In this day of rapid fire indictments and complex criminal and political investigations, a classic oldy but goody of criminal prosecution has been resurrected – indictment by the IRS for tax evasion. Brought vividly to life in Brian De Palma’s 1987 classic gangster film The Untouchables where Robert De Niro’s Al Capone is ultimately not brought down the Kevin Costner’s Elliot Ness, but by Frank Wilson, the IRS agent, this tactic to bring wrong doers to justice seems to never lose its bite. In the modern era, people like Nicolas Cage, Wesley Snipes, Heidi Fleiss, and Willie Nelson, continue to prove the power of the mighty IRS. But just how far does this power go and is there any way to get around it?
“Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without appointment among the several States, and without regard to any census or enumeration.”
Enacted in 1913, the Sixteenth Amendment gave Congress the authority to enact an income tax. Initially, income tax was set at 1% of net personal income over $3,000 and a 6% surtax on incomes of more than $500,000. During World War I, the top taxation rate was 77% to finance the war effort. It decreased post-war and then rose again during the Depression. During World War II, Congress introduced the payroll and quarterly tax payments we are accustomed to today.
Income Subject to Taxation
Disclosure: This is not tax advice. For tax advice, please consult a tax attorney or other tax professional.
The most common types of income subject to taxation are employee wages. However, there are additional types of income subject to taxation including income from self-employment, business or investment income, partnership income, and S-corporation income. Income received from royalties from copyrights, patent, oil, gas, or mineral properties is also subject to taxation. The newest form of income, virtual currencies, also has some tax implications as well. According to the IRS, “the sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability.”
Additionally, according to IRS Publication 525, “[i]n most cases, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income.” There are certain limited exceptions to this requirement including certain student loan debts.
Each type of income has specific requirements and exceptions, but generally any income received must be reported as income in an appropriate filing with the IRS.
With the onerous requirements and intricacies of tax filings, one might think “Can I just plead the Fifth on my taxes?”
First, the Fifth Amendment contains numerous provisions including the guaranteed right to a grand jury and the prohibition against double jeopardy. The most relevant part to this discussion though states “No person …shall be compelled in any criminal case to be a witness against himself…”
While the Fifth Amendment does grant a privilege against self-incrimination, that privilege only extends so far. Additionally, if an individual or a business invoke the Fifth Amendment privilege against self-incrimination on a filing with the IRS, it may not only lead to penalties for failure to properly file, but also it may invite additional inquiry by the IRS into your affairs.
As far back as 1927, the Supreme Court has had little sympathy for taxpayers wishing to avoid prosecution from the IRS by invoking the Fifth Amendment protection against self-incrimination. In U.S. v. Sullivan, Justice Holmes writing for the majority held that a bootlegger was required to file an income tax regardless of how the income was made. He went on to say that “[i]t would be an extreme, if not extravagant application of the Fifth Amendment to say that it authorized a man to refuse to state the amount of his income because it had been made in a crime. … He could not draw a conjurer’s circle around the whole matter by his own declaration that to write any word upon the government blank would bring him into danger of the law.” (Id. at 274)
So, if an individual or business must file a return and disclose the income, how can they get around prosecution if the IRS looks further into the matter? Once an investigation has been commenced, the common issue is whether the taxpayer can assert the Fifth Amendment protection against self-incrimination as grounds to refuse to produce books and records. Two fundamental principles guide this analysis: (1) the Fifth Amendment privilege protects only “testimonial” conduct; and (2) the Fifth Amendment privilege is personal and cannot be claimed in a representative capacity.
When an taxpayer is being investigated and records are subpoenaed, the Court traditionally looked at two principles in determining whether the Fifth Amendment privilege would be applied: (1) the contents of the documents (Boyd v United States); and (2) the privilege is not being claimed on behalf of another person or entity (Bellis v United States). However, in 1976, the Supreme Court altered this analysis in the case of Fisher v United States when it was faced with an issue regarding whether a taxpayer could plead the Fifth to prevent the compelled production of his accountant’s workpapers which he turned over to his attorney during the course of his representation. While the case had attorney-client implications intertwined, the court ultimately shifted away from the emphasis on the contents of the documents to an evaluation of the testimonial aspects entailed in the production of the documents.
Post-Fisher decisions narrowly applied the privilege against self-incrimination with regard to the production of documents. In 1984, the Supreme Court held in United States v Doe, that the contents of business records of sole proprietorships have no privilege against self-incrimination. In this same case, they create what would be called the act of production doctrine. The Court ruled there that the production of the records could be compelled only with a grant of statutory immunity. However, that immunity only extended to the production of the documents. The contents of the records were not privileged and would not be deemed to be the “fruits” of the act of production and thus could be used in Court.
