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The White House released a statement on February 8, 2018 that President Trump nominated Charles Rettig as the new Commissioner of Internal Revenue Code for the remainder of a five year term that began in November 2017.  Unlike other recent presidential nominees that may have ignited fierce debate among political parties, Rettig’s nomination has been universally praised across party lines and by both the public and private sector of tax practitioners.  Rettig spent over thirty-five years in private practice defending clients against the IRS, but also recently published an article discussing the pitfalls of tax collection today and encouraging greater tax enforcement.  Although Rettig’s professional experience is in the private sector, he has consistently encouraged and advocated for voluntary tax compliance and tax enforcement.  Rettig will likely bring this perspective to his new position as IRS Commissioner.

Professional Experience

Rettig spent the last thirty-five years at Hochman, Salkin, Rettig, Toscher & Perez, P.C. in Beverly Hills, California representing clients in a variety of tax matters.  His peers and other national sources have deemed Rettig as a leading practitioner in tax fraud, tax law, and tax litigation and controversy.  See Charles P. Rettig, Biography, Hochman, Salkin, Rettig, Toscher & Perez, P.C.  Throughout his career, Rettig represented thousands of individual, business, and corporate taxpayers involved in civil examinations, tax collection matters, and criminal tax investigations, often representing clients against the IRS.

Concurrent to defending clients in tax matters, Rettig was appointed by the IRS to serve as Chair of the IRS Advisory Counsel (“IRSAC”), and was an active member since 2008.  The IRSAC receives commentary from the public regarding the public’s perception of IRS activities.  The IRSAC then advises the IRS Commissioner on its findings to encourage the public’s involvement regarding tax administration policy, programs, and initiatives.  See Internal Revenue Service Advisory Council Facts, IRS.

With Rettig’s professional backdrop in mind, an analysis of Rettig’s recent publication regarding IRS tax enforcement paints a full picture of Rettig’s viewpoints.  These viewpoints will most likely follow Rettig to his position as IRS Commissioner.

Viewpoint on the IRS and Tax Enforcement

In a fall 2017 issue of the Journal of Tax Practice and Procedure, Rettig published an article entitled A Lesson in Accountability and IRS Enforcement.  Overall, Rettig sets a tone for the need for a new era of increased tax enforcement. The article addresses three main areas: (1) facts on the IRS and current tax collection efforts; (2) the underlying causes of the problems with tax collection and enforcement; and (3) proposed solutions to increase tax collection.

Tax Facts

After providing statistics on the billions of tax dollars collected by the IRS, Rettig explains the current tax gap.  The gross tax gap is the difference between the amount of tax imposed on taxpayers in any given year and the amount that taxpayers voluntarily and timely pay.  The gross tax gap from 2008 to 2010 is about $458 billion.  The net tax gap is the portion of the gross tax gap that never gets paid.  It is the gross tax gap less the tax that the IRS will subsequently collect, either through voluntary payments or IRS enforcement.  Rettig says that it is estimated that the IRS will be able to collect $52 billion of the gross tax gap, leaving a net tax gap of $406 billion.

Problems with Closing the Tax Gap

Rettig addresses three issues that lead to the tax gap.  First, Rettig explains the direct causes of the tax gap: underreporting income, underpaying taxes owed, and not filing taxes at all.  Of those three, underreporting accounts for the greatest portion of the tax gap: $387 billion.  Underpayment accounts for $39 billion and non-filing accounts for $32 billion.  In addressing underreporting, Rettig explains that IRS research shows that people that have federal taxes withheld from income report 99% of their income.  Taxpayers that have reporting requirements under the law also tend to report almost all of their income (96%).  The problem lies with taxpayers that are not subject to withholding or information reporting, with that group only reporting only 68% of their income, and sole proprietors often reporting only 48% of their income.

Second, Rettig highlights that the IRS currently has a historically low number of enforcement agents, which is most likely attributable to the IRS budget.  Rettig cautions that the resource-challenged IRS impacts tax enforcement efforts, which in turn explains another contributing factor to the billion dollar tax gap.

Lastly, Rettig explains that the IRS relies on voluntary compliance.  Rettig states that research shows that increasing civil tax penalties do not increase voluntary compliance by taxpayers.  With IRS examination of taxpayers operating at low rate, Rettig suggests that this may only encourage tax payers to “push the compliance envelop” because it seems like there is not much risk of detection from the IRS.

Proposed Solutions to Close the Tax Gap

Rettig offers three solutions that will target this billion dollar tax gap.  First, Rettig suggests that the IRS should “hunt” for under-reporters and non-filers.  He suggests that technology can help target the taxpayers that fall in the categories of significant underreporting through electronic programs designed to identify these tax payers.  Technology can also be used to identify those tax payers that underreport foreign income, with the cooperation of foreign governments.

Second, Rettig discusses the need for tax practitioners to enhance professional responsibilities within their own fields.  Although the IRS is the governmental tax enforcement agency, Rettig suggests that tax practitioners also play an important role in the voluntary compliance aspect of our tax system.  Specifically, Rettig states that attorneys, accountants, and other tax practitioners must make sure their clients follow the law and observe the appropriate standards set within each profession.  Rettig states, “Tax returns are not to be perceived as an offer to negotiate with the government–information set forth on a tax return, signed by a paid return preparer, must be accurate with a reasonable foundation and reasonable support for the characterization of items set forth within the return.”

Lastly, Rettig suggests that the only way to increase voluntary tax compliance is to increase tax enforcement.  If tax payers know that there is a significant risk of IRS detection associated with underreporting, underpayment, or non-filing, tax payers will be more likely to voluntarily comply.  Because Rettig stated that research shows that increased civil penalties alone do not create the needed effect of increased compliance, only increased tax enforcement through civil examination, field (in-person) examination, and investigation will create the needed effect of increased voluntary compliance by taxpayers.

Conclusion

In sum, Rettig offers both sides of the coin: extensive experience in advocating from the taxpayer’s point of view against the IRS and extensive experience with the inner workings of the IRS and the contributing factors to the billion dollar tax gap.  With this two-sided experience, taxpayers can expect a new frontier of the IRS focusing its resources on targeting the greatest causes of the tax gap, increasing examination of these taxpayers, and hopefully adding millions, if not billions, of uncollected tax revenue to the federal treasury.

The Internal Revenue Service has announced that the nation’s tax season will begin on Monday, January 29, 2018. As is typically the case, the annual opening of tax season is accompanied by well-publicized enforcement actions intended to warn potential tax cheats of the perils of filing a false tax return. This year is no different, with the announcement that reality television personality Michael “The Situation” Sorrentino and his brother, Marc Sorrentino, pleaded guilty today to violating federal tax laws.

Michael Sorrentino was a reality television personality who gained fame on “The Jersey Shore,” which first appeared on the MTV network.  According to documents and information provided to the court, he and his brother created businesses, such as MPS Entertainment LLC and Situation Nation Inc., to take advantage of Michael’s celebrity status. Michael Sorrentino admitted that in tax year 2011, he earned taxable income, including some that was paid in cash, and that he concealed a portion of his income to evade paying the full amount of taxes he owed.  He also made cash deposits into bank accounts in amounts less than $10,000, in an effort to ensure that these deposits would not come to the attention of the IRS.  Marc Sorrentino admitted that for tax year 2010, he earned taxable income and that he assisted his accountants in preparing his personal tax return by willfully providing them with false information and fraudulently underreporting his income.  Gregg Mark, the accountant for the Sorrentino brothers, previously pleaded guilty in 2015 to conspiring to defraud the United States with respect to their tax liabilities.

Sentencing is scheduled for April 25, 2018.

