TIGTA Report on Criminal Enforcement Against Employment Tax Noncompliance (3/25/17)

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TIGTA issued a report titled A More Focused Strategy Is Needed to Effectively Address Egregious Employment Tax Crimes (Ref # 2017-IE-R004 3/21/17), here.  I highly recommend the report to readers, both those watching the trajectory of criminal tax prosecutions and for students wanting to know more about the process.  I will report on some of the key features here to encourage readers to read or at least puruse the whole report.

I briefly introduce the key context for the report.

Employment taxes withheld from employee compensation and remitted to the IRS are the backbone of our tax and FICA system.  There must be robust incentives to encourage compliance by employers and those within the employer organization reponsible for employment tax withhold and payment to the IRS.  Those incentives include the standard range of civil and criminal penalties applicable to employers that apply to tax noncompliance.  But employment tax noncompliance requires that the penalty disincentives include potential civil liability and criminal penalties of those inside the employer organization that were responsible for the employment tax noncompliance.

The Trust Fund Recovery Penalty ("TFRP") in § 6672, here, is a civil collection mechanism whereby persons within an employer organization required to withhold, collect and pay over employment taxes from the compensation paid employees can be held civilly liable for those taxes.  Liability requires that the person have acted willfully.

The parallel criminal penalty for that failure to withhold, collect and payover employment taxes is in § 7202, here.  That provision imposes up to a 5-year incarceration period for each failure.  Liability requires that the person have acted willfully, but this is generally perceived as a higher level of willfulness than required for the TFRP.

The IRS investigates failures to withhold, collect and pay over.  Where it can, it tries to collect from the employer.  In order to insure collection, it may assert the TFRP against persons it believes are responsible for the noncompliance.  An IRS collection officer investigates the delinquent employment taxes and makes determinations as to potential TFRP liability.  The IRS collection officer will also look for indicators and fraud and, if firm indicators of fraud (also called badges of fraud) are found, may, in conjunction with his supervisor and the fraud technical adviser, refer the the case to IRS Criminal Investigation ("CI") to consider whether the case should be further investigated for potential criminal prosecution and referred to DOJ Tax Criminal Enforcement Section.

With that introduction the following is the the cover memorandum for the TIGTA report (I omit footnotes):

Synopsis 

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. 

Recommendation 

The TIGTA recommended that the Commissioner, Small Business/Self-Employed Division and the Chief, CI, should consider a focused strategy to enhance the effectiveness of the IRS’s efforts to address egregious employment tax cases. This strategy should include use of 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, the Collection function should expand the criteria used to refer potentially criminal employment tax cases to CI to include any egregious cases (not only those where a firm indication of fraud is present).  

Response 

The IRS partially agreed with our recommendation. The IRS agreed with the portion of our recommendation describing a focused strategy to enhance effectiveness of the IRS’s efforts to address egregious employment tax cases by citing various initiatives in process and completed. However, the IRS did not specifically address our recommendation to enhance the use of data analytics. The IRS disagreed with the portion of our recommendation that the Collection function should expand the criteria used to refer potentially criminal employment tax cases to CI to include any egregious cases (not only those where a firm indication of fraud is present) citing the need to balance several factors by a number of stakeholders and limited government resources including limitations on the number of criminal tax cases the United States Attorneys and the US Courts can accommodate. Management’s response to the draft report is included as Appendix IX.

Office of Inspections and Evaluations Comment: 

The Treasury Inspector General for Tax Administration disagrees with the IRS position that criminal conduct beyond willfully not reporting and paying employment taxes is necessary for criminal investigation and referral to the Department of Justice (DOJ). We believe the position allows egregiously noncompliant taxpayers—including those involved in cases of over $1 million or involved in 10 or more companies that fail to remit payroll taxes to IRS—to escape criminal prosecution contrary to the statute. The IRS insistence that fraud is a prerequisite for applying I.R.C. § 7202 is not in agreement with stated DOJ guidelines: 

“To establish a violation of section 7202, the following elements must be proved beyond a reasonable doubt: 1. Duty to collect, account for, and pay over a tax; 2. Failure to collect, truthfully account for, or pay over the tax; and 3. Willfulness. Cases prosecuted under this statute usually involve social security taxes (FICA) and withholding tax.”  

We fully understand there are limited resources available to pursue employment tax noncompliance. Our purpose in the recommendation is to clarify that deceit is not required for a conviction under I.R.C. § 7202. For example, the statute does not require that a taxpayer convert withheld trust fund taxes for personal use. In addition, there are numerous egregious cases available that should be considered for investigation that are not even referred to CI or considered. This includes cases with over $1 million and individuals involved with 10 or more companies that failed to provide the money to IRS that was being held “in trust” for the Federal government.

