Lensink was referring to a civil settlement rather than to criminal prosecution.
In order to determine whether these communications were affirmative misrepresentations of the type prohibited by Tweel, the court must decide whether the revenue agents were in fact conducting a criminal investigation. It has been shown that a civil audit evolves into a criminal investigation at the point when the auditors develop a firm indication of fraud. Under this rule, the court must find that the revenue agents were engaged in a covert criminal investigation if they continued to audit defendant after they developed a firm indication of fraud.
In this case, there is insufficient evidence to support the conclusion that the revenue agents had a firm indication of fraud prior to the completion of their fraud referral. See, e.g., IRM § 4565.21(1); Piper, 681 F. Supp. at 838. First, the fact that the investigation was prompted by an information item does not, by itself, establish a firm indication of fraud. The IRS routinely channels public information items to the CID without making any preliminary evaluation of their probable merit. Because many of these tips ultimately prove to be frivolous, it would be impractical for the CID to launch full-scale criminal investigations into each of the thousands of information items that it receives each year.
Second, it is apparent that the particular information items that Mr. Peters furnished to Special Agent Padar did not constitute a firm indication of fraud. While the information was sufficiently compelling to prevent Padar from disposing of the file altogether, it certainly did not capture his immediate attention. In fact, Padar did nothing to pursue the case over the next eighteen months but drive by defendant's house exactly one time. The fact that he waited until the IRS moved its offices to carry the case file across the hall to the Examination Division suggests that the transfer may have had more to do with routine housecleaning than with a calculated attempt to use a civil audit as a front for a criminal investigation. This conclusion is further supported by the fact that the CID relinquished all connection with the case after transferring it to the Examination Division. For these reasons, the court cannot accept that the CID had a firm indication of fraud prior to the time that it transferred the Peters file to the Examination Division.
Third, the Examination Division did not act improperly by continuing its audit of Dr. Peters after Revenue Agent Thompson initiated her fraud referral in the spring of 1991. Bruce Wilson, Thompson's immediate supervisor at that time, explained that the audit continued because Thompson's work contained significant errors which rendered the initial fraud referral defective. This explanation closely resembles that which the Fifth Circuit accepted in Powell, 835 F.2d at 1096-1097, where the Examination Division continued an audit in the face of a faulty fraud referral prepared by an inexperienced revenue agent. The court accepts this explanation for why the audit continued after Thompson initiated her fraud referral in May of 1991.
Fourth, and finally, there is no reason to believe that Revenue Agents Lensink and Mittl developed a firm indication of fraud at any point before they initiated their fraud referral in December of 1991. The IRS would not have needed to seek consent to extend its investigation on November 4, 1991, if it already had enough evidence to refer the case to the CID. More significantly, however, the firm indications rule confers broad discretion on the Examination Division to decide exactly how much evidence is necessary to substantiate a fraud referral. Defendant has presented insufficient evidence to support her contention that the Examination Division abused this discretion by collecting more information during the fall of 1991 than it needed to substantiate a fraud referral.
The court therefore finds that, under the "firm indications rule," the revenue agents were not engaged in a covert criminal investigation of defendant. This conclusion is amply supported by existing case law. In Caldwell, 820 F.2d at 1400, the Fifth Circuit held that a civil audit did not constitute a criminal investigation merely because it was prompted by an information item and referred to the Examination Division from the CID. The court decided that the information item did not constitute distinct evidence of fraud per se and thus did not require a full CID investigation. Id. at 1397, 1400. It therefore rejected the argument that the civil audit was nothing more than a clandestine criminal investigation by the CID. Id. at 1400.
Similarly, in Piper, 681 F. Supp. 833, the court held that a revenue agent properly characterized an audit as "routine" even though it had been prompted by a tip from an informant and referred by the CID. The CID had reviewed the information item, determined that the case lacked criminal potential, and referred it to the Examination Division for an audit. Id. at 838. Upon discovering firm indications of fraud, however, the Examination Division referred the case back to the CID. Id. The court held that the audit was not a criminal investigation prior to the fraud referral because "the decision to refer a matter from the civil division to the CID is a discretionary one." Id. at 838-839.
