Taxpayers ‘Gamble’ by Committing Fraud, Even With Diminished IRS

Anyone thinking about pushing the boundaries of tax law in the face of a weakened IRS should remember that the agency has a high batting average for fraud prosecution and a long runway to enact penalties, said Carolyn Schenck, who spent 20 years at the agency primarily combating tax evasion.

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“If people think that a current administration or a past administration might go soft on tax fraud, that’s still an awfully big gamble,” said Schenck, who’s now at Caplin & Drysdale. “And I know that that’s not one I personally would want to take.”

The IRS is coming off a tumultuous year with deep staffing cuts from the Trump administration’s efforts to downsize the federal government and a parade of new commissioners. But increasing IRS staff and resources would be one of the best ways the government could combat fraud and collect more of the money it’s owed, Schenck said.

On this episode of Talking Tax, Schenck sat down with Bloomberg Tax reporter Erin Schilling to discuss what Trump administration workforce cuts mean for IRS enforcement and how the agency could improve its efforts to go after illegal tax shelters, even with a diminished staff.

Do you have feedback on this episode of Talking Tax? Give us a call and leave a voicemail at 703-341-3690.

This transcript was produced by Bloomberg Law Automation.

Host (David Schultz):

From Washington, I’m David Schultz, and this is Talking Tax.

There’s a certain kind of person who would see headlines about massive staffing cuts at the IRS and think to themselves, hey, this seems like a good time to evade taxes. Well, today’s guest is here to say that’s not a good idea. Carolyn Schenck spent 20 years at the IRS, primarily working on combating tax evasion, in particular offshore. She just left the agency earlier this year and is now with Caplin & Drysdale. Schenck spoke with Bloomberg Tax reporter Erin Schilling about how even a weakened IRS can still go after tax cheats years and years into the future.

But she started the conversation by acknowledging that tax enforcement in the near future isn’t going to look like it did in the recent past.

Guest (Carolyn Schenck):

I think the IRS is currently facing a staffing crisis. That being said, the focus on tax fraud remains strong. I think the IRS has a vested interest to encourage compliance. Sometimes that encouragement comes through enforcement and campaigns, but it also extends to revenue agents doing their day-to-day work. So I think the focus on fraud is still there. The IRS could certainly benefit from having additional staffing, additional tools, additional funding to get it back to a place where it can function at the level that it’s used to functioning at.

Reporter (Erin Schilling):

I feel like even in the best of times when the IRS is fully staffed up, it often feels like a game of catch-up when you’re talking about enforcing tax fraud. Are there ways that you think could sort of speed up the way that the IRS deals with fraud and why does it, you know, why is the process so long?

Guest:

I think a couple of things, you know, first, to a certain extent, you’re right. I think the overall environment is a reactive one and it’s probably just because of the nature of the process itself and that the tax return is filed with the government and really the tax return is evaluated and whether or not there are misstatements or large questionable items on the return, then the audit goes from there.

There are other instances though where certain types of schemes or abusive transactions come into the eye of the government and the Office of Fraud Enforcement or the Office of Promoter Investigations or even CI to a certain extent or Office of Chief Counsel would flag that for the IRS and then the issue would be examined that way. So there are a couple of different ways that a fraud investigation could start, either from an actual filed return or from an issue that’s brought to the service’s attention.

As far as other ways that the government could be less reactive and more proactive, I think are really probably trifold. I mean, first of all, there needs to be an increase in the overall resources and staffing that the government has at its disposal, you know, to use in this regard. Second, equipping agents with technology in order to search maybe filings or search other databases to uncover areas of fraud would also be extremely helpful. And the third thing I think the government would benefit from, at least at the IRS level, is to have some standalone either business units or standalone task force type teams to work on an issue by issue basis. So they’re not necessarily auditing tax returns, but they’re really auditing an issue and figuring out how that issue may translate to a fraudulent return or a group of fraudulent returns being filed.

Reporter:

And in light of the fact that the IRS is actually losing resources right now, and I know you just said that that was something that could help with tax fraud enforcement, do you think that tax fraud will increase? Do you think that, you know, with the lack of resources that the IRS has, that sort of emboldens tax cheats?

