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									This article was originally published in The CPA Journal. Reprinted with permission.

                                                                  T A X A T I O N
                                                             state & local taxation

                        New York Criminal Tax Investigations
                                                  Strategies Used by the Special Investigations Unit

       By Mark S. Klein and                                     criminal investigation in the first three     How Does SIU Find Its Targets?
       Jack Trachtenberg                                        months of 2008 then there had been in total      The Office of Tax Enforcement is becom-
                                                                for the prior four years combined (Jason      ing more sophisticated in identifying and

                 s many tax professionals are by                Subik, “State getting tough on sales tax      investigating potential fraud and now has
                 now aware, the New York State                  cheaters,” Daily Gazette, August 12, 2008).   more resources to carry out its mission. It
                 Department of Taxation and                        Because of the new emphasis on tax         has adopted (or reinstituted) some enhanced
       Finance (DTF) has been reorganized to                    enforcement, the state has staffed SIU with   tactics to bolster its fraud detection efforts.
       include a new bureau called the Office of                a multidisciplinary cadre of new attorneys,   These include the following:
       Tax Enforcement. This new bureau                                                                                          ■ Issuing more subpoe-
       is composed of the previously exist-                                                                                      nas to taxpayers and third
       ing Audit Division, the Collections and                                                                                   parties for records and
       Civil Enforcement Unit, as well as the                                                                                    testimony;
       new Special Investigations Unit (SIU).                                                                                    ■ Subpoenaing accoun-
       William Comiskey, formerly the chief                                                                                      tants to take advantage of
       prosecutor at New York State’s                                                                                            the fact that there is no
       Medicaid Fraud Control Unit, is the                                                                                       accountant–client privilege;
       deputy commissioner in charge of                                                                                          ■ Establishing a new data
       the Office of Tax Enforcement.                                                                                            resource unit for third-party
          Recently, the Office of Tax                                                                                            records (e.g., data-mining);
       Enforcement has focused on imple-                                                                                         ■ Increased coordination
       menting what it calls a “tax gap enforce-                                                                                 with other states and fed-
       ment strategy.” The goal of this strate-                                                                                  eral agencies; and
       gy is to enhance voluntary compliance                                                                                     ■ Proposed legislation
       (by deterring unlawful taxpayer con-                                                                                      aimed at increased com-
       duct) and in the process increase the col-                                                                                pliance and enforcement,
       lection of lawfully owed taxes in order                                                                                   including a new law that
       to alleviate the negative impact of                                                                                       would require banks and
       New York’s budget shortfall. To this end,                auditors, investigators, forensic accoun-     financial institutions to annually report
       the Office of Tax Enforcement is seeking                 tants, and others charged with the task of    the amount of deposits into accounts of
       to use a “carrot and stick” approach to                  ferreting out fraud. SIU has also been        registered sales tax vendors; and a new
       change taxpayer behavior. The carrot                     charged with conducting comprehensive         whistleblower statute for tax evasion.
       includes a new voluntary disclosure program,             investigations across a broad range of tax       The Office of Tax Enforcement has also
       under which taxpayers may voluntarily                    (and non-tax) areas. As a result, many SIU    increased its use of undercover and covert
       approach the tax department to report past               cases that begin with a focus on one type     operations. This has included enlisting and
       delinquencies and obtain a certain degree                of tax often will spill over into an inves-   making deals with allegedly corrupt tax-
       of amnesty. The stick has been a significant             tigation of other areas. For example, the     payers or preparers. New York State has
       increase in criminal investigations, referrals,          authors have seen cases start with a focus    even begun sending in undercover agents
       convictions, and plea bargains (Jack                     on sales tax, but quickly evolve into an      acting as taxpayers to meet with accoun-
       Trachtenberg and Michelle Merola, “New                   investigation of alleged fraud related to     tants and other tax preparers. During
       York’s Less Kind and Gentle Tax                          income tax, franchise tax, and withhold-      these meetings, the undercover investiga-
       Department: Preparing for Criminal                       ing tax. Other cases have grown to include    tor will wear a wire or camera to record
       Investigations,” State Tax Notes, March 31,              money laundering, embezzlement, and           the suspects (“Accountant Arrested as Part
       2008). According to Comiskey, the DTF has                other fraud-related charges. More recent-     of the Tax Department’s Statewide
       quintupled the number of staff fighting fraud            ly, SIU has targeted fraud that it believes   Investigation of Corrupt Tax Preparers,”
       since the inception of this program. Indeed,             is being committed by accountants and tax     press release, New York State Department
       there were more cases referred to SIU for                preparers.                                    of Taxation and Finance, September 29,

