By Anthony Diosdi
An individual who is the subject of a criminal tax fraud case has the same rights as any other criminal defendant against unreasonable search and seizure in a criminal tax fraud case. The Fourth Amendment constitutional right against unreasonable searches and seizure typically comes into play in tax evasion cases principally in warrantless searches of a taxpayer’s books and records. The usual Fourth Amendment question arises as follows: An individual consents to the examination of his books and records believing the examination concerns only civil tax liability; he believes it is only a civil audit because the special agent has not advised him of the function of a special agent or of his constitutional rights. The taxpayer therefore contends 1) that a search of his “papers” has taken place; 2) no search warrant was issued authorizing the agent to search the records; and 3) no “consent” was given to the search by the taxpayer because the consent was only for a civil examination. The fact pattern of each case varies, but usually the variations relate to the question of “consent” and the conduct of the agent. For example, a revenue agent delays a fraud referral until he completes his examination, or a special agent is working behind the scenes while the taxpayer permits a revenue agent to examine his records, or the special agent misleads the taxpayer into believing the information supplied will not be used for criminal purposes.
Fourth Amendment warrantless-search arguments have usually been made in addition to Fifth Amendment privilege against self-incrimination claims. However, the Fourth Amendment protects corporations as well as individuals, whereas the Fifth Amendment protects only individuals. If the books and records of a corporation are subject to unlawful search and seizure, the corporation and the shareholders may have the evidence suppressed.
The Fourth Amendment constitutional protections against unreasonable searches and seizures does not so much prohibit searches and seizures as it requires formal steps to be taken in order to conduct them. Under the present law, if a search is conducted after a search warrant has been obtained, and if the search warrant is supported by probable cause, if the place and items to be searched and seized are described with “particularity” in the warrant, and if the warrant is issued by a neutral and detached magistrate, almost anything can be lawfully searched and seized by the IRS. The question has arisen whether there is any limit on materials subject to seizure, provided that the formalities of obtaining a warrant are observed. This discussion is beyond the scope of this article.
If something is searched and seized without a warrant, it can be lawful only if the search is incident to a lawful arrest, or if the item searched is in “plain view,” or if the defendant consents. Consent has been the principal question in warrantless searches in tax fraud cases. Did the agent obtain actual, voluntary consent to examine the taxpayer’s books and records?
If an agent, whether special or revenue, is authorized to inspect certain records, but expands his inspection to include material not authorized by the individual, what he uncovers is the product of an unlawful search and seizure. It is not enough to know the law regarding unauthorized inspections. A criminal tax attorney must be able to limit the fact situation as well. If the agent asks to examine all of the taxpayer’s records for certain tax years, the fact that he received material not intended to be inspected may be difficult to prove. In cases we have handled involving the routine inspection by a revenue agent of potentially fraudulent returns, we have always complied with the original request for returns, and nothing more, assembling the material in a room or area reasonably removed from other information, and answering subsequent requests for information with the same formality. An individual is not obligated to demonstrate his cooperation by guessing what the agent would like to see. He is not obligated to show an agent anything more than the agent requested to see. The same formalism should be observed when cooperating with the special agent. The principal objective is to force the agent to make the investigation with whatever talent, industry, and thoroughness he possesses. A residual benefit of this kind of formalism is a possible suppression of essential information the agent did not request to see and the taxpayer did not consent to supply.
Manner of Objecting to an IRS Summons
Although the IRS often uses search warrants to obtain evidence of a tax crime from an individual subject to a criminal investigation, the IRS may also utilize a summons to obtain evidence of a tax crime. An IRS summons is an official order to produce information or provide testimony to aid in an IRS investigation. Summonese may be issued to an individual being investigated or to third parties who may have information that the IRS wants to use in its criminal investigation.
The summons itself must give the individual ten days to appear before a designated IRS agent. If an individual wants to object to an IRS summons on constitutional or other grounds, he or she should appear before the designated IRS agent with counsel and state his objections if he intends not to comply. The IRS may then seek enforcement of the summons by filing an ex parte petition with the local district court, which will enter an order directing the person summoned to show cause why the summons should not be enforced and causing the petition and the order to be served upon him. The “show cause” proceeding is a civil and adversarial hearing to which the Federal Rules of Civil Procedure apply, including rights of discovery. See Reisman v. Caplin, 375 U.S. 440 (1964).
The best procedure is to file an answer to the petition stating the constitutional and procedural objections to compliance. A hearing on the objections will be held. If the summons is ordered to be enforced, the individual or business summoned may appeal. If the district court refuses to stay enforcement pending appeal, the individual or business summoned may appeal to the court of appeals for an order staying enforcement.
It is important to follow these procedures when a summons is issued because they will avoid a finding by the court that the individual or business that refused to obey the summons in contempt and prevent the IRS from proceeding under the contempt provisions of Internal Revenue Code Section 7604(b). Under Section 7604(b), in addition to authorizing the district court to punish an offer for contempt, Section 7606(b) authorizes the application for and issuance of an “attachment against him as for a contempt” and “for the arrest of such person.” The United States Supreme Court has held that Section 7640(b) “was intended only to cover persons who were summoned and wholly made default or contumaciously refused to comply.” See Reisman v. Caplin, supra note 78. Good faith objections made by a person who has appeared before the hearing officer and in the enforcement proceeding will receive a judicial hearing without exposing that individual or business to contempt proceedings.
Considerations in Objecting to a Search Warrant or Summons
There may be constitutional, privilege and procedural objections to compliance with a summons. Whether or not they should be made depends upon an experienced criminal tax attorney’s assessment of their legal merit and their probability of achieving success or relief. There is an overwhelming judicial disposition to permit the IRS to see what it wants to see, in the absence of compelling considerations of personal rights. Nevertheless, objections to summons have resulted in avoiding compliance altogether, or in clarifying the summons’ demand, or in limiting its scope, or in providing useful discovery opportunities.
Unconstitutional Objections to Summons Issued to Taxpayer Materiality and Relevancy
Internal Revenue Code Section 7602 permits the use of a summons “for the purpose of ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax…or collecting any tax.” The documents or testimony sought by the summons must be “relevant or material to such inquiry.” See IRC Section 7602(1)(2) and (3). Under the relevancy and materiality requirement, taxpayers have challenged a demand for records that were not used in the preparation of the returns being audited. Under the relevancy and materiality requirement, individuals and businesses that have been issued summons have challenged a demand for records that were not used in the preparation of the returns being audited. One court has held that internal budgets prepared by a corporation that were not used in preparing its tax returns were not subject to production. Another court has refused to order a corporation to supply its minute books, correspondence files, paid bills, invoices, and other records unless suh items were in categories which reflected the receipt and disbursement of money or related to financial or proprietary transactions of the corporation or its president. The test employed for determining relevancy is not one of probable cause to believe that the records are relevant, but that they will throw “light upon the correctness of the …return.”
There is an obvious and major problem in determining the relevancy of particular items, i.e., how can relevancy be determined without the production of the records in question? With that said, if an individual or business can make a case that the records summoned were not used in preparing the tax return under investigation or in preparing information used in preparing the return under investigation and that they do not relate to financial transactions of the person summoned or the person or entity under investigation, the IRS may have difficulty demonstrating the relevancy of the information summoned. If it appears that the IRS is demanding records that are not relevant, a tax attorney should produce the records for an in camera inspection by a district court, with a memorandum outlining the purpose of a Section 7206 summons and a statement to the district court explaining why the records are not relevant in the particular case.
Objection to Summons Issued to Taxpayer Examination Barred by the Statute of Limitations
Individuals summoned to produce evidence have also argued that summons demanding the production of records issued for years beyond that statute of limitations (typically three years) for assessments are not relevant. When a summons was issued covering years barred by the three year statute of limitations for civil assessments, individuals argued, in the past, that it was not relevant to any of the permissible purposes of a summons. When the IRS pointed out that the civil statute of limitations did not apply when fraud was involved, individuals issued summons countered by claiming that the IRS should then be obligated to show probable cause to believe that fraud had been committed, which he was not inclined to do, even if he could.
The controversy was settled by the United States Supreme Court in United States v. Powell, 379 U.S. 48 (1964) which held that the “government need make no showing of probable cause to suspect fraud unless the taxpayer raises a substantial question that judicial enforcement of the administrative summons would be an abusive use of the court’s process, predicted on more than the fact of reexamination and the running of the statute of limitations on ordinary tax liability.” The United States Supreme Court stated that the IRS need only show that the summons was issued for a legitimate purpose, that it does not already have the information.
Objecting to Third Party Summons
Sometimes individual taxpayers have reason to object to summons issued to third parties. There are three ways in which individuals or businesses can obtain a hearing on the validity of a summons issued to a third party: 1) he can request the third party refuse compliance before the hearing officer and enter objections to the enforcement of the summons in the district court on his own behalf; 2) he can request the third party to refuse compliance before the hearing officer and, when the enforcement proceeding is commenced, the taxpayer can seek to intervene in the proceeding under Rule 24(a)(2) of the Federal Rules of Civil Procedure; or 3) if the third party refuses to cooperate, the taxpayer can seek an injunction against compliance and seek to intervene under Rule 24(a)(2) at the enforcement proceeding.
Objections to Summons Issued to Third Party Privileged Communications- Attorney-Client
In certain cases, individuals being investigated by the IRS can prevent their attorney from turning over records summoned by the IRS. However, in order to object to a summons based on the attorney-client privilege, an attorney-client relationship must be established. The requirement of the attorney-client privilege are often codified by statute but can generally be described as: 1) where legal advice of any kind is sought; 2) from a professional legal advisor in his capacity as such; 3) the communication relating to that purpose; 4) made in confidence; 5) by the client; 6) are at his instance permanently protected; 7) from disclosure by himself or by his legal advisor; 8) except the protected by waived. See 8 Wigmore, Evidence 2292.
The privilege has probably been challenged more often in tax fraud or tax evasion cases than in any other area of the criminal law, and with some success. The principal attacks have related to issues such as whether legal as opposed to business or accounting advice was sought, whether the testimony or documents relate to communications made in confidence, and whether the privilege was waived by the communication of the privileged item to a third party who was not an agent of the attorney or essential for the rendering of legal services.
If an individual hires an accountant to prepare his income tax returns, communications between the taxpayer and the accountant will not be privileged merely because the accountant is also a lawyer. The generally stated view of the courts is that the taxpayer, in such instances, is seeking accounting, not legal advice. Some courts have recognized that the privilege can exist between a client and an attorney in the process of preparing a tax return, but it must be clear that legal advice was sought and that confidentiality was both expected and required for the communication to be made. One major difficulty an attorney will encounter in preparing the return, either by himself or through an employee, is the fact that the tax return will be filed. Thus, the work papers of an accountant employed by an attorney that otherwise would have been covered by the attorney-client privilege will be lost.
Often, transactions between a client and an attorney will become involved in a tax fraud or tax evasion investigation. Dates and amounts of legal fees paid, invoices, correspondences, ledgers, etc., relating to the payment of legal fees, do not constitute confidential communications. Neither does the privilege apply if the attorney is a conduit for handling funds, or the transaction involves a simple transfer of title to real estate, without consultation for legal advice.
As discussed above, no privilege between an accountant and his client is recognized under federal law. In fact, in most tax fraud or tax evasion cases, the accused’s accountant is an important witness for the prosecution. Once a special agent appears, an accountant should refuse to discuss anything with the individual being investigated until a criminal tax attorney is employed and the accountant is employed by the criminal tax attorney. This procedure will not privilege the accountant’s prior conversations with the defendant, or workpapers prepared in connection with prior returns, but performance of work at the criminal tax attorney’s direction and necessary communications incident to that work will be covered by the privilege. The accountant’s prior workpapers are considered to be owned by him and subject to production, unless the defendant can show both that he possesses the workpapers and owns them. If the defendant owns them, he or she may claim a Fifth Amendment privilege against self-incrimination with respect to them.
Sometimes the husband-wife privilege is raised by defendants in a criminal tax case. The federal courts have recognized that confidential communication made between a husband and wife may be privileged communications. The privilege may be claimed by the husband or wife, in or out of court, and it may be waived. In order to prevent a spouse from turning over recorders summoned, the defendant must establish that the records summoned can be characterized as communications made during the marriage relationship, not before marriage or after divorce; it must have been intended as confidential and not made in the presence of others.
Complying With a Summons
A summons is made of words and the summoner is required to do or to produce only what the words command. The exact language of the summons must be carefully examined before efforts to comply are undertaken, and then the documents demanded are in fact produced. Most business books and records are not set up for compliance with summonses. For example, the summons may demand “all invoices” respecting certain transactions, but a check of the invoice file may indicate that correspondence, memoranda, copies of checks, etc. are also included. If only the invoices are demanded, only the invoices and not the file should be produced.
A criminal tax attorney, however, must be careful in analyzing the summons. He is not permitted to determine himself what a lawful summons requires and produce only those items. The same requirement applies to complying with a summons as in filing a tax return, namly, disclosure. If counsel has objections to the production of certain items, he must state that such items will not be produced because of those objections. He cannot, however, withhold documents clearly required to be produced unless such objections are made.
In determining what is and is not covered by the summons, gray areas will be found where the determination is difficult: It is not helpful to indicate the problem to the agent or the hearing officer, because it will then promptly be cured by the issuance of a new summons. The best position to adopt is a reasonable one, not an overly technical one. A criminal tax attorney can deliver the material with a written statement of exactly what is covered in the submittal and what counsel understands to be the requirements of the summons.
If you are being investigated by the IRS, you should immediately consult with a qualified criminal tax attorney. Do not make any statements to the IRS or turn over any documents to the IRS without consulting with a criminal tax attorney.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi represents clients in tax audits, civil tax litigation, criminal investigations, and voluntary disclosures throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: email@example.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.