Today’s announcement was replete with the usual warnings to would-be tax evaders from Justice Department and IRS officials:

“Today’s pleas are a reminder to all individuals to comply with the tax laws, file honest and accurate returns and pay their fair share,” said Principal Deputy Assistant Attorney General Zuckerman. “The Tax Division is committed to continuing to work with the IRS to prosecute those who seek to cheat the system, while honest hardworking taxpayers play by the rules.”

“What the defendants admitted to today, quite simply, is tantamount to stealing money from their fellow taxpayers,” said U.S. Attorney Carpenito. “All of us are required by law to pay our fair share of taxes. Celebrity status does not provide a free pass from this obligation.”

 “As we approach this year’s filing season, today’s guilty pleas should serve as a stark reminder to those who would attempt to defraud our nation’s tax system,” stated Jonathan D. Larsen, Special Agent in Charge, IRS-Criminal Investigation, Newark Field Office.  “No matter what your stature is in our society, everyone is expected to play by the rules, and those who do not will be held accountable and brought to justice.”

It is well-known that the IRS and Justice Department typically increase the frequency of their press releases announcing enforcement activity in the weeks leading up to the tax filing deadline. In fact, academic research confirms that these agencies issue a disproportionately large number of tax enforcement press releases as “Tax Day” approaches:

Every spring, the federal government appears to deliver an abundance of announcements that describe criminal convictions and civil injunctions involving taxpayers who have been accused of committing tax fraud. Commentators have occasionally suggested that the government announces a large number of tax enforcement actions in close proximity to a critical date in the tax compliance landscape: April 15, “Tax Day.” These claims previously were merely speculative, as they lacked any empirical support. This article fills the empirical void by seeking to answer a straightforward question: When does the government publicize tax enforcement? To conduct our study, we analyzed all 782 press releases issued by the U.S. Department of Justice Tax Division during the seven-year period of 2003 through 2009 in which the agency announced a civil or criminal tax enforcement action against a specific taxpayer identified by name. Our principal finding is that, during those years, the government issued a disproportionately large number of tax enforcement press releases during the weeks immediately prior to Tax Day compared to the rest of the year and that this difference is highly statistically significant. A convincing explanation for this finding is that government officials deliberately use tax enforcement publicity to influence individual taxpayers’ perceptions and knowledge of audit probability, tax penalties, and the government’s tax enforcement efficacy while taxpayers are preparing their annual individual tax returns.

Joshua D. Blank and Daniel Z. Levin, When Is Tax Enforcement Publicized?, 30 Virginia Tax Review 1 (2010).

As “Tax Day 2018” approaches, we can expect similar — and more frequent — announcements intended to deter would-be tax cheats from filing false tax returns.

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BNA’s Michael J. Bologna and Paul Shukovsky have written a comprehensive article about a pervasive problem facing state tax auditors:  the use by restaurants and other cash-intensive businesses of electronic revenue suppression software, commonly referred to as “Zappers.”  We have previously blogged about efforts by state and federal tax authorities to crack down on the use of “Zapper” software here (reporting on the Connecticut Department of Revenue’s arrest of a New Haven restauranteur) and here (predicting a federal crackdown on tax zapper software).  In their article, entitled “Tax-Zapping Software Costing States $21 Billion,” Messrs. Bologna and Shukovsky note that the use of revenue suppression software by businesses costs states a whopping $21 billion in lost tax revenue.  In a related article, entitled “Zapper Fraud Case Results in Mandatory Real-Time Monitoring,” the authors describe the recent prosecution of a Bellevue, Washington restaurant owner which resulted in a “first-in-the-nation settlement requiring continuous monitoring by the state for five years,” the first time any state has ever required monitoring to resolve charges involving the use of “Zapper” software.

Connecticut’s Department of Revenue Services (DRS) has arrested and charged a New Haven restauranteur with various offenses for using sales tax suppression software. According to a press release announcing the charges, this is the first time the State of Connecticut has charged an individual for using “zapper” software, which it describes as “a type of commercial ‘phantom-ware’ used to create fraudulent point-of-sale records that deliberately understate taxes actually collected.” Zapper programs are used to delete some or all of a restaurant’s cash transactions and then reconcile the books of the business. The result is that the company’s books appear to be complete and accurate, but are in fact false because they reflect fewer sales than were actually made.

We previously wrote about the Justice Department’s efforts to crack down on the use of tax suppression software by charging a software salesman in Seattle who worked for a Canadian company that sold “point of sale” program that enabled restaurants to underreport their sales. Historically, state law enforcement agencies, not the Justice Department or Internal Revenue Service, have taken the lead in cracking down on the use of revenue suppression software. In early 2016, the Attorney General of Washington filed what he called the “first-of-its-kind” criminal case against a restauranteur, Yu-Ling Wong, for allegedly using sales suppression software to avoid paying nearly $400,000 in state sales tax. That case began as a routine audit by the Washington State Department of Revenue, which trains its auditors to detect the use of revenue suppression software. Auditors noted an unusual change in cash receipts, as compared to the restaurant’s historical cash receipts, determined that the restaurant’s point-of-sale system could not be trusted, and eventually uncovered the use of Zapper software.

Many states have passed laws outlawing the use of revenue suppression software, including Washington, Michigan, Florida, Georgia, Utah, and West Virginia, and others are considering proposals to enact such laws. And the problem is not just confined to the United States. In a 2013 report entitled “Electronic Sales Suppression: A Threat to Tax Revenues,” the Organisation for Economic Co-operation and Development concluded that revenue suppression software “facilitate[s] tax evasion and result[s] in massive tax loss globally.”

In the Connecticut case, the defendant, Xiaoning Fan of New Haven, was arrested by DRS Special Agents from the Criminal Investigations Unit at her Lao Sze Chaun restaurant in Milford. Ms. Fan was charged with possession of tax suppression software, larceny in the 1st degree and willful delivery of a false return. She is charged with two Class D felonies subject to a fine of up to $100,000 and a sentence of one to five years or both, a Class B felony subject to a fine of up to $15,000 and a sentence of one to twenty years or both. She is also liable for all taxes, penalties, and interest due to the state as a result of the crime, forfeiture of all profits associated with the sale, and confiscation of the zapper device as contraband.

Said DRS Commissioner Kevin B. Sullivan, “[t]his arrest is a big breakthrough for DRS. We have been working with other states to develop our ability to detect and prosecute ‘zapper’ fraud. What began as a routine tax audit became a DRS arrest when our specially trained auditors successfully detected illegal use of sales suppression software from 2008 to 2016 that resulted in over $80,000 of state tax evasion plus an additional $60,000 in penalty and interest charges. At DRS, we continue to step up our game in the fight to stop tax fraud.”

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In a recent criminal prosecution of a medical doctor/entrepreneur for defrauding his company’s shareholders, the government employed a novel theory of securities fraud premised, in part, upon the defendant’s failure to pay federal employment taxes withheld from his employees’ wages. The government alleged that the defendant, Sreedhar Potarazu, an ophthalmic surgeon licensed in Maryland and Virginia, made repeated false statements to shareholders about the financial condition of VitalSpring Technologies Inc., a company he founded, including concealing the fact that the company failed to pay more than $7.5 million in federal employment taxes. Ensuring that companies are fully compliant with their employment tax obligations is one of the top priorities of the Justice Department and Internal Revenue Service, and this case stands as a rare example of the confluence of the federal securities and employment tax laws.