       48                                                                                                             OCTOBER 2009 / THE CPA JOURNAL
2008, available at          understand that there are a multitude of tax       ■   Concealing bank accounts or assets;
press/2008/pordy092908.htm).                     crimes provided for in New York State tax          ■   Concealing the existence of New York
                                                 law. Some of the most common (and most             living quarters;
Identifying Potential Fraud Cases                familiar) include the failure to file a return,    ■ Reporting income or sales in an amount
   Accountants, tax preparers, and other tax     filing a false return, disclosing false infor-     that does not support one’s standard of liv-
professionals should make a concerted            mation, and failing to collect or pay tax.         ing or business expenditures;
effort to identify potential tax fraud cases.    Professional preparers should be aware             ■ Dealing in cash only;
Doing so helps to inform the practitioner        that there are a host of more obscure tax          ■ Failing to follow normal business prac-
of his professional obligations in repre-        crimes, such as the selling of taxable items       tices, such as not depositing revenues into
senting the client. For example, if a tax pre-   without a certificate of authority and the fail-   an operating account;
parer suspects that a client is committing       ure to charge state sales tax separately.          ■ Employees working off the books;
sales tax fraud and is not providing all         Moreover, some tax crimes can be charged           ■ Selling items that do not appear on
relevant information regarding the               under penal law (as opposed to tax law).           the business’s purchase records;
amount of sales made, the preparer               Examples here include the failure to keep          ■ Failing to file a return (especially on a
should decline representation and refuse to      records required by law, falsifying busi-          repeated basis);
prepare or file a false sales tax return.        ness records, and even larceny (e.g., theft of     ■ Failing to make estimated tax pay-
The failure to terminate the relationship        sales tax trust fund taxes).                       ments;
could lead to the tax department’s conclu-           Though this is not a complete list of          ■ Maintaining inadequate records or no
sion that the tax preparer was, at the very      New York’s tax-related crimes, the discus-         records at all;
least, an accomplice to the fraud.               sion above should alert tax professionals to       ■ Destroying records;
   There are other reasons for tax prepar-       the fact that many types of conduct—not just       ■ Refusing to make records available;
ers to be on the lookout for potential fraud.    the failure to file or the filing of a false       ■ Keeping two sets of books;
First, taxpayers sometimes engage in con-        return—may be subject to criminal sanctions.       ■ Falsifying books or business records;
duct that is not fraudulent but may at first     Preparers should broaden their radar and be        ■ Inconsistencies between the sales fig-
glance look like fraud. Indeed, cases are        on the lookout for any activity that a New         ures recorded on a business’s income, cor-
sometimes referred to SIU due to factors         York State tax agent may find suspicious. In       porate, and sales tax returns;
such as sloppy (or nonexistent) record-          this regard, it is important for practitioners     ■ Other discrepancies between books and
keeping, a lack of internal controls, and        to be familiar with some of the “badges of         tax returns (e.g., amounts or treatment of
inconsistent or unexplained tax filings, all     fraud” that auditors and investigators look        items);
of which may have an innocent explana-           for in deciding whether to refer a case for        ■ Claiming fictitious deductions or
tion. In such cases, the preparer can advise     criminal investigation.                            exemptions for fictitious individuals (e.g.,
the client on how to remedy these short-             Badges of fraud are what auditors and          a dependency deduction for a deceased
falls before they even have an opportuni-        investigators seek when direct evidence            individual);
ty to become problems. Moreover, if a pro-       of a taxpayer’s intent to commit fraud is          ■ Implausible or inconsistent explanations
fessional has identified a candidate for a       unavailable. In other words, investigators         of behavior;
potential criminal investigation, criminal       frequently look to establish fraud from            ■ Failing to follow the requirements of the
prosecution can sometimes be avoided by          the surrounding circumstances, including           law where the taxpayer knows his obliga-
quickly filing a voluntary disclosure            the conduct of the taxpayer. Indeed, at a          tions (e.g., based on advice of counsel or
application and bringing them into com-          criminal trial, the government can seek to         experience in the business).
pliance on a going-forward basis. (It’s          establish criminal fraud through the intro-           In addition to the above, certain types
important to note that, among other restric-     duction of circumstantial evidence. Some           of conduct almost invariably increase
tions, the voluntary disclosure program is       of the badges of fraud that may become             one’s chance of becoming the target of a
not available to taxpayers who are               evidence of a deliberate attempt to commit         criminal investigation. Failing to cooper-
already under audit or investigation by          tax fraud include the following:                   ate with the tax authorities, making false
the DTF.) Finally, identifying potential         ■ Omitting income or sales on a return             statements about relevant facts (especial-
fraud cases will help the tax professional       where similar types of other income or             ly if under oath), and hindering an audit
understand how to handle any civil audit         sales are reported;                                or investigation (e.g., constantly cancelling
that may arise, specifically in the appro-       ■ Unexplained increases in reported                appointments or failing to provide a power
priate way to respond to an auditor’s            income or sales (especially if substantial);       of attorney or other requested records) are
request for information or documentation         ■ Unexplained bank deposits in excess              notable examples and should be avoided.
(i.e., do not voluntarily provide informa-       of reported income or sales;                       And, although it should go without say-
tion in a civil examination that could later     ■ Substantial understatements of income            ing, taxpayers should never threaten or
be used in a criminal prosecution).              or sales. This can include substantial under-      attempt to bribe an auditor or investiga-
   How does one go about deciding whether        statements discovered by the investigator          tor. Even an innocent gesture (e.g.,
a taxpayer could become the subject of a         through the use of indirect audit method-          offering an auditor tickets to a sporting
New York State or New York City crimi-           ologies (e.g., observation audits or mark-         event that would otherwise go unused)
nal tax investigation? The first step is to      up audits for sales tax);                          might be misconstrued.

