A Look at When a Civil Examination Turns Criminal
- Introduction.
This article addresses a civil tax examination that has gone quiet, and the difference between an internal referral to the Service’s criminal function and a later referral to the Department of Justice.
An examination, which most people call an audit, can move in that direction without a letter that says so. Generally speaking, the examiner is instructed to stop the work and not to tell the taxpayer why. The calls stop. The requests for documents stop. The report that was expected does not arrive.
A return preparer may assume the revenue agent is away, or that the file is waiting on a manager. That assumption is understandable. The handbook describes a different reason for the silence. The silence is an instruction to the examiner. It is not, by itself, the point at which the statute ends the civil examination.
- The Handbook.
Let’s take a look at the handbook.
The Internal Revenue Manual is the Service’s own instruction book for its employees. It is not the Code. It tells the employee what to do when fraud is suspected.
The handbook starts with a sign, not with proof. A first indicator of fraud, which the handbook also calls a badge of fraud, is that sign. The handbook states the difference in two sentences.
“Fraud is substantiated by establishing affirmative acts (firm indications) of fraud. Affirmative acts of fraud are actions taken by the taxpayer, return preparer and/or promoter to deceive or defraud.”
IRM 25.1.2.1.1 (Apr. 23, 2021).
A messy set of books may be a sign. A backdated invoice, a destroyed record, or a false explanation of a material fact is an action taken to deceive. That is the conduct the second sentence describes. The bottom line is that a sign may start an internal process. It does not, by itself, establish fraud.
When first indicators are suspected, and the group manager agrees, the examiner contacts a Fraud Enforcement Advisor. The handbook calls that advisor the FEA. The FEA is not the revenue agent assigned to the examination. The contact is made through an internal system, the Specialist Referral System. See IRM 25.1.3.3 (Nov. 17, 2023).
If, after that consultation, the case has firm indications of fraud or willfulness, and it meets criminal criteria, the handbook states what happens next.
“[T]he compliance employee will suspend the examination/collection activity without disclosing to the taxpayer or representative the reason for the suspension.”
IRM 25.1.3.3 (Nov. 17, 2023).
The examination stops, and so does collection of a tax already assessed. The taxpayer is not told why.
People ask whether the examiner must say that a criminal referral is under consideration. The employee does not have to open that subject. If the taxpayer asks whether a fraud referral is being considered, or whether Criminal Investigation is involved, the handbook forbids a false answer.
“[T]he examiner or revenue officer must not give a false or deceitful response.”
Id. Criminal Investigation, which the handbook calls CI, is the Service’s criminal function. The employee may decline to answer a question about criminal potential. The employee may not deceive the taxpayer about the character of the investigation. The employee is not required to volunteer that a referral to CI is being considered. The employee may simply say that, when firm indications of fraud are present, a referral to CI is required. See IRM 25.1.3.3 (Nov. 17, 2023).
The expected report may not arrive for a separate reason. A Revenue Agent Report is the written report of the examination adjustments.
“A Revenue Agent Report (Form 4549 or similar) must not be sent to the taxpayer and/or power of attorney unless and until this action is specifically discussed with the FEA.”
IRM 25.1.2.4 (Apr. 23, 2021).
The closing report stays in the file until the fraud advisor has discussed sending it.
The interview is written down as it was said. “Questions asked should be recorded verbatim. Similarly, nonresponsive answers should be noted verbatim.” Id. In ordinary words, the questions, and the answers that do not respond to them, are recorded word for word.
III. The Justice Department Referral.
Clients often assume that a referral to Criminal Investigation is the point at which the civil examination is barred by statute. Section 7602 does not draw the line there.
The internal referral is made on Form 2797, Referral Report of Potential Criminal Fraud Cases. Criminal Investigation evaluates that form. It may accept the referral. It may decline it. Form 2797 stays inside the Service. It is not a referral to the Department of Justice.
The Code draws the line later. A summons is the Service’s written demand that a person produce books or give testimony.
“No summons may be issued under this title, and the Secretary may not begin any action under section 7604 to enforce any summons, with respect to any person if a Justice Department referral is in effect with respect to such person.”
26 U.S.C. § 7602(d)(1).
A Justice Department referral is in effect with respect to a person if the Secretary has recommended to the Attorney General a grand jury investigation of, or the criminal prosecution of, that person for any offense connected with the administration or enforcement of the internal revenue laws, or if any request is made under section 6103(h)(3)(B) for the disclosure of any return or return information relating to that person. See id. § 7602(d)(2)(A).
A Form 2797 from a revenue agent to Criminal Investigation is not that recommendation. The Code does not, however, take the examination power away at the internal referral. Until a Justice Department referral is in effect, the purposes for which the Secretary may examine books and take testimony include “the purpose of inquiring into any offense connected with the administration or enforcement of the internal revenue laws.” See id. § 7602(b).
Those are different times. The handbook stops the examination without disclosing the reason. Section 7602(d) bars a new summons and bars a suit to enforce a summons only when a Justice Department referral is in effect.
If Criminal Investigation declines the referral, the examination does not stay on hold.
“The referring compliance employee will resume the examination/collection activity once notification of the declination is received.”
IRM 25.1.3.6 (June 10, 2021). If the criminal criteria are not met, or the case is returned after a criminal investigation, the handbook directs the examiner, the group manager, and the FEA to consider two civil penalties. One is the civil fraud penalty under section 6663. The other is the fraudulent failure to file penalty under section 6651(f). The group manager makes the final decision. See IRM 25.1.2.2 (Apr. 23, 2021). Those penalties are civil. They are not a criminal charge.
- Explanations at the Referral Conference.
The explanations already given to the revenue agent are part of the referral evaluation. At the conference held to decide whether Criminal Investigation accepts the referral, the topics include the following.
“[E]xplanations offered by the taxpayer, the taxpayer’s representative, and/or the return preparer concerning the alleged offense.”
IRM 25.1.3.4 (June 10, 2021). The return preparer who has been explaining the deposits is, in those words, a source of explanations concerning the alleged offense. A further letter, sent while the examination is quiet, should be read with that list in mind. It is not ordinary cooperation in an examination that is merely running late.
- Insights.
If the examination has gone quiet, or if the examiner will not answer a direct question about Criminal Investigation, the taxpayer should pause further production.
It is usually best, in this practitioner’s opinion, to have counsel review what would be sent, and to ask, on the record, whether a fraud referral is being considered and whether Criminal Investigation is involved. The examiner may decline to answer. The examiner must not give a false or deceitful response.
An internal referral should not be confused with a Justice Department referral. The form inside the Service does not, by itself, bar a summons. Until that later referral is in effect, the explanations already offered remain a topic at the referral conference.