I offer the key part of the IRS response summarized above in the TIGTA memo (this excerpt is in Appendix VIII Comparison of Internal Revenue Code Sections 6672 and 7202 (pp. 38-39):

We do not agree with the second part of your recommendation dealing with expanding the criteria to refer employment tax cases to CI to include any egregious case (not only those with a firm indication of fraud).  CI has always put an emphasis on case selection which includes a number of factors, one of which is a firm indication of fraud.  The selection of criminal tax cases, including which criminal statute(s) to charge in a given case, involves a careful balancing of several factors by a number of stakeholders.  Given the reality of limitated government resources including limitations on the number of criminal tax cases the United States Attorneys and US Courts can accommodate and the fact that the same conduct may violate more than one criminal statute, each case we undertake should have significant potential for incarceration, publicity and broad impact in furtherance of our mission to deter would-be criminals and demonstrate to the law abiding public that we are applying their tax dollars purposefully and responsibly. 

The Collection function refers cases when firm indications of fraud/willfulness are present and they meet criminal criteria.  IRS § 7202 is considered and referred to as a tax fraud statute, and therefore the criteria used to criminally prosecute employment tax cases to CI under § 7202 require the Service to prove the willfulness standard that the taxpayer committed "a voluntary, intentional violation of a known legal duty."  That level of fraud/willfulness (known as "mens rea") is the key differentiation between civil and criminal cases.  Cases that do not meet this standard should continue to be pursued under applicable civil remedies.

Key excerpts from the report:

Page 7
While there are 1.4 million employers who have at least one quarter of delinquent employment taxes as of December 2015, the IRS had only assessed TFRPs against individuals responsible for approximately 154,000 (11 percent) delinquent employer accounts.  

Pages 7-8
Figure 2 shows that nearly 52 percent of employers with more than five years of delinquent employment taxes have an associated TFRP. On the other hand, this means that almost half (48 percent) of all employers with five years or more of unpaid employment taxes do not have a responsible person who has been assessed a TFRP. Additionally, the IRS had assessed a total of $15 billion in TFRP penalties against responsible persons connected to approximately 154,000 employers. In FY 2015, the IRS conducted a study n15 on the collection success rate of TFRP assessments. It determined that approximately 28 percent of assessed TFRPs were collected over a nine-year period. In addition, the IRS found that its collection success decreases proportionately with an increase in the assessed TFRP amount. For example, the study found that for FY 2010 assessments below $10,000, 65 percent of the total value of these assessments was collected by May 2015. However, for assessments greater than $100,000, only 15 percent of the total value of these assessments was collected by May 2015.

Page 9
There has been a significant decrease in the Collection function’s staffing in recent years. The number of revenue officers declined over 40 percent, from 4,068 at the end of FY 2010 to 2,425 as of June 2016. According to the IRS, despite the decline in resources, the number of TFRP recommendations made per revenue officer increased over 17 percent. Most individuals who are assessed a TFRP are assessed the penalty because they have been found to be a responsible person for only one employer. However, some individuals are assessed TFRPs on more than one employer with unpaid employment taxes.
* * * *
Both Congress and the GAO have long expressed concerns over egregious employment tax abuse by employers and their owners or principals. n17 However, based on resource limitations, the IRS is assessing fewer TFRPs overall. When this trend is combined with the declining number of employment tax cases referred to CI for investigation, there is very little opportunity of significant punishment for individuals who do not pay over the funds they are holding in trust for the Federal Government. 

Page 10
Employment tax investigations represent a small portion CI casework. For example, in FY 2015, CI initiated 102 employment tax investigations, which is less than 3 percent of all initiated cases. In comparison, the top two priorities—identity theft and abusive return preparer fraud and questionable refund fraud—resulted in almost 1,800 new investigations and accounted for 47 percent of new initiations in FY 2015.Figure 5 shows the number of employment tax cases initiated and referred for prosecution from FYs 2011 through 2015.

Criminal investigations are initiated in a number of ways. First, the IRS initiates investigations from referrals when a compliance employee such as a revenue officer or revenue agent detects indicators of fraud, also known as “Badges of Fraud.” For additional information on the Badges of Fraud, see Appendix IV. However, not all referrals result in an investigation. Additionally, CI receives information from U.S. Attorney’s offices, other law enforcement agencies, the public, Bank Secrecy Act reports, and whistleblower claims.  Figure 6 provides detailed information about the sources of CI employment tax initiations from FYs 2011 through 2015.

