I wish to graciously acknowledge the work of Valerie Vlasenko, Esq. from the law firm of Agostino & Associates, P.C. whose keen insight and innovative thinking as reflected in her article entitled, “Fifth Amendment Privilege in Tax: How to Keep the Case Moving While Protecting the Taxpayer,” has proven invaluable. Her guidance offers a practical and sound strategy for tackling these complex issues.
If you’ve ever heard someone “plead the Fifth” on a crime-related television show, you’re aware of the power of the Fifth Amendment. A key part of the United States Constitution, the Fifth Amendment protects Americans from self-incrimination, meaning that if you are arrested for a crime, you are under no obligation to reveal information that may be used against you. While cases of pleading the Fifth are a little less common in real life than they are on Investigation Discovery, the Fifth Amendment does occasionally rear its head for ordinary individuals – particularly where taxes are concerned.
In cases potentially involving the Fifth Amendment, it’s important for taxpayers and attorneys alike to tread carefully. After all, anything you say or do can be held against you – whether you meant to reveal such information or not. As such, taxpayers may find themselves between a rock and a hard place, as the willingly-provided information gathered in an audit – personal information and details about potential wrongdoing that taxpayers would ordinarily never admit to in a court of law, for example – can then be used in a criminal proceeding, like in cases of fraud or tax evasion.
Facing the potential for criminal charges stemming from an IRS investigation is a slippery slope. In order to keep taxpayers as protected as possible in these proceedings, it’s critical to understand policies, procedures, and best practices to reduce the risk of penalty.
The Fifth Amendment and the Filing of Tax Returns
As the adage goes, there are only three absolutes in life – birth, death, and taxes – and pleading the Fifth isn’t always enough to send the IRS packing.
Under Code Sec. 6012, individuals in the U.S. are required to file annual income tax returns, and also to keep adequate records to support the gross income and expenses included with an annual filing. For those with a penchant for tax fraud, doing as such may seem as though it’s toeing the line of the Fifth Amendment, but the Supreme Court decided this isn’t the case; in United States v. Sullivan, the Court determined that preparing tax returns is not a violation of personal liberties. There may be some case for pleading the Fifth in cases in which the taxpayer is asked to disclose information that is otherwise privileged, but there is no defense for failing to file at all. Returns also cannot be substantially incomplete; they must provide enough information for the IRS to reasonably determine an individual’s tax liability.
If the IRS requests information the taxpayer feels should be privileged, a privilege claim can be made under select circumstances, on a case by case basis. In fact, the Tax Court recently ruled that the privilege against self-incrimination can be used to keep taxpayers from disclosing the source of certain forms of interest income if the return otherwise contains enough information for the IRS to accurately assess the correctness of the overall return.
Invoking the Fifth Amendment
Think invoking the Fifth Amendment may be enough to get the IRS off your case? It may be, but it also may not be.
Section 7602 grants the IRS fairly broad power to compel taxpayers into providing requested information in the course of a return examination. This power is not unlimited, however, and in the right occasion, the Fifth Amendment may indeed provide protection. However, before pleading the Fifth willy-nilly, it’s best to understand its exact role in the Constitution. It reads as follows: “No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offence to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.” In essence, this protects against government abuse, helping to safeguard citizens from having to choose between following the law and self-incrimination or perjury.
These privileges don’t just stop at criminal cases, however; civil proceedings are also included. This means that taxpayers are indeed permitted to plead the Fifth in proceedings with the IRS, assuming there is a valid reason to do so. If a taxpayer is found to be “faced with hazards of self-incrimination that are real and appreciable, not merely imaginary and unsubstantial” the request will be upheld.
