Ironclad Defenses To Quash IRS Summonses

What should you do if you (or your client) has been issued an IRS summons? Below is a hypothetical to provide guidance in defending against an IRS summons. Because these issues rise to the level of constitutional magnitude, specifically the fifth amendment privilege against self-incrimination, it is recommended that you consult with a criminal tax attorney.

The IRS has been investigating Sharon Michael for more than a year. Sharon is the president and sole shareholder of Michael’s, a high-end clothing manufacturing corporation. She travels extensively to Europe and Asia on business. On frequent trips through Zurich, she deposits large amounts of cash in an account at Grosser Schweizer Bank, which she refers to as her “retirement account.”

The IRS investigation began as a civil audit, and Sharon was represented by her longtime accountant during that investigation. Sharon and her accountant resisted the production of most of the documents requested by the revenue agent. A rather unnerving silence followed, and the accountant referred the case to you to see if anything could be done to pressure the agent to close the case.

You advised Sharon and her accountant that the silence – not to mention the transfer of substantial sums by Sharon to a Swiss bank account – meant that there was a possibility that the case had been referred to IRS CI for criminal investigation. Your suspicions were confirmed when, within a week of your first meeting with Ms. Michael, floods of summons were issued by IRS Special Agent Moira McQuaid.

A summons was issued to Sharon’s U.S. bank for all records on all bank accounts for the past four years. Another summons was issued to Sharon’s accountant, requesting all books and records pertaining to Sharon’s business and personal taxes, all workpapers prepared by the accountant, and all written advice given by the accountant to Sharon.

Finally, a summons was issued to Sharon herself to produce all records for her business, her records regarding her personal tax and financial information, and her personal calendar. The summons to Sharon asks her to provide “any and all documents relating to any direct or indirect sources of money or other things of value received from Michael’s and any records or information relating to transfers to any bank account outside the United States.”

1. Sharon would like you to oppose, in court if necessary, all of the summonses. Which of the summonses do you recommend that she contest, and what privileges and defenses would you allege on her behalf?

Issue # 1: What about the summons issued to Sharon’s U.S. bank for all records on her bank accounts?

The argument in opposition to this summons isn’t very strong. It is a third party summons. Taxpayers are entitled to receive notice of any third party summonses. When Sharon receives notice, does she have an argument? She can theoretically intervene to oppose the summons.

To meet its prima facie case, the government must establish the four Powell factors:

(1) the summons is issued for a legitimate purpose (investigating Sharon’s tax liability is a legitimate purpose);

(2) the material sought is relevant to that purpose. Are bank accounts relevant to one’s taxes? Maybe;

(3) The information sought is not already within the possession of the IRS;

(4) The requisite administrative steps have been followed.

The Government will have no difficulty establishing the four Powell factors. Then the burden shifts to Sharon to assert a defense.

What bad faith is involved?

Do any privileges exist? These are the bank’s records so it’s not a Fifth Amendment situation.

Issue # 2: What about the summons issued to Sharon’s accountant?

The government must establish the Powell factors. But if the government satisfies its burden, can Sharon rely on Section 7525 as a defense?

Under Section 7525, the same common law protections of confidentiality that apply to communications between a taxpayer and his attorney also apply to communications between a taxpayer and any “federally authorized tax practitioner.” Thus, if the communication would be considered a privileged communication if it was between the taxpayer and his attorney, it will – subject to key limitations – be privileged if it was between the taxpayer and his tax preparer.

A key limitation is that the preparation of tax returns is generally not considered to be legal advice within the scope of the privilege. While preparation of tax returns may require some knowledge of the law, courts have held that return preparation is primarily an accounting service. The line between what constitutes return preparation and what amounts to legal advice with respect to a position on a return is hazy at best.

Some courts take a literal interpretation, holding that any legal advice by a tax lawyer that ultimately ends up on the client’s return is considered as given “as part of return preparation” and thus, not covered by the privilege. The problem is that it is difficult to conceive of much in the way of prospective tax advice that would not end up on a tax return.

Fortunately, this does not appear to be the majority view. In United States v. Frederick, Judge Posner took a more nuanced view of the privilege:

“We do not, however, accept the government’s argument that there is no issue of privilege here because the information was transmitted to a tax preparer with the expectation of its being relayed to a third party, namely the IRS … But the taxpayer here was also the taxpayers’ lawyer, and it cannot be assumed that everything transmitted to him by the taxpayer was intended to assist him in his tax-preparation function and thus might be conveyed to the IRS, rather than in his legal-representation function.”

