THE LOTTERY OF
CRIMINAL ENFORCEMENT

By John J. Tigue Jr. and Linda A. Lacewell

Last month, the New York Times reported what tax practitioners had long suspected: The chances of being recommended by the IRS to the U.S. Attorney's Office for prosecution on criminal tax charges vary dramatically across the country, depending on the taxpayer's district of residence. Once prosecution is commenced, the chances of conviction and jail are extremely high.

The Department of Justice data on referrals was released to the Transactional Records Access Clearinghouse at Syracuse University under the Freedom of Information Act and is now being made available on the Internet. The newly released data shows that, in 1994, chances of being recommended for criminal tax prosecution were "57 times greater if you lived in the Roanoke area than if you lived in New Mexico. They were 29 times greater in the Pittsburgh area than in Idaho, and 17 times greater around Tulsa than in South Dakota."

In the New York region, the Southern District of New York ranked eighth out of 90 districts in the nation (39 referrals per one million residents), and the Eastern District of New York ranked 16th (28 referrals per one million residents). As a point of reference, the national average was 17 referrals per one million residents for tax fraud, money laundering, and related offenses. The Syracuse report concluded, "Americans are five times more likely to be murdered than they are to be prosecuted for Federal tax crimes."

The disparity in criminal referrals may be explained in part by the number of agents per person in each district. Nationwide, only 3,200 special agents handle 118 million individual tax returns, and that does not include the millions of tax returns filed by corporations and the tax returns not filed by people who are required to file them.

Theoretically, the more agents scrutinizing the same number of returns, the more tax fraud will be uncovered. For example, Washington, D.C., which ranked first in the nation (71 referrals per one million residents), had 663 agents per million residents. Burlington, VT, which ranked last (three referrals per one million residents), had only 50 agents per million residents. Washington, D.C., had by far the largest proportion of agents per resident. The next closest was the Southern District of New York, with 230 agents per one million residents. (The national average was 73 agents per one million residents.)

Discretion and Discrepancies

The IRS defended its record by stating that it tries to treat taxpayers in similar situations the same regardless of district and that it applies directives, advisories, and other guidelines to ensure uniformity. However, the IRS admitted that special agents have some discretion in deciding how to handle a particular case.

The discrepancies in criminal referrals can also be explained in part by the fact that some U.S. attorneys are more interested in tax cases than others. For example, the three districts in Florida, which have traditionally been aggressive in tax enforcement, all ranked above the national average. Miami, in particular, a center for narcotics and money-laundering prosecutions, ranked 14th.

Not all districts share Miami's enthusiasm. As Shirley D. Peterson, former IRS Commissioner and Assistant Attorney General of the Tax Division of the U.S. Department of Justice stated, when the IRS brings tax cases to U.S. attorneys, "They are too often relegated to the bottom of the barrel." She explained: "They are complex, they are sometimes difficult to prosecute, and they aren't always sexy."

One IRS spokesperson was quoted as follows: "We don't think this data tells the whole story because of the way different types of cases are mixed in there. Our history shows over 90% of our tax fraud and tax evasion cases result in indictments or information being filed." The spokesperson was referring to the fact that tax fraud represents only 45.5% of the cases the IRS refers to Federal prosecutors. The IRS also refers cases involving money-laundering, assaulting a tax auditor, and allegations of wrongdoing by IRS employees themselves.

Of course, the mere fact that relatively few people end up caught in the criminal justice system is not cause for tax cheats to take heart, given the severe penalties meted out to convicted tax offenders and the high likelihood of jail time. As the U.S. attorney for the Western District of New York remarked, "If you stand outside in a thunderstorm holding a metal rod, the odds of getting struck by lightning are pretty small. But if you do get hit, God help you."

IRS Prosecution Guidelines

Just how the IRS decides which cases to refer for prosecution is becoming less of a mystery. In January 1996, the IRS made available for the first time a Litigation Guideline Memorandum (LGM) disclosing the dollar amounts necessary to trigger tax prosecutions. The LGM was released under the Freedom of Information Act at the request of Tax Analyst, publisher of Tax Notes and other tax publications. In two earlier lawsuits, Tax Analysts had succeeded in requiring the IRS to release general counsel memoranda, actions on decision memoranda, and private letter rulings.

