TAX FRAUD

PAST EXAMINATIONS

1995 Examination

TAX FRAUD AND MONEY LAUNDERING
SPRING 1995
UNIVERSITY OF HOUSTON SCHOOL OF LAW

EXAMINATION

Instructions:

1. Write legibly. Lawyers must communicate. You are not communicating if I can't read your writing. Your grade will suffer if you do not communicate your knowledge to me (on the other hand, it might suffer if you do, but I hope that is not the case).

2. I recommend that you outline your answer before you start writing. Try to figure out where you are going before you start. Your path will probably be much more direct if you do so. I, as well as most clients, judges, lawyers and other persons with whom you will deal as a lawyer, place a premium on directness. You will get a premium here for direct, clear and lucid exposition.

3. Persons in the graduate law program must put beside their identification number the term (LLM Student).

4. The percentages at the beginning of each paragraph number are guides as to the relative importance of the questions and answers. You may use this as a guide in budgeting your time. Please note that question number 1 has a great deal more weight than the other questions.

Examination:

1. (30%) A client comes to your office for an initial visit. After first confirming that the information he gives you is subject to the attorney-client privilege, he advises you that he failed to include $500,000 of income on his 1990 tax return, which he timely filed on October 15, 1991 pursuant to the usual filing extensions. He further advises that his regular CPA, whom he likes and trusts, did not know about the $500,000 item and thus is not at fault for failure to include the income on his return. He brought the 1990 return for you to review. The other items of income on the return were his salary of $75,000 and his wife's salary of $50,000. The $500,000 was, he says, his net gambling earnings for that year. Only his wife knew that he had a substantial amount of net gambling earnings and even she did not know the precise amount. In all other years, he had net losses from his gambling activities, which stopped in any event in 1992 when he joined gamblers anonymous. He and his wife are currently in the midst of a messy divorce. She found out about his girl friend and is hell bent to break him. He is concerned that she may go to the IRS with this information. Advise him generally as to any risks and opportunities, addressing specifically the following:

a. What potential criminal tax penalties might the client be subject to. Identify each potentially applicable penalty by Code section and state the elements of the crime and the prescribed punishment for the crime (setting aside how the calculation would work in the sentencing guidelines)?

b. Could a civil penalty apply? If so, identify the civil penalty you would be most concerned about.

c. Give him a general overview of the federal tax criminal enforcement program as it might apply to him if his wife went to the IRS, discussing briefly the role of the roles Criminal Investigation Division, the District Counsel of the IRS, the Tax Division of the Department of Justice, and the United States Attorneys office, in the approximate chronological order that they would ordinarily be involved.

d. Explain the voluntary compliance program and how the client might pursue voluntary compliance.

e. Advise whether he should or must file an amended return, and what the effect of the amended return would be from the perspective of his potential criminal exposure.

i. Advise who should prepare the return.

f. What is the statute of limitations for any crime that may apply and when does it run?

2. (10%) Assume that, in question number 1, the client also advises that he maintained a record of his winnings though cryptic symbols that he entered into his personal diary. His ex-wife knew that he recorded symbols in the diary, but he thought she could not decipher them. He thinks she may have made a copy of his diary; as an aside, he tells you that he is trying to think of some way to relieve her of the burden of possessing such a document (if in fact she possesses a copy).. He asks you, however, to advise him whether the Government can force him to deliver up his diary and, if so (or if your answer is equivocal), should he cause the diary to disappear?

3. (12%) What is the difference between a guilty plea and a nolo contendere plea in a tax case?

4. (16%) Discuss the differences between the grand jury subpoena and the IRS administrative summons in relation to their effectiveness in investigating tax crimes.

5. (16%) Your client is a large corporation on the accrual method of reporting. You deal with the tax director for the corporation. The tax director is aware that accruals for unfunded deferred compensation cannot be deducted pursuant to the Code. (Students: you may take this as true.) The Code provision denying the deduction is designed to achieve a timing match by allowing the corporate employer to deduct the deferred compensation when the employee reports it as income in the year the deferred compensation is paid to the employee (employees almost invariably being on the cash method of accounting). The tax director says, however, that the costs that accrue each year for future unfunded deferred compensation are composed of two economic elements -- a compensation element and an interest element. The compensation element compensates the employee for his services; the interest element compensates the employee for deferring receipt of the cash and is thus economically interest rather than deferred compensation. The tax director reasons that, although the Code requires that unfunded deferred compensation not be deducted until paid, that deferral provision does not address the interest element (which can be a substantial portion of the ultimate compensation) should be deductible. You research the Code and advise the tax director that (1) the IRS position adopted in a revenue ruling is that the gross unfunded deferred compensation (including the interest element) must be deferred and deducted only as paid and (2) your best judgment is that, although the technical analysis is correct that interest is not compensation, the intent of Congress in adopting the provision was to require the gross amount to be deducted only as deferred compensation. The tax director nevertheless decides to have the corporation claim the interest element as a deduction on its corporate income tax return and decides not to disclose the position on the return (i.e., the interest element is buried in the corporation's line item for interest accrued). Subsequently, the Tax Court confirms your conclusion in another case that the interest element is not deductible as it accrues. However, a panel of the Court of Appeals decides that the interest component is deductible and, on rehearing of the panel decision, the full en banc Court of Appeals decides that the interest component is not deductible. The IRS schedules an audit of your client and, in setting up the audit plan, advises the tax director that the IRS will review the material accrued interest items. Because of the number of executive level employees having deferred compensation plans, the tax director believes that the amount of accrued interest is material and will be reviewed. The tax director comes to you seeking advice as to whether the corporation (or, of more immediate importance, the tax officer) has any criminal exposure for having taken this position on the return. Advise him.

6. (16%) You have a new client who is an airline pilot. A number of his colleagues have filed W-2's with hundreds of claimed exemptions and then have filed blank tax returns with a claim on the face of the returns that the income tax system is unconstitutional. He plans to do that also. Upon questioning the client, you are convinced that he believes the income tax system is unconstitutional. You attempt to explain to him that the best current legal thinking, and your personal judgment and advice to him, is that the income tax system is constitutional. He nevertheless persists, drawing comfort from the Federalist Papers and the Proceedings of the original Constitutional Convention. He is convinced of the merits of his position, but he is not so out of touch that he desires to ignore the risks of this course of conduct. That is why he came to you so that you can advise him of the risks. If there are any criminal penalties potentially applicable to the course of conduct, please advise of them by identifying each Code Section involved and stating the elements of the offense and the penalties involved. You should also address whether the sentencing guidelines might apply, but do not attempt to make any calculations of the actual sentence.

GOOD LUCK ON THE EXAM. HAVE A GREAT SUMMER. IT HAS BEEN MY PRIVILEGE AND PLEASURE TO HAVE YOU AS STUDENTS.

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1997 Examination

TAX FRAUD AND MONEY LAUNDERING
SPRING 1997
UNIVERSITY OF HOUSTON SCHOOL OF LAW

EXAMINATION

Instructions:

1. Write legibly. Lawyers must communicate. You are not communicating if I can't read your writing. Your grade will suffer if you do not communicate your knowledge to me (on the other hand, it might suffer if you do, but I hope that is not the case).