Figure 6 indicates that over the last five fiscal years, IRS sources referred just over half of all employment tax initiated investigations. During this time, the Collection function was responsible for 39 percent of all the employment tax cases initiated. This is despite the nearly 175,000 TFRP assessments made in the same period. Since the statutes for the TFRP and the criminal counterpart I.R.C. § 7202 are similar, there is a high likelihood that some portion of the egregious noncompliance is the result of willful criminal acts.
    In order to refer a case to CI, Collection function procedures require that firm indications of fraud must be present. These firm indications of fraud must establish that a particular action was deliberately done for the purpose of deceit, subterfuge, camouflage, concealment, some attempt to color or obscure events, or to make things seem other than what they are. However, I.R.C. § 7202 clearly indicates that the statute applies to any person required to collect, account for, and pay over tax who willfully fails to do so. A felony conviction under I.R.C. § 7202 does not require an attempt at concealment, deception, or false or fraudulent statements. The DOJ Criminal Tax Manual section specific to I.R.C. § 7202 also confirms that in order to prosecute persons who willfully fail to comply with their obligation to collect, account for, and pay over taxes, an element of fraud need not be proven. According to the DOJ, to establish a violation of I.R.C § 7202, the prosecutor must prove three elements beyond a reasonable doubt:
1. A duty to collect, account for, and pay over a tax.
2. Failure to collect, truthfully account for, or pay over the tax.
3. Willfulness.
The DOJ Criminal Tax Manual states:
The element of willfulness under § 7202 is the same as in other criminal offenses under Title 26…. The government must show that a defendant voluntarily and intentionally violated a known legal duty…. Evil motive or bad purpose is not necessary to establish willfulness under the criminal tax statutes. 
There is considerable similarity between the elements that must be proven in order to assess a TFRP (I.R.C. § 6672) and those required to prosecute someone under I.R.C. § 7202, yet the Collection function refers very few cases to CI. In the five year period between FY 2011 and FY 2015, the Collection function assessed nearly 175,000 new TFRPs but referred fewer than 1,000 cases to CI. During that time period, CI initiated investigations based on the Collection function referrals in 260 cases, or less than one quarter of one percent of the employers connected to the TFRP penalties assessed during that time period. Even fewer are eventually referred by CI to the DOJ. We are concerned that the Collection function requirement that I.R.C. § 7202 cases only be referred when an element of fraud is present is overly restrictive and may affect the quality and quantity of referrals that are made to CI. In fact, when we reviewed the top five percent of TFRP cases (based on total TFRP dollars assessed) each year from FYs 2010 through 2015, our analysis showed that few of the cases had any indication of previous or current CI activity. Figure 7 provides detailed information about the top five percent of cases with TFRPs and the level of associated CI activity from FYs 2011 through 2015.