Tweel does not require a contrary result. In that case, the court held that a revenue agent may not characterize an audit as routine if the taxpayer is the subject of a concurrent criminal investigation by the IRS or some other law enforcement agency. Here, however, the Examination Division had no firm indication of fraud prior to making its fraud referral in December of 1991. Moreover, there is no evidence that the CID or any other law enforcement agency was conducting a criminal investigation in conjunction with the civil audit. Thus, the revenue agents properly characterized their investigation as a routine civil audit.
While the court is compelled to reach this conclusion on the basis of the prevailing "firm indications" rule, it nevertheless has grave reservations about relying exclusively on this rule to determine whether a criminal investigation is in progress. The court perceives that the "firm indications" rule suffers from two significant flaws. First, the Examination Division uses the term "firm indication of fraud" merely to describe the quantum of evidence that it needs to transfer a case to the CID. Thus, Revenue Agent Margo Thompson testified that her group manager had exclusive authority to determine what evidence constitutes a firm indication of fraud. Then Bruce Wilson, a supervisor in the Examination Division, testified that "a firm indication of fraud is when I, as group manager, sign the fraud referral form." Unless the term "firm indication of fraud" is defined in relation to fixed evidentiary criteria, however, its meaning evaporates in circularity. In its current usage, the term is a classic example of bureaucratic double-talk and improperly shields the fraud referral process from judicial scrutiny.
Second, the "firm indication" rule supports a bifurcated system of tax enforcement which is based on the assumption that a civil audit is not really a criminal investigation. This assumption is simply erroneous. Although the vast majority of civil audits do not lead to criminal prosecutions, some do. To argue that the subject of a civil audit should be denied the same constitutional protections afforded to the subject of a CID investigation is analogous to arguing that the subject of a police stop should be denied constitutional protections because most such stops do not lead to criminal prosecution. If the evidence gathered in a civil audit may be used in a criminal prosecution, then the civil audit is part of a criminal investigation. The "firm indications rule" is at best a permeable and at worst an invisible barrier between the civil and criminal investigative functions of the IRS.
To the extent that the current rule hangs on a formalistic distinction between civil and criminal tax investigations, it invites the IRS to engage in "constructive dishonesty" with the taxpayer. The court finds this result highly disturbing for the reason that
a private person has the right to expect that the government, when acting in its own name, will behave honorably. When a government agent presents himself to a private individual, and seeks that individual's cooperation based on his status as a government agent, the individual should be able to rely on the agent's representations. [It is] clearly improper for a government agent to gain access to records which would otherwise be unavailable to him by invoking the private individual's trust in his government, only to betray that trust.
S.E.C. v. ESM Government Securities, Inc., 645 F.2d 310, 316 (5th Cir. Unit B 1981). Under the prevailing "firm indications" rule, however, the court must conclude that Revenue Agents Thompson and Lensink did not affirmatively misrepresent their inquiry by describing it as routine civil audit.
Defendant suggests that the revenue agents breached an affirmative duty to warn her that their audit might lead to criminal sanctions. It is well established that revenue agents have no duty to provide Miranda warnings to taxpayers in non-custodial interviews. Beckwith, 425 U.S. 341, 48 L. Ed. 2d 1, 96 S. Ct. 1612. Nevertheless, "revenue agents must not affirmatively mislead a taxpayer into believing that [an] investigation is exclusively civil in nature and will not lead to criminal consequences." United States v. Lehman, 468 F.2d 93, 105 (7th Cir. 1971); see also Mapp, 561 F.2d at 689, United States v. Prudden, 424 F.2d 1021, 1032 (5th Cir. 1970), Cohen, 405 F.2d at 36, and Robson, 477 F.2d 13, 15 (9th Cir. 1973).
