advise the client on the legal risks associated with the conduct. Conversely, the privilege does not apply where the accountant provides accounting services or business advice.”

The safest route when employing an expert accountant is to make clear – in writing ‑ that the retention is in connection with the criminal investigation or trial only. Many practitioners prefer to engage a new accountant rather than a client’s prior accountant to avoid having to delineate between prior non-privileged communications and privileged communications. In addition, it is probably best practice to avoid using that same accountant for tax filings and other business advice during the course of the investigation or prosecution.

IRS Investigations, Presentations by the Defense Team and Prosecution Recommendations

One of the most basic and effective strategies in managing tax investigations is determining whether there is criminal exposure and attempting to limit the scope of the investigation and the potential for a criminal case. This is often best done through the use of an expert accountant to present to the investigator why a referral to the criminal authorities is not necessary.

Tax investigations begin with the IRS. An initial indication of criminal exposure is whether the Internal Revenue Service Criminal Investigation Division (“CID”) is leading the investigation. CID “serves the American public by investigating potential criminal violations of the Internal Revenue Code and related financial crimes.” After concluding an investigation CID may refer its written results to the Department of Justice for recommended prosecution.

Investigations can be initiated by a CID Special Agent when it is referred by an auditor or revenue officer, from the public, or other law enforcement agencies. The first step is the “primary investigation,” where the front line supervisor reviews the preliminary information and either approves or declines further development. If that supervisor approves the requests for further development the head of the office must decide whether to initiate a “subject criminal investigation.” Once an investigation is opened, the special agent begins an investigation which typically includes subpoenaing records, interviewing witnesses, surveillance and other investigative efforts. It is during this stage that a target of the investigation may have an opportunity to present to CID that it should not proceed with a criminal recommendation and that the target has not engaged in any criminal behavior. This is when an expert accountant could be of great value to those seeking to derail a CID investigation by pointing out that there has been no criminal tax violation. Making a presentation to CID is most effectively performed with the combined efforts of strong advocacy from the lawyers and expert tax code analysis from a qualified accountant.

After the investigation, the special agent and supervisor decide whether or not to make a referral to the criminal authorities recommending prosecution. If the agent determines a recommendation of prosecution is appropriate, it will make a written report called a “special agent report” which will be reviewed by multiple higher ups within the IRS. After this report is completed, it is forwarded to the Department of Justice, Tax Division for tax investigations or the United States Attorney for other investigations. In 2016, there were 3395 investigations initiated, and CID decided to make 2744 prosecution recommendations.

For some defendants, the most important piece of any criminal tax investigation is making a pitch to CID early on and trying to convince it against referring the case to the criminal authorities. As a matter of statistics, failing to do so can signal the beginning of the end. In 2016, CID made 2744 criminal prosecution recommendations and the criminal authorities formally charged 2761 defendants. Moreover, in 2016, there were 2672 convictions.[1] That is why it is critical for those facing criminal tax investigations to get into CID early with their best pitch – and a qualified expert accountant – because once the case is referred to the Department of Justice or the United States Attorney it is rarely resolved without a formal criminal charge, and a large percentage of those charges result in convictions.

Expert Accountants at Trial

In criminal tax trials, the government must generally show that there has been a willful tax violation. It often utilizes at least two IRS agents to explain the tax code and summarize the government’s evidence. To combat what has been referred to as the government’s “dynamic duo” the defense should put on its own qualified accountant expert.

In many criminal tax trials the government educates the jury about the tax laws the defendant allegedly violated by using two key IRS agents: “the government’s ‘expert’ witness, and the government’s ‘summary’ witness.”

IRS agents routinely testify as experts and Courts have held that “an IRS agent which expresses an opinion as to the proper tax consequences of a transaction is admissible evidence.” “In a tax trial, the examining revenue agent is often used by the government as an expert witness to establish the computations of deficiencies as set forth in the indictment or information.”