Page 13-15
During an investigation, special agents determine if there is sufficient evidence of criminal acts (see Appendix VI for additional information about the phases of a criminal investigation). In FY 2013, CI initiated 140 employment tax investigations. CI considers a number of factors when it decides whether or not to initiate an employment tax investigation. According to CI, these factors include deterrence, willfulness, and jury appeal.
We reviewed the supporting documents for 71 non–grand jury n22 criminal employment tax investigations (administrative cases) completed in FY 2013. Our analysis determined that CI discontinued 37 (52 percent) of the 71 administrative cases. The reasons why CI discontinued these investigations included insufficient tax losses for prosecution, insufficient evidence or witnesses to prove all criminal elements, and the inability to prove intent.
The Deterrent Effect of Employment Tax Case Prosecutions Is Unknown
Once accepted for prosecution, it took the DOJ an additional 1.7 years on average to complete the case for those non–grand jury cases closed in FY 2013. This means that it takes close to four years, on average, from the time CI initiates an employment tax investigation to the time that sentencing is complete. In the past five fiscal years, fewer than 100 individuals a year have been convicted for willfully failing to pay over employment taxes when grand jury and non–grand jury cases are combined. The length of incarceration in FY 2013 averaged around 24 months for grand jury and non–grand jury cases. For the 29 non–grand jury cases closed in FY 2013 that we reviewed, eight convicted individuals received no prison time. For the remaining 21 individuals, the average incarceration sentence was 27 months, with a low of six months and a high of 60 months, or 5 years. Examples of the types of cases investigated by
CI and prosecuted by the DOJ are in Appendix VII.
According to CI, one of the most effective methods to encourage compliance is from the deterrence effect achieved through publicity. Although CI highlights criminal convictions on the IRS website, penetrating hundreds of local media markets throughout the country remains a challenge. For example, when we reviewed court records for all employment tax prosecutions completed in FY 2013, we found that generally one or two employment tax cases were prosecuted per State and some States had no employment tax prosecutions that year. While the prosecutions we reviewed often received some media attention, it is unknown what deterrent effect such a small number of infrequently prosecuted cases might have. However, TIGTA concludes that the limited number of convictions each year (fewer than 100 per year on average) results in only a limited deterrence effect because the likelihood of criminal punishment for egregious employment tax embezzlement is very low.
Although TIGTA found declining civil and criminal enforcement, according to the DOJ, since January 2015 the Tax Division has increased its focus on civil and criminal employment tax enforcement. We met with DOJ Tax Division staff to understand their perspective on employment tax noncompliance. The DOJ’s increased efforts include developing a centralized database of criminal employment tax resources for prosecutors and educating employers, through a public campaign, about the serious nature of employment tax violations. In addition, the DOJ and IRS worked collaboratively to provide training to IRS personnel and to update the employment tax chapter of the DOJ Criminal Tax Manual. The DOJ also noted that although the IRS and DOJ are in frequent contact, there is no formalized process for priority setting between the two agencies.
According to the IRS, Since May 2015, CI has been working with the Collection function, the DOJ, and the IRS Criminal Tax Counsel to promote the employment tax program within the IRS. CI collaborated with the Collection function, DOJ, IRS Criminal Tax Counsel, and IRS National Fraud Program throughout FYs 2015 and 2016 in efforts to promote the cross-agency focus on employee tax fraud compliance and deterrence. The effort has included promotion of the program to senior and frontline leadership, internal and external presentations, prosecutorial assistance from the DOJ, and training for both civil and criminal agents. As a result of this collaboration, CI’s direct investigative time has increased in this area. It has gone up from 3.7 percent in FY 2015 to 4.2 percent in FY 2016.
Given the dramatic increase in the number of egregious employment tax cases with 20 or more quarters of noncompliance since FY 1998 and the lack of investigation of individuals responsible for 10 or more employers’ noncompliance or individuals assessed in excess of $1 million in TFRPs from FYs 2011 through 2015, a more focused approach could result in a more effective deterrent to egregious noncompliance. We believe this is especially important in light of declining IRS collection and law enforcement resources. Figure 8 provides information on the number of prosecution recommendations for each of the past five fiscal years in comparison to the number of TFRPs assessed in the same year.

In addition to the foregoing excerpts that I think are most important, the report has certain important appendices that readers might want to review.  There are:

Appendix IV Indicators of Fraud (pp. 22-24)
Nothing new here since it is lifted from IRM 25.1.2.3, Indicators of Fraud.
Appendix, V Fraud Referral Process (p. 25)
This is an excellent chart showing the steps in the fraud referral process from the civil divisions to IRS CI.

Appendix VI Steps in Subject Criminal Investigation to Prosecution Recommendation (pp. 26-27)
This is a narrative explanation of the process, with a nice flow chart on p. 27 for the process of investigation through CI recommendation to DOJ Tax CES

Appendix VIII Comparison of Internal Revenue Code Sections 6672 and 7202 (pp. 32-33)
This is a useful comparison in chart format

Appendix IX Management’s Response to the Draft Report (pp. 34-39) We don't have the draft report, but management's discussion of the procedures and initiatives it has in place is very useful.  I have quoted the key part above.

JAT Comment:

1.  Simply because the language of §§ 6672 and 7202 substantially overlap does not mean that a § 6672 case could be prosecuted under § 7202.  Fraud is certainly necessary for the prosecution in chief and, more importantly, to obtain incarceration which is principally driven by the tax loss -- a tax fraud concept.  I think that TIGTA just does not understand the turf.  And, I would say that almost certainly in the types of illustrations TIGTA uses -- cases with over $1 million and individuals involved with 10 or more companies that failed to provide the money to IRS that was being held “in trust” for the Federal government -- there is more than likely fraud involved.  But, still the presence of fraud must continue to be the benchmark required to devote the systemic resources to prosecution.

2.  DOJ Tax CES can in most tax crimes fact patterns charge any number of crimes.  This is true in employment tax cases as well.  The charge may be tax evasion, § 7201, as well as the more specific charge, § 7202.  Both of these are 5-year felonies.  And, the facts could usually support tax obstruction, § 7212(a) or, if more than one is involved as is often the case, the defraud/Klein conspiracy, 18 USC 371.  All of these other crimes would require fraud.