The “act of production” doctrine established in Fisher and Doe had a two-fold effect. First, there was no privilege against self-incrimination applicable to the contents of business records. Second, under Doe, an individual could refuse to produce records on Fifth Amendment grounds unless the government granted production immunity. In some cases, this resulted in a broader availability of Fifth Amendment protections than under prior precedent. Hand in hand with the “act of production” doctrine is the “foregone conclusion” exception to the Fifth Amendment privilege. This provides that where certain documents are already known to the government, the act of producing the records would not incriminate the tax payer and thus the records would not be protected. For the government to meet the standard for a foregone conclusion exception to the Fifth Amendment privilege, it must demonstrate its prior knowledge of the evidence, and/or the defendant’s possession of it and its authenticity with “reasonable particularity.” (United States v Ponds, 454 F3d 313, 320 (DC Cir 2006))
The protection went further in United States v Greenfield where the Second Circuit held that in order for the “foregone conclusion exception to apply ‘the Government must know, and not merely infer, that the sought documents exists, that they are under the control of the defendant, and that they are authentic.” In 2001, the Supreme Court clarified this and expanded the protection against self-incrimination regarding records.
United States v Hubbell involved Independent Counsel Kenneth Starr’s investigation into former Associate Attorney General Webster Hubbell for alleged obstruction of justice. The Government served an expansive grand jury subpoena seeking many categories of personal financial records and the district court ordered him to comply with the subpoena after granting act of production immunity. After producing thousands of pages of records, Hubbell was indicted on tax fraud charges. The charges were dismissed based on immunity grounds and various appeals occurred which brought the matter before the Supreme Court. Ultimately, the Supreme Court affirmed the dismissal of the indictment and found that “Hubbell’s act of production had a testimonial aspect, to wit, that Hubbell’s ‘collection and production of the materials demanded [in the broadly worded subpoena] was tantamount to answering a series of interrogatories asking a witness to disclose the existence and location of particular documents fitting certain broad descriptions.” (Id. at 41).
What Hubbell tells us is that if the IRS issues a subpoena and it is too broad or expansive, push back. If the IRS is seeking any and all documents ever produced by anyone, seek legal counsel to help you properly navigate the waters to refuse to comply with the request for production.
Furthermore, the type of documents the IRS is seeking is just as critical as the scope of the request. If they are requesting documents such as a diary or a letter, the Court has found documents such as these to enjoy absolute protection under the Fifth Amendment from compelled production because they allow the Court to see inside the author’s mind and acts in a testimonial capacity. The privacy of such documents also necessarily implicates Fourth Amendment concerns that will not be discussed here.
Certain documents by their very nature and circumstances in which they are either created or required to be kept have been held to have “public aspects.” The Supreme Court in Shapiro v United States held “certain records that were required to be kept by regulation….were, in essence, public documents as to which no privilege against self-incrimination could attach.”
In order for the required records doctrine to apply to a request for production, three factors must be present: “(1) the reporting requirement must be imposed in ‘an essentially non-criminal and regulatory area of inquiry;’ (2) the records must be ‘of the same kind’ as the regulated party has customarily kept; and (3) the records must possess ‘public aspects.’” (United States v. Marchetti, 390 US 39 (1968) United States v. Grosso, 390 US 62 (1968)). If all three factors are present, then a tax payer cannot invoke the Fifth Amendment protection against production of the documents covered by the exception. This exception is also limited only to those records which are specifically required by law. Recent precedent in this area has also reached to the area of foreign bank account information.
Lastly, the Fifth Amendment right against self-incrimination is personal and corporations have no right against self-incrimination. (Wilson v. US, 221 US 361 (1911)) Corporations are products of the state in which they are incorporated. Its privileges are subject to the laws of the state in which it is incorporated. State and federal governments have reserved powers to be able investigate corporations. Corporate officers or record guardians cannot invoke the Fifth Amendment right against self-incrimination to prevent production of corporate records. The only exclusion to this is in a narrow-construed exception where an independent entity has not been established independent of the partners or members of an entity. For example, if you and members of your family farm, but you have not formed a separate entity for the farm, you may be able to invoke a Fifth Amendment privilege against producing records you personally possess regarding the farm. The Government may have other means of getting at the document, but they would not be able to get it through the corporation exclusion.
In short, there are some ways around being required to produce documents to the IRS, but those are difficult to find, and one should have skilled legal counsel to help them navigate the waters during an IRS investigation. The experienced business attorneys at Avisen Legal can help you properly form your entity and prevent problems before you get to the point of asking whether you can claim the Fifth.
For almost 20 years Kim Lowe has lawyered from the trenches. Kim lawyers from experience, using her knowledge of the law and understanding of how both for-profit and nonprofit business enterprises operate.
Rachell Henning is a third-year student at in Mitchell Hamline School of Law's innovative Hybrid program. Rachell is an Avisen Fellow alum who enjoys spending time with her husband and two young daughters when she is not working or studying.