2. I recommend that you outline your answer before you start writing. Knowing where you are going before you start the answer in the exam booklet will permit you to get there with more communicative grace and style. I, as well as most clients, judges, lawyers and other persons with whom you will deal as a lawyer, place a premium on forethought and directness. You will get a premium here for direct, clear and lucid exposition.

3. Persons in the graduate law program must put beside their identification number the term (LLM Student).

4. The percentages at the beginning of each paragraph number are guides as to the relative importance of the questions and answers. You may use this as a guide in budgeting your time.

Examination:

1. (25%) Mr. Jones runs several restaurants in Houston and Dallas that are quite successful. He operates these restaurants through an S Corporation which offers limited liability and a single level of taxation. For the year 1995, these restaurants generated gross revenue of $10,000,000. Related expenses, including depreciation, were $5,000,000. 40% of the gross revenue ($4,000,000) was cash. Mr. Jones required that each restaurant fax to his home fax a daily report at the close of business of the gross revenue, broken down by gross charge items and gross cash and that each restaurant's retained copy of the fax be destroyed weekly. He also required that each day's receipts (cash and charge slips) be transferred daily in a sealed courier pouch to his corporate headquarters in Houston. Cash register tapes were transported at the same time, analyzed by Mr. Jones personally to spot improper cash withholdings, and then destroyed. At the corporate headquarters, Mr. Jones skimmed one-half the cash ($2,000,000), thus reflecting on his books only 80% of the actual revenue -- consisting of the 60% charged items and the 20% representing one-half the cash. The skimmed cash was retained by Mr. Jones and periodically smuggled out of the country for deposit in a numbered Swiss bank account. Mr. Jones believes that no one knows of this account, except his Swiss banker and his wife. His wife did not participate in the skimming or deposit into the Swiss bank account, but did discover the existence of the account during a trip to Europe in June 1996. When the accountant prepared the tax return for the corporation for 1995, he reported only 80% of the revenue and a resulting taxable income of $3,000,000, rather than the actual taxable income of $5,000,000. As a result of the S corporation return, Mr. and Mrs. Jones report only $3,000,000 of taxable income for the year 1995 on their joint return which was filed on April 15, 1996. Furthermore, Mr. and Mrs. Jones did not properly answer the question regarding foreign bank accounts.

a. With only the foregoing facts, Mr. Jones comes to you and spills his guts. Advise him:

(1) what crimes, if any, may be involved in his conduct?

(2) what options are open to him? and

(3) your recommendation as to the option he should pursue, along with your reasons for the recommendation.

b. Assume the additional fact that Mr. Jones is in the midst of a very bitter divorce dispute when he comes to you. His wife has made an "off the book" proposal that Mr. Jones give her her share (50%) of all assets other than the Swiss bank account and 90% of the Swiss Bank account, with an implicit threat that she might contact the IRS if that is not acceptable. Does this change any of your answers to question a?

c. Assume further that Mr. Jones has been contacted by the IRS for an audit of his S corporation and personal returns for 1995. Does this change any of your answers to the questions a and b?

2. (25%) Assume the same facts as Question Number 1, except that (1) instead of skimming cash, Mr. Jones added to his gross revenue from the restaurant business about $4,000,000 of cash from an illegal activity, drug sales, so that his books reflected gross revenue of $14,000,000 from the restaurant business, (2) Mr. Jones expenses related to the restaurant business was $10,000,000, so that in effect his profit was the $4,000,000 from the drug sales, and (3) the entire indicated gross proceeds of $14,000,000 was deposited into the corporation's operating account with every appearance as being from the restaurant business. The accountant dutifully recorded these amounts on the corporate tax return and flowed the results through to the Jones's individual income tax return for 1995. Mr. Jones thus included net income from the S Corporation on his personal tax return of $4,000,000. Mr. Jones paid the resulting tax liability and is satisfied that he has paid all income taxes due on his actual economic income, both legal and illegal income. Your fee for representing Mr. Jones in this type matter would be $500 per hour, with a $100,000 retainer, a check for which Mr. Jones is prepared to deliver to you because of his high esteem for your ability and experience.

a. Advise Mr. Jones as to his potential criminal liability, advise him of his options and recommend a plan of action for him.

b. Map out any concerns you may have as to whether and how you should undertake the representation.

3. (25%) Assume the same fact pattern as in questions 1 and 2. Upon advice of his psychiatrist, Mr. Jones kept an extensive diary in which he recorded his innermost feelings and fantasies and a considerable amount of his objective circumstances, such as the fact of his skimming, the fact of his illegal activity, and the amounts involved in each (with the amounts being appropriately coded, with the code committed only to his memory and, he thinks, unbreakable by someone who does not know the code). Before each psychiatric session, Mr. Jones photocopies the portions of the diary that the psychiatrist had not previously seen and delivers them to the psychiatrist. The psychiatrist reviews the pages in developing themes for discussion and analysis. The taxpayer keeps the original diary for his personal use, including preparing for and following through on his psychiatric sessions. Incident to an audit in which the IRS clearly suspects fraud -- as evidenced by the presence of an IRS Special Agent from CID -- the IRS summonses all records of the taxpayer that fall within a laundry list of descriptions, including any "documents, notes, diaries, calendars and other written or printed material that reflects in whole or in part your gross receipts, gross revenue, income or other similar items." Advise the taxpayer as to whether he can withhold any portion of the diaries and how he should do so. Advise the taxpayer also of what the Government might do to proceed with the issue, from summons on through a court ruling.

4. (15%) Your client is the accountant in the above facts. You cannot exclude the possibility that the IRS will not seek some type of criminal prosecution against your client. You are particularly concerned that the Government might perceive from the underlying facts some criminal purpose on your client's part (i.e., he knew or should have known, etc.). You do not think that your client is actually guilty, but you cannot advise your client that there is no possibility that the Government might view the facts otherwise. You feel, however, that, under the circumstances, your client (the accountant) was merely the taxpayer's pawn. The AUSA in charge of the grand jury investigation has caused a grand jury subpoena to be issued for your client's testimony. Advise your client as to his strategies in dealing with the AUSA and the grand jury.

5. (10%) Your client is under criminal investigation by the CID for possible tax evasion. You have watched the investigation progress steadily and it is clear that the Agent and her boss have more than enough information to refer the case to the Department of Justice for criminal prosecution. The CID agent nevertheless continues to work the case and issues a summons to the taxpayer seeking her backup computer tapes for the year 1995. Your client advises that the information on the backup tapes is redundant to the information she already provided the civil agent -- the underlying computer files that were backed up. The client therefore wants you to resist the summons.

a. Can your client resist the summons? If you think she can, briefly describe the process by which the client would resist the summons and summarize (note I said summarize) the argument he would make and procedurally how he would make it.

b. Assume that, after your client resists the summons and before the IRS has sought to enforce the summons, the IRS refers the case to the Department of Justice. DOJ determines that more work is needed. DOJ returns the case to the IRS and closes its files, but advises the IRS that, with more information, the IRS may resubmit the case to DOJ. Can the IRS then seek to enforce the summons it previously issued? Summarize your reasons for your answer.

1999 Examination

TAX FRAUD AND MONEY LAUNDERING
SPRING 1999
UNIVERSITY OF HOUSTON SCHOOL OF LAW

EXAMINATION

Instructions:

1. Write legibly. Lawyers must communicate. You are not communicating if I can't read your writing. Your grade will suffer if you do not communicate your knowledge to me (on the other hand, it might suffer if you do, but I hope that is not the case).

