USA v. McKee, 98-5413

• Decision Date: 27 April 1999
• Docket Number: No. 98-5413,98-5413
• Citation: 192 F.3d 535
• Parties: (6th Cir. 1999) United States of America, Plaintiff-Appellee, v. Iva L. McKee, Defendant-Appellant. Argued:
• Court: U.S. Court of Appeals — Sixth Circuit

Page 535

192 F.3d 535 (6th Cir. 1999)

United States of America, Plaintiff-Appellee, v. Iva L. McKee, Defendant-Appellant.

No. 98-5413

UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT

Argued: April 27, 1999

Decided and Filed: September 27, 1999

Appeal from the United States District Court for the Eastern District of Tennessee at Knoxville; No. 97-00027--James H. Jarvis, District Judge. [Copyrighted Material Omitted] Hugh B. Ward, Jr., OFFICE OF THE U.S. ATTORNEY, Knoxville, Tennessee, for Appellee.

Herbert S. Moncier, Knoxville, Tennessee, for Appellant.

Before: JONES, NELSON, and NORRIS, Circuit Judges.

JONES, J., delivered the opinion of the court, in which NORRIS, J., joined. NELSON, J. (p. 545), delivered a separate concurring opinion, in which NORRIS, J., joined.

OPINION

NATHANIEL R. JONES, Circuit Judge.

Defendant-Appellant Iva L. McKee appeals her conviction for tax fraud on the grounds that (1) the evidence against her should have been suppressed because the Internal Revenue Service's ("IRS") investigation violated her constitutional rights, and (2) the IRS failed to comply with its own regulations during the course of its investigation against her. We affirm McKee's conviction, but not without reservations.

I.

A.

This case illustrates that the substantive distinction between an IRS civil audit and a criminal tax investigation is not always clear. As the district court put it in a manner reminiscent of the Watergate Hearings, the issues in this case are essentially: "(1) What did the IRS know about the McKees' individual and corporate tax affairs?; and (2) when did the IRS know it?" See J.A. at 420 n.3 (Dist. Ct. Op.).

In a recent opinion involving similar issues as the case sub judice, the Seventh Circuit provided preliminary background to the structure of IRS tax investigations. See United States v. Peters, 153 F.3d 445, 447 (7th Cir. 1998), cert. denied, 119 S.Ct. 801 (1999). We find the Seventh Circuit's introductory explication helpful to the purposes of this case, and will repeat it here:

The IRS splits the responsibility for enforcing the nation's tax laws between its two investigative divisions. The Criminal Investigative Division ("CID") is charged with investigating criminal violations of the tax code and related federal statutes. CID investigators are called "special agents." Like many other criminal law enforcement agents, they carry firearms and badges. In addition, special agents must recite an administrative warning prior to soliciting information from taxpayers. See Beckwith v. United States, 425 U.S. 341, 343, 96 S. Ct. 1612, 48 L. Ed. 2d 1 (1976) (quoting warning provided by special agents).

On the other hand, the Examination Division of the IRS is responsible for conducting civil tax audits. Examination Division investigators are known as "revenue agents." In contrast to special agents, revenue agents do not carry firearms; nor are they required to provide taxpayers with an administrative warning. Although an Examination Division audit typically concludes with some sort of civil settlement between the IRS and the taxpayer, such an audit may uncover evidence that causes the revenue agent to refer the case to the CID for criminal investigation. Under IRS regulations, a revenue agent who uncovers a "firm indication of fraud on the part of the taxpayer" must immediately suspend her audit and refer the case to the CID. See Internal Revenue Manual § 4565.21(1). At that point, the CID enters the case and the IRS' efforts become focused on the possibility of criminal [prosecution]. See generally Michael I. Saltzman, IRS Practice and Procedure ¶¶ 12.01 & 12.03[1][a].

Peters, 153 F.3d at 447.

B.

The facts underlying this appeal are generally not in dispute. McKee ¹ and her husband William McKee were managers and shareholders of an electrical services company called Valley Electric, Inc., in Knoxville, Tennessee. For seven months in 1991, a woman named June Pique worked at Valley Electric as a bookkeeper.

In August 1992, Pique contacted IRS Revenue (i.e., civil) Agent Dee Loges regarding possible tax violations on the part of the McKees. Most of the alleged improprieties involved the use of corporate funds for personal expenses, such as trips, household goods, and home utility bills. According to Pique, the McKees did not disclose this "additional" personal income on their income tax returns. Apparently, Pique had previously alerted Loges about violations in another unrelated tax investigation, and Loges believed Pique to be a credible source. Loges was informed later that month by another anonymous source (although she knew the person's identity) that the McKees' personal expenses were being paid through Valley Electric in the form of vacations, electric bills, food, and household necessities.