OCTOBER 2009 / THE CPA JOURNAL                                                                                                               49
   The bottom line is that tax profession-     up (or feel free to do so just because there    pend the civil examination in the face of
als must be alert to the existence of the      is no subpoena), because anything said          suspected fraud. Even if New York were
badges of fraud. If a client has not yet       could later be used against the taxpayer,       to follow (or be forced to follow) a sim-
come under audit or investigation, there       even if not stated by the taxpayer directly.    ilar policy, it is possible that the infor-
may be steps that the taxpayer can take        If the preparer does not have the document      mation provided during the civil phase
to come into compliance, reduce the            requested or does not know the answer to        of an audit, if it is provided before the
potential tax exposure, and avoid crimi-       the investigator’s question, she should gen-    auditor suspects fraud, could be used
nal sanctions. Being attuned to possible       erally just say so.                             against the taxpayer after the case is
fraud is also important for taxpayers             The situation changes if a subpoena          referred for criminal investigation. This
who are already undergoing a civil exam-       has been issued, whether for testimony or       makes the above considerations regarding
ination, but who have not yet been             records. Generally, the taxpayer or other       the proper handling of information or doc-
referred to SIU. In these cases, the client    party must comply with the subpoena.            umentation requests all the more crucial.
can be monitored and encouraged to not         Compliance can be withheld if, for exam-
dig deeper by stalling, misleading, or         ple, a privilege can be asserted or a court     Tax Preparer Obligations
obstructing the auditor. More important-       order has been obtained to quash all or part    and Responsibilities
ly, however, the client should be advised      of the subpoena. Some of the privileges            As noted above, the Office of Tax
to engage an attorney so as to ensure          that may apply include the attorney–client      Enforcement is focusing much of its
that the auditor’s requests for information    privilege, the doctor–patient privilege, the    antifraud campaign against tax preparers.
and documentation are handled in way           marital privilege, and the Fifth Amendment      According to the state, this is because it
that does not do harm to the taxpayer          privilege against self-incrimination. Keep      believes that: 1) preparers are uniquely sit-
should the civil examination at some later     in mind, however, that because the failure      uated to influence compliance; 2) preparers
date turn into a criminal investigation.       to comply with a subpoena issued by the         are generally not regulated; and 3) the state’s
                                               DTF is a crime, one’s refusal, even if for      data mining has revealed a pattern of fraud
Handling Requests for Information              good reason, should be handled carefully        tied to preparers. Indeed, the Office of Tax
   DTF auditors and investigators will         and according to proper procedure.              Enforcement has begun to rely on technol-
inevitably request that the taxpayer provide      Tax professionals should also be on the      ogy to snuff out credit and refund schemes
documentation regarding the transaction or     lookout to determine whether a client           and to identify fraud tied to specific pre-
tax filing at issue. They may also ask that    should be taking steps to challenge or at       parers. The state has established a “ques-