Potarazu served as the company’s chief executive officer and also served on its board of directors. The government alleged that from at least 2008, Potarazu provided materially false and misleading information to VitalSpring’s shareholders to induce more than $49 million in capital investments in the company. According to the government, Potarazu induced investments from shareholders by making false representations, concealing material facts, and telling deceptive half-truths about VitalSpring’s financial condition, tax compliance, and alleged imminent sale. Potarazu represented on numerous occasions that VitalSpring was a financially successful company and that a sale of VitalSpring was imminent, which would have resulted in profits for shareholders. Potarazu concealed from shareholders that VitalSpring failed to account for and pay over more than $7.5 million in employment taxes to the IRS. Potarazu provided false corporate income tax returns to some shareholders that overstated VitalSpring’s income and omitted the accruing employment tax liability. From 2011 to 2015, in addition to his salary paid by VitalSpring, Potarazu diverted at least $5 million from the investors and VitalSpring for his own personal use.

Between 2007 and 2016, VitalSpring accrued federal employment tax liabilities of more than $7.5 million. The company withheld taxes from VitalSpring employees’ wages, but failed to fully pay over the amounts withheld to the IRS. As chief executive officer, Potarazu was a “responsible person” obligated to collect, truthfully account for, and pay over VitalSpring’s employment taxes. According to the government, ultimate and final decision-making authority regarding VitalSpring’s business activities rested with Potarazu. Potarazu was aware of the employment tax liability as early as 2007 and between 2007 and 2016, was frequently apprised of VitalSpring’s employment tax responsibilities by his employees. In addition, IRS special agents interviewed Potarazu in 2011 and informed him of the employment tax liability. In all but one quarter between the first quarter of 2007 and the last quarter of 2011, as well as the second and third quarters of 2015, Potarazu failed to file VitalSpring’s Employer’s Quarterly Federal Tax Return (Forms 941) with the IRS. Potarazu also failed to pay over any of the employment tax withheld from VitalSpring’s employees’ wages in all but one quarter between the second quarter of 2007 and the third quarter of 2011, as well as the third and fourth quarters of 2015. Between 2008 and 2015, instead of paying over employment tax, Potarazu caused VitalSpring to make millions of dollars of expenditures, including thousands of dollars in transfers to himself and others, the publication of his book, a sedan car service, and travel.

Potarazu eventually pleaded guilty to one count of securities fraud and one count of failing to account for and pay over federal employment taxes. In his guilty plea, Potarazu acknowledged that he provided materially false and misleading information to his company’s shareholders to induce further capital investments, including concealing the fact that the company had accrued a multi-million dollar tax liability as a result of unpaid employment taxes. On July 19, Potarazu was sentenced to nearly ten years in prison, and ordered to pay $49.5 million in restitution to shareholders and $7.6 million to the Internal Revenue Service. He was also ordered to forfeit several homes, vehicles, and bank accounts.

Aggressive criminal and civil enforcement of the federal employment tax laws has been a top priority of both the Justice Department and the IRS for the past several years. Amounts withheld from employee wages represent nearly 70% of all revenue collected by the IRS. According to a recent report from the Treasury Inspector General for Tax Administration (TIGTA), as of December 2015, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties. The Justice Department’s Tax Division reports that as of June 30, 2016, more than $59.4 billion of taxes reported on quarterly federal employment tax returns remained unpaid. Employment tax violations represent more than $91 billion of the “Tax Gap,” which measures the difference between the total amount of tax owed to the U.S. Treasury and the amount actually paid. During fiscal year 2016, employment tax investigations were one of the few categories of tax crimes for which IRS-Criminal Investigation initiated more investigations than in the prior fiscal year.

Employment tax schemes can take a variety of forms. Some of the more common schemes include employee leasing, paying employees in cash, filing false employment tax returns, failing to file employment tax returns, and “pyramiding.” Pyramiding refers to the practice of withholding taxes from employee wages, but failing to remit such taxes to the IRS. After the employment tax liability accrues, the business owner starts a new business and begins to accrue employment tax liabilities anew.

In securities fraud cases, the government often charges that a company’s books and records are manipulated in order to falsely inflate revenue and earnings. For example, in United States v. Hyunjin Lerner (S.D. Fla. Mar. 29, 2017), the indictment alleged that the defendant and his co-conspirators engaged in a complex accounting fraud, utilizing unsupported expense accruals, improper accounting entries, misclassification of expense items, and false revenue items, in order to boost the company’s revenue and earnings. Similarly, in United States v. Joseph A. Kostelecky (N. Dakota Jan. 6, 2017), the defendant was charged with securities fraud in connection with an alleged scheme to artificially inflate his company’s revenue based upon the booking of revenue from oil and gas contracts, where such contracts did not exist or the revenue from such contracts was not collectible. In United States v. Brian Block (S.D.N.Y. Sept. 8, 2016), the indictment charged the chief financial officer of a publicly-traded real estate investment trust with securities fraud in connection with his alleged fraudulent inflation of a key metric used to evaluate a REIT’s financial performance in filings made with the Securities and Exchange Commission.

In securities fraud cases alleging materially false and misleading statements, it is rare for such statements to involve a company’s general tax compliance. Even more rare are cases involving false statements about a company’s employment tax compliance.  Indeed, the Potarazu case may be the first securities fraud case to allege that shareholders and investors were misled about a company’s employment tax compliance. With the intense focus now being paid to employment tax enforcement by the Justice Department and Internal Revenue Service, we may well see more cases, like Potarazu, where securities fraud schemes and employment tax fraud schemes are intertwined.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

2000px-Seal_of_the_United_States_Department_of_Justice_svgFollowing a relentless flurry of press releases announcing criminal charges against tax evaders in the run up to today’s tax filing deadline (see here, here, and here), the Justice Department wasted no time in turning its attention to its next target:  employers and individuals who violate the federal employment tax laws. In a press release entitled “Justice Department Continues To Sue, Prosecute Delinquent Employers,” the Justice Department emphasizes that it is continuing its employment tax “enforcement push” by bringing civil and criminal enforcement actions against employers and individuals who violate employment tax laws:

Many Americans associate April with “Tax Day” and the annual deadline for filing individual income tax returns. But the end of April is also the first deadline for employers to file quarterly employment tax returns. Those who do not comply with filing requirements or who fail to pay the taxes withheld from their employees’ wages face civil lawsuits or criminal prosecutions as part of the Department of Justice’s ongoing focus to enforce employment tax laws using all tools available.

By way of background, employers in the United States are required to collect, account for, and pay over to the Internal Revenue Service tax withheld from employee wages, including federal income tax and social security and Medicare taxes. Employers also have an independent responsibility to pay their matching share of social security and Medicare taxes.

“Employers who willfully fail to comply with their employment tax obligations are cheating the U.S. Treasury at the expense of taxpayers, such as law-abiding employers and employees, who pay their taxes on time and in full,” said Acting Assistant Attorney General David A. Hubbert of the Justice Department’s Tax Division. “The Department is committed to holding employers that willfully fail to pay their employment taxes accountable with, as appropriate, criminal prosecution, bringing these offenders into compliance through civil injunctions, and working with the IRS to collect what is owed.”

“Employment taxes are a critical part of the tax system, generating more than $1 trillion a year in payments to the government, and the IRS works closely with employers and the payroll community to help ensure compliance in this area,” said IRS Commissioner John Koskinen. “We want to help employers avoid problems in the employment tax area. When problems do arise, we use civil enforcement tools and, when appropriate, work closely with the Justice Department in the pursuit of criminal cases. The collection of employment taxes is a priority area for the IRS and helps ensure fairness for employers and taxpayers. Employers who fail to pay or withhold these taxes enjoy an unfair economic advantage over those who comply with the tax laws.”

The Justice Department’s press release serves as a reminder that an individual’s willful failure to comply with employment-tax obligations is not simply a civil matter. Employers whose business model is based on a continued failure to pay employment tax, who use withheld employment taxes as a slush fund to pay personal expenses or other creditors, who pay employees in cash to avoid employment tax obligations, or who file false employment tax returns can subject themselves to prosecution, imprisonment, monetary fines, and restitution.