Based on the information from both Pique and the anonymous source, Loges instituted a civil audit of the McKees in early September 1992. On September 2, 1992, Loges initiated contact with the McKees by sending them a letter requesting an appointment for an audit. The September 2, 1992 letter was a form letter setting forth the purposes of the audit. The letter informed the McKees of their right to have present an attorney, a certified public accountant, or any other representative of their choosing. The letter also states that "[a]n examination of such a taxpayer's return does not suggest a suspicion of dishonesty or criminal liability." J.A. at 40.

Loges also attached copies of two other documents which are routinely sent to the taxpayer when the IRS initiates a civil audit: (1) an IRS Publication 1, which is a form entitled "Your Rights as a Taxpayer"; and (2) an IRS Notice 609, the "Privacy Act Notice." The purpose of IRS Publication 1 is to inform the taxpayer of her rights and some of the basic procedures and policies associated with a civil audit, and allows for postponement of an audit if the taxpayer wishes to consult an attorney. J.A. at 47. The Privacy Act Notice informs the taxpayer of the IRS' legal right to ask for information, the reason the agency is asking for it ("to carry out the U.S. tax laws") and the consequences of failing to cooperate with the audit ("you may be charged penalties and, in certain cases, you may be subject to criminal prosecution"). J.A. at 42-43. Finally, the letter also included an attached standard Information Document Request for a corporate audit, requesting numerous corporate and accountant records. The letter and attached forms contained no indication that the audit had been prompted by Pique's or the anonymous informant's tips.

Loges met with William McKee on September 8, 1992. Loges inquired about a specific $23,800 loan from Valley Electric to the McKees, and Mr. McKee admitted that it was for personal work done on his home. He further explained that there was no formal loan document establishing an interest rate or setting forth a repayment plan because Valley Electric was a small company and did not conduct such formalities. Loges asked Mr. McKee if the company paid personal expenses for him, but he responded in the negative. The activities for which Loges questioned Mr. McKee at this meeting eventually became the basis for the later criminal prosecution against the McKees. The next day, Loges informed Mr. McKee that Valley Electric would be audited for the 1991 tax year.

Loges and Mr. McKee met again on September 24, 1992 in conjunction with the Valley Electric corporate audit. Loges questioned Mr. McKee about the company minute book, stock record book, and shareholder loan documents. Again, Mr. McKee responded that the company simply didn't keep such things. Loges and Mr. McKee met again the following day, and Loges found several checks and expenses that should have been, but were not, listed in Mr. McKee's corporate account or employee loan account.

Over the ensuing months, Loges continued to request additional records and documents from Valley Electric and discovered discrepancies pointing in the direction of possible tax violations, including at least two notes payable to the corporation that were dated March 5, 1990, and March 15, 1991, respectively. In her notes for the McKees' file, Loges expressed concern, if not suspicion, that the notes looked "identical," and Loges theorized that one of the notes had been backdated. At times, Loges requested more specific information from the McKees, such as original documents instead of the provided copies.

Loges finally conducted the audit with McKee and her husband on February 17, 1993. Loges directed several questions regarding the discrepancies of Valley Electric's records at McKee, including why personal expenses did not get included in their shareholder/loan records. Loges also interviewed four or five Valley Electric employees in the course of her investigation. She did not have any contact with the CID during the civil investigation and audit.

Following the February 17, 1993 meeting, Loges terminated all contact with the McKees and determined that a criminal referral might be appropriate. After several levels of review by the IRS's Civil Division, the case was referred to the CID on May 5, 1993. The CID officially informed the McKees that they were under criminal investigation on November 9, 1993.

The case was transferred to the U.S. Department of Justice Tax Division for evaluation for criminal prosecution on March 11, 1996. On March 4, 1997, a federal grand jury in the Eastern District of Tennessee returned a two-count indictment charging the McKees with tax fraud under 26 U.S.C. § 7206(1) and 18 U.S.C. § 2. The case was assigned to a magistrate judge.

The McKees filed several pretrial motions, including a motion to suppress and for a Kastigar hearing,² which are bases of this appeal. After a hearing on the motion, the magistrate judge issued a lengthy report on September 26, 1997, recommending that the motion to suppress be denied. Although the McKees...