Pre-Trial Decisions on Motion to Suppress (Tweel Issue) and Dismiss Tax Obstruction Count (Marinello Issue) (11/5/17)

I offer today two interesting pre-trial opinions in a tax crimes case.  United States v. Wright, 2017 U.S. Dist. LEXIS 167300 (S.D. Ohio 10/10/2017), here (referred to as Wright 1); and United States v. Wright, 2017 U.S. Dist. LEXIS 169007 (S.D. Ohio 10/12/2017), here (referred to as Wright 2).  Wright 1 rejected Wright's suppression claim that the IRS investigation was an improper disguised criminal investigation and that the agent misled Wright.  Wright 2 dismissed in part, but inter alia rejected Wright's argument for dismissal based on the pending investigation issue currently before the Supreme Court in Marinello, albeit in a superseding indictment context.  I address these opinions in their chronological order.  But, I offer now the docket entries in the case, here, the superseding indictment, here, and the jury verdict, convicting on all counts except the tax obstruction count, Count 1, here.

Wright 1

The facts are the key to the suppression claim. Highly summarized, the facts as recounted by the Court are:

In 1997, Wright pled guilty to attempted tax evasion.  In the sentencing, the court ordered that Wright pay restitution "restitution in the amount of taxes determined by the [IRS] to be owing."  That amount was never quantified by the sentencing court.  The IRS, however, subsequently assessed taxes for a number of years and a substantial amount remained outstanding.

In 2010, the IRS started an audit of one of Wright's corporate businesses.  At that time, the auditing agent learned from her manager that Wright had a substantial outstanding tax liability.

On 11/2/10, the agent discussed with the Fraud Technical Adviser ("FTA") "possible indicators of fraud ... with all the related entities." Then

Bettelon [the agent] subsequently prepared and forwarded to Rowe a Form 13680, which allows RAs to "request research using the yK1 Link Analysis Tool. This tool provides a graphic representation of flow-through relationships created by partnerships, trusts, and S corporations. The tool uses Schedule K-1 data to depict ownership relationships and income/loss flows between payers and payees." Internal Revenue Manual ("IRM" or "Manual") § 4.10.4.3.4.3(5) (Aug. 9,2011). On November 17, 2010, Bettelon again met with Wright, and asked him "if he or [B&P] had ever been involved with any prior audits or dealings with the IRS." Doc. #52-3, PAGEID #457. Bettelon claims that in response, "Wright stated [that] he has [sic] never been involved with the IRS prior to my visit" on August 13, 2010. Id. Wright denies having ever made such a statement.

The agent then had another meeting with Wright to request credit card statements previously requested.  About two weeks later, after discussion with the FTA, the FTA instructed the agent to prepare Form 11661: Fraud Development Recommendation - Examination.  In the form, the agent listed several possible indicators of fraud and calculated a tax underpayment of more than $600,000. The Court said about the Form:

By completing Form 2797, Bettelon [the agent] was informing IRS Criminal Investigation ("IRS-CI") that there existed firm indicators of fraud as to B&P, Remnant and Wright, such that a criminal investigation was warranted. Internal Revenue Manual § 25.1.3.2(1). Upon completing the form, Bettelon was required to "suspend the examination/collection activity without disclosing to the taxpayer or representative the reason for the suspension." 

Shortly after the completion of the form, the agent contacted Wright to request a Form 872, Consent to Extend the Statute of Limitations.  The following occurred:

Wright indicated that he would not sign it, and asked for an update on the status of his audit. Bettelon replied that Rowe [the Group Manager] needed to review the credit card statements that Wright had sent to Bettelon, but that Rowe was on sick leave and had not had a chance to review them. Doc. #52-3, PAGEID #458. In her Examining Officer's Activity Record ("EOAR") for the B&P audit, Bettelon wrote that she was "postponing telling [Wright] any information regarding the criminal investigation." Id. Bettelon made a similar note in her EOAR after a conversation with Wright on May 5, 2011, as IRS-CI had not yet accepted the audit transfer requested via Form 2797. Id.; see also Internal Revenue Manual § 25.1.3.3-4 (IRS-CI's process for evaluating and accepting a criminal referral). On June 2, 2011, Bettelon met IRS-CI Agents Tony Westendorf ("Westendorf") and Thomas Buchenroth ("Buchenroth") to discuss the B&P audit and her reasons for referral. Id. On June 7, 9, 10, and 22, 2011, Wright called Bettelon to [*8]  inquire about the status of the civil audit; Bettelon did not return the calls. Id. On June 24, 2011, Bettelon talked to Rowe about Wright's "many phone calls . . . and the fact that she was running out of things to postpone" returning his calls. Id. That same day, Rowe called Wright and informed him that Bettelon was no longer working on the audit, and that the case had been transferred to IRS-CI. Id.

Now, I am sure readers of this blog already know the defendant's arguments for suppression.

After Guilty Verdict, District Court Denies Motions for Dismissal and New Trial in Tax Crimes Case (11/13 /15; 11/15/15)

I previously reported on the denial of the Tweel type claim that the IRS civil agent been conducting a criminal investigation.  See Court Holds that Civil Agent Did Not Continue Investigation Too Long and Even If Deceptive Did Not Prejudice Defendant (5/2/15), here, discussing United States v. Hee, 2015 U.S. Dist. LEXIS 54971 (D. HI Apr. 27, 2015).  Hee sought in that pre-trial motion to have the indictment dismissed or, alternatively, to suppress certain evidence.  Usually, this type of claim, if valid, would suppress statements that defendant made to the civil agent who conducted a criminal investigation in the guise of a civil investigation.  As reported in the prior blog, the Court denied the motion (as well as other motions).

The case went to trial.  The jury convicted Hee of one count of tax obstruction, § 7212(a), here, and 6 counts of tax perjury, § 7206(1), here.  Hee then filed post-trial motions on several issues.  The Court rejected the post-trial motions.  United States v. Hee, 2015 U.S. Dist. LXIS 145406 (D. HI 2015), here. The Court also rejected a pre-conviction motion that had been deferred.  I only discuss the ones I found most interesting.

1.  Renewed Tweel Claim.

Hee renewed his Tweel Claim.  The Court discusses the renewed claim, including a focus on the relevant facts and law, and denies the motion for the same reasons noted in the earlier blog.  I will not discuss this denial of the renewed claim, but it is interesting reading even though substantially redundant to the prior discussion.

2. Grand Jury Abuse.

Hee argued that the charges "the charges should be dismissed because the Government allegedly provided the grand jury with erroneous instructions regarding three issues."  Because of the focus of my comments, it is not important to get into merits of the alleged error in the instructions offered the grand jury.  I will start with this recitation of this motion's history (docket citations omitted for easier readability):

Hee's trial commenced on June 23, 2015. On July 6, 2015, as the trial was nearing conclusion, Hee submitted his motion concerning grand jury issues. The court discussed with the attorneys the scheduling of briefing and a hearing on the motion. Attorneys for the Government and for Hee noted that the motion could be heard following trial, and Hee's attorney expressly stated that the trial did not need to be interrupted for a decision on the motion. Briefing and a hearing were therefore scheduled for dates following the completion of the trial. With the motion awaiting further briefing, the petit jury returned a verdict of guilty beyond a reasonable doubt on all counts.

I emphasize in bold the key fact.

Court Holds that Civil Agent Did Not Continue Investigation Too Long and Even If Deceptive Did Not Prejudice Defendant (5/2/15)

In United States v. Hee, 2015 U.S. Dist. LEXIS 54971 (D. Haw. Apr. 27, 2015), here, the Court denied various defense motions.  I discuss here the denial of the motion to dismiss the indictment based upon the alleged improper use of the civil tax audit to conduct the criminal tax investigation.  Tax crimes enthusiasts will know that this general genre of argument is based on United States v. Tweel, 550 F.2d 297 (5th Cir. 1977), here, and its progeny.  Hence, the court starts its analysis as follows:  "The court's analysis of Hee's claim of improper revenue agent conduct begins with United States v. Tweel, 550 F.2d 297 (5th Cir. 1977)."  First, the facts, highly summarized.