Aggressive criminal and civil enforcement of the federal employment tax laws has been a top priority of both the Justice Department and the IRS for the past several years. Amounts withheld from employee wages represent nearly 70% of all revenue collected by the IRS. According to a recent report from the Treasury Inspector General for Tax Administration (TIGTA), as of December 2015, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties. The Justice Department’s Tax Division reports that as of June 30, 2016, more than $59.4 billion of taxes reported on quarterly federal employment tax returns remained unpaid. Employment tax violations represent more than $91 billion of the “Tax Gap,” which measures the difference between the total amount of tax owed to the U.S. Treasury and the amount actually paid. During fiscal year 2016, employment tax investigations were one of the few categories of tax crimes for which IRS-Criminal Investigation initiated more investigations than in the prior fiscal year.

Employment tax schemes can take a variety of forms. Some of the more common schemes include employee leasing, paying employees in cash, filing false employment tax returns, failing to file employment tax returns, and “pyramiding.” Pyramiding refers to the practice of withholding taxes from employee wages, but failing to remit such taxes to the IRS. After the employment tax liability accrues, the business owner starts a new business and begins to accrue employment tax liabilities anew.

Today’s press release highlights recent examples of employment tax enforcement in both the criminal and civil arenas, starting with the following examples of employers who engaged in “pyramiding” taxes by opening successive businesses:

In January, Napoleon Robinson of Lauderhill, Florida, was sentenced to serve 18 months in prison for evading more than $500,000 in employment taxes. Robinson owned and operated a series of ship welding and repair businesses in Virginia and New York. Robinson was not paying over employment taxes and would close down one company and open a new one in the name of a nominee owner, while continuing to run the company, making its financial and personnel decisions and controlling the businesses’ bank accounts. He was also ordered to pay restitution to the IRS.

In January, two West Virginia business owners, Michael and Jeanette Taylor, were sentenced to serve 21 and 27 months in prison for failing to pay over more than $1.4 million in employment taxes. The Taylors owned a construction business that transported steel and sold gravel and concrete. They changed the name of their business several times, though the operations of the business remained the same. Both were responsible for collecting, accounting for and paying over the employment taxes withheld from their employees’ wages. Instead of paying over the taxes that they collected, the Taylors used the funds to purchase property and finance their horse farm. They were also ordered to pay restitution to the IRS.

The following cases demonstrate examples of employers who used withheld employment taxes to pay personal expenses, or to pay other creditors:

In January, Paul Harvey Boone of Hillsborough, North Carolina, was sentenced to serve 15 months in prison for failing to pay over employment taxes. Boone owned and operated Boone Audio Inc. From 2008 through 2011, Boone used company funds for personal expenses while failing to pay over the employment taxes withheld from his employees’ wages. He was also ordered to pay restitution to the IRS.

In December 2016, Sreedar Potarazu, a Maryland surgeon and entrepreneur, pleaded guilty to failing to account for and pay over $7.5 million in employment taxes and to shareholder fraud. Potarazu founded VitalSpring Technologies Inc., a corporation that provided data analysis and services related to health care expenditures. Potarazu was responsible for collecting, truthfully accounting for and paying over VitalSpring’s employment taxes. Instead of paying over the employment tax, Potarazu spent millions on personal expenses including transferring funds to himself and others, travel, car service and the publication of a book.

In January, Steven Lynch, a tax attorney and owner of the Iceoplex in Pittsburgh, Pennsylvania, was sentenced to serve 48 months in prison, fined $75,000 and ordered to pay restitution to the IRS of more than $793,000, after being convicted of failing to collect, account for and pay over employment taxes. Lynch co-owned and operated the Iceoplex, a recreational sports facility which included a fitness center, ice rink, soccer court, restaurant and bar. He controlled the finances for these businesses and was responsible for collecting, accounting for and paying over tax withheld from employee wages and timely filing employment tax returns. Lynch failed to pay over more than $790,000 in employment taxes withheld.

In June 2016, Muzaffar Hussain of Pleasanton, California, pleaded guilty to failing to account for and pay over employment taxes for Crossroads Home Health Care Inc. Hussain was the CFO and was responsible for filing the company’s employment tax returns and paying over the employment taxes. Hussain transferred funds in an amount equal or close to the amount of employment taxes from the business bank account into other accounts and used the money to fund other business and personal expenses.

In the following case, the Justice Department prosecuted an employer who paid employees in cash to avoid paying employment taxes:

In September 2016, Phillip Hui of Sicklerville, New Jersey, was sentenced to serve 15 months in prison for conspiring to evade payroll taxes on cash wages paid to illegal immigrants employed at his dry cleaning business. Hui hired foreign nationals from Mexico and Guatemala who did not have legal status in the United States and paid them in cash. Their wages were not reported on the quarterly employment tax returns filed with the IRS. He was also ordered to pay restitution to the IRS.

Employers who file false employment tax returns are also subject to prosecution, as the following cases demonstrate:

In March, Richard Tatum, a Houston, Texas, business owner of an industrial staffing company, pleaded guilty to failing to pay more than $18 million in employment taxes. Tatum filed false employment tax returns that did not report the majority of his employees and did not pay over the taxes he withheld from his employees. Instead, he used the money for luxury travel and to make payments on his ranch.

In January, Janis Ann Edwards, an Oklahoma City, Oklahoma, business owner, pleaded guilty to evading more than $3.5 million in employment taxes. Edwards was the sole owner of Corporate Resource Management Inc. and a number of related companies that operated as professional employer organizations. Edwards directed her employees to alter quarterly employment tax returns to reflect less payroll tax liability than was actually owed.

The Justice Department’s Tax Division is also aggressively pursuing civil enforcement action against those who fail to meet their employment tax obligations. Since 2003, the Division has permanently enjoined more than one hundred employers and obtained tens of millions of dollars in money judgments. Civil injunctions are court orders requiring the employer and principal officers to timely deposit and pay employment taxes to the U.S. Treasury. These court orders also impose various other requirements and prohibitions, including the obligation to provide notice of each deposit to the IRS, as well as restrictions on opening and operating new businesses and transferring or dissipating assets.

In recent years, the Tax Division increased the number of civil actions brought against employers who violate employment tax laws. In 2016, the Tax Division obtained employment tax injunctions against 38 employers—more than double the number of injunctions obtained in 2015. The injunctions obtained in the past year include court orders against employers throughout the United States, such as a St. Louis concrete business, a Florida restaurant, an Iowa lawn care business and a Michigan custom kitchen company.

Since January 1, 2017, the Tax Division filed 17 suits, collectively seeking more than $10 million in unpaid employment taxes, against tax-delinquent medical-care providers who, despite IRS notices and efforts to collect, have been non-compliant for three or more quarters, despite persistent attempts by the IRS to remind them of their obligations and to collect the unpaid taxes.

These 17 suits collectively seek more than $10 million in unpaid employment taxes and are part of an ongoing effort by the Justice Department and the IRS focusing on employment tax compliance. Among these cases is a suit filed in federal court in Minnesota to enjoin Dawda Sowe and Nurse Staffing Solutions Health Care from failing to pay employment taxes and to obtain a $2 million judgment against the business for employment taxes the business allegedly failed to pay over an eight-year period. Also, this month the Tax Division filed suit in federal court in Texas to obtain a court order requiring Jeanna Smith to timely file employment and unemployment tax returns for her business and pay those taxes in full, amongst other requirements. In this suit, the government also seeks a judgment for unpaid employment taxes and alleges that Smith incorporated several home-health care businesses, such as Paris Senior Care Group Inc., which accumulated more than $1.3 million in unpaid employment taxes.