2. I recommend that you outline your answer before you start writing. Knowing where you are going before you start the answer in the exam booklet will permit you to get there with more communicative grace and style. I, as well as most clients, judges, lawyers and other persons with whom you will deal as a lawyer, place a premium on forethought and directness. You will get a premium here for direct, clear and lucid exposition. In order to give you the incentive to outline to think through your answer first, you should commence your answer with a yes or a no if a yes or no answer can be given.

3. Persons in the graduate law program must put beside their identification number the term (LLM Student).

4. The percentages at the beginning of each paragraph number are guides as to the relative importance of the questions and answers. You may use this as a guide in budgeting your time.

Examination:

1. (25%) In a criminal investigation, the IRS discovers that your client omitted $100,000 of income from her return. She won this amount from a foreign lottery, and it was not reported on her return. She received this money while she was overseas, wired it into her mother's account at a U.S. bank, and then had her mother withdraw the money and give the cash to her. She kept the cash rather than depositing it in her own bank account for fear that the IRS would discover this income if she did. After analyzing her bank accounts and other records it had available, the IRS was not able to identify gambling expenses exceeding $5,000, hence indicating that she had net gambling income of $95,000, upon which she did not pay tax. In the investigation, the IRS learned that she had a tendency to bet a lot, often used cash to bet and, through analysis of her bank records, found large cash withdrawals that appeared to exceed the amount necessary to support her lifestyle. The IRS is thus concerned that it may not be able to prove a tax due and owing required for a Section 7201 conviction. The IRS nevertheless wants to nail this taxpayer on a tax crime because the agents believe she is a money launderer who has successfully evaded detection and prosecution for money laundering. Although in the year involved, as noted, the taxpayer took steps to hide the income, since the inception of the investigation, the taxpayer has not done anything to hide the nature or extent of the income, other than to invoke her Fifth Amendment right against self incrimination. On these facts, can CID make another tax felony against her? In your answer, 

a. cite the Code Section(s) involved;

b. briefly summarize the elements of each such crime and whether those elements are present;

c. with respect to each such crime, state whether there is a split of authority as to whether the taxpayer can be prosecuted under these facts and the nature of the split. (You do not have to identify the courts of appeals that are split, but you should state generally the nature of the split.)

2. (35%) A client comes to your office for an initial visit. After first confirming that the information he gives you is subject to the attorney-client privilege, he advises you that he failed to include $500,000 of income on his 1994 tax return, which he timely filed on October 15, 1995 pursuant to the usual filing extensions. He further advises that his regular CPA, whom he likes and trusts, did not know about the $500,000 item and thus is not at fault for failure to include the income on his return. He brought the 1994 return for you to review. The other items of income on the return were his salary of $75,000 and his wife's salary of $50,000. The $500,000 was, he says, his net gambling earnings for that year. Only his wife knew that he had a substantial amount of net gambling earnings and even she did not know the precise amount. In all other years, he had net losses from his gambling activities, which stopped in any event in 1996 when he joined gamblers anonymous. He and his wife are currently in the midst of a messy divorce. She found out about his girl friend and is hell bent to break him. He is concerned that she may go to the IRS with this information. Advise him generally as to any risks and opportunities, addressing specifically the following:

a. What potential criminal tax crimes might the client be subject to? You may limit your answer to the Code sections identified in the review materials. Identify each potentially applicable crime by Code section and state the elements of the crime and the prescribed punishment for the crime as set forth in the Code (setting aside how the calculation would work in the sentencing guidelines).

b. Could a civil penalty apply? If so, identify the civil penalty you would be most concerned about.

c. Give him a general overview of the federal tax criminal enforcement program as it might apply to him if his wife went to the IRS, discussing briefly the roles of the Criminal Investigation Division, the District Counsel of the IRS, the Tax Division of the Department of Justice, and the United States Attorneys office, in the approximate chronological order that they would ordinarily be involved.

d. Explain the voluntary disclosure program and how the client might pursue voluntary disclosure.

e. Advise whether he should or must file an amended return, and what the effect of the amended return would be from the perspective of his potential criminal exposure.

1. Advise who should prepare the return.

f. What is the statute of limitations for any tax crime that may apply and when does it run?

3. (20%) Your client is under criminal investigation by the CID for possible tax evasion for the year 1997. You have watched the investigation progress steadily and it is clear that the Agent and her boss have more than enough information to refer the case to the Department of Justice for criminal prosecution and that they have decided to make a recommendation that the DOJ Tax Division prosecute. The CID agent nevertheless continues to work the case and issues a summons to the taxpayer seeking her backup computer tapes for the year 1997. Your client advises that the information on the backup tapes is redundant to the information she already provided the civil agent -- the underlying computer files that were backed up. The client therefore wants you to resist the summons.

a. Can your client resist the summons? If you think she can, briefly describe the process by which the client would resist the summons and summarize (note I said summarize) the argument she would make and procedurally how she would make it.

b. Assume that, after your client resists the summons and before the IRS has sought to enforce the summons, the IRS refers the case to the DOJ Tax Division which determines that more work is needed. DOJ Tax Division returns the case to the IRS and closes its files, but advises the IRS that, with more information, the IRS may resubmit the case to DOJ Tax Division. Can the IRS then seek to enforce the summons it previously issued? Summarize your reasons for your answer.

4. (20%) After a brief stint of private law practice, you become a tax director for a large corporation. An accounting firm that specializes in financial and tax products has brought to your boss, the chief financial officer ("CFO"), a financial product involving exotic financial instrument straddles that are otherwise unrelated to the corporation's business and that appears to be too good to be true because of the tax savings that are touted. You read the offering materials and find that they piece together a scenario in which each piece seems to connect, depending upon how the tax risks are resolved. Some pieces exploit tax sections that, in your judgment, were not contemplated when Congress enacted the rule or the IRS issued the interpretation by regulation. When considered together, something just doesn't seem right, and you are sure that the IRS, if it discovered the deal, will audit and attempt to deny the benefits. Your CFO, who is an accountant with audit experience, however, has been sold and is insistent upon pursuing this opportunity immediately (in order to pump up this year's financial earnings, thus buoying the corporation's stock) if you will just give it your blessing. You feel that, that in order to fully address the merits, you need independent expert assistance in both financial instruments and the accounting aspects of the deal, but desire to limit the Government's ability to discover any advice you receive in the event the CFO, who is a bit headstrong, decides to invest in the deal even if you recommend against it. How do you protect these independent experts' work and advice received from discovery by the IRS?

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TAX FRAUD AND MONEY LAUNDERING
SPRING 2001
UNIVERSITY OF HOUSTON SCHOOL OF LAW
EXAMINATION

Instructions

1. Resource Materials: Students may use only the following in the examination:
    a. the text book;
    b. the Code;
    c. the student's personal notes.

2. The examination is two hours, start to finish.

3. You may use Code Sections and terms of art so long as you give sufficient indication that you know what you are talking about.

4. Please read the questions carefully. Some hints or roadmaps may be contained in the question.

5. Please think your answer through, preferably outlining your answer, before you start answering. Succinct correct answers are valued over long, unfocused correct answers.

