Heavy Handedness in Charging and Forcing Pleas

I point readers to an excellent article in yesterday's Wall Street Journal, John A. Emshwiller and Nathan Koppel, Plea Bargains Get Renewed Scrutiny (WSJ 12/19/09). I previously blogged here that the Judge had dismissed indictments against some broadcom defendants for prosecutorial abuse. At the same time, the Judge voided a prior guilty plea in the case. Here is the article's intro:

A surprise twist in the criminal case against Broadcom Corp. co-founder Henry Samueli again raises questions about plea bargains, one of the most important and controversial aspects of the justice system.

In a Santa Ana, Calif., court last week, federal Judge Cormac Carney dismissed the criminal complaint charging Mr. Samueli with lying to the Securities and Exchange Commission in its investigation of whether Broadcom misstated its earnings by improperly accounting for executive stock options. Judge Carney's dismissal came even though Mr. Samueli had stood before him in 2008 and pleaded guilty to that very crime.

Mr. Samueli did what lawyers and legal scholars fear a disturbing number of other people have done: pleaded guilty to a crime they didn't commit or at least believed they didn't commit. These defendants often end up choosing that route because they feel trapped in a corner, or fear getting stuck with a long prison sentence if they go to trial and lose.

I have previously blogged on facets of this matter here. The major aspect of the problem is the combination of the Government's virtually unlimited charging decisions permitting the piling or stacking on of counts and the large amounts involved in some white collar crimes. The defendant is at risk of major incarceration if he does not plea and, as in Samueli, may be convinced that he is guilty when he is really not in order to make the required allocation.

I obvserved this phenomenon in the KPMG criminal case. The defendants through their own alleged conduct and Pinkerton conspiracy concepts faced draconian Guidelines calculations driven principally by the alleged tax loss. Pre-Booker that was a major problem that the Government sought to exploit by offering a plea first to two counts and then to one. The Government forced out one guilty plea while sentencing was in flux. Even after Booker, the problem was only mitigated by the discretion given judges, because they started with the Guidelines calculations.

Fortunately, as in the broadcom case, Judges can mitigate that Government's abuse of power in forcing plea agreements. For Samueli, the Judge simply overturned the guilty plea. In KPMG criminal tax case, the Judge sentenced David Rivkin to one year of probation, using the Booker discretion to effectively nullify all but the collateral consequences and stigma of the guilty plea.

Requirement to Notify Attorney General of Foreign Proceedings

This item is a bit late in the cycle of tax crime news, but I thought I would post it anyway as a resource for readers since the issue may arise in later cycles of offshore account advice and maneuverings. Readers will recall that 18 U.S.C. § 3506 requires that U.S. persons contesting in a foreign country a U.S. request to that foreign country for information must notify the Attorney General of the foreign proceeding. Readers desiring further information on this issue will find a good resource on the web in the form of a Pillsbury Winthrop Shaw Pitmann LLP memorandum from Stephan E. Becker to Michael Leupold and Suzanne Kuster dated 9/6/09. The memorandum is here.

Tax Loss Estimations for Sentencing Purposes

In United States v. Poltonowizc (3rd Cir. 2009), an unreported, nonprecedential decision, the court approved tax loss estimations for a convicted return preparer (former IRS CI analyst). His tax evasion scheme was unsophisticated. In a sting operation,

Although the agent never mentioned charitable contributions, and provided him with no evidence whatsoever of any such contributions, he included $2,190 in cash ontributions to charity and $495 in non-cash contributions to charity on the agent's return. As a result, the agent's tax return showed that she was entitled to a $12 refund, instead of reflecting that she owed $1,012 in additional taxes. Subsequently, the agent requested a meeting with Poltonowicz to discuss a letter she received from the IRS informing her that she would be audited. Again, the agent wore a recording device. He admitted to the preparation of a false tax return and that he included the false deductions to save her from paying additional taxes (as he operated under the assumption that she would not be audited). He reassured her that she would not get in trouble for the fraudulent return.