The newly released LGM states that, for tax evasion (IRC section 7201) cases using the specific item method of proof and involving simple fact patterns, prosecution will be recommended only if the average yearly additional tax for criminal purposes is $2,500 or more. In tax evasion cases using an indirect method of proof or involving complex and sophisticated evasion schemes, criminal prosecution will be recommended only if the additional tax for criminal purposes totals at least $10,000 and the additional tax for criminal purposes for any single year is at least $3,000. Indirect methods of proof include the net worth, cash expenditure, bank deposit, percentage markup, and source-and-application of funds methods.

For willfully failing to file tax returns (IRC section 7203) in noncommunity property states, prosecution will be recommended only if the average yearly additional tax for criminal purposes would be at least $2,500. In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), prosecution will be recommended for failure to file only if the average yearly additional tax for criminal purposes would be $1,500 or more.

For subscribing to a false tax return [IRC section 7206(1)], prosecution will be recommended only if the average yearly additional tax for criminal purposes would be $2,500 or more. Finally, for the rarely used misdemeanor of furnishing fraudulent returns and other statements (IRC section 7207), prosecution will be recommended only if the additional tax for criminal purposes is $500 or more for any year in question. This statute is usually used when taxpayers produce false documentation to support previously deducted expenses.

The IRS is careful to note in the LGM that dollar amounts below the stated threshold will not prevent prosecution if the taxpayer has engaged in continued noncompliance or flagrant conduct. For example, the taxpayer may have persisted in attempting to mislead the special agent or seriously attempted to conceal the fraudulent scheme by submitting false documents or attempting to suborn perjury.

Similarly, the IRS may recommend prosecution if the taxpayer engaged in a scheme known to be frequently used by other taxpayers, thereby diminishing voluntary compliance. In general, prosecution may be recommended if the facts and circumstances are so flagrant that a reasonable probability of conviction exists, unlike most cases involving small amounts of additional tax.

Finally, the LGM states that the IRS prefers cases that include three prosecution years rather than only one or two years, particularly in cases involving indirect methods of proof. Obviously, it is easier for the government to obtain a conviction of a taxpayer who has committed a tax offense for three or more successive years.

According to the most recent government statistics, the IRS and the Justice Department have been active and successful in prosecuting IRC violations. For the year ended Sept. 30, 1994, the IRS initiated about 5,400 criminal investigations. Of those cases, about 3,800 were referred to the Department of Justice for prosecution. Ten percent of those recommendations were declined by the Department of Justice, and criminal charges were filed in 3,440 cases.

It is at this point that the government is dramatically successful: Of the cases in which charges were filed, the government had a 90% conviction rate. The IRS statistics did not include information showing the percentage of the convictions due to guilty pleas as opposed to jury verdicts.

These statistics do not vary dramatically from year to year, with one important exception--the number of people actually sentenced to jail as a result of conviction. The U.S. Sentencing Guidelines were inaugurated as of Nov. 1, 1987. Their avowed purpose in tax cases was "(t)o increase the average time served for this offense (failure to file returns) and to increase significantly the number of violators who receive a term of imprisonment." That purpose has been achieved for all tax offenses.

In the first year after the effective date of the sentencing guidelines, the percentage of convicted tax offenders was 54%. That percentage has increased steadily since then, and as of 1994, it stood at 75%. This means that three quarters of those convicted of tax fraud were sent to Federal penitentiaries. The numbers for 1995, 1996, and beyond will continue to climb.

The reason for this pattern is that the guideline sentences were substantially increased in 1993 for tax returns filed after that date, generally April 15, 1994 and thereafter. The consequence of the 1993 amendments will be that even more taxpayers will be jailed and for even longer periods. In some cases, the amount of time in jail will have tripled. Generally, it takes a few years to investigate, prosecute, and convict taxpayers. Therefore, the 75% incarceration figure for 1994 may inch closer to the 100 percent mark in the foreseeable future. *

John J. Tigue, Jr., is a principal of Morvillo, Abramowitz, Grand, Iason & Silverberg and Linda A. Lacewell is an associate there.

Reprinted with permission of the authors. The article first appeared in the June 5, 1996, New York Law Journal.

Editor:
Edwin B. Morris, CPA
Rosenberg, Neuwirth & Kuchner

Contributing Editor:
Richard M. Barth, CPA