Grinches, Liechtenstein Royal Princes, Bankers, Toymakers (and Offshore Evasion): A Holiday Summons Tale

In today’s post returning guest blogger Dave Breen, the acting Director of Villanova’s Low Income Taxpayer Clinic, discusses the case of Greenfield v US. The issue in the case relates to the IRS’s cat and mouse game of finding assets and the unreported income from those assets that citizens have parked in offshore accounts. The issue in these cases does not generally involve much tax law.  The battle is won and lost on the issue of information.  If the IRS gets the information, the taxpayer generally loses.  Summons work is key and the Greenfield case is a major development.  For many years, Dave worked with IRS attorney John McDougal, whose retirement I wrote about last week.  In the spirit of the season, Dave recounts the story of the case and its implications.  Keith

A recent IRS setback in a summons enforcement case out of the Second Circuit piqued my interest, because I spent the final twelve years of my career in IRS Counsel working on IRS’s offshore initiatives addressing tax evasion through the use of offshore accounts in tax secrecy jurisdictions.  My take on this recent case is that taxpayers and some practitioners may believe that the era of IRS investigating offshore tax evasion has run its course.  I think this case does just the opposite.  The Court’s decision demonstrates that much of IRS’s data on offshore tax evasion is dated – possibly even too old to be of any value – but I also suspect that IRS has come to the same conclusion.  Rather than moving on to other areas of non-compliance though, I suspect IRS at this moment is developing more tools to secure the next wave of current information on offshore tax evasion.  This does not bode well for taxpayers who so far have avoided IRS’s inquiry into their offshore holdings.


A bit of history

In 2000 IRS used permission to use John Doe summonses to secure information on U.S. taxpayers who accessed funds in their secret offshore accounts through American Express and Mastercard credit cards.  IRS’s first major success occurred in 2002 when the U.S. District Court entered an order requiring American Express to comply with IRS’s John Doe summons.  The information IRS received pursuant to this summons provided the data for what became known as the Offshore Credit Card Project.  Rather than go into the specifics, I refer readers to Keith Fogg’s 2012 Villanova Law review article Go West: How the IRS Should Foster Innovation in Its Agents. Subsequent offshore initiatives relied on data secured through John Doe summonses to UBS and other foreign banks, information received from whistleblowers, and information provided by taxpayers applying to one of IRS’s voluntary disclosure programs.

Despite the success in securing records identifying offshore tax evaders, the quality of the information IRS received was sometimes problematic, because it was out of date or incomplete.  For example, when a federal judge in Miami ordered compliance with the aforementioned John Doe summons in 2002, it only covered records for tax years 1998 and 1999 – “old years” in IRS parlance. Further, information received often did not dove-tail with IRS’s information.  IRS is driven by social security number, name, and to a lesser extent, last known address.  Credit card data is driven by credit card number and billing address.  This created a mismatch.  Once IRS received the summoned information it took many months to link a specific taxpayer to a particular offshore account through a credit card, assemble the case, and assign it to an agent specially trained in examining offshore transactions.  The IRM discourages IRS from beginning examinations of “old” tax years – generally those returns beyond the most recent two tax years – unless there are compelling reasons.  IRS prefers to examine more current tax years where plenty of time remains on the 3 year statute of limitations under IRC §  6501(a).   Although the 1998 and 1999 credit card data was sufficient to prove a taxpayer had a foreign bank account in 1998 or 1999, the information was not particularly helpful in proving how much income was unreported in those years or whether there was unreported income in later, more current years.

As a result, examiners assigned to these early cases often had to issue administrative summonses under IRC § 7602 to taxpayers for their most recent foreign bank account records to secure foreign account information for years after 1999.  The Department of Justice, which handles summons enforcement matters before the U.S. District Courts for IRS, has been extremely successful in securing orders enforcing these summonses, but the process takes time.  During this long process the data gets older and has diminishing value to IRS.  Proof that the data has a limited shelf life was recently demonstrated in a summons enforcement case.