Let’s apply the Section 7525 test. To do that, we need to ask the question, “what if the accountant in this problem wasn’t an accountant but instead an attorney?” Would records of the type described here, in the possession of the taxpayer’s attorney – be protected by the attorney-client privilege? If the answer to this question is “yes,” then those records in the hands of the accountant would be entitled to the same common law protections of confidentiality.

Even if these records were held by an attorney, and not an accountant, the attorney-client privilege would not apply. The summons asked for the following information: (1) all books and records pertaining to Sharon’s business and personal taxes, (2) all work papers prepared by the accountant, and (3) all written advice given by the accountant to Sharon.

Let’s examine the books, records, and workpapers. Are they protected by the attorney-client privilege? Very simply, no. The IRS will rely on two primary arguments. First, it will argue that the Supreme Court of the United States has held that accountants’ workpapers are not protected from IRS summons under the work-product doctrine. Moreover, records that are otherwise discoverable do not automatically become privileged simply because they are in the hands of an attorney. Therefore, Section 7525 doesn’t prevent these books and records from being discoverable.

Second, the IRS will argue that these workpapers relate to items that were reported on the return. And because return preparation is considered to be primarily an accounting service and not a legal service, even if the workpapers were prepared by an attorney, they wouldn’t be privileged.

What about the written advice given by the accountant. Sharon has a good argument for withholding the written advice given by her accountant from the IRS. Let’s once again indulge in the fiction of replacing the accountant with an attorney. Had that advice been given by an attorney, and not an accountant, would it still be privileged? To the extent that it relates to items appearing on the return, then it would be considered as given as part of return preparation. In that case, it would not be covered by the privilege.

But to the extent that it involves legal advice with respect to a position on a return that was given by the attorney in his capacity as a legal representative, it would be covered by the privilege. That would be Sharon’s strongest argument.

Issue # 3: What about the summons issued to Sharon herself?

The summons asks for all records of Sharon’s business, her records regarding her personal tax returns and financial information, and her personal calendar.

First sub-issue: Are the documents themselves privileged? The short answer is “no,” even though these records could potentially incriminate Sharon. For example, these records might show that Sharon’s net income is far greater than the income she reported on her tax return.

The Fifth Amendment privilege against self-incrimination only protects a person against being incriminated by his own compelled testimonial communications.

Voluntarily prepared documents are not privileged because no compulsion is present. Indeed, the summons did not compel Sharon to restate, repeat, or affirm the truth of the contents of the documents sought. Therefore, the contents of the documents are not privileged.

Second sub-issue: Even though the documents themselves aren’t privileged, how about the act of producing them in response to a subpoena? Doesn’t that have communicative aspects of its own, wholly independent of the contents of the documents produced?

Ordinarily, the Fifth Amendment applies to the live testimony of a witness in a judicial proceeding. But live testimony is not all that the Fifth Amendment protects. It also protects the compelled production of business records when certain conditions exist.

Compliance with the subpoena tacitly concedes:

i. The existence of documents demanded,

ii. Their possession or control by taxpayer, and

iii. Taxpayer’s belief that the documents produced are those described in the subpoena, a fact that the government may use to authenticate them.

According to the Supreme Court of the United States in Fisher, these questions do not lend themselves to categorical answers. The resolution depends upon the facts and circumstances of a particular case. Notwithstanding this, Sharon has a strong act of production argument that can be asserted under the Fifth Amendment. Should she prevail, the government would still be able to obtain the documents but it wouldn’t be able to disclose the fact that Sharon was the person who provided them.

Third sub-issue: What if Sharon is successful in thwarting off the summons that was issued for the documents in her possession? If the government still wants these documents, what if anything can it do or are these documents destined to remain out of their reach forever? The government could confer active production immunity on Sharon. If the government wants information that otherwise would be protected from disclosure under the Fifth Amendment, the government can offer Sharon immunity. In that case, Sharon must turn over the requested documents. But to the extent that she has been granted transactional immunity, she is immune from criminal prosecution.