Finally, those who violate an injunction can be charged with civil and criminal contempt and face being shut down, paying compensation for the damage the contempt caused and incarceration of the principal corporate officers. For example, a federal court in Washington held Dr. James Hood and his wife, Karen Hood, in contempt of court for a consistent pattern of failing to meet their tax obligations. The court later ordered the two to close their dental care businesses, cease operating as employers, and barred them from opening any new businesses where the Hoods would serve as employers by June 8, 2017.

Any individual who is responsible for ensuring that employment taxes are collected, truthfully accounted for, and paid over to the IRS, and willfully fails to do so or willfully attempts to evade or defeat paying employment taxes may be subject to a civil penalty equal to the amount of the unpaid withholdings. This civil penalty, referred to as the Trust Fund Recovery Penalty (TFRP), may be imposed even if the individual uses the employment tax to pay other creditors or keep the business afloat. Individuals subject to these penalties include, but are not limited to, corporate officers, treasurers, managers, and, in some circumstances, bookkeepers. In fiscal year 2015, the IRS assessed the TFRP against approximately 27,000 responsible individuals.

Since January 2013, the Tax Division has obtained tens of millions of dollars in money judgments against individuals subject to these penalties. For example, in July 2016, a Florida jury found the CEO and owner of a professional employer organization personally liable for more than $4.2 million due to his failure to pay his company’s employment taxes. In addition, in December 2016, the U.S. Court of Federal Claims found that the CFO of an Internet-marketing platform was responsible for his company’s failure to pay its employment taxes and entered a judgment of more than $500,000 against him. And in April, a federal court found the co-manager of an architectural woodwork installation company personally liable for $1.9 million due to his failure to pay his company’s employment taxes.

In contrast to the Justice Department’s press release touting its successes in the employment tax field, a TIGTA report issued less than 30 days ago painted a considerably less rosy picture of the government’s efforts to ensure employment tax compliance. In a report entitled “A More Focused Strategy Is Needed to Effectively Address Employment Tax Crimes,” TIGTA concluded that the IRS needs a better strategy to enhance the effectiveness of the agency’s efforts to address, and punish, egregious employment tax violators:

Employment tax noncompliance is a serious crime. Employment taxes finance Federal Government operations plus Social Security and Medicare. When employers willfully fail to account for and deposit employment taxes, which they are holding in trust on behalf of the Federal Government, they are in effect stealing from the Government. As of December 2015, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties. The TFRP is a civil enforcement tool the Collection function can use to discourage employers from continuing egregious employment tax noncompliance and provides an additional source of collection for unpaid employment taxes. In FY 2015, the IRS assessed the TFRP against approximately 27,000 responsible persons – 38 percent fewer than just five years before as a result of diminished revenue officer resources. In contrast, the number of employers with egregious employment tax noncompliance (20 or more quarters of delinquent employment taxes) is steadily growing—more than tripling in a 17-year period. For some tax debtors, assessing the TFRP does not stop the abuse. Although the willful failure to remit employment taxes is a felony, there are fewer than 100 criminal convictions per year. In addition, since the number of actual convictions is so miniscule, in our opinion, there is likely little deterrent effect.

TIGTA recommended that the IRS should use data analytics to better target egregious employment tax noncompliance, including identification of high-dollar cases and individuals with multiple companies that are noncompliant. In addition, TIGTA recommended that the IRS Collection Division expand the criteria used to refer potentially criminal employment tax cases to IRS-CI to include any egregious cases (not only those where a firm indication of fraud is present).

Notwithstanding TIGTA’s recent criticism, it is readily apparent that employment tax enforcement is a top priority for both the Justice Department and the IRS.  With the massive amounts of unpaid employment taxes that remain outstanding, we can undoubtedly expect to see vigorous enforcement in this area, both criminal and civil, in the coming months and years.

2000px-Seal_of_the_United_States_Department_of_Justice_svgWith only four days remaining until “Tax Day,” the Justice Department’s well-publicized campaign to deter potential tax evaders continues with more stern warnings to taxpayers. In a bleak press release entitled “With the Individual Income Tax Filing Deadline Approaching, Justice Department Warns Willful Violations of Tax Laws Are Criminal,” the Justice Department sounds the warning once again that taxpayers who attempt to violate the federal tax laws that they face prosecution, jail, restitution and significant monetary penalties.

“Most Americans follow the tax law and rightfully expect that each of their fellow citizens will do the same,” said Acting Deputy Assistant Attorney General Stuart M. Goldberg of the Justice Department’s Tax Division. “Yet every year some taxpayers try to take a different path – they hide money offshore, declare only a small portion of their income, make up bogus deductions and lie to the IRS if they are caught. With this year’s filing deadline approaching, these taxpayers should stop, reverse course and simply pay what they owe. As the Justice Department’s recent criminal prosecutions make clear, the consequences for willful violations are severe: jail time and substantial monetary penalties.”

“The majority of Americans file their taxes without issue and they would tell you that they want strong enforcement of the tax laws to ensure that we are all paying our fair share,” said Chief Richard Weber of IRS Criminal Investigation. “For those thinking about intentionally evading the tax laws – IRS-CI has the finest financial investigators and are trained to follow the money trail wherever it may lead.”

The press release then proceeds to summarize recent tax prosecutions, starting with the following examples of individuals prosecuted for “garden variety” tax evasion or filing false tax returns:

  • In March, Denver Nichols, a Labadie, Missouri roofing contractor, pleaded guilty to filing false 2007 and 2008 income tax returns. Nichols operated his roofing business under the name Eagle Roofing Co. He late filed false 2007 and 2008 returns that underreported his business’s gross receipts by approximately $959,500 and $794,680.
  • In March, Stephen Leib, a Philadelphia, Pennsylvania tech business owner, pleaded guilty to tax evasion. Leib owned New Wave Logistics Inc. He evaded more than $800,000 in taxes by cashing a significant amount of his business’s gross receipts at a check cashing facility, lying to his accountant about the total amount of income he earned and filing false tax returns.
  • In March, Jeffrey Nowak, a Las Vegas, Nevada liquor storeowner, was sentenced to serve 41 months in prison for tax evasion and conspiring to defraud the United States. Nowak conspired with Ramzi Suliman, with whom he jointly owned and operated liquor stores in Las Vegas. Nowak and Suliman skimmed cash receipts and provided their accountant with a phony set of books that omitted nearly $4 million in cash receipts.
  • In February, Jose Echeverria, a Chelan Falls, Washington businessman, pleaded guilty to filing a false individual income tax return. Echeverria owned and operated a produce sales business. He underreported his income by approximately $564,292.
  • In December 2016, James and Mardeen Perin, former owners of Sully’s Pub in West Des Moines, Iowa, pleaded guilty to aiding and assisting in filing a false tax return. The Perins filed a false 2013 tax return that did not report cash that they earned through their business.

Individuals who fail to file returns are also subject to prosecution, as the Justice Department points out with the following examples:

  • In March, James Burton and Lucretia Pecantte-Burton, two Louisiana attorneys, pleaded guilty to failing to file individual income tax returns. Burton and Pecantte-Burton were partners of the law firm Pecantte-Burton & Burton (PB&B) and regularly received cash payments. They also had a partnership interest in a tax return preparation business. Burton and Pecantte-Burton did not file 2007 through 2009 income tax returns.
  • In February, Samuel Frazier, a Gulfport, Mississippi businessman, was sentenced to serve 12 months in prison for failing to file an individual income tax return. Frazier owned two companies in Gulfport: Frazier Fire Systems LLC and EZ Haul Demolition and Construction LLC. Frazier failed to file a 2009 tax return despite earning more than $618,253 in income.
  • In December 2016, John Raschella, a former Parma, Ohio resident, was convicted at trial for failing to pay more than $1 million in income taxes, interest and penalties for 1995, 1996 and 1998 through 2012 on income earned as an insurance salesman. He also failed to timely file income tax returns between 1989 and 2012.
  • In June 2016, Carlos Cortes, a San Antonio, Texas artist, was sentenced to serve 12 months in prison for failing to file an individual income tax return. Cortes did not file tax returns for 2006 through 2009, despite earning more than $1.3 million in income during this time.