Greenfield decision

In August 2016 the Second Circuit placed a speed bump along IRS’s road to identifying offshore tax evasion with dated information.  In United States v Greenfield, 118 AFTR 2d 2016-5275 (2016) the court vacated the District Court’s order enforcing an IRS summons and remanded the case for further proceedings consistent with its opinion.  The case is noteworthy for several reasons, but most importantly I see this as a wake-up call for IRS as well as a reminder to offshore tax evaders that IRS continues to pursue offshore tax evasion rigorously.

In the spirit of the holiday season, I offer the following tale.

Once upon a time there was a toy maker named Harvey Greenfield, his son, Steven, and their toy shop, Commonwealth Toy, Inc.  We also have a Grinch, Heinrich Kieber, whose job was to copy, file, and safeguard records at Liechtenstein Global Trust (LGT) a financial institution owned by the Liechtenstein royal family.  One day, while tending to his copying duties at the bank, Mr. Kieber decided to press “2” instead of “1” and make an extra copy of records that identified individuals who banked (translate: “hid their untaxed income”) at LGT.  Kieber, playing “Secret Santa”, offered the documents to several nations.  Many told him to “go Fish,” while other countries, including the U.S. did not.  The U.S. found the information to be very helpful in finding out who was naughty and who was nice. Needless to say, Mr. Kieber’s decision did not make him any new friends among the 38,000 residents of Liechtenstein.  He was charged with theft of information under Liechtenstein law and promptly went into hiding, leaving a trail of Angry Birds in his wake.  Like the Cabbage Patch doll you stood 3 hours in line to buy for your daughter in 1983, his whereabouts today are unknown.

Back to the Greenfields.  Several of Kieber’s cache of confiscated documents tied Steven and Harvey to certain offshore entities that had been used, or were being used, to evade taxation.  It just so happens that at this time the U.S. Senate’s Permanent Subcommittee on Investigations had begun hearings in response to the LGT disclosure and a similar leak from the Swiss bank, UBS.  Harvey died in 2009, leaving Steven as primary beneficiary of the LGT holdings.  PSI twice invited Steven to come in and talk about LGT, Liechtenstein, and foreign accounts in general.  The first time Steven failed to appear.  PSI was not too pleased with being stood up for its Mystery Date with Steven, so they invited him again.  The second time he appeared but asserted his Fifth Amendment right to remain silent.

Enter the IRS, who decided to audit Steven’s 1040’s for 2005 – 2011.  But there was a snag.  Kieber did not copy everything about the Greenfields – just enough to identify them as beneficial owners controlling the funds in the offshore accounts.  These documents included some memos, a 2001 year-end statement for their Maverick Foundation (a stiftung, under Liechtenstein law), LGT account information forms for Maverick and two entities it owned, and a 2001 LGT profile for Maverick and another company.  Of particular interest to IRS was a March 23, 2001 memorandum prepared by LGT personnel, detailing a meeting in Liechtenstein between the Greenfields, LGT employees, and Prince Philip of Liechtenstein.  The memo stated in part:

“The clients are very careful and eager to dissolve the Trust with the Bank of Bermuda leaving behind as few traces as possible. The clients received indications from other institutions as well that U.S. citizens are not those clients that one wishes for in offshore business.”

Great stuff, but not enough for IRS to determine how much tax was owed.  IRS didn’t have a Clue as to Steven’s gross income.  To fill in the considerable gaps in information, IRS issued an administrative summons to Steven for records and testimony.  After discussions with Steven’s counsel regarding the breadth of the summons, IRS reduced its scope to the production of documents related to foreign entities to the 2001 through 2006 tax years.

Greenfield refused to comply with the “kinder, gentler” version of the IRS summons.  Convinced that this was no Trivial Pursuit, IRS refused to Lego of the issue and brought suit to enforce yet another less expansive version of the original summons in district court.  Steven wasn’t having any of that one either and defended by invoking his Fifth Amendment right to remain silent.

General Summons Law and Greenfield

Generally, a Fifth Amendment right to remain silent is not effective for documents because contents of documents are not testimonial.  Fisher v. United States, 425 U.S. 391 (1976).  However, while Fisher held that documents were not testimony, the Court held that the act of producing the documents could be testimonial, because it may communicate incriminatory statements of fact.  For example, if the only person with access to offshore bank statements is the person who controls the funds in them, the person coming to court with the bank statements is essentially saying (testifying or admitting), “The documents you want exist, I control them, they are authentic, and here they are.”  This is the “act of production” defense Steven raised.  But the Ping-Pong game did not end there.