Revenue agents do not, however, have an affirmative duty to disclose that an audit might result in criminal charges unless they are asked. See Serlin, 707 F.2d at 956 ("failure to inform defendant that ... the investigation was criminal in nature, does not amount to affirmative deceit unless defendant inquired about the nature of the investigation and the agent's failure to respond was intended to mislead"); Powell, 835 F.2d at 1099 ("Revenue agents have no duty to inform taxpayers that the agents' investigations might result in criminal charges"); Lehman, 468 F.2d at 105 (no misrepresentation where revenue agents said nothing regarding criminal liability and defendant made no inquiries); Robson, 477 F.2d at 18 (revenue agents have "no duty to mention the possible criminal consequences of [an] audit" if they are "never queried as to the scope of [their] investigation"); Kaatz, 705 F.2d at 1243 ("failure to warn that a criminal investigation may ensue is not fraud, deceit, or trickery").
The Fifth Circuit held in Prudden that the "mere failure of a revenue agent (be he regular or special) to warn the taxpayer that the investigation may result in criminal charges, absent any acts by the agent which materially misrepresent the nature of the inquiry, does not constitute ... deceit." 424 F.2d at 1033. Accord Powell, 835 F.2d at 1099; Caldwell, 820 F.2d at 1399; Robson, 477 F.2d at 17-18. The court reasoned that "silence can only be equated with fraud where there is a legal or moral duty to speak or where an inquiry left unanswered would be intentionally misleading." Prudden, 424 F.2d at 1032. Nevertheless, it concluded that auditors have no duty to explain the potential criminal results of a civil audit because "the warning at the bottom of every tax form" provides adequate notice of potential criminal liability. Id. at 1034.
The Second Circuit adopted a similar position in United States v. Squeri, 398 F.2d 785, 788 (2d Cir. 1968), where it asserted that the mere fact of an audit should be sufficient to confer notice of potential criminal liability. The court held that "the information that a taxpayer's returns are under audit gives notice of the possibility of criminal prosecution regardless of whether the agents contemplate civil or criminal action when they speak to him." Cited with approval Prudden, 424 F.2d at 1033 n.26.
Applying this rule to criminal investigations, the First Circuit held in Irvine that two special agents of the CID did not misrepresent their investigation by failing to mention that the defendant was the subject of a criminal investigation. 699 F.2d at 45. The court indicated that "no case holds that an IRS agent breaches a constitutional duty when he obtains information merely by failing to state specifically that he is conducting a criminal investigation." Id. at 46.
As noted above, the only conceivable circumstance under which an auditor may have a duty to reveal the possibility of criminal liability is in response to a direct question from the taxpayer. There is no credible evidence in this case, however, that defendant or her agents ever asked the auditors whether the investigation might lead to criminal charges. It is therefore unnecessary for the court to decide whether the warning of potential criminal liability contained in the Privacy Act Notice was sufficient to discharge this contingent duty to warn. The court concludes, then, that the revenue agents did not have a duty to inform defendant that their audit might lead to criminal charges.
Finally, defendant suggests that the IRS breached a duty to inform her that the audit was prompted by an information item. It is clear, however, that no such duty exists. See United States v. Meier, 607 F.2d 215, 216-217 (8th Cir. 1979) (agent's silence in response to inquiry about whether audit was prompted by informant was not misleading), Robson, 477 F.2d at 17 (revenue agent has no duty to disclose that the purpose of an audit is to verify information rendered by an informant), and Cardwell, 765 F.2d at 780 (same).
Rather, IRS regulations prevent revenue agents from revealing that an audit was prompted by an information item. The Internal Revenue Code prohibits the IRS from disclosing "any return or return information" that "would identify a confidential informant." 26 U.S.C. § 6103(i)(6). Similarly, the Internal Revenue Manual provides that
the source of information when furnished by informants or other confidential sources, [the] identity of any informants, and [the] methods of obtaining information will not be divulged to the taxpayer under investigation or other unauthorized persons.
IRM § 9373.1(1). When a taxpayer asks an agent directly whether a particular audit was prompted by an information item, then, the revenue agent must respond that he or she is not permitted to answer that question. These rules, together with the cases cited above, clearly establish that the IRS did not affirmatively mislead defendant by failing to explain the genesis of its investigation.
ORDERED: Defendant, Dr. Florence L. Peters' motion to suppress is denied.
George W. Lindberg
United States District Judge
Date: Oct 21, 1996
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