Two IRS agents were in the initial stages of conducting audits of corporations related to the defendant, Hee.  The had limited initial contact with each other.  One of them noticed early, however, that "there was a $324,684 difference between" the payments reported by one corporation to the other and the income reported by the other corporation.  "This difference turned out to stem from different accounting methods for reflecting management fees."  So, no fraud there.

Five months into the audit, one of the agents discussed the possible referral of the case to CI with her On the Job Instructor, her manager and the fraud technical advisor.  The FTA "said 'no,' indicating that the information Carey presented did not demonstrate corporate fraud and that more facts were needed before anyone could say that Hee might be liable for fraud. Carey was told to consider examining Hee's personal tax returns."

The agent then visited with the corporation's CPA, on the POA, who allegedly told the agent:  "Mr. Hee and he had talked about keeping receipts and other forms of documentation, and that 'Mr. Hee was aware of the requirements,' but choose to 'close deals with handshakes' and would rather 'play the odds' of being audited rather than keep records."

The agent then received permission to audit Hee's personal returns.

Another CPA, also on POA, then called the agent's acting manager and made the allegation that the agent had told him -- the POA - that Hee had committed fraud.  In a later discussion between the acting manager and the agent, the agent disputed the statement, saying that he had told the POA that "things look bad, and that we should try to solve as many things at my level as possible."  Apparently in a subsequent call with the POA, the POA "conceded" that the agent had not referred to fraud.

The agent then later met with the FTA and agreed to write up the referral to CI on Form 2797, "Referral Report of Potential Criminal Fraud Cases."  (Although not discussed in the case, for the procedures on the preparation of this form, see IRM 25.1.3 Criminal Referrals, here.)

At that point, the agent did not continue the investigation.

Finally:

On November 4, 2009, Yanagihara [the POA] left a voicemail for Carey [the agent] asking about the status of the audits of Waimana Enterprises and Clearcom. Carey returned the call. Instead of discussing the status of the audits, Carey told Yanagihara, "Hi Danielle, this is Crystal Carey from the IRS, returning your earlier phone call regarding Waimana Enterprises and Clearcom. In regard to time frames, my manager has asked me to work on another time sensitive matter, and I will have to get back in contact with you at a later date regarding resolution of the Waimana and Clearcom exams."

TIGTA Report on Actions to Identify Potential Fraud During Civil Audits (4/17/13)

TIGTA issued a new report, Actions Can Be Taken to Reinforce the Importance of Recognizing and Investigating Fraud Indicators During Office Audits, here.  Here are the published highlights:

IMPACT ON TAXPAYERS 

Penalties, such as for civil fraud, are designed to promote voluntary compliance by imposing an economic cost on taxpayers who choose not to comply with the tax law. Because indicators of fraud are not always recognized and properly investigated, the IRS may be missing opportunities to further promote voluntary compliance and enhance revenue for the Department of the Treasury. 

WHY TIGTA DID THE AUDIT 

This audit was initiated to determine whether fraud is recognized and pursued during office audits of individual tax returns in accordance with IRS procedures and guidelines.  The review is part of our Fiscal Year 2013 Annual Audit Plan and addresses the major management challenge of Tax Compliance Initiatives.  

WHAT TIGTA FOUND 

TIGTA reviewed a statistical sample of 100 office audits, closed between October 2009 and September 2010, that involved high-income and sole proprietor taxpayers agreeing they owed additional taxes of at least $10,000.  The review identified 26 audits with fraud indicators that were not recognized and investigated in accordance with some key IRS procedures and guidelines.  When the sample results are projected to the population of 3,674 closed office audits meeting the above characteristics, TIGTA estimates that fraud indicators were not recognized and investigated in approximately 939 office audits during Fiscal Year 2010.  TIGTA estimates that additional assessments totaling approximately $5.8 million in civil fraud penalties may have been avoided by taxpayers. 

TIGTA’s evaluation indicates that a combination of factors caused the quality problems and that actions can be taken at the examiner and first-line manager levels to better ensure that fraud indicators are recognized and properly investigated.