For those potentially facing IRS sanctions or penalties, it’s only natural to ask, “why not invoke the Fifth Amendment at all times when dealing with the IRS?” After all, confessing to tax fraud or other challenges that the IRS may investigate would be self-incrimination, would it not? This is certainly a valid question, but it’s also one that may stand in the way of resolving complex tax situations, particularly for those with an educated appointed representative, like a tax accountant or lawyer. With a qualified representative speaking on behalf of a taxpayer, it’s unlikely that a case will evolve into one in which pleading the Fifth becomes essential, even in cases concerning fraud or other potentially criminal charges. It is also important to understand the rights of a taxpayer and his representative; when asked, the IRS must produce a copy of their administrative file under code section 7803. Generally, reviewing files and workplaces indicates that pleading the Fifth isn’t necessary. However, if the IRS refuses to give up files based on the perceived influence to proper tax administration, the taxpayer may want to proceed with as many privileges invoked as possible.
In addition to the above, the burden of proving privilege falls on the one asserting privilege, which means that the taxpayer must be able to demonstrate why he is claiming privilege – and saying “because” isn’t a good reason at all. From there, it is up to the court to decide whether this choice is valid, and if it’s deemed to be unnecessary, the ability to plead the Fifth is essentially voided.
While the IRS occasionally issues threats, it’s highly unlikely that the results of an investigation will actually yield prosecution, making the need to invoke the Fifth essentially moot. Further, invoking the Fifth immediately colors the way a taxpayer looks to the IRS. Even if there’s nothing criminal to hide, simply bringing up privilege will lead to a presumption that there is. Doing this unnecessarily can send the IRS digging deeper than previously intended, and may also significantly delay the examination process and send legal costs soaring.
Invoking the Fifth Amendment for an IRS Document Request
Under code section 7602, the IRS has the broad authority to summons books, papers, files, or any other data that may be relevant to an IRS investigation. While not a formal legal proceeding, it is possible to invoke the Fifth under these circumstances, but it’s not common, and doing so requires a thorough understanding of section 7602, the act of production doctrine, and the required records doctrine.
If a taxpayer receives a summons but believes that any part of it is incorrect, unwise, or otherwise a poor idea, he can refuse to comply with any part of the summons. At this point, it’s up to the IRS to bring a court order to attempt to secure the data not willingly provided. To do this, the IRS will have to prove to a court that a court order is necessary to conduct an investigation, that the investigation will be conducted properly, and that the information is not currently in the hands of the IRS.
However, attempting to use the Fifth Amendment for this reason gets a little murky according to case law, with several applicable principles to consider. First, there is no naturally assumed privilege for pre-existing, voluntarily created documents, like personal bookkeeping records, because these weren’t created on behest of the IRS. Second, the act of procuring requested documents may incriminate a summoned person by admitting that the documents exist, that they are in the taxpayer’s possession, and that they are presumably required by the summons, making the Fifth Amendment privilege largely available on a case-by-case basis. Third, an “act of production” immunity is not an option for required records, like foreign bank account records, under the required records doctrine as these records are required to be maintained by law and the government is given the right to inspect these documents as a condition of voluntary participation in one of the covered regulated activities. Fourth and finally, it’s not possible for the IRS to use its powers to force a taxpayer to waive his Fifth Amendment rights by requiring the preparation of documents that, under the right circumstances, may be covered by privilege.
Sound confusing? It is. But that’s the nature of using the Fifth Amendment as a defense.
Obligations of Tax Professionals: Weighing a Prompt Resolution with Protecting Taxpayer Privilege
The tax system is built on the voluntary compliance of taxpayers. To facilitate this, the Treasury Department maintains numerous rules and regulations that govern the practice of tax professionals, like tax attorneys and IRS Enrolled Agents. These individuals are meant to serve as pillars of the taxation system, not as a backdoor around the IRS’ stated intentions. In layman’s terms? Cooperation is expected, even in challenging circumstances.
However, the role of the Fifth Amendment does put many tax professionals lucky enough to stumble upon an applicable case between a rock and a hard place. While it’s in their best interest to help the taxpayer, they are also obligated to help the IRS uphold its responsibilities, which means both protecting privilege while simultaneously ensuring expedited proceedings. This essentially means that representatives are expected to fully understand the potential role of the Fifth Amendment and, more importantly, whether or not it is appropriate. After all, if every taxpayer pled the Fifth whenever the IRS came knocking, the cost of performing audits would skyrocket, putting even more burden on an already-stretched agency.