One of the Justice Department’s top priorities in tax cases is prosecuting individuals who employ nominee entities and offshore bank accounts to hide assets and income, as the following cases demonstrate:

  • In March, Casey Padula, a Port Charlotte, Florida owner of Demandblox, a marketing and information technology business, pleaded guilty to conspiracy to commit tax and bank fraud. Padula conspired to move more than $2.5 million to offshore accounts in Belize and disguised them as business expenses in the corporate records. Padula used the funds to pay for personal expenses and purchase significant personal assets.
  • In March, Masud Sarshar, a Los Angeles, California businessman, was sentenced to serve 24 months in prison for hiding more than $23.5 million in offshore bank accounts. Sarshar maintained several undeclared bank accounts at Israeli banks, both in his name and in the names of entities that he created. Between 2006 and 2009, Sarshar diverted more than $21 million in untaxed gross business income to those undeclared accounts and earned more than $2.5 million in interest income. Sarshar reported none of this income on his individual and corporate tax returns.
  • In January, three Orange County, California residents pleaded guilty to hiding millions of dollars in secret foreign bank accounts. Dan Farhad Kalili, David Ramin Kalili and David Shahrokh Azarian, willfully failed to file legally required reports, commonly known as FBARs, disclosing their bank accounts in Switzerland and Israel.
  • In January, Peggy and John DeYoung, a Missoula, Montana couple, pleaded guilty to conspiring to defraud the United States. The DeYoungs had not filed an income tax return since 1998. Peggy DeYoung earned income through her ownership interest in two companies that owned Southern California mobile home parks. The DeYoungs also established a number of purported trusts. They owned bank accounts in the names of these trusts using fabricated taxpayer identification numbers and paid personal expenses from the accounts, causing a tax loss of $376,350.

The Justice Department also prosecutes individuals who engage in obstruction of IRS efforts to assess and collect taxes:

  • In November 2016, Richard Thomas Grant, a Point Richmond, California man, was sentenced to serve 33 months in prison. Grant stopped filing income tax returns and paying income taxes despite earning significant income as a partner with an engineering company. Grant attempted to frustrate IRS collection and audit efforts by filing lawsuits against the IRS. To conceal his income, Grant used prepaid debit cards and money orders to pay personal expenses.
  • In November 2016, Steven Headden Young of St. Petersburg, Florida, was sentenced to serve 21 months in prison. Young evaded a substantial portion of his individual income taxes for 2007 through 2011 and interfered with an IRS audit. He fabricated a letter from the IRS to a bank directing the bank to send subpoenaed records to a bogus address.
  • In October 2016, Henti Lucian Baird, a Greensboro, North Carolina resident and former IRS revenue officer, pleaded guilty. Baird filed tax returns each year but has not paid since at least 1998. Baird created nominee bank accounts to hide hundreds of thousands of dollars from the IRS, submitted false information to the investigating IRS officer regarding these accounts and transferred funds from nominee accounts to avoid impending IRS levies.
  • In June 2016, Paul Tharp, a North Carolina man, was sentenced to serve 21 months in prison. Tharp failed to file tax returns for 2003 through 2006, and the IRS assessed income tax against him for those years. Tharp attempted to evade payment of his tax debt by filing false disclosures with the IRS, omitting businesses that he owned as well as bank accounts and rental income.

Ironically, the Justice Department’s press release touting its successes in prosecuting tax crimes comes at a time when the Criminal Investigation Division of the Internal Revenue Service – which is responsible for investigating potential tax crimes – finds itself more resource-constrained than at virtually any other time in its history.  IRS-CI’s most recent annual report for FY2016 reveals that the agency has only 2,217 criminal investigators, its lowest point in two decades.  During FY2016, only 889 criminal tax cases were authorized for prosecution, a substantial decrease and the lowest number of authorizations in a decade.  Of all the myriad categories of crimes investigated by IRS-CI, only four — employment tax, public corruption, healthcare fraud, and offshore tax evasion — reflected an increase in the number of investigations initiated as compared to FY2015.  In every other category, the number of investigations initiated by IRC-CI during FY2016 decreased.  A substantial decrease in the number of tax investigations initiated by IRS-CI during the past year will have a lasting impact, as such cases typically require several years of investigation followed by prosecution, if approved.  As a result, we can expect to see fewer and fewer criminal tax prosecutions in the coming years.  And only if Congress agrees to fully fund the IRS will IRS-CI be able to hire new special agents to replace the hundreds of agents who have left the agency over the last 10 years without being replaced.

 

With less than two weeks until the April 18 deadline for filing individual federal income tax returns, the Justice Department and Internal Revenue Service are issuing stern warnings to potential tax cheats. Today the U.S. Attorney for the Western District of North Carolina and the Special Agent in Charge of the IRS Charlotte Field Office issued a joint press release entitled “Federal Prosecutors Warn Potential Tax Cheats: Tax Crimes Result In Criminal Prosecution, Lengthy Prison Sentences, And Fines.” Their press release announced recent tax fraud prosecutions and sentencings, and is intended to “deliver a powerful warning to those who are thinking about breaking the law by committing tax crimes.”

“As tax filing season reaches its peak, we are putting would-be tax cheats on notice: My office will prosecute those who try to cheat the tax system at the expense of honest taxpayers who file their returns on time and pay the taxes they owe. Our tax system is built on voluntary compliance and tax criminals who do not pay their fair share increase the tax burden on law-abiding taxpayers,” said U.S. Attorney Jill Westmoreland Rose.

“The 2017 income tax filing season is soon coming to a close, however, special agents of the IRS – Criminal Investigation work year-round to combat criminal violations of the Internal Revenue Code and related financial crimes. Agents in the Charlotte Field Office have pursued, and will continue to pursue, those who prepare returns fraudulently, steal and misuse identities, and those who take extraordinary measures to conceal their income in an effort to evade their tax responsibility,” said Special Agent in Charge Thomas J. Holloman, III. “To build faith in our nation’s tax system, honest taxpayers need to be reassured that everyone is paying their fair share and we will work vigorously to pursue those who do not.”

The press release proceeds to highlight recent successes in prosecuting tax evaders and those who file false tax returns:

Matthew Moretz, 31, of Taylorsville, N.C., pleaded guilty to one count of filing a false tax return. From April 2010 to March 2011, Moretz collected unemployment income from the North Carolina Division of Employment. However, beginning in or about March 2010 and continuing through in or about 2013, Moretz was self-employed as the owner of MJM Recycling, a scrap metal business. From tax year 2010 through tax year 2013, Moretz earned additional personal income totaling approximately $529,622.44 that Moretz failed to report on his U.S. Individual Income Tax Returns Form 1040 filed with the IRS. As a result of the unreported taxable income, Moretz had additional tax due and owing of approximately $116,409.38 from 2010 to 2013. Moretz is currently awaiting sentencing.