2. Assume you are an attorney with IRS Chief Counsel’s office. Special Agent McQuaid has come to you for advice. She suspects that Sharon has an account with the Zurich branch of Grosser Schweizer Bank and she wants to obtain the records of the account. The bank has offices in New York and San Francisco, as well as various other countries around the world. What options are available to the government to obtain the records on the Swiss bank account?

i. First, think about the traditional summons and subpoena power.

Since the Swiss bank has U.S. offices, the agent will serve the IRS summons on the U.S. branch demanding information – wherever that may be.

The dance begins. The Swiss bank will say, “We’d love to help but unfortunately, Swiss law prohibits us from doing so.” Foreign banks rather incur sizeable contempt sanctions than produce subpoenaed information.

In some instances, the foreign government intervenes. The Swiss bank might seek assistance from the Swiss government to ward off the summons. Or the foreign government might block the action. For example, the Swiss Department of Justice may seize Grosser Schweizer’s records pertaining to Sharon in order to prevent a violation of Swiss banking confidentiality laws.

At the end of the day, it is an open question of what will happen.

ii. Second, think about MLAT, TIEAs.

MLATs are special treaties specifically designed for tax enforcement. They consist of two countries bilaterally pledging to assist each other in information gathering to deal with tax avoidance and evasion.

TIEAs are agreements which specifically provide for mutual assistance in criminal and civil tax investigation. This assistance includes obtaining foreign-based documents, including bank records and testimony in admissible form. They are creatures of the internal revenue code.

Of course, MLATs and TIEAs are only effective to the extent that the United States and Switzerland have signed such an agreement for international cooperation.

That works with many foreign countries but not with U.S. tax treaties that the United States has with Switzerland.

Alternatively, the IRS may consider a letter rogatory. This is a technique by which a U.S. court transmits – through the U.S. state department and through the foreign ministry of the foreign country – a request to a foreign court asking it to provide assistance with respect to an ongoing matter in the U.S. court. If the foreign court honors the request, it does so based on comity rather than any treaty obligation.

But would a Swiss court respond affirmatively to a letter rogatory? Likely, not.

iii. Third, an informant.

Remember that it was a former UBS banker that turned the government onto UBS. Maybe the government can find an informant in Sharon’s case.

3. Once the summons issue is resolved, Sharon would like you to prepare a defense. She would like you to use her existing accountant should the need for forensic accounting arise. What do you advise?

i. First, will the need for forensic accounting arise? Yes.

With respect to methods of proof, there are indirect methods and specific items methods. The government will prefer to proceed by specific items in Sharon’s case: “Here are items that Sharon skimmed from the business, and diverted to the foreign bank account.” But the government’s ability to do that is hindered by the evidence-gathering problems it now encounters. The government might have to pursue an indirect items method case against Sharon – maybe net worth method or expenditures method – if it can’t go the specific items route.

Would a forensic accountant be desirable? Absolutely. Even if the government can show specific items, if Sharon can show that there were additional deductions or credits to offset that additional income, then there is no tax due and owing. The importance of that cannot be overstated, especially in light of the fact that “tax due and owing” is a critical element of tax evasion. The defense would want to hire a forensic accountant to see if he can find any unclaimed deductions or credits.

ii. Second, if the government uses an indirect method, Sharon will want a forensic accountant to counter the government’s accounting expert in the application of one or more of the indirect methods.

iii. Finally, for reasons of privilege, a new accountant is desirable. As a Kovel accountant, he or she should be hired by the lawyer and paid by the lawyer. Now is not the time for Sharon to be penny wise and pound foolish!

In accordance with Circular 230 Disclosure

Original Post By: Michael DeBlis

As a former public defender, Michael has defended the poor, the forgotten, and the damned against a gov. that has seemingly unlimited resources to investigate and prosecute crimes. He has spent the last six years cutting his teeth on some of the most serious felony cases, obtaining favorable results for his clients. He knows what it’s like to go toe to toe with the government. In an adversarial environment that is akin to trench warfare, Michael has developed a reputation as a fearless litigator.

Michael graduated from the Thomas M. Cooley Law School. He then earned his LLM in International Tax. Michael’s unique background in tax law puts him into an elite category of criminal defense attorneys who specialize in criminal tax defense. His extensive trial experience and solid grounding in all major areas of taxation make him uniquely qualified to handle any white-collar case.

   

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