6. Please letter/number your answers using the same letter/number used in the question.

7. Write legibly. Lawyers must communicate. You are not communicating if I can't read your writing. Your grade will suffer if you do not communicate your knowledge to me (on the other hand, it might suffer if you do, but I hope that is not the case).

8. Please indicate on your blue book (or other examination answer paper) whether you are an LL.M. or J.D. candidate.

9. The percentages at the beginning of each paragraph number are guides as to the relative importance of the questions and answers. You may use this as a guide in budgeting your time.

Examination

1. (20%) After a brief stint of private law practice, you become a tax director for a large corporation. An accounting firm that specializes in financial and tax products has brought to your boss, the chief financial officer ("CFO"), a financial product involving exotic financial instrument straddles that are otherwise unrelated to the corporation's business and that appears to be too good to be true because of the tax savings that are touted. You read the offering materials and find that they piece together a scenario in which each piece seems to connect, depending upon how the tax risks are resolved. Some pieces exploit tax sections that, in your judgment, were not contemplated when Congress enacted the rule or the IRS issued the interpretation by regulation. When considered together, something just doesn't seem right, and you are sure that the IRS, if it discovered the deal, will audit and attempt to deny the benefits. Your CFO, who is an accountant with audit experience, however, has been sold and is insistent upon pursuing this opportunity immediately (in order to pump up this year's financial earnings, thus buoying the corporation's stock) if you will just give it your blessing. You feel that, that in order to fully address the merits, you need independent expert assistance in both financial instruments and the accounting aspects of the deal, but desire to limit the Government's ability to discover any advice you receive in the event the CFO, who is a bit headstrong, decides to invest in the deal even if you recommend against it. How do you protect these independent experts' work and advice received from discovery by the IRS?

2. (30%)You have entered private practice in Houston, specializing in tax controversy matters. A litigation attorney contacts you and indicates that he represents the sole shareholder of a C Corporation that owns three retail stores in the Houston area. For the years 1997 through 2000, approximately $1 million dollars of cash receipts have been "skimmed" by the owner of the corporation. These receipts were registered as sales at the cash registers, but cash was removed from the cash register routinely and put into a safe deposit box. About one-half of the cash was used to pay legitimate business expenses, such as purchasers from vendors, compensation to employees and contractors, and bonuses. Approximately $100,000 was used to pay cash dividends off-the-books to the sole shareholder and to four prior shareholders, all of whom sold their stock to the sole shareholder on December 31, 1998. The balance of the skimmed funds, or approximately $400,000, was used to pay the gambling debts of the current shareholder. The attorney advises you that another attorney has been hired by all of the former shareholders, who now claim that they were defrauded in their sale of stock in 1998, on the grounds that the shareholders were unaware of the skimming that was ongoing at the corporation. The attorney has a feeling that there are tax consequences to what was going on at the corporation and how he should handle the resolution of the dispute, and he has asked for your advice. 

    a. Describe the key elements of the advice that you would give to the attorney and his client. 

    b. Assume the same facts as in the previous question, but add these additional facts: the former shareholders have filed a suit in State District Court alleging that they were defrauded in the sale of their stock and that "substantial amounts of cash were skimmed from the corporate cash registers, such amount being at least $1 million dollars." How would this change your advice?

    c. Assume the same facts as the prior question, but add one additional fact: the current and former shareholders are all members of a minority group that is known for preferring to operate in cash, and they are well known due to their success as businessmen. Does this change your advice?

3. (30%) You represent a client in a IRS criminal investigation (also called an administrative investigation). The case has not yet been forwarded to DOJ's Tax Division. The IRS has focused the investigation on whether the taxpayer was skimming much of the cash from the restaurant business. The revenue agent who initially conducted the civil audit became concerned when the records of the restaurant that he was given showed no cash receipts -- only credit card receipts. The IRS's records and statistics show that a restaurant business such as your client's should have at least 25% cash receipts, but your client shows no cash receipts. You have diligently tracked the investigation and stayed one step ahead of the IRS in investigating the potential witnesses. In the course of your due diligence, you discover that, about a year ago, your client's ex-wife made a copy of your client's personal diary secretly in preparing to get a divorce from your client. The ex-wife was more concerned about the diary's revelations about the other woman. But, your client has advised you that, in his diary, he recorded all of his "off-the-books" skimmed cash earnings from his business. The diary records the skimming and amounts through a code which his ex-wife and her lawyer were unable to understand or decipher. Incident to negotiating the financial terms of the divorce, your client's divorce attorney negotiated a requirement that the ex-wife return all copies of the diary which she supposedly did. Your client, however, says that he would bet that either the ex-wife or her lawyer or both retained a copy. You and your client are concerned that the IRS might discover the existence of the diary. Your client is fairly certain that neither will admit to having retained a copy of the diary in violation of the divorce agreement. Nevertheless, your client is also confident that neither will go out of his or her way to do your client a favor and, if they understood the importance of the diary in terms of recording the skimmed cash, they might well serve their copy up to the IRS and would almost certainly do so if the IRS were to inquire about it.

Advise your client on the following:

    a. May the IRS obtain a copy of the diary from the ex-wife or her lawyer via the IRS administrative summons? In the course of answering this question, advise your client as follows:

        (1) Would your client be notified by the IRS of the issuance of the summons?

            (a) If the answer to the question is yes, advise whether and how the client may then contest the propriety of the issuance of the summons.

            (b) If the answer to the question is no, advise how your client may learn whether the IRS has issued a summons and, if he then can learn of the issuance of the summons, whether and how he may contest the propriety of the issuance of the summons.

        (c) In either event, if the client may bring a contest as to the propriety of the issuance of the summons, what are your client's chances of prevailing.

    b. If the IRS learns of the existence of the diary but is unable to obtain a copy from the ex-wife or her lawyer, can the IRS obtain the diary from your client by issuing an IRS administrative summons to your client?

        (1) If you answer to this question is yes, what defenses might your client assert?

   c. Your client asks whether, since the IRS has not yet discovered the existence of the diary and may not be able to obtain it from his ex-wife or her lawyer, a good defensive strategy would be for him to "deep-six" the diary. Advise him.

4. (20%) A client comes to your office for an initial visit. He asks whether the information that he will tell you is subject to the attorney/client privilege, and you assure him that it is. He then advises you that he failed to include $600,000 of income on his 1995 individual income tax return. The return was a joint return, signed by both the husband and wife and timely filed on October 15, 1996 (pursuant to timely filed extensions). The certified public accountant who prepared the return also prepared the joint returns that were filed by the client and his wife for the ten years prior to the 1995 return. The CPA had no knowledge of the $600,000 that was left off of the return at the time that return was prepared. Yesterday, however, the client visited his CPA and confessed to leaving a $600,000 slot machine jackpot off his return and asked the CPA what to do. The CPA immediately advised the client to make an appointment with you. The client provides you with a copy of the 1995 return, which shows salary income for the husband of $100,000 and salary income for the wife of $125,000. The client states that his wife knew that a jackpot had been won by the client on a trip to Las Vegas, but that the wife did not know the amount of the jackpot. The client asked you the following specific questions. 

    a. What potential criminal charges might the client be subject to? Identify each potentially applicable penalty by Code Section and state the elements of the crime.

        (1) What is the statute of limitations for each of the crimes that you have described and when will it run? 

        (2) The client has heard something about the federal sentencing guidelines and asks how the guidelines would affect the potential sentences for the various crimes you have outlined.