Patrick Emanuel Sutherland, 48, of Charlotte, was convicted of filing false tax returns and obstructing a federal grand jury investigation. Court documents and trial evidence showed that, from at least 2007 to 2015, Sutherland was an actuary, and the owner and operator of numerous companies in the insurance and financial industries. Between 2007 and 2010, Sutherland engaged in an elaborate scheme to conceal a substantial amount of income, including filing false tax returns with the IRS which underreported business receipts and personal income of approximately $2 million in income received from an offshore bank account in Bermuda, as well as from domestic sources. Sutherland is currently awaiting sentencing.

Reuben T. DeHaan, 44, of Kings Mountain, N.C., was sentenced to 24 months in prison for tax evasion and possession of an unregistered firearm. DeHaan owned a holistic medicine business, which he operated out of his residence in Kings Mountain under the names Health Care Ministries International Inc. and Get Well Stay Well. During the years 2008 through 2014, DeHaan earned more than $2.7 million in gross receipts from his holistic medicine business, but failed to file income tax returns for those years and evaded approximately $678,000 in income taxes due and owing. DeHaan was also ordered to pay 567,665 in restitution to the IRS and $110,449 to the state of North Carolina.

Another area of focus for the Justice Department and IRS are unscrupulous return preparers and those who perpetrate stolen identity refund fraud:

Ramos, formerly of Lincolnton, N.C., was previously sentenced to 48 months in prison for her role in a false claims conspiracy. The conviction stemmed from Ramos’s role in a conspiracy to defraud the government by filing fraudulent tax returns seeking refunds totaling more than $5 million, by using stolen identity information of individuals in Puerto Rico. Ramos fled the United States and failed to report to federal prison after the sentencing. She is awaiting sentencing on charges of obstruction of justice and failure to report and faces additional jail time and fines.

Cara Michelle Banks, Carmichael Cornilus Hill, and Priscilla Lydia Turner conspired with Senita Dill and Ronald Jeremy Knowles, and others, to file false federal and state tax returns using stolen personal identifying information. From 2009 to 2012, this conspiracy defrauded the United States Treasury of over $3.5 million. Banks, Hill, Turner and others stole personal identifying information and then provided it to Dill to file the false returns in exchange for payment. Dill and Knowles used stolen personal information to file over 1,000 false tax returns. Court records show that Hill provided approximately 26 percent of the stolen identifications used to file the fraudulent returns. In 2016, Banks and Hill were sentenced to 70 months and 75 months in prison, respectively. In November 2016, Turner pleaded guilty to aggravated identity theft and is currently awaiting sentencing. Senita Dill was sentenced to 324 months and Knowles to 70 in prison for their roles in the conspiracy.

Finally, an area of recent intensity for the Justice Department and IRS is employment tax fraud:

Frank Alton Moody, II, 57, of Arden, the co-founder and former Chairman of the Board of CenterCede Services, Inc., a payroll services company, was ordered to serve 30 months in prison, two years in supervised release, and to pay $2,146,380.97 as restitution, for conspiring to steal over $2 million from client companies. Moody’s co-conspirators, Jerry Wayne Overcash and John Bernard Thigpen, were previously sentenced to 46 months and 21 months in prison, respectively. The three men used the more than $2 million they stole from client companies to fund their exorbitant salaries. Overcash and Thigpen were also ordered to jointly pay $1.3 million as restitution to the victim client companies.

The press release concludes with a reminder to taxpayers to exercise caution during tax season to protect themselves against a wide range of tax schemes ranging from identity theft to return preparer fraud. Illegal scams can lead to significant penalties and interest and possible criminal prosecution. IRS Criminal Investigation works closely with the Department of Justice to shutdown scams and to prosecute the criminals behind them. The IRS has issued its annual “Dirty Dozen” which lists common tax scams that taxpayers may encounter, particularly during filing season. Taxpayers are urged look out for, and to avoid, the following common schemes:

  • Phishing
  • Phone Scams
  • Identity Theft
  • Return Preparer Fraud
  • Fake Charities
  • Inflated Refund Claims
  • Excessive Claims for Business Credits
  • Falsely Padding Deductions on Returns
  • Falsifying Income To Claim Credits
  • Abusive Tax Shelters
  • Frivolous Tax Arguments
  • Offshore Tax Avoidance

As we have written previously, it is well-known that the IRS and Justice Department typically increase the frequency of their press releases announcing enforcement activity in the weeks leading up to the filing deadline. In fact, academic research confirms that these agencies issue a disproportionately large number of tax enforcement press releases as “Tax Day” approaches:

Every spring, the federal government appears to deliver an abundance of announcements that describe criminal convictions and civil injunctions involving taxpayers who have been accused of committing tax fraud. Commentators have occasionally suggested that the government announces a large number of tax enforcement actions in close proximity to a critical date in the tax compliance landscape: April 15, “Tax Day.” These claims previously were merely speculative, as they lacked any empirical support. This article fills the empirical void by seeking to answer a straightforward question: When does the government publicize tax enforcement? To conduct our study, we analyzed all 782 press releases issued by the U.S. Department of Justice Tax Division during the seven-year period of 2003 through 2009 in which the agency announced a civil or criminal tax enforcement action against a specific taxpayer identified by name. Our principal finding is that, during those years, the government issued a disproportionately large number of tax enforcement press releases during the weeks immediately prior to Tax Day compared to the rest of the year and that this difference is highly statistically significant. A convincing explanation for this finding is that government officials deliberately use tax enforcement publicity to influence individual taxpayers’ perceptions and knowledge of audit probability, tax penalties, and the government’s tax enforcement efficacy while taxpayers are preparing their annual individual tax returns.

Joshua D. Blank and Daniel Z. Levin, When Is Tax Enforcement Publicized?, 30 Virginia Tax Review 1 (2010).

As “Tax Day 2017” approaches, expect to see similar announcements intended to deter would-be tax cheats from filing false tax returns.

The Internal Revenue Service continues to make frequent use of a relatively unknown information-gathering tool in its nearly decade-old crusade against offshore tax evasion: the “John Doe” summons. A John Doe summons may be used to obtain information and records about a class of unidentified taxpayers if the IRS has a reasonable belief that such taxpayers are engaged in conduct violating the U.S. laws.

Because the identities of the targeted taxpayers are unknown, the summons is denoted with a “John Doe” moniker. Expressly authorized by Internal Revenue Code, a John Doe summons must first be approved by a federal judge before it can be served.

To date, federal judges have authorized the IRS to issue sweeping John Doe summonses for information and records around the globe, in countries including Switzerland, India, the Bahamas, Barbados, Belize, the Cayman Islands, Guernsey, Hong Kong, Malta, the United Kingdom and others.

In its most recent John Doe summons, the IRS obtained authority to summons documents and records relating to the use by U.S. taxpayers of debit cards linked to secret offshore bank accounts, a common technique used to repatriate funds held in foreign accounts.

IRS Authority to Seek John Doe Summonses

The Internal Revenue Code authorizes the IRS to issue a summons to gather information and/or testimony about a specific taxpayer whose identity is known, and the IRS frequently uses traditional summonses in the normal course of conducting audits and investigations.

A John Doe summons, by contrast, allows the IRS to gather information about a group of unidentified taxpayers believed to be violating the tax laws, such as investors in a tax shelter or account holders at a financial institution.

In United States v. Bisceglia, 520 U.S. 141 (1975), the United States Supreme Court expressly recognized the authority of the IRS to issue a John Doe summons in order to uncover the identities of individuals who may have failed to disclose all of their income.

Congress subsequently enacted section 7609(f) of the Internal Revenue Code, which authorizes service of a John Doe summons if the IRS convinces a federal judge that (1) the summons relates to the investigation of an ascertainable group or class of persons; (2) there exists a reasonable basis for believing that such group or class or persons may have failed to comply with U.S. tax laws; and (3) the information sought by the summons is not readily available from any other source.