Is the Civil Audit a Set Up?

The Internal Revenue Manual directs revenue agents conducting a civil examination to refer the case to the Criminal Investigation branch ("CI") of the IRS when there is a "firm indication of fraud." Transfer of the matter to CI means that contact thereafter while there is still fraud investigation potential will be by a CI "Special Agent" who will read the taxpayer the modified Miranda warnings, including the right not to answer questions and the right to consult with an attorney. (Taxpayers are given modified Miranda warnings only because full-blown Miranda warnings are required only if the person is in the potentially coercive setting of custody, which is rarely the case in tax investigations.) Once the Special Agent is on the scene and surfaces, the taxpayer will be on notice that he has rights that he must consider exercising.

Sometimes a civil agent finding such indications of fraud may believe that he should pursue the matter further and either is oblivious to firm indications of fraud or just ignores them. Some civil agents just want to be more involved in the process of nailing the bad guy, and they will be out of the loop once the case is referred. But, for whatever reason, the civil agent may continue on despite firm indications of fraud.

From the taxpayer's perspective, he and his advisors may know that there is some fraud potential in a civil audit, but they are aware of the IRM provision requiring a fraud referral upon firm indications of fraud. The continued civil audit activity by the revenue agent may lead the taxpayer and his advisor to believe that the agent is continuing the civil examination rather than sub silentio conducting a criminal investigation. The continued civil audit activity, as they read the IRM, is an indication that the civil audit continues, and they may read that indication as some type of implicit representation by the revenue agent that the criminal investigation has not begun. The problem then arises when the civil agent develops damning admissions in an interview of the taxpayer without giving them any notice that the investigation has turned criminal -- much less the modified Miranda warning.

When the taxpayer is thereafter criminally prosecuted, the taxpayer may seek to exclude the damning admissions. In some cases, the mere exclusion of that evidence will knock out the Government's case altogether. Generally, of course, where the Government has violated constitutional rights in the process of gathering evidence in an investigation, Courts will exclude the evidence from a criminal trial. Do these exclusionary concepts extend so far to cover a revenue agent who violates the IRM by continuing to conduct the civil investigation when the revenue agent really is pursuing a criminal investigation?

The courts have been troubled by this question. The most extreme case is where the taxpayer or his advisor specifically asks if the investigation has turned criminal and, even though it has (albeit not referred to CI yet because the revenue agent is holding on and conducting his own criminal investigation), the revenue agent denies that it has. That would be an express misrepresentation, and the courts have indicated that suppression may be appropriate for such an express misrepresentation. What about any implicit misrepresentation that a taxpayer or his advisor may infer from continued civil audit activity. The clear trend in the cases is to reject a taxpayer's attempt to exclude the resulting evidence. This is an application of the so-called Caceres rule (United States v. Caceres, 440 U.S. 741 (1979)), which says that the mere failure to follow an internal rule -- here the IRM rule requiring referral upon firm indications of fraud -- does not justify suppression, absent some constitutional consideration.

These rules were announced and applied in a recent case from the Sixth Circuit Court of Appeals in United States v. Rutherford, ___ F.3d ___ (6th Cir. 2009). In Rutherford, the court rejected as dicta a prior Sixth Circuit's panel opinion in United States v. McKee, 192 F.3d 535 (6th Cir. 1999), which in a footnote had held out some possibility of suppressing such evidence. The court held that the mere continuance of the civil audit will not alone suffice for exclusion, absent some other indication of the type of coercion that would constitutionally require some type of warning such as Miranda. Rutherford is the most recent in a series of cases dealing with this issue and is must reading for practitioners as an object lesson in how they and their clients behave in a civil audit.

Bottom line, taxpayers and advisors who are cooperating in a civil audit need to be specially careful in any case with criminal potential. They should never assume that the matter cannot turn criminal, and certainly should avoid doing anything that would shoot the taxpayer in his own foot through damning admissions carelessly made. And, of course, if there is potential criminal potential against the advisor, this will give the advisor increased incentive be proceed cautiously himself.