        (3) Assuming that the IRS investigates the 1995 year criminally, what can the client expect as far as the procedure that the IRS will follow? Discuss briefly what governmental agencies and offices might be involved, the order in which the matter is likely to proceed, and the function of each office that ordinarily would be involved. 

        (4) The client has decided that he wants to amend the return, and pay all the tax, civil penalties and interest that may apply. He has had no contact from the Internal Revenue Service of any kind about the matter. He asks if he should just have his regular CPA amend the return for him.

---

TAX FRAUD AND MONEY LAUNDERING
SPRING 2003
UNIVERSITY OF HOUSTON SCHOOL OF LAW
EXAMINATION

Instructions

1. Resource Materials: Students may use only the following in the examination:
    a. the text book;
    b. the Code;
    c. the student's personal notes.

2. The examination is two hours.

3. You may use Code Sections and terms of art so long as you give sufficient indication that you know what you are talking about.

4. Please read the questions carefully. Answer the questions asked.

5. Please think your answer through, preferably outlining your answer, before you start answering. Succinct, correct answers are valued over long, unfocused correct answers.

6. Please number/letter your answers using the same number/letter used in the question. For example, if the question to which you are responding is 2.a., mark your answer 2.a.

7. Write legibly. Lawyers must communicate. You are not communicating if we can't read your writing. Your grade will suffer if you do not communicate your knowledge to us (on the other hand, it might suffer if you do, but we hope that is not the case).

8. Please indicate on your blue book (or other examination answer paper) whether you are an LL.M. or J.D. candidate.

9. The percentages at the beginning of each paragraph number are guides as to the relative importance of the questions and answers. You may use these guides to budget your time.

1. 50%

    Lucky Lenny comes to your office for an initial visit. After first confirming that the information he gives you is subject to the attorney-client privilege, Lenny advises you that he failed to include $500,000 of income on his 1998 tax return, which he and his wife filed as a joint return. The return was timely filed on October 15, 1999 pursuant to the usual filing extensions. Lenny further advises that his regular CPA, whom he likes and trusts, did not know about the $500,000 item and thus is not at fault for failure to include the income on his return. Lenny brought the 1998 return for you to review. The other items of income on the return were Lenny's salary of $75,000 and his wife's salary of $50,000. Lenny tells you that the $500,000 of omitted income represents Lenny's net gambling earnings for that year. Lenny says his wife knew that he had a substantial amount of net gambling earnings in 1998, although she did not know the precise amount. In all other years, Lenny thinks he had net losses from his gambling activities. Lenny stopped all his gambling in 1999 when he joined Gamblers Anonymous. Lenny and his wife are currently in the midst of a messy divorce. She found out about his girlfriend and is hell bent to break him. Lenny is concerned that his wife may go to the IRS with this information. Discuss the following issues as they pertain to Lenny's circumstances:

a. (10%) What potential criminal tax crimes might the client be subject to?
You may limit your answer to the crimes identified in our class materials.
Identify each potentially applicable crime by Code section and state the elements of the crime and the prescribed punishment for the crime as set forth in the Code (setting aside how the calculation would work in the sentencing guidelines).

b. (5%) Could a civil penalty apply? If so, identify the civil penalty you would be most concerned about.

c. (10%) Give Lenny a general overview of the federal tax criminal enforcement program as it might apply to him if an IRS administrative (not grand jury) investigation should occur, discussing briefly the roles of the IRS personnel and the government lawyers who would be involved from the beginning to the end of the process, in the approximate chronological order that they would ordinarily be involved.

d. (10%) Advise whether an amended return should be filed, and what the effect of the amended return would be on the potential criminal exposure.

e. (5%) Would your answer to the previous question change if during the deposition of his wife in the divorce proceedings, the wife threatened to turn Lenny in to the IRS for tax fraud?

f. (5%) Would you take any special precautions with regard to the preparation of an amended return and the other accounting work done to advise Lenny about the possible amendment of the return?

g. (5%) What is the statute of limitations for any tax crime that may apply and when does it run?

2. 30%

    John Smith has owned a restaurant since year 1. For all times here relevant, he has operated the restaurant through an LLC (limited liability company), that gives him limited liability vis-a-vis those dealing with the restaurant, but is treated for federal income tax purposes like a sole proprietorship (i.e., he reports the tax results of operations on a Schedule C to his federal income tax return).

    The restaurant has become increasingly popular. During the time period we discuss here, Smith had off the books income by skimming cash. Since his tax returns were prepared from his books (which for gross receipts reflected only the deposits into the restaurant’s bank account), he significantly underreported his tax liabilities in each year. (Assume that all tax returns were filed timely, without extensions (i.e., on or before April 15 of each of the years). Smith kept good records of the amounts he skimmed by recording the amounts in a code in his personal diary. Smith’s calculations indicate the following:

Year	Gross Receipts Per Books	Off the Books Receipts	True Receipts	Tax on Off the Books Receipts
1	1,000,000	100,000	1,100,000	35,000
2	2,000,000	200,000	2,200,000	70,000
3	3,000,000	200,000	3,200,000	70,000
4	4,000,000	200,000	4,200,000	70,000
5	5,000,000	200,000	5,200,000	70,000
6	6,000,000	200,000	6,200,000	60,000
Totals	21,000,000	1,100,000	22,100,000	375,000

    Because he was concerned about detection of the scheme, Smith has kept the proceeds in a lock box at a bank in another state that he otherwise has no business with. Smith insists that he stopped the evasion after filing his returns for year 6. In making the decision to quit the scheme, Smith took into consideration that he had no other criminal history and just did not feel good about himself. He was not aware of the voluntary disclosure policy but was aware generally that there was a statute of limitations on criminal prosecution and just hoped that he could put the matter behind him.

    In year 8, the IRS started a criminal investigation targeting Smith. Smith first found out about the investigation when two Special Agents showed up at his business unannounced, read him his modified Miranda rights, and then attempted to interview him. He had the good fortune to decline further interview, advising the Special Agents that he would first consult with an attorney. He then scrambled to find the best criminal tax attorney he could and hence he came to you.

    Incident to your representation, you establish that Smith’s diary is secure – that is, he is certain that no one else has had access to the diary. You also establish that it will not be easy for the IRS to become aware of his lock box. His practical exposure, therefore, arises from the cash register tapes. The IRS summonsed the cash register tapes during the investigation and, consistently with the law’s mandate, you produced them on Smith’s behalf. The IRS thus has a clear roadmap to the crime and can quantify the federal tax evaded with reasonable accuracy. (The unreported gross receipts from the cash register tape also indicate an unreported sales tax liability of $30,000, but the state has not yet discovered the sales tax underreporting.)

    On August 20 of year 9, the IRS forwards the case to DOJ’s Tax Division (“DOJ Tax”) with a recommendation of prosecution for tax evasion (§ 7201). DOJ Tax decides to pursue criminal prosecution and, on December 15 of year 9, forwards the case to the United States Attorney, where an Assistant United States Attorney (“AUSA”) is assigned to prosecute. On April 1 of year 10, the AUSA obtains the indictment.