Poltonowicz pled to one count of filing a false tax return. He thereafter continued his pattern of conduct through another company in the name of a female, described as his "long-time roommate and housekeeper." In a second trial, a jury convicted him of unspecified tax crimes. Moving to the sentencing phase, the defendant's position was that a particularized inquiry should be made into the dollars included in the estimated tax loss calculation under the Sentencing Guidelines. The Government, however, calculated the tax loss in a less precise way. The Government's calculations included only tax losses for returns personally prepared by Poltonowicz. (Specifically, it excluded returns prepared by employees who had, according to the testimony, claimed similar false deductions at Poltonowicz's direction or teaching.) Of that set,

Of that subset of tax returns, the government included only those that contained one of the methods of falsifying tax returns established at trial, such as fictitious cash and non-cash charitable contributions, employee non-reimbursed expenses, and claims of eligibility for the earned income tax credit. The government filtered that subset to include two types of returns: (1) returns for which the IRS had conducted an audit and had subsequently assessed the taxpayer with additional tax liability based on the tax payer's inability to substantiate their return, or (2) returns for taxpayers interviewed, who confirmed that they did not provide any evidence of the deductions at issue or request that they be included. The estimate of $419,853.20, in the manner calculated, was actually under inclusive.

Addressing Poltonowicz's arguments on appeal, the court of appeals said:

The district court relied on evidence presented at trial and the sentencing hearing to reach its conclusion. The government established the modus operandi -- preparing tax returns with fictitious data for charitable contributions, employee non-reimbursed expenses, and claims of eligibility under the earned income tax credit. It did not err in including tax returns in the tax loss calculation which had been subject to and had failed an audit by the IRS, even if the government did not interview the tax payer. Poltonowicz is on audiotape informing a potential client that he knew exactly how to claim fictitious deductions without getting caught. Indeed, the evidence suggests a much larger tax loss. He personally prepared 20,000 to 25,000 tax returns, yet the government calculated its tax loss based on just 225 of those returns. One former employee testified that at least 25% of the returns Poltonowicz filed contained fictitious deductions. The government excluded from its calculation any returns that were prepared by employees, even though several employees testified that he directed them to add fictitious deductions to the returns they filed. On average, 50-54% of returns claim charitable contributions; whereas, 98% of Poltonowicz's clients claimed such deductions. Notably, his clients uniformly claimed to donate in one of three precise amounts: $490, $495, and $500.

Poltonowicz also challenges the government's calculation of additional losses by comparing his average claims for certain deductions, such as the charitable deduction, with that of the national average. He asserts that it was improper to compare his clients to the national average because his clients were not average tax payers; rather, his clients consisted of blue-collar, religious, conservative tax payers who were far more likely to make charitable contributions than the average tax payer. He makes a similar argument with respect to the government's comparative information on employee non-reimbursed expenses. These arguments lack merit. The District Court did not rely on the government's comparative data in reaching its conclusion that the tax loss exceeded $ 400,000. The District Court based its conclusion on the audited returns and mentioned the additional statistical evidence in noting that the government's calculation was extremely conservative. There is no error with a District Court's consideration of statistical evidence in a case involving upwards of 20,000 tax returns.

This type of estimation would appear to be appropriate under the Guidelines in setting a reasonable minimum tax loss for sentencing purposes. There is a related, but quite different, issue of whether anything less than actual proof of a substantial tax loss due for purposes of the evasion element of tax due and owing is appropriate in the case in chief. I have previously argued in my blogs in the context of criminal prosecutions of tax enablers where the taxpayers are absent such estimations are not appropriate.

Civil Tax Statute of Limitations for Fraudulent Tax Shelters

I address in this blog the civil statute of limitations for tax shelters. I start with the basics:

1. General. The general statute of limitations is 3 years. § 6501(a).

2. 25% Omission. In the case of a 25% omission of income, the statute of limitations is 6 years. § 6501(e). Many of the shelters exploited basis overstatements which, the cases have held, do not invoke this section, but the IRS may have put the quietus on those holdings by Regulation. See T.D. 9466, 2009-43 I.R.B. 551.

3. False Return. "In the case of a false or fraudulent return with the intent to evade tax," the statute of limitations is unlimited. § 6501(c)(1).

4. Willful Attempt to Evade Tax. "In case of a willful attempt in any manner to defeat or evade tax," the statute is unlimited. § 6105(c)(2).

I focus here on the third and fourth exceptions – principally the third – because the IRS imagines many of these abusive shelters -- the poster child being Son-of-Boss in its various iterations -- as fraudulent and somebody in the mix among the enablers and taxpayers had fraudulent intent to evade tax and thus necessarily willfully attempted to evade or defeat tax.

In Allen v. Commissioner, 128 T.C. 37 (2007), the Tax Court held that a tax return preparer's fraud would invoke the unlimited period of limitations in § 6501(c)(1) even if the taxpayer had no fraudulent intent. The court applied what it called a plain meaning interpretation of the statutory language quoted above.