The government’s comeback to the “act of production” defense is the “foregone conclusion” rule.  If the testimonial aspects of production are a “foregone conclusion”, that is, if the government can establish the “existence, control, and authenticity” of the records independent of the witness’s production of them, the act of producing them loses its testimonial nature.  But the government must be ready to establish independently that the documents exist, the witness controls them, and they are authentic.

Based on the record, the Court found the Government met the first two tests: it accepted the existence of the documents in 2001 and Greenfield’s control of them in 2001.  It was not so willing, however, to accept their authenticity and turned to the Government to establish the third prong of the test.

The Government elves had their work cut out for them.  They went back to their workshop and crafted several arguments with respect to the authenticity of the 2001 records. It put on its Poker face and argued that the 2001 documents could be authenticated in three ways: (1) an LGT employee could come to the United States and authenticate them in court; (2) Kieber himself could come out of hiding and authenticate them; or (3) authentication was possible through Letters of Request issued under the Hague Evidence Convention.

The Second Circuit wasn’t buying any of the Government’s arguments.  First, the Court found it unlikely that LGT would send a witness to the United States to authenticate the records.  Secondly, it was highly unlikely Kieber, who was in hiding, would do it; and (3) the Government could not show a single instance where Letters of Request issued under the Hague Evidence Convention had been used to authenticate documents from LGT or any other Liechtenstein financial institution in the past.  Why would the Government think it would work in this case?

The Court didn’t stop there.  Assuming arguendo that the Government passed the 2001 hurdle, it would still have to show that the documents existed and that Steven controlled them in 2013, twelve years later.  Existence and control in 2001 does not create an inference of existence and control in 2013.  Factors such as the type of records, the likelihood of transfer to another person, and the time interval involved all bear on the matter.  In rejecting the Government’s arguments the Court found any number of reasons why Steven may not have had a Monopoly on control of the records from 2001 to 2013 or that the documents still existed in 2013.  Therefore, the Court did not enforce most of the summons and Steven did not have to produce the records.


But before you settle your brains for a long winter’s nap, think about this.  Even though Steven may have sunk IRS’s Battleship, today IRS is not in any immediate Trouble.  In fact, it is already working on a new Mousetrap.  On November 30, 2016 IRS received permission to issue a John Doe summons to Coinbase, Inc., a virtual currency exchanger headquartered in San Francisco, California, that Les discussed last month in his post IRS Seeks Information via John Doe Summons Request on Bitcoin Users.  

The moral of the story?  Uno’s?  I suspect many clients with assets hidden offshore will still take a big Risk by not coming in under IRS’s voluntary disclosure program, but you don’t have to be a Mastermind to see that many of them will ultimately be Sorry.  But, I guess that’s The Game of Life.  Happy Holidays!




Using the IRM to Help Taxpayers During Audits Exploring a Taxpayer’s Unreported Income

Today we welcome first time guest poster David Breen, the Acting Director of Villanova’s Federal Tax Clinic, former Senior Counsel with the IRS Office of Chief Counsel in Philadelphia and longtime adjunct faculty member in Villanova’s Graduate Tax Program. In addition to his Counsel experience, Dave began his career with Exam. He has taught courses in Villanova’s graduate tax program for years, including Tax Procedure and our innovative trial litigation simulation course. While Keith has been visiting at Harvard, Dave has ably directed our tax clinic. In today’s guest post, he discusses some of the IRS’s own rules relating to examinations that focus on unreported income as well as some of the powers practitioners can but rarely do exercise in the context of those examinations. Les

The country is approaching the half way point of the NFL season and during the Eagles games I’ve watched so far, I can’t help but again notice the tendency of coaches to cover their mouths while talking to one another. This practice, which dates back to at least 2000, prevents opposing teams from employing lip readers to intercept the play the opposition is calling. Stealing plays in a game? By professional lip readers? Really? A bit of overkill, don’t you think? But football is not alone in this type of larceny. Less than one month into this year’s baseball season, the Padres were accused of positioning a spy inside the scoreboard with binoculars to telegraph pitches to San Diego batters.