    Please answer the following with respect to the above facts (in the indicated order and with the indicated order of importance):

a. (5%) For which years can Smith be prosecuted and what is the criminal tax loss that the Government could allege in the indictment and prove at the trial to determine guilt or innocence?

b. (20%) Advise Smith of the guideline range for the worst case. You may assume that there are no adjustments after the Base Offense Level is calculated. Explain how the Base Offense Level is determined, addressing specifically the components included in the tax loss number and a brief summary statement of why they are included.

c. (5%) The benefit, if any, of acceptance of responsibility and how Smith can qualify for the benefit.

[Note: The students were provided an excerpted copy of the Sentencing Guidelines to assist in answering this question.  The excerpted Sentencing Guidelines may be reviewed here.]

3. 20%

After a brief stint of private law practice, you become a tax director for a large corporation. An accounting firm that specializes in financial and tax products has brought to your boss, the chief financial officer ("CFO"), a financial product involving exotic financial instrument straddles that are otherwise unrelated to the corporation's business and that appears to be too good to be true because of the tax savings that are touted. You read the offering materials and find that they piece together a scenario in which each piece seems to connect, depending upon how the tax risks are resolved. Some pieces exploit tax rules that, in your judgment, were not contemplated when Congress enacted the sections or the IRS issued the interpretation by regulation. When considered together, something just doesn't seem right, and you are sure that the IRS, if it discovered the deal, will audit and attempt to deny the benefits. Your CFO, who is a CPA with audit experience, however, has been sold and is insistent upon pursuing this opportunity immediately (in order to pump up this year's financial earnings, thus buoying the corporation's stock) if you will just give it your blessing. You feel that, in order to fully address the merits, you need independent expert assistance in both financial instruments and the accounting aspects of the deal, but desire to limit the Government's ability to discover any advice you receive in the event the CFO, who is a bit headstrong, decides to invest in the deal even if you recommend against it. How do you protect these independent experts' work and advice received from discovery by the IRS? In answering these questions please address the privileges that might apply.

GOOD LUCK ON THE EXAM. HAVE A GREAT SUMMER. IT HAS BEEN OUR PRIVILEGE AND PLEASURE TO HAVE YOU AS STUDENTS.

Larry ☺ and Jack ☺

TAX FRAUD AND MONEY LAUNDERING
SPRING 2005
UNIVERSITY OF HOUSTON SCHOOL OF LAW
EXAMINATION

Instructions

1. Resource Materials: Students may use only the following in the examination:

a. the text book;
b. the Code;
c. the student's personal notes.

2. The examination is two hours.

3. You may use Code Sections and terms of art so long as you give sufficient indication that you know what you are talking about.

4. Please read the questions carefully. Answer the questions asked.

5. Please think your answer through, preferably outlining your answer, before you start answering. Succinct, correct answers are valued over long, unfocused correct answers.

6. Please number/letter your answers using the same number/letter used in the question. For example, if the question to which you are responding is 2.a., mark your answer 2.a.

7. Write legibly. Lawyers must communicate. You are not communicating if we can't read your writing. Your grade will suffer if you do not communicate your knowledge to us (on the other hand, it might suffer if you do, but we hope that is not the case).

8. Please indicate on your blue book (or other examination answer paper) whether you are an LL.M. or J.D. candidate.

9. The percentages at the beginning of each paragraph number are guides as to the relative importance of the questions and answers. You may use these guides to budget your time.

Question 1.   50%

You have hung out your shingle as a lawyer in Houston. Fortunate Frank comes to your office for an initial visit. After first confirming that the information he gives you is subject to the attorney-client privilege, Frank advises you that he won $500,000 gambling in 2001 that he failed to include as income on his 2001 federal income tax return, which he and his wife filed as a joint return. The return was timely filed on October 15, 2002 pursuant to the usual filing extensions. Frank further advises that his regular CPA, whom he likes and trusts, did not know about the $500,000 item and thus is not at fault for failure to include the income on his return. Frank brought the 2001 return for you to review. The other items of income on the return were Frank's salary of $75,000 and his wife's salary of $50,000. Frank tells you that the $500,000 of omitted income represents Frank's net gambling earnings for 2001. In all other years, Frank thinks he had net losses from his gambling activities. Frank says his wife knew that he had a substantial amount of net gambling earnings in 2001, although she did not know the precise amount. Frank stopped all his gambling in 2001 when he joined gamblers anonymous. Frank and his wife are currently in the midst of a messy divorce. She found out about his girlfriend and has threatened to take every last dime of his money. Frank is concerned that his wife may go to the IRS with the information about his gambling income. Discuss the following issues as they pertain to Frank's circumstances:

a. (10%) What potential criminal tax crimes could be charged against Frank? You may limit your answer to the crimes identified in our class materials. Identify each potentially applicable crime by Code section and state the elements of the crime and the prescribed punishment for the crime as set forth in the United States Code (without regard to the punishment that would be determined under the sentencing guidelines).

b. (5%) Could a civil penalty apply? If so, identify the civil penalties you would expect to be asserted by the IRS.

c. (15%) Give Frank a general overview of the federal tax criminal enforcement program as it might apply to him if an IRS administrative (not grand jury) investigation should occur, discussing briefly the roles of the IRS personnel and the government lawyers who would be involved from the beginning to the end of the process, in the approximate chronological order that they would ordinarily be involved.

d. (15%) Advise Frank on whether an amended return should be filed and what the effect of the amended return would be on the potential criminal exposure.

e. (5%) Would you take any special precautions with regard to the preparation of an amended return and the other accounting work done to advise Frank about the possible amendment of the return?

Question 2. 25%

Your new client advises you that, yesterday, he received a surprise visit from two IRS Special Agents. The Agents read him his rights from a card and then attempted to question him about tax matters. He was savvy enough to decline to answer pending consulting with an attorney. The Agents then presented him with a summons requesting him to appear in two weeks at the IRS office for questioning and the production of documents meeting the following descriptions: (1) the records of the income and expenses of his business; and (2) in broad language, calendars and diaries and such related documents that relate in any way to his business. He called his accountant who referred him to you. The first thing you do is to assure the client that his communications to you are confidential and that it is in his best interest to be forthcoming as to the problems that he perceives. He advises you that he has been skimming cash from his restaurant business and not reporting it on his federal income tax returns. He has been skimming about $100,000 per year in cash which he has spent, he thinks, in ways (gambling and the like) that are not visible in terms of the amount of income he regularly reports and pays tax on (about $1,000,000 per year). Since you know that criminal tax cases are usually document-based, you inquire into the document trail. He advises he is fairly confident that there is no paper trail in the business that would show the amount of cash he skimmed ($100,000) and that he only skimmed about 1/3 of the cash receipts of the business, so the books do show substantial cash coming in that was reported properly. You keep inquiring about documents and he then advises you, reluctantly, that: (1) being somewhat anal, he maintains a separate ledger sheet of the skimmed cash which he hides in his attic in a secret place carved from the wood and covered by insulation; and (2) he maintains a diary which also is kept in that secret place. No one but he knows about these matters, except perhaps the diary. You inquire about the diary. He is reluctant to talk about it, but you gradually draw him out. He is undergoing psychiatric treatment. He has unnatural fantasies. Since he was raised in a strong fundamentalist Baptist family, he is hard wired to feel himself unworthy and in need of redemption. He therefore has felt guilty about these fantasies and, to a far lesser extent, about his tax shenanigans. So he sought treatment from a psychiatrist for his fantasies. His psychiatrist asked him to maintain the diary to record matters that trouble him. Every night, he retrieves the diary and records the items that are on his mind. As it turns out, it is virtually all about his fantasies, except for about 20 pages that ruminate on his pangs of conscience about his tax shenanigans and what might happen to him if he went to jail. So far as he knows, only his psychiatrist knows about the diary. You advise your client generally about the situation. In the course of the advice you advise him specifically about the summons. Summarize that advice here, addressing the following matters:

a. Can he assert a Fifth Amendment privilege and that will be the end of it?

b. How does he assert a Fifth Amendment privilege, if he even can?

c. Does he have a Fifth Amendment privilege with respect to the documents which meet the description in the summons?

d. Are there any other defenses he may assert to the production of all or any of the documents?