Guest:

I do think it emboldens people to take opportunities that they might not have otherwise taken. You know, there are certainly a lot of sources online and a lot of chatter online that the IRS is broken or wounded or winded, and they’re not capable of keeping up with either returns that are filed that are potentially incorrect, or also, you know, keeping up with the tax fraud that’s going on.

You know, I’ve been asked this question numerous times, and my warning is always the same, which is now is not the time to take a knee. First of all, there is no statute on a civil fraud penalty. So regardless of the regime that may be in any leadership role at this point or the administration at this point, I mean, there is no statute with respect to civil fraud. Of course, on a criminal fraud regime, there is a series of statutes, but still we’re talking about five years, six years, and even those can be extended if there’s continuing conduct.

So a taxpayer has to have a significant constitution for risk, I think, to proceed down a path that they know is fraudulent, because if you look at also not only the success rate on a civil fraud penalty case in Tax Court, but also the department’s conviction rate on tax cases is in like the mid to high 90s, I mean, that is an enormous batting average. So going against the government in a financial fraud case, especially involving taxes is one that it’s just not going to be a winning proposition for a taxpayer.

Reporter:

And even if a taxpayer might feel like they can get away with fraud right now, they could still be caught from the next administration or the next administration, because like what you were saying, there’s no statute of limitations on those cases.

Guest:

That’s right. On the civil side, with civil fraud, there is no statute of limitations. So if there is a particular administration that’s focused on X or focused on Y, sometimes that doesn’t always translate back down to the IRS, by the way. But in the event that it does, if people think that a current administration or a past administration might go soft on tax fraud, that’s still an awfully big gamble. And I know that that’s not one that I personally would want to take.

Reporter:

And I also wanted to talk about what you said about improving technology, because I think, you know, improving technology is something that the IRS has always struggled with. I mean, throughout multiple administrations, that has been a big critique. And I’m curious, you know, while you were there, what were some of the technological advancements that you guys did in order to better combat fraud?

Guest:

You know, one of the things in the last decade or so that has really risen to the level of scrutiny for a number of different agencies is the use of digital assets. The ability to transfer funds and the movement of money is just astronomically fast. And using tools like digital assets really allow that sort of money transfer to occur in such a quick and sometimes an anonymous scenario.

So the IRS did a John Doe summons with respect to an exchange back in 2015 that I was involved with, and that was probably one of the first major steps that the government had taken into digital assets. And from there, the IRS took a number of different steps to not only increase awareness as far as what the filing obligations were, but also in equipping its agents and revenue officers with tools.

So getting to your question about technology, while I was there, the Office of Fraud Enforcement partnered with CI as well as with the National Fraud Counsel in an endeavor called Operation Hidden Treasure to equip revenue officers and revenue agents with the tools that they would need to do analysis on the blockchain and analysis of digital asset transactions in order to help fight tax evasion in that area. So the Office of Fraud Enforcement was able to put hundreds of licenses for various tools, investigative tools, software, and other types of things like that in the hands of revenue officers and revenue agents.

And I think there have been a fair amount of prosecutions over the last decade, and a lot of them are starting to focus on legal source income with respect to digital assets. Of course, a legal source income, drugs, money laundering, trafficking, that sort of thing. But there have been a handful of financial cases involving legal source digital assets. So I think that trend is going to continue.

Reporter:

There’s been a lot of changes at the IRS, as we’ve talked about, but there’s also been a lot of changes at the tax division in the Department of Justice. And the tax division is splitting up its enforcement between the broader criminal and civil divisions in the department. And I’m curious, what do you think that change is going to do to tax fraud enforcement?

Guest:

I will say that the IRS and the Department of Justice have had a phenomenal relationship over the years. Obviously, the two organizations go hand in hand when it comes to prosecuting tax cases. The department, the long and the short of it is, is the IRS’s lawyer when it comes to cases in district court and other federal courts. Of course, the IRS represents itself in tax court, but in any other criminal prosecution, the Department of Justice is the person who’s standing up for the agency.

