The Tax Man Cometh

Navigating a criminal investigation from the IRS

Back Article Mar 31, 2012 By Robert Celaschi

Perry Ghilarducci holds a vivid memory from the day the Internal Revenue Service showed up unannounced at his office.

Nobody wants a surprise visit from the IRS, and it’s even more nerve-wracking when the agents are from the criminal investigation division and when, like Ghilarducci, you’re an accountant.

Perry Ghilarducci holds a vivid memory from the day the Internal Revenue Service showed up unannounced at his office.

Nobody wants a surprise visit from the IRS, and it’s even more nerve-wracking when the agents are from the criminal investigation division and when, like Ghilarducci, you’re an accountant.

“They were there to inspect records of one of our clients,” says Ghilarducci, president of Avaunt Ltd. CPAs & Consultants in Elk Grove. “We had mail coming to our office, so they thought it was the client’s place of business. They were there for about an hour; it wasn’t terribly long, but it was a little frightening.”

From the government’s perspective, a trip to the accountant is standard procedure. They are after people suspected of hiding income or assets, filing fraudulent returns or otherwise evading taxes. The CPA is a prime source of information.

Just don’t expect a warning.

“We would usually do it shortly after we would talk to the taxpayer, sometimes the same day. We would just show up,” says Special Agent Arlette Lee. “If you know that you are running a legitimate business, there’s usually not too much of a concern.”

But if you’re the taxpayer they’re after, your main concern is what you told your CPA, the documentation provided and the questions your accountant asked. Unlike doctors and lawyers, accountants don’t have any confidentiality protection; there’s no CPA/client privilege.

“One of the things I have seen is that once we contact the taxpayer, because the next step is to contact the CPA, they may try to tell the CPA what to do,” Lee says. “You never want to destroy anything or remove anything, especially if you know that an IRS special agent may be coming. It could be a form of obstruction.”

CPAs do have a few rules working in their favor. First of all, the IRS has to have all its paperwork in order. “They may sound big, mean and nasty, but without a summons or a court order, there isn’t anything they can require you to do,” Ghilarducci says.

Usually the IRS is looking for information that has been left out of tax returns, Lee says. Since the IRS is prepping to take someone to court, it wants original documents, but that doesn’t preclude the accountant from making copies for later.

And for the most part, accountants shouldn’t have to manage the situation alone.

“The first thing I would do is contact my malpractice insurance carrier,” says Amy Lehmkuhl, a principal at Ueltzen & Co., which specializes in forensic accounting, a form of accountancy done in preparation for litigation. “They have loss-prevention professionals and resources within their organization to help you find the right steps to take. The next step is to contact legal counsel for myself.”

CPAs say it’s rare to get dragged into IRS criminal investigations — an accountant could go through an entire career without encountering one. But it could start happening more often.

“The government has really cracked down on trying to find taxpayers who are hiding money offshore in foreign accounts. They are criminally prosecuting some people for not reporting the income,” Lehmkuhl says.

Because conversations with clients aren’t protected, CPAs say the smartest action is to stop a conversation as soon as it sounds like a client is talking about criminal behavior. Instead, send them to a tax attorney.

“We can work with that attorney to work with these issues to file tax returns,” Lehmkuhl says. “An accountant can be engaged by an attorney and have what is called a work product privilege. It’s always important to get that attorney involved at first.”

When a tax attorney hires an accountant to do the work, it’s called Kovel protection, named for the 1961 court case that established the principle.

“I see this screwed up a lot,” says Sacramento tax attorney Betty Williams, managing shareholder at the Law Office of Williams & Associates. “It’s a necessary tool, but it can be difficult to implement because of the variety of moving parts.”

She’s seen cases where the engagement agreement has come from the CPA, for instance. That’s wrong. The attorney has to establish the relationship. And the payment has to come from the attorney, not the client under investigation — even if that’s ultimately where the attorney gets the money to pay the CPA.

Most CPA firms, especially large ones, have internal quality controls and have pounded home the message not to impair the firm’s reputation, says accountant Kip Dellinger of Cooper Moss Resnick Klein & Co. in Van Nuys. But sole practitioners may succumb to misguided good intentions.

“CPAs are so terrified of losing a good client, they don’t go to the lawyer soon enough. They want to solve the client’s problem,” Dellinger says. “By the time you have digested enough to think there is a serious problem, you’ve become a witness.”

He has taken a few handoffs in his career, temporarily taking over the work for another CPA’s client while an IRS investigation is going on, then stepping out of the picture when the investigation is over. One instance involving a grand jury investigation went on for two years, with no finding against the client.

Sometimes there’s not much a CPA can do to stay out of the IRS crosshairs once an investigation is under way.

“Trying to save his own hide, the client is invariably going to say, ‘I talked it over with my CPA, and he said not to worry about this,’” Dellinger says. Even if that’s a lie and the CPA is exonerated, it’s still expensive and emotionally draining to mount a defense, he says.

The U.S. tax code has never been known for its simplicity. Accountants are sometimes asked to make judgment calls when they recommend a particular course of action.

“When you have a supportable position, sometimes there are disclosure requirements that can protect the CPA from penalties if those items are eventually disallowed,” Ghilarducci says. “It’s a little bit tricky because if you do the disclosure forms … that’s basically a road map to finding the questionable items.”

Even an audit notice can be enough to raise a red flag for a CPA. Ghilarducci had a client who was nervous about the IRS’s requests for bank statements and other paperwork for an audit a couple of years ago.

“They said there could be a problem, lets put it that way. I threw up my timeout sign,” he says. “It’s tempting for me to want to know what happened, but I have learned not to ask for details.”

As for the files Ghilarducci turned over, he never saw them again. “We never got the client back either,” he says. “They simply went away.”

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