Question 3. (25%)

On May 10, 2005, your new client, an artist (aka stripper), advises you that she regularly omitted about $100,000 in her self-employment income from her tax returns for 1995 through 2002, all of which were filed timely on or before April 15 of the succeeding. Despite the stereotype of her profession, your client is financially savvy and has invested wisely and will start UH Law School in the fall, knowing that she has a short “shelf life” for her current gainful activity. She prepares her own returns in Quicken; each year she “what ifs” in Quicken to see what her tax liability would be if she included her real income. She is certain that, given her tax situation, the tax she failed to pay was $20,000 per year, for an aggregate of $160,000. After she filed her 2002 tax return on April 15, 2003, she began to be concerned about this activity. Artists are not without consciences, and starting law school has made her focus on all aspects of her life. So, she timely filed her 2003 and 2004 returns including all of her income. She has heard that, within the past two months, the local IRS office has started an investigation into tax compliance by persons in her profession. She is now concerned. She seeks your advice. You advise her generally on the voluntary disclosure problem. (In answering the subquestions below, do not further discuss voluntary disclosure.) You then turn to her potential criminal exposure. Advise her as to the following (if you need to make a key assumption in order to answer, expressly state that you are doing so; also, I provide for some subquestions copies of Sentencing Guidelines excerpts which are the 2004 Sentencing Guidelines and for purposes of answering the subquestions, you may assume that there are no material variances between the 2004 Sentencing Guidelines and earlier Guidelines):

a. The tax crime or crimes that she may have committed on these facts. In answering this question, just provide the Code sections. Although you would elaborate for the client, for purposes of this answer, do not provide anything other than the Code sections.

b. The statute of limitations for the crimes. In answering this question, just provide the limitations period and the Code section number(s).

c. Your judgment is that, if the IRS were to investigate her and the case were to end up in prosecution, the earliest date she could be indicted (given the time to investigate and prosecute) would be May 1, 2006. Advise her as to the years, if any, for which the criminal statute of limitations is still open and the aggregate unpaid taxes for the years that are still open.

d. The tax loss number for Sentencing Guideline purposes.

e. The Base Offense Level for Sentencing Guideline purposes. I attach (i) SG § 2T1.1 Tax Evasion; Willful Failure to File Return, Supply Information, or Pay Tax; Fraudulent or False Returns, Statements, or Other Documents and (ii) §2T4.1. Tax Table.

f. Calculate her adjustment for acceptance of responsibility. I attach SG §3E1.1 Acceptance of Responsibility.

g. Assuming no other adjustments, state (1) her offense level to which the Sentencing Table applies and (2) the indicated sentencing range from the Sentencing Table. Assume in answering this question that she has no criminal history. I attach Chapter 5's Sentencing Table

h. You are advising her with respect to the 2004 edition of the Guidelines and, as noted above, you are comfortable that the earliest she could be indicted is May 1, 2006. In advising her, do you need to be concerned that, by the time she could be sentenced (say June 1, 2006, if she were to plead guilty), the then current Guidelines could produce a worse result?

GOOD LUCK ON THE EXAM. HAVE A GREAT SUMMER. IT HAS BEEN OUR PRIVILEGE AND PLEASURE TO HAVE YOU AS STUDENTS.

Larry ☺ and Jack ☺

TAX FRAUD AND MONEY LAUNDERING
SPRING 2007
UNIVERSITY OF HOUSTON SCHOOL OF LAW
EXAMINATION

Instructions

1. Resource Materials: Students may use only the following in the examination:
    a. the text book;
    b. the Code;
    c. the student's personal notes.

2. The examination is two hours.

3. You may use computers subject to the following rules: (a) you can use your word processor of choice; (b) you can review the Tax Crimes textbook or your notes or other materials related to the class that are on your computer; (c) you may not cut and paste from any document (including the text) on your computer; and (d) you may not access the internet. Please turn in your disks to the proctor when you are finished.

4. You may use Code Sections and terms of art so long as you give sufficient indication that you know what you are talking about.

5. Please read the questions carefully. Answer the questions asked.

6. Please think your answer through, preferably outlining your answer, before you start answering. Succinct, correct answers are valued over long, unfocused correct answers.

7. Please number/letter your answers using the same number/letter used in the question. For example, if the question to which you are responding is 2.a., mark your answer 2.a.

8. Write legibly. Lawyers must communicate. You are not communicating if we can't read your writing. Your grade will suffer if you do not communicate your knowledge to us (on the other hand, it might suffer if you do, but we hope that is not the case).

9. Please indicate on your blue book (or other examination answer paper) whether you are an LL.M. or J.D. candidate.

10. The percentages at the beginning of each paragraph number are guides as to the relative importance of the questions and answers. You may use these guides to budget your time.

1. (25% of total exam grade)

    You represent a client, a restaurant owner, in an IRS criminal investigation (also called an administrative investigation). The IRS has not yet been forwarded the matter to DOJ Tax Criminal Enforcement Section. The IRS has focused the investigation on whether the taxpayer was skimming cash from the restaurant business. The revenue agent who initially conducted the civil audit became concerned when the records of the restaurant that he was given showed no cash receipts -- only credit card receipts. The IRS's records and statistics show that a restaurant business such as your client's should have at least 25% cash receipts, but the records given the IRS show no cash receipts. You have diligently tracked the investigation and stayed one step ahead of the IRS in investigating the potential witnesses. In the course of your efforts, you discovered that, about a year ago, your client's ex-wife made a copy of your client's personal diary secretly in preparing to get a divorce from your client. The ex-wife was more concerned about the diary's revelations about the other woman. But, your client has advised you that, in his diary, he recorded most of his “off-the-books” skimmed cash earnings from his business. The diary records the skimming and amounts through a code which his ex-wife and her lawyer were unable to understand or decipher. Incident to negotiating the financial terms of the divorce, your client's divorce attorney negotiated a requirement that the ex-wife return all copies of the diary which she supposedly did. Your client, however, says that he would bet that either the ex-wife or her lawyer or both retained a copy. You and your client are concerned that the IRS might discover the existence of the diary. Your client is fairly certain that neither will admit to having retained a copy of the diary in violation of the divorce agreement. Nevertheless, your client is also confident that neither will go out of his or her way to do your client a favor and, if they understood the importance of the diary in terms of recording the skimmed cash, they might well serve their copy up to the IRS and would almost certainly do so if the IRS were to inquire about it.

    Advise your client on the following:

    a. (15% of the total exam grade)

    May the IRS obtain a copy of the diary from the ex-wife or her lawyer via the IRS administrative summons? In the course of answering this question, advise your client as follows:

(1) Would your client be notified by the IRS of the issuance of the summons?