To ensure that the John Doe summonses are not used as pure “fishing expeditions,” internal IRS policy mandates that such summonses may only be used in investigations that are at an advanced stage, rather than at the outset of an investigation. In addition, only certain high-ranking IRS officials are authorized to approve issuance of a John Doe summons; special agents, revenue agents and revenue officers are not authorized to issue such summonses.

A federal court’s determination of whether the IRS has satisfied the requirements for a John Doe summons is required to be conducted ex parte and must be based solely on the basis of a petition and supporting affidavits. Once a court determines that the IRS has met its burden, the agency is then authorized to serve the John Doe summons on the party to whom it is directed.

IRS Use of John Doe Summonses In Its Offshore Crackdown

Since 2009, the IRS (working hand-in-hand with the U.S. Department of Justice) has worked aggressively to combat tax evasion by U.S. taxpayers making use of secret offshore bank accounts, and John Doe summonses have played a prominent role in that enforcement effort.

In 2009, the IRS served a John Doe summons seeking the identities of U.S. taxpayers maintaining bank accounts at UBS in Switzerland. Two years later, the IRS received court approval to serve a John Doe summons seeking the identities of U.S. taxpayers maintaining undisclosed bank accounts at HSBC in India.

In January 2013, a federal judge authorized the IRS to serve a John Doe summons seeking the names of account holders at Swiss bank Wegelin & Co. In September 2015, a federal court in Miami authorized the issuance of a John Doe summons seeking information about U.S. taxpayers who held offshore accounts at Belize Bank International Limited or Belize Bank Limited.

The Latest John Doe Summons Target: Users of Offshore Debit Cards

Most recently, on Jan. 25, 2017, a federal judge in Montana authorized the IRS to serve a John Doe summons seeking information about U.S. taxpayers who had been issued a debit card that could be used to access the funds in offshore accounts in such a manner as to evade their tax obligations.[1]

The summons specifically seeks records regarding U.S. taxpayers who possessed a “Sovereign Gold Card” during the years 2005 to 2016 which could be used to access funds held in accounts established by Sovereign Management & Legal LTD, a Panamanian company (Sovereign).

Sovereign is an offshore services provider alleged to have offered clients, among other things, the formation and administration of anonymous corporations and foundations. The IRS believes that Sovereign’s related services included the maintenance and operation of offshore structures, mail forwarding, availability of virtual offices, re-invoicing and the provision of professional managers who appoint themselves directors of the client’s entity while the client maintains ultimate control over the assets.

The IRS has long been concerned with the use of debit cards by U.S. taxpayers as a way to repatriate funds held in offshore accounts. In 2000, the IRS began investigating the use of offshore credit cards and served numerous John Doe summonses on major credit card companies.

Based upon information gathered through that project, the IRS confirmed that the use of payment cards (including credit and debit cards) linked to offshore bank accounts is a common means of obtaining access to such funds. A United Nations report focused on money laundering similarly concluded that “[c]redit and debit cards are the way people who have laundered money draw ready cash without leaving a financial trail. As one advertisement for a bank put it, it is the best way to stay in touch with your offshore account.”[2]

In its petition seeking court approval for the John Doe summons, the government alleged that Sovereign advertised various “packages” that afforded individuals the ability hide assets offshore. These packages include corporations owned by other entities (including phony charitable foundations) which are held in the name of nominee officers provided by Sovereign.

Sovereign would then open bank accounts for these entities and provide debit cards in the name of the nominee to the U.S. taxpayer. By using such debit cards, taxpayers could access their offshore funds without revealing their identities.

Upon consideration of the government’s petition, the court determined that the IRS had a reasonable basis for believing that U.S. taxpayers may be using Sovereign Gold Cards to evade their U.S. tax obligations.

The IRS investigation of Sovereign has been ongoing for several years, and was initiated as a result of information derived from a federal narcotics investigation. As part of an investigation of online marketplaces for drug trafficking, the Drug Enforcement Administration learned that traffickers frequently moved money through Panamanian bank accounts controlled by Sovereign using debit cards.

Using information generated through that drug investigation, the IRS sought, and obtained, court approval for several John Doe summonses in late 2014 requiring various courier delivery services and U.S. financial institutions to produce information about U.S. taxpayers who might be evading or have evaded federal taxes by using Sovereign’s services.[3]

The IRS alleged that Sovereign used certain couriers to correspond with U.S. clients, and certain money transmission services to transmit funds to and from clients in the United States. In addition, the IRS alleged that wire services operated by various financial institutions, and U.S. correspondent bank accounts held for Sovereign’s banks in Panama and Hong Kong, were believed to have records of financial transactions between Sovereign and its clients in the United States.

The IRS also relied upon information generated through its ongoing Offshore Voluntary Disclosure Program to support its latest application for the John Doe summons seeking debit card information. In a revenue agent’s affidavit submitted to the court, the IRS disclosed that its “voluntary disclosure program databases” revealed at least one taxpayer who acknowledged using Sovereign’s services to establish numerous offshore structures and 21 undeclared accounts, 11 of which were opened in Panama.

During an IRS interview, that taxpayer stated that he discovered Sovereign through an Internet search and subsequently utilized Sovereign’s services to set up structures, establish offshore accounts and open a Sovereign Gold Card to access funds in those accounts.

Warning to Non-Compliant Taxpayers

The most recent John Doe summons stands as yet another stern warning to non-compliant taxpayers that the era of bank secrecy and secret offshore accounts in tax haven jurisdictions is over.

Indeed, in a Justice Department press release announcing court approval of the latest John Doe summons, Tax Division Acting Assistant Attorney General David A. Hubbert stated that “[t]his John Doe summons is yet another example of how we are using all available tools to identify, investigate and hold accountable those who cheat our nation’s tax system by hiding money offshore, as well as those individuals and entities facilitating U.S. taxpayers engaged in this conduct.”[4]

Hubbert further warned that “[t]he time to come forward and come into compliance is running short, and those who continue to violate U.S. tax and reporting laws will pay a heavy price.”

The IRS continues to offer voluntary disclosure initiatives, including the Offshore Voluntary Disclosure Program, that provide a pathway for taxpayers with undisclosed foreign assets to come back into compliance and avoid criminal prosecution, but those options are generally available only if the taxpayer comes forward before the IRS or Justice Department learn of their non-compliance.

Conclusion

As its latest John Doe summons demonstrates, the IRS now has more access to information about the offshore activities of U.S. taxpayers than at any previous time in the tax agency’s history. With a wealth of information gathering tools at its disposal, including John Doe summonses, the IRS has the ability to command production of a vast array of documents relating to offshore tax evasion schemes and to uncover the identities of those involved.

And the IRS can be expected to make full use of that information in undertaking enforcement activity against non-compliant taxpayers. Taxpayers with undisclosed offshore financial assets would be well-advised to take advantage of IRS voluntary disclosure options promptly, as time is of the essence as the IRS continues to aggressively crack down on offshore tax evaders.

[1] See In the Matter of the Tax Liabilities Of: John Does, Case No. CR 17-02-BU-BMM (D. Mont.).

[2] United Nations, Global Programme Against Money-Laundering, Office for Drug Control and Crime Prevention, “Financial Havens, Banking Secrecy and Money Laundering” (1998).

[3] See In the Matter of the Tax Liabilities Of: John Does, Case 1:14-mc-00417 (S.D.N.Y.).

[4] U.S. Department of Justice Press Release, “Court Authorizes Service of John Doe Summons Seeking the Identities of U.S. Taxpayers Who Have Used Debit Cards in Furtherance of Tax Evasion” (Jan. 25, 2017).

Reprinted with permission from Law360. (c) 2017 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.