the taxpayer offer testimony in response to    least register an objection to a subpoena       tionable preparer” database and is looking
specific questions. It is important, there-    issued to a third party. This may be            to build cases against preparers on the
fore, to remember the differences regard-      appropriate, for example, in the context        basis that they are accomplices to fraud. This
ing the burden of proof in civil cases as      of a subpoena issued to a former attor-         has resulted in the imposition of civil pre-
opposed to criminal cases. In a civil audit,   ney. In that case, the taxpayer may             parer penalties, criminal charges, and the
the taxpayer generally bears the burden of     wish, depending on the information              publicizing of those preparers found guilty
proving that an asserted tax liability is      requested, to ask that the former attorney      of fraud. In terms of penalties, New
incorrect. Conversely, in a criminal case,     not comply with the subpoena on the             York’s recently enacted 2009/2010 budget
the burden ultimately rests with the gov-      grounds that compliance could be treat-         legislation provides for a $5,000 penalty to
ernment to prove that there is a liability     ed as a waiver of the taxpayer’s Fifth          be assessed against any paid tax preparer
and that the taxpayer intended to commit       Amendment privilege.                            who aids or assists in the preparation of
fraud. Consequently, whether dealing with         One final consideration regarding infor-     fraudulent returns, reports, statements, or
a civil audit that could turn criminal or a    mation or document requests: At the             other documents, or who supplies false
case that is already under criminal inves-     federal level, IRS regulations require          information to the DTF.
tigation, an advisor must carefully            that a civil tax audit be suspended once           The DTF has also issued Publication
analyze whether and how to provide             the auditor has reason to believe that fraud    135, “Consumer Bill of Rights Regarding
information requested by the state. A tax      has been committed. In other words,             Tax Preparers.” It describes the rights of
preparer does not want to voluntarily pro-     federal tax auditors cannot conduct a crim-     taxpayers and how they can protect them-
vide information to the investigator that      inal investigation under the guise of a civil   selves from unfair practices by tax pre-
could be used against the taxpayer in a        audit. Though it may be that the courts         parers. New York is also mailing taxpay-
criminal proceeding.                           would enforce a similar set of rules            er alerts notifying taxpayers that their pre-
   Whether and how information should be       against the DTF on the grounds that             parer is under investigation or has admit-
provided is often a function of how it is      such rules are required by the Fifth            ted to filing fraudulent or inaccurate
requested. If the taxpayer has not been sub-   Amendment to the U.S. Constitution              returns. These taxpayers are urged to act
poenaed, the tax practitioner should ask       [see United States v. Tweel, 550 F.2d 297       quickly (e.g., file a voluntary disclosure)
whether there is a way to satisfactorily       (5th Cir. 1977)], New York has not yet          to avoid penalties, criminal charges, or
answer the auditor’s inquiry without hurt-     adopted specific regulations to address the     other compliance actions.
ing the taxpayer’s position. Tax preparers     issue. Consequently, it is unclear if and          So what does all of this mean for tax
should never, however, lie or make things      when an auditor in New York must sus-           preparers?