The question in the case of fraudulent tax shelters is whether the taxpayer's standard defense that other professionals were involved so that he or she lacked fraudulent intent will avoid the application of the unlimited statute of limitations. Of course, the Government imagines that the taxpayers (or at least most of them who were not comatose) intended to defraud the Government of tax, but has not chosen so far to indict the taxpayers. I hear that the Government simply missed or did not timely pursue many of the abusive tax shelters within the applicable period -- 3 years or 6 years, as appropriate. Can the Government now pursue these shelters under an unlimited civil statute of limitations inspired by the Allen decision? Although certainly not authoritative, the Tax Notes publication of Allen was under the caption "Limitations Period Extended Regardless of Who Commits Fraud." I think a more technical analysis would get there also under Allen.

Let's look at Allen more closely. The Court applied a "plain meaning analysis" (pp. 39-40):

Nothing in the plain meaning of the statute suggests the limitations period is extended only in the case of the taxpayer's fraud. The statute keys the extension to the fraudulent nature of the return, not to the identity of the perpetrator of the fraud. Nor do we read the words "of the taxpayer" into the statute to require the taxpayer to have the intent to evade his or her own tax.

Respondent argues, and we agree, that statutes of limitations are strictly construed in favor of the Government. Badaracco v. Commissioner, 464 U.S. 386, 391, 104 S. Ct. 756, 78 L. Ed. 2d 549 (1984); Lucia v. United States, 474 F.2d 565, 570 (5th Cir. 1973). An extended limitations period is warranted in the case of a false or fraudulent return because of the special disadvantage to the Commissioner in investigating these types of returns. Badaracco v. Commissioner, supra at 398. Three years may not be sufficient for the Commissioner to investigate or prove fraudulent intent. Id. at 399.

We agree with respondent that the special disadvantage to the Commissioner in investigating fraudulent returns is present if the income tax return preparer committed the fraud that caused the taxes on the returns to be understated. Accordingly, taking into account our obligation to construe statutes of limitations strictly in favor of the Government, we conclude that the limitations period for assessing petitioner's taxes is extended if the taxes were understated due to fraud of the preparer.

* * * *

We conclude that the limitations period for assessment is extended under section 6501(c)(1) if the return is fraudulent, even though it was the preparer rather than petitioner who had the intent to evade tax. The plain meaning of the statute indicates that it is the fraudulent nature of the return that extends the limitations period. We therefore find that the limitations period for assessing tax against petitioner is extended indefinitely.

Allen thus clearly stands for the proposition that a preparer's fraudulent intent suffices for the unlimited statute of limitations § 6501(c)(1). And, under the definition of return preparer in the Code and Regulations, a person other than the signing preparer who materially participates in the reporting of a fraudulent item could be a preparer within the scope of the holding. Finally, since all that is needed under the Allen analysis and, seemingly, the statute, is a "a false or fraudulent return with the intent to evade tax," then at least arguably the fraudulent intent of anyone involved materially in the reporting on the return, including the shelter promoters might be sufficient.

Professor Bryan Camp has criticized the Allen holding in two articles. Bryan T. Camp, Presumptions and Tax Return Preparer Fraud, 120 Tax Notes 167 (2008); and Bryan T. Camp, Tax Return Preparer Fraud and the Assessment Limitation Period, 116 Tax Notes 687 (Aug. 20, 2007). Professor Camp argues in his articles that the Tax Court mis-interpreted the plain language of the statute and that, in addition, the history of statute shows it is supposed to reach only bad-acting taxpayers. Professor Camp's analysis would thus not sweep in the fraudulent intent of enablers, whether they fit the technical definition of preparers or not.

So, we have two plain language advocates reaching opposite conclusions; which may suggest that the plain language is not so plain and that therefore resort to something other than plain language is critical and, as Professor Camp notes in his articles, a persuasive case can be made from the sources other than the statutory text that it is the fraudulent conduct of the taxpayer that must control both the unlimited statute of limitations and the civil fraud penalty. Nevertheless, we have Allen as the only direct authority, and it stands for the proposition that the conduct of others than the taxpayers may trigger the unlimited statute of limitations (albeit not the civil fraud penalty).

Professor Camp urges if Allen were correct (which he vigorously disputes) on the bare words of the statute, the IRS should exercise its enormous discretion to "walk away from these new powers that it has been granted [by the Allen case] and focus on the tools that Congress gave it to combat the problem of tax return preparer fraud." Professor Camp is presuming that the wholly innocent taxpayer (and not the bad-acting enