Criminal Tax Investigations and Current-Year Returns: New Thoughts on a Perennial Issue.

This article was originally published in Andrews Litigation Reporter-December 2004

Criminal tax cases present many issues unique to the world of white-collar criminal practice, but perhaps the most complex and intriguing one arises from the annual requirement that every U.S. taxpayer file a timely, accurate and complete tax return, and the implications of this requirement for the target of the investigation.

Most criminal tax inquiries take more than a year to investigate, and thus persons under scrutiny by the Internal Revenue Service's Criminal Investigation Division have to "return to the scene of the crime" each year by confronting a filing likely to bear on one or more issues in the prior years' returns already under scrutiny.

The situation is fraught with peril for the target of the investigation - filing a complete and truthful return may provide important and incriminating leads to investigating agents; anything less risks expanding the inquiry to include the current year's filing as part of the criminal conduct.

For example, a taxpayer under investigation for having a previously undisclosed foreign bank account must still confront the question on the 1040 form asking whether, in the previous calendar year, he or she had signatory authority over or a financial interest in a foreign account. A "yes" answer, with the additional required information, would be a potentially incriminating admission. Failing to answer, or worse, a "no" answer, may be a new criminal offense.

Or, an accurate portrayal of a taxpayer's partnership or other holdings might reveal the existence of an entity not known to the IRS during previous years, in which the taxpayer might have attempted to hide substantial unreported income; yet failing to provide complete information on the current return may trigger additional charges.

Most starkly, an individual under investigation for failing to file a tax return in previous years confronts the annual dilemma every April 15 - not filing is a new offense, but any tax return will provide the investigating agent with important leads regarding issues relating to prior years.

For the lawyer, the situation is also complex. Advice to a client not to file, or to file anything other than a complete and accurate return, may run afoul of ethical rules or even prompt a view among federal prosecutors that the attorney has aided a client's submission of a false or incomplete tax filing.1 Turning away from the issue is a disservice to the client and risks that the client will simply file false returns on counsel's "watch."

Inevitably, these issues create tension between the lawyer's obligation to turn square corners and the client's sheer disbelief not only that a return is required, but that it might have to contain admissions prejudicial to the defense of the criminal inquiry.

The current-return issue has been the subject of numerous previous articles2 and is often discussed at programs relating to criminal tax fraud. This article will not rehash these old debates, but rather will describe some new case law and recent anecdotal experiences that suggest to this author that practitioners may wish to re-examine how they deal with the annual dilemma of advising a taxpayer under criminal investigation with regard to current filings.

Multiple Strategies

The U.S. Supreme Court ruled years ago that the Fifth Amendment was not a valid basis for simply failing to file a tax return.3 Thus, over the years, criminal tax lawyers have developed creative approaches to this sometimes confounding problem, and often disagreed with one another as to the right one. While some early strategies, such as filing an "anonymous return" or making an "anonymous payment," appear to have fallen out of favor, three general approaches appear to have emerged.

The first involves the selective assertion of the Fifth Amendment privilege on the return. It is well established that a taxpayer may assert the Fifth Amendment privilege on a tax return in response to one or more specific line items.4 The privilege may not be used in response to every question on the return, nor can it be used arbitrarily.

Most circuits looking at the issue have ruled that the taxpayer must always report the total amount of taxable income, even if the privilege has been asserted as to the source or amount of a particular item.5 For example, a taxpayer may decline to answer the question about foreign bank accounts or to identify the source of income earned in such an account, and instead may claim the privilege explicitly on the return as to those line items.

But because the taxpayer generally …