50                                                                                                    OCTOBER 2009 / THE CPA JOURNAL
   It means that preparers should ensure        nal investigation. Finally, an effort should      news for honest and diligent tax preparers
that they are performing the requisite          be made to gather, organize and analyze           who struggle to do the right thing. At the
amount of due diligence before preparing        all relevant documents, especially if they        same time, unscrupulous taxpayers, and
or filing a return. A tax preparer’s lawful     are currently being held by third parties.        those who assist them, have plenty to fear.
duty is to assist in the preparation and fil-                                                     And while it is unusual for defendants
ing of correct and accurate returns. This       The Role of Voluntary Disclosure                  indicted in tax crimes to serve any signifi-
should be the guiding rule, and all advice         Recently, the New York State legisla-          cant time in jail, the imposition of hefty
and conduct should be aimed toward this         ture, at the urging of the Office of Tax          fines, penalties, taxes, and interest has the
end. Tax preparers are not obligated to         Enforcement, adopted a statutory frame-           potential of being devastating to all con-
police or investigate their clients, but if     work for voluntary disclosure, under which        cerned. Moreover, when one of the partic-
there is reason to believe that a taxpayer      taxpayers can voluntarily approach the            ipants is a licensed CPA, New York State
is not providing complete or accurate infor-    tax department to report past delinquencies       may attempt to publicize the criminal
mation, a preparer should ask follow-up         and obtain a certain degree of amnesty.           charges and notify other clients of the
questions. Knowingly turning a blind eye        Eligible taxpayers who file a disclosure          accountant’s misdeeds. The state is also like-
to fraud may create the level of intent         statement and execute a voluntary disclo-         ly to make every effort to revoke the CPA’s
necessary for the state to charge the pre-      sure and compliance agreement will                license. Faced with such a downside, the
parer as an accomplice, especially if they      avoid incurring any civil penalties and will      DTF hopes that more taxpayers and pro-
assist in the preparation or filing of a        not be subject to any criminal proceed-           fessionals will do the right thing. Those who
false return.                                   ings for the period disclosed. Taxpayers          don’t, act at their own peril.              ❑
                                                will not, however, be able to enter into such
What to Do if a Case Goes Criminal              an agreement if: 1) they are currently under
   If a taxpayer has come under criminal        audit or a party to a criminal investigation;     Mark S. Klein is a partner at the Hodgson
investigation, SIU will generally issue a       2) the tax department has already identi-         Russ law firm with offices in New York and
letter to the taxpayer and the taxpayer’s       fied the disclosed deficiency; or 3) the tax-     Buffalo, N.Y. Jack Trachtenberg is an
representative informing them of this fact.     payer is disclosing participation in a tax        associate at Hodgson Russ who specializes
If a taxpayer has not received such a let-      avoidance transaction that is a federal or        in New York tax matters.
ter but the preparer believes that the audi-    New York State reportable or “listed”
tor or investigator suspects criminal activ-    transaction.
ity, one should ask the question: Is there a       The voluntary disclosure program is avail-
pending criminal investigation? The             able to taxpayers who wish to disclose a
response will help to inform many of the        delinquent tax liability, even one that was
decisions a preparer will have to make          deliberately or fraudulently evaded. In
regarding requests for documentation and        such cases, the taxpayer may be able to
other information. If the auditor or inves-     obtain immunity from prosecution, but it is
tigator misleads the taxpayer into believ-      crucial to remember that such immunity will
ing that there is no suspicion of fraud, it     apply only to those years disclosed and paid
may become a defense at a later date (i.e.,     under the program. Because various statutes
because the auditor arguably was con-           of limitation apply to the different tax
ducting a criminal investigation under the      crimes, and due to the potential application
guise of a civil audit).                        of prosecutorial theories such as the
   If a criminal investigation has been com-    “ongoing crimes” doctrine (which may act
menced, certain steps should be taken           to toll or extend these periods of limitation),
immediately. Most importantly, all direct       taxpayers who wish to disclose a potential-
communication between the taxpayer and          ly fraudulent transaction should first consult
the government should cease. In particu-        with an attorney. Indeed, while there is an
lar, taxpayers and their advisors should be     automated process available on the tax
cautious if government agents show up           department’s website, the voluntary disclo-
unannounced. In addition, the taxpayer          sure program can be confusing for a host of
should retain counsel and execute a             reasons. Talking to legal counsel beforehand
power of attorney authorizing counsel’s         will help to ensure that disclosure is the best
representation in the matter. An assessment     course of action and that the taxpayer ulti-
should be undertaken to analyze the nature      mately receives the fullest protection possi-
of the relationship between the taxpayer        ble from the program.
and the accountant or tax preparer.
Depending on the circumstances, a new           Incentive to Do the Right Thing
accountant may need to be retained to assist       New York’s current criminal tax com-
the attorney in connection with the crimi-      pliance initiative should be viewed as good

OCTOBER 2009 / THE CPA JOURNAL                                                                                                              51

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