As far as where I think it’s going, based on what I’ve seen, that division is moving into an already existing civil division and an already existing criminal division. And what I hope happens is the level of coordination that the tax division provided already for U.S. attorney’s offices around the country. That kind of coordination leads to consistent prosecutions, consistent handling, which I think is both important, not only for the government, but also for the tax bar as well.

I think it’s extremely important for the tax bar to know how a case is going to be handled by a U.S. attorney in Texas and whether or not it’s going to be the same as how it’s handled by a U.S. attorney in Florida, as far as a tax charge is concerned. And I’m not talking about a cookie cutter type situation, but more about consistency. And now as a member of the private tax bar, I think that sort of consistency is imperative in giving good advice to clients who come in with pretty large problems and pretty big areas where there’s potential criminal exposure there.

I think that having the tax division in some form, whether it be a mini civil tax division and a mini criminal division, would also facilitate the continuation of prosecution with respect to this area. You know, tax law, to a certain extent, people say is an easier charge than some of the other financial frauds out there. There are still very specific rules with respect to information sharing under Section 6103 as tax information is very sensitive. So it’s important that a body of tax prosecutors stay in place to make sure that some of those checks and balances remain.

Reporter:

You know, the IRS hasn’t really had a lot of consistent leadership through much of the year, making it kind of hard to predict where fraud compliance campaigns might come from. The Trump administration has indicated plans to increase scrutiny on tax exempt organizations, especially around criminal tax fraud. I’m curious, how do you expect this to play out?

Guest:

I have read that multiple sources are warning that the Trump administration has directed the IRS criminal investigation to zero in on these left leaning organizations. That’s not something that I saw during my tenure at the IRS. I’m not sure how it’s going to play out. I do know that tax exempt organizations have the ability to equip themselves, hopefully to challenge some of these types of investigations.

And when I say equip themselves, I mean just by doing, you know, some basic due diligence, which many of them are already doing in terms of making sure that their books and records are in order, they have fostered and reinforced a culture of compliance, that their stated purpose on their any filed form 990s or any other documents with the IRS matches what they’re actually doing, tracing funds, tracing expenditures, all those types of things I think are steps that exempt organizations can take to try to combat some of these types of issues that are coming up.

But in my tenure at the Service, I’ve never seen anything like this before. And I’m not exactly sure how it’s going to play out, but it does seem to be moving forward based on what I’ve read.

Reporter:

How do clients feel about all the changes happening at the IRS? Is there a sense of like, oh, we don’t have to worry about getting into compliance as much because they don’t have the resources?

Guest:

Well, in my short 40-plus days in private practice, I will say that I’ve spoken with a lot of different practitioners. And these are practitioners who are at every level, CPAs, enrolled agents, as well as attorneys from all across the country. And I think that there is a concern with the IRS’s ability to manage the current set of not only business responsibilities it has, which is, I’m talking about the basics of processing returns, posting refunds, processing collection items like offers in compromise, installment agreements, that sort of thing, like the business aspect of it. But also the concern is about following through with some of the enforcement provisions that have been enacted in some of the cases that are currently underway.

Just based on my impression so far, I think there are a lot of taxpayers who try extremely hard to come into compliance and to be in compliance. I mean, there are tens of millions of Americans who file their tax returns every year, who meet with tax return preparers, who keep track of their expenses on Excel, on QuickBooks and that sort of thing. And I think that those people are continuing to do that. I just hope that the IRS can be funded to a level that it can help those taxpayers who desperately want to come into compliance and be in compliance as well.

Host:

That was former IRS tax attorney Carolyn Schenck speaking with Bloomberg Tax’s Erin Schilling.

And that’s it for today’s podcast. You can find up-to-the-minute news on the latest tax and accounting developments at our website, news.bloombergtax.com. That website, once again, is news.bloombergtax.com.

Today’s episode was produced by myself, David Schultz, and our editor was Kim Dixon. From Washington, I’m David Schultz. Thanks for listening.