In spite of the IRS’ need for adherence to guidelines and prompt cases, the current guidance provided by the IRS does address how to navigate these conflicts of interest, and the priority is often with protecting the taxpayer. For example, Circular 230 indicates that tax professionals are obligated to promptly inform their clients of non-compliance, error, or omission, and must also explain the potential consequences of any mistakes made. Circular 230 then goes on to explain that all records must be submitted in a timely manner “unless the practitioner believes in good faith and on reasonable grounds that the records or information are privileged.” In essence, practitioners must thoughtfully and carefully weigh their obligations to their clients and their obligations to the IRS while giving proper regard to each.
This does, however, become more challenging in what is known as an eggshell audit, or an audit in which the taxpayer and his representative are aware of erroneous entries in prior tax years, but the IRS auditor is not. In this case, a tax professional must somehow balance providing the IRS with the information it needs without misstating any facts or otherwise misleading the course of the audit while still safeguarding the taxpayer’s best interest. However, this can get into murky territory regarding Misprision of Felony in the United States Code, which effectively states that concealment of a felony by anyone who knows about a felony and fails to report it to the proper authority can result in a fine or three years in prison. However, this statute implies active concealment, which means that a tax representative doesn’t necessarily have to speak up when not asked, but should be honest if the issue arises.
Balancing Pleading the Fifth and Continuation Penalties in Offshore Audits
Offshore audits are challenging enough, but the complications only grow in magnitude when issues of the Fifth Amendment are added into the mix. Taxpayers who don’t properly report their foreign assets or earnings and are not enrolled in an Offshore Voluntary Disclosure Program are likely candidates for audit – and likely candidates for either civil or criminal penalties. There are a few different ways the Fifth can be used here, depending on the circumstances and the past precedent set by the IRS.
While interviews aren’t common in many onshore audits, they are more likely in an offshore environment. Interviews of this sort are inconsistent with code section 7521(c) and, according to some, the right to representation under section 7803. Some practitioners see these interviews as part interview, part fishing expedition, using carefully worded questions to attempt to catch taxpayers in a lie or confession that could support a penalty assertion or, worse, lead to a criminal referral. For this reason, it is often suggested that a taxpayer take the Fifth for any question asked in this form of interview, instead requesting all questions in writing so that answers can be carefully constructed under proper legal counsel.
In Filing Late Foreign Information Forms
For those living overseas or who hold assets overseas, the IRS requests a lot of information – and these requests can’t just be ignored. Fail to file and steep penalties may be incoming. However, filing late can raise red flags and send the IRS knocking. In general, a penalty of $10,000 applies for each late form filed for every year in which a form should have been filed but was not. If this delay drags on past 90 days of the date in which the IRS sent a notice, a separate $10,000 continuation penalty applies for each proceeding 30-day period. Kindly, the IRS often caps these penalties at $50,000 per form, for a total of $60,000 per form per year.
When the IRS realizes that an offshore form is not filed, they send a notice to the taxpayer, which then creates a serious conundrum: does the taxpayer file the return and admit to violating tax law, or does the taxpayer not file the form and risk a potential $60,000 penalty in doing so? At this point, it is often of use for a tax professional to inform the taxpayer of the pros and cons of a Fifth Amendment return. As stated above, it is understood that the Fifth Amendment does not relieve a taxpayer of his filing requirements, but in cases in which the Fifth Amendment is affirmed before a return is filed, it can apply. However, whether this method can be used to resolve a continuation penalty issue is another story, and one for which the courts haven’t yet crafted a resolution. While some may argue that a Fifth Amendment assertion is enough to circumvent a failure-to-file penalty, others assert that because the IRS considers an information return that does not contain full, complete, and correct information as not filed, taking the Fifth is the same as failing to file.