The government usually selects another IRS agent as a summary witness, who will typically prepare some sort of diagram and depict the defendant’s tax liability and essentially summarize the government’s case. However, the summary witness testimony is somewhat limited. Since the government refers to the agent as a “summary witness” rather than an “expert witness” there are also more limited discovery obligations. In one recent case, the defense argued that the government is unfairly using the IRS agent “[as] an expert witness disguised as a summary witness in order to evade the [expert witness disclosure] requirements of Federal Rule of Criminal Procedure 16.” United States v. Barnwell, No. 15-cr-620, 2017 U.S. Dist. LEXIS 39767, at *3. (S.D.N.Y. Mar. 20, 2017). The Court denied the defendant’s motion but held that the IRS agent can do “no more than analyze facts already introduced into evidence and spell out the tax consequences that necessarily flow from those facts.” Id., at *4. The Court also reminded the government that the witness “must avoid adding any gloss of expertise when she performs this function” and “her role is to testify as a summary witness on behalf of the IRS, not to lend an aura of credibility to any lay opinion regarding Defendant’s culpability.” Id., at *5-6. Even though the Court allowed the IRS agent to testify in Barnwell, it required the government to provide the defense a summary of her expected testimony because it is “mindful of Defendant’s concern and agrees there is a risk that [the IRS agent’s] non-expert summary witness testimony will be used as an end-run around the Government’s expert witness disclosure obligations.” Id.

Despite certain limitations on the testimony from the government’s summary witness and tax expert testimony, the fact remains that the jury will likely be informed about the tax code from at least two government witnesses. After the jury hears two government witnesses outline the tax code and the government’s case, “having a qualified tax expert with whom the defense can consult is often essential to mounting a successful challenge to the government’s experts.” In criminal tax cases, accountant expert witnesses may be used to testify concerning various matters such as accounting practices, bookkeeping matters and computation of income tax liability. These are critically important witnesses for the defense. A study conducted by the Journal of Forensic & Investigative Accounting highlights the importance of the use of forensic accounting experts in tax cases. It tracked both civil and criminal cases and summarized its findings as follows:

“The expert witnesses were not considered to be effective by the judge in the majority of the cases that were decided for the government. When a case was decided for the taxpayer, the expert testimony was always considered to be effective by the judge.”

It should be noted that there are a series of post-conviction proceedings in which convicted individuals petitioned the court to argue that they received ineffective assistance of counsel because their trial lawyer did not call an expert accountant to testify. For example, in Litwok v. United States, a convicted tax-defendant made a motion for ineffective assistance of counsel for failure to call a forensic accountant at her trial. No. 14-cv-4341, 2016 U.S. Dist. LEXIS 162715 (E.D.N.Y. Nov. 23, 2016). The Court denied her petition and held that “this reasonable inquiry and determination is the sort of tactical decision-making that courts are reluctant to second-guess, and merely presenting a ‘vague hope that another expert might have reached a different result than the government expert’ is insufficient to overcome that deference.” Id., at *15 (internal citations omitted). In contrast, there has been at least one case where the Ninth Circuit held that because the case involved a “difficult tax statute” and was otherwise complex “it should have been obvious to a competent lawyer that the assistance of an accountant would be necessary to trace the distribution of the funds alleged to have been illegally spent.” See United States v. Tucker, 716 F.2d 576, 578 (9th Cir. 1983).

It is important for lawyers to consider the use of expert accountants in federal criminal tax trials. The jury is likely to hear expert testimony through one IRS agent testifying as an expert witness and another IRS agent giving “summary” testimony that quite closely resembles expert testimony. In most cases, this sort of testimony should not go unchallenged and the defense would be wise to set forth its own accountant expert to explain the tax issues in the case.

Solely relying on defense counsel is a mistake for those under serious criminal tax investigations. An expert accountant’s explanations of the tax code can carry significant weight in complex criminal tax investigations and trials. When trying to convince CID against making a criminal referral, an expert accountant allows the defense to make a more comprehensive and credible presentation. In most criminal tax trials, the defense should not let the government witnesses’ explanation of the tax code go untested. The defense significantly increases its likelihood of success by deploying an expert accountant to help deflect criminal investigations and to combat testifying IRS agents.

[1] “Since actions on a specific investigation may cross fiscal years, the total shown under Investigations Initiated may not represent the same universe of investigations displayed under other actions within the same fiscal year.”

Joseph B. Evans focuses his practice on the defense of Federal and New York State criminal and regulatory inquiries and the prosecution of complex litigation matters. He is an associate at Gage Spencer & Fleming LLP, a trial law firm well known for defending the nation’s most high-profile white-collar criminal cases from inception to verdict.