This got me to thinking about the lengths that professional athletes will go to increase ever so slightly an edge over their opponents. And with that in mind, it made me look to my own profession as a tax attorney for whatever edge, legally, of course, that I could exploit as well. I didn’t have to look far.


When I was an IRS Revenue Agent back in the 1970s, the Internal Revenue Manual was IRS’s playbook, containing well-guarded tips, resources, recommendations, and directions on how to audit taxpayers. As a Senior Counsel in IRS’s Office of Chief Counsel from 1987 to my retirement in 2014, Part 35 of the IRM, also called the CCDM, provided the same practical guidance and advice for IRS attorneys. Today the IRM continues to guide IRS employees in the performance of their duties and thanks to the Freedom of Information Act (FOIA) it can be an invaluable resource for practitioners as well. In my experience, however, I find that many practitioners fail to avail themselves of this resource. In other words, they don’t take advantage of the ability to read IRS’s lips from across the gridiron to see what IRS’s next step will be.

When it comes to an IRS audit, particularly in the SBSE division which includes self-employed Schedule C filers, unreported income is the name of the game. From 2008 – 2010 the average annual tax gap was $458 billion, up from $450 billion in 2006. IRS revenue agents are given discretion in deciding which deductions to scrutinize on a return. Proof for deductions that are LUQ (large, unusual, or questionable) is sure to be requested. Examiners do not, however, have discretion in examining gross income. Unlike deductions, gross income must be examined in all audits. It is one of the relatively few mandatory items examiners must investigate.

This article discusses how a practitioner can utilize the IRM to represent clients more competently during an audit of gross income. I am limiting my comments to IRM Part 4 – Examining Process, but the advantages of being well-versed in IRS’s own procedures applies well beyond this area.

The law is clear on gross income: all income from any source is taxable unless specifically excluded somewhere in the Code. Taxpayers are required to maintain books and records to support items on their returns. If a taxpayer refuses to provide books and records, IRS may issue a summons to the taxpayer and third parties to compel production of documents and to give testimony under oath. Finally, before an examiner may use financial status or economic reality examination techniques to determine the existence of unreported income there must be an indication that there is a likelihood of unreported income.

While the above paragraph would score well on a law school tax final, it provides little insight into how the law is put into action. Let’s put some flesh on the bones by looking at how examiners are taught to audit returns.

To insure that returns are examined within the 3 year statute of limitations, IRM requires that the examination and disposition of individual income tax returns be completed within 26 months after the due date of the return or the date filed, whichever is later. For example, if an examiner is assigned a timely filed 2015 return, the audit should not be started if it cannot be completed by June 2018 (26 months from April 15, 2016). This includes, however, the time to process the return, select it for examination, ship it to the examination group closest to the taxpayer’s location, assign it to an examiner, and schedule an appointment. To add additional incentive to IRS to examine returns promptly, interest is suspended if the Service fails to notify the taxpayer of a liability within 36 months of the later of the date the return is filed, or the due date for the return without regard to extensions. Like soggy hors d’oeuvres once the main course is served, returns falling short of this timeframe are forgotten about, “surveyed” as excess inventory and replaced by fresher, more current work. The lesson here is that despite the three year statute of limitations on assessment of tax, the likelihood of a return being audited is actually much less than three years after its filing under the 26 month cycle rule.

For those returns that are audited, however, examiners are given specific guidelines for verifying gross income. How does an IRS examiner decide how detailed the gross income investigation must be? To answer, we have to consider one more Code section, IRC § 7602(e), enacted as part of the IRS Structuring and Reform Act of 1998:

(e)Limitation on examination on unreported income

The Secretary shall not use financial status or economic reality examination techniques to determine the existence of unreported income of any taxpayer unless the Secretary has a reasonable indication that there is a likelihood of such unreported income.