To get around this, some tax professionals believe that a taxpayer should indeed fill out the return as required, but take the Fifth on a line-by-line basis as needed. Then, as the IRS continues to send notices, respond consistently with the return claiming the Fifth. When the final bill for the penalty comes due, the taxpayer can then file Form 12153, Request for a Collection Due Process or Equivalent Hearing, and request a de novo review of the penalty.
While there isn’t much precedence on these kinds of antics, the Tax Court did appear to view this strategy favorably in Youssef Youssefzadeh vs. Commissioner of Internal Revenue. After taking the Fifth for an item on Schedule B, the IRS retaliated with a frivolous return penalty and proposed a levy to collect said penalty. Youssef filed an Appeal, at which point the IRS’ opinion was upheld. However, he then took his case to court, which resulted in the Tax Court ruling in his favor.
The Fifth Amendment During an Examination on the Scope of Review
Asserting the Fifth during an audit is among the most compelling times in which to claim privilege, but also one of the most problematic. Doing so will result in a Notice of Deficiency, imputing income and disallowing deductions. The taxpayer can challenge the tax set forth by the IRS in Tax Court or, alternatively, in the District Court or the Court of Federal Claims, depending on whether the taxpayer wants to prepay his tax before proceeding in court. In all courts, however, the IRS’ determination is assumed to be correct and it is up to the taxpayer to demonstrate otherwise. Choosing a court shouldn’t be like rolling the dice; the onus is on the taxpayer and his representatives to do the proper legwork to ensure the right decision.
The Tax Court hears prepayment cases and all review is de novo, or decided anew based on the circumstances and facts presented. Asserting privilege will not result in a negative response, and the taxpayer is free to later waive privilege once the fear of a criminal charge is addressed and dismissed. Refund cases are generally held in the District Court or the Court of Federal Claims, and also use de novo review, but this practice is limited by the doctrine of variance and the administrative record. This bars taxpayers from making claims that are too far outside existing legal theories and factual bases presented by the IRS. These courts also generally only consider evidence that was actually presented to the IRS, so taking the Fifth may limit the detail that can be considered in a court case.
Whether court is in the future or not, invoking the Fifth Amendment does limit the right to shift the burden of proof in any forum. When all of the information isn’t on the table, whether the reason is valid or not, it’s hard to make a full, cohesive case.
Collections Due Process Cases
In an IRS collection case, asserting the Fifth Amendment can be highly problematic. IRS collection cases generally involve the submission of financial information under penalty of perjury, and failing to do so may result in a tax lien, at which point an Appeals hearing can be requested. The Tax Court is the authority here, but the no-holds-barred de novo review in examination cases is a little different here. If the underlying tax liability is the issue at hand, the de novo standard of review will be applied. If another issue is at the center of the case, administrative record will instead be used. In some circuits – First, Eighth, and Ninth, currently – the tax court is limited to exclusively administrative review. For taxpayers in these jurisdictions, it’s worth carefully considering the ramifications here; charging forward with a Fifth plea may end up very differently than anticipated – and not in a good way.
When evaluating a case, the Tax Court is limited to only issues that arose during the CDP Appeal hearing – yet another limitation to consider. This also includes issues brought up in Appeals but are not supported by adequate evidence. Unfortunately, invoking the Fifth Amendment by nature means that some information will go unsaid, which creates further logistical stressors in determining how to best proceed in collections due process cases.
To Take the Fifth, or to Not Take the Fifth
Navigating the choppy seas of the Fifth Amendment is never easy, and things only become more difficult when the IRS gets involved. With somewhat contradictory rules governing how and when it’s appropriate or acceptable to invoke the Fifth Amendment, the fine line tax professionals must walk, and the additional complications posed by circumstances like offshore audits, there are no easy, clear answers available. In general, it is usually considered best to comply with IRS requests whenever possible – even if you would rather not – unless a clear-cut case of personal privilege is at hand. And even then, the road ahead won’t be hurdle-free. After all, as with most IRS issues, it’s often damned if you do, and damned if you don’t.