(2) If the answer to the question (1) is yes, advise whether and how the client may then contest the propriety of the issuance of the summons.

(3) If the answer to question (1) is no, advise how your client may learn whether the IRS has issued a summons and, if he then can learn of the issuance of the summons, whether and how he may contest the propriety of the issuance of the summons.

    b. (10% of the total exam grade)

    If the IRS learns of the existence of the diary but is unable to obtain a copy from the ex-wife or her lawyer, can the IRS obtain the diary from your client by issuing an IRS administrative summons to your client? Summarize any defense to compulsory production that your client may have.

    2. (25% of total exam grade)

    John Smith has owned a restaurant since year 1. For all times here relevant, he has operated the restaurant through an LLC (limited liability company), that gives him limited liability vis-a-vis those dealing with the restaurant, but is treated for federal income tax purposes like a sole proprietorship (i.e., he reports the tax results of operations on a Schedule C to his federal income tax return).

    The restaurant has become increasingly popular. During the time period we discuss here, Smith had off the books income by skimming cash. Since his tax returns were prepared from his books (which for gross receipts reflected only the deposits into the restaurant’s bank account), he significantly under-reported his tax liabilities in each year. (Assume that all tax returns were filed timely, without extensions (i.e., on or before April 15 of each of the years). Smith kept good records of the amounts he skimmed by recording the amounts in a diary but the information is coded (securely he thinks). Smith’s calculations indicate the following:

    Because he was concerned about detection of the scheme, Smith has kept the skimmed cash in a bank lock box at a bank in another state that he otherwise has no visible business with. Smith insists that he stopped the evasion after filing his returns for year 6. In making the decision to quit the scheme, Smith took into consideration that he had no other criminal history and just did not feel good about himself. He was not aware of the voluntary disclosure policy but was aware generally that there was a statute of limitations on criminal prosecution and just hoped that he could put the matter behind him.

    In year 8, the IRS started a criminal investigation targeting Smith. Smith first found out about the investigation when two Special Agents showed up at his business unannounced, read him his modified Miranda rights, and then attempted to interview him. He had the good fortune to decline further interview, advising the Special Agents that he would first consult with an attorney. He then scrambled to find the best criminal tax attorney he could and hence he came to you.

    Incident to your representation, you establish that Smith’s diary is secure – that is, he is certain that no one else has had access to the diary. You also establish that it will not be easy for the IRS to become aware of his lock box. His practical exposure, therefore, arises from the cash register tapes. The IRS summonsed the cash register tapes during the investigation and, consistently with the law’s mandate, you produced them on Smith’s behalf. The IRS thus has a clear roadmap to the crime and can quantify the federal tax evaded with reasonable accuracy. (The unreported gross receipts from the cash register tape also indicate an unreported sales tax liability of $30,000, but the state has not yet discovered the sales tax under-reporting.)

    On August 20 of year 9, the IRS forwards the case to DOJ’s Tax Division (“DOJ Tax”) with a recommendation of prosecution for tax evasion (§ 7201). DOJ Tax decides to pursue criminal prosecution and, on December 15 of year 9, forwards the case to the United States Attorney, where an Assistant United States Attorney (“AUSA”) is assigned to prosecute. On February 1 of year 10, the AUSA advises that he is prepared to indict for tax evasion for the open years.

Please answer the following with respect to the above facts (in the indicated order and with the indicated order of importance), assuming that you are doing so on February 2 of year 10. Where appropriate to answering your question, discrete portions of the Sentencing Guidelines are attached to this examination; you may assume that they are the current Sentencing Guidelines and that no earlier version of the Guidelines is applicable under the “one book” rule; and you, of course, do not know what the Guidelines in the future might provide.

    a. (5% of total exam grade)

    For which years can Smith be prosecuted and what is the criminal tax loss that the Government could allege in the indictment and prove at the trial to determine guilt or innocence?

    b. (15% of total exam grade)

Advise Smith of the Sentencing Guideline range for the worst case. You may assume that there are no adjustments after the Base Offense Level is calculated. Explain how the Base Offense Level is determined, addressing specifically the components included in the tax loss number and a brief summary statement of why they are included.

    c. (5% of total exam grade)

    Advise Smith of the benefit, if any, of acceptance of responsibility and how he can qualify for the benefit.

3. (50% of total exam grade)

   You have entered private practice in Houston, specializing in tax controversy matters. A new client, Leo Lucky, comes to your office for an initial visit. He asks whether the information that he will tell you is subject to the attorney/client privilege, and you assure him that it is. Leo then advises you that he failed to include $600,000 of income on his 2004 individual income tax return. The return was a joint return, signed by both Leo and his wife and timely filed on October 15, 2005 (pursuant to timely filed extensions). The certified public accountant who prepared the return also prepared the joint returns that were filed by Leo and his wife for the ten years prior to the 2004 return. The CPA had no knowledge of the $600,000 that was left off of the return at the time that return was prepared. Yesterday, however, Leo visited his CPA and confessed to leaving a $600,000 slot machine jackpot off his return and asked the CPA what to do. The CPA immediately stopped the conversation and advised Leo to make an appointment with you. Leo provides you with a copy of the 2004 return, which shows total income of his salary of $100,000 and his wife's salary of $125,000. Leo tells you that his wife knew that he won a jackpot in 2004 on a trip to Las Vegas, but that his wife did not know the amount of the jackpot. Leo asks you the following specific questions:

    a. (10% of total exam grade)

    What potential criminal tax crimes could be charged against Leo? You may limit your answer to the tax crimes identified in our class materials. Identify each potentially applicable crime by Code section and state the elements of the crime and the prescribed punishment for the crime as set forth in the United States Code (without regard to the punishment that would be determined under the sentencing guidelines).

    b. (10% of total exam grade)

Assuming Leo is investigated criminally and then prosecuted for his 2004 tax return, what can the client expect as far as the procedure that the government will follow? Assume the investigation is conducted by the IRS not by the grand jury. Discuss briefly what governmental agencies and offices would be involved, the order in which the matter is likely to proceed, and the role of each government agent or lawyer who ordinarily would be involved.

    c. (10% of total exam grade)

    Leo wants to amend the 2004 return, and to pay all the tax, civil penalties and interest that may apply. He has had no contact from the Internal Revenue Service about the matter. Advise Leo on whether an amended return should be filed and what the effect of the amended return would be on the potential criminal exposure.

    d. (5% of total exam grade)

Would your answer to the previous question change if Leo's wife has filed for divorce and threatened in her deposition to tell the IRS about Leo's jackpot?

    e. (10% of total exam grade)

Leo asks if he should just have his regular CPA amend the return for him. Advise Leo regarding what precautions should be taken, if any, with regard to the accounting work and the preparation of the amended return.

    f. (5% of total exam grade)

How would your answer to the previous question change if instead of leaving one jackpot off his 2004 tax return, Leo had skimmed the $600,000 from his wholly owned corporation from 2003 to 2005 and not reported any of the income either on the corporate return or his personal return?

Attachments:
Sentencing Guidelines
§ 2T.1.1
§ 2T.4.1 (Tax Loss Table)
§ 3E.1.1. (Acceptance of Responsibility)
§ 5A (Sentencing Table)