Prior to the enactment of IRC § 7602(e) examiners could (and often did) investigate gross income by engaging in intrusive inquiries into a taxpayer’s private life and finances. Interviews of business associates, co-workers, lenders, and even neighbors were conducted, sometimes without the taxpayer’s knowledge. Time consuming, intensive, expensive requests for voluminous records were the norm rather than the exception.

IRC § 7602(e) put the brakes on IRS examiners. Before an examiner may conduct an in-depth, intrusive examination – what the statute refers to as financial status or economic reality techniques – the examiner must first have some reason to suspect that a taxpayer has not reported all gross income. So called “indirect methods” are economic reality techniques. How does an IRS agent determine if there is a likelihood of unreported income to gain entrée into a detailed investigation? The answer is in the IRM.

IRM 4.10.4 sets forth a number of mandatory “minimum income probes” examiners must perform. If the minimum income probes indicate a likelihood of unreported income, the examiner must consult with a group manager. They jointly determine whether to conduct a more in-depth examination of income and document their findings in the workpapers. This more in-depth examination may include, but is not limited to a bank deposits and cash expenditures analysis, a source and application of funds analysis, or a net worth analysis – what IRS calls a formal indirect method of proof. ( Note, however, that IRC § 446(b) allows IRS to use any reasonable method. The high water mark of reasonable may have been IRS’s Atlantic City Tip Income Project back in the 1980s when IRS reconstructed cocktail waitress tip income by placing undercover special agents in casinos to watch how much tip income waitresses typically received during a shift and applying those findings to compute tip income for a “normal waitress.”).

All practitioners want to dissuade examiners from conducting time-consuming, costly, detailed indirect methods. Volumes have been written on defending a client when IRS determines under one of these methods that a taxpayer hasn’t reported all income. But remember, the minimum income probes are the gateway to the use of a formal indirect method of proof. For that reason, they should be the first line of defense in representing clients.

What are these “MIPs”? It depends on the type of taxpayer. The minimum income probes for individual business returns, i.e. Schedule C taxpayers, include: preparing a financial status analysis; conducting an interview with the taxpayer or representative; touring the business; evaluating internal controls; reconciling the income per return to the taxpayer’s books and records; testing gross receipts by tying original source documents to the books; preparing an analysis of the taxpayer’s personal and business bank and financial accounts; preparing an analysis of business ratios; and determining if there is Internet use and e-commerce income activity.

I present two ways for the minimum income probes to be used proactively by representatives.

  1. Lay the groundwork during return preparation. Most return preparers send some form of tax organizer to clients which clients complete (or at least are supposed to complete) as part of having their returns filed. I encourage preparers to include questions concerning the minimum income probes in their client surveys. Gathering information on internal controls, bank accounts, business ratios, and e-commerce activity will serve as reminders to clients on what they records they should be keeping and also identify potential weak areas in the client’s operations. Weaknesses that can be corrected or anticipated in the event of an audit.
  2. Challenge the examiner’s conclusions regarding the use of an indirect method. If early in the audit, say after the initial meeting and taxpayer interview, an examiner issues a detailed, voluminous information document request (IDR) clearly focused on income or personal living expenses, that is a clear indication that the examiner is “ramping up” the examination of gross income. Representatives should not simply shrug and hope for the best. I encourage representatives to ask the examiner in writing, if the examination has extended into IRC § 7602(e) territory. If the examiner answers affirmatively, or doesn’t answer at all, the representative should take the offensive and request a meeting with the group manager, request the examiner’s workpapers detailing the minimum income probe analysis and the discussion with the group manager green-lighting the indirect method, file a FOIA request for the workpapers, or all of the above. A taxpayer should be given an opportunity to respond to an examiner’s determination that the minimum income probes reflect unreported income. If the agent’s analysis is flawed, it is better for IRS and your client to not waste time on needless issues. To date, however, I have yet to find a representative who has taken any of these pre-emptive steps. My suspicions were confirmed when my opinion search of 7602(e) on the Tax Court’s website produced a single case which dealt only with the effective date of the statute.

In summary, as a representative you should adhere to the old adage, “Forewarned is forearmed” and study the IRM as if it were the Cowboys playbook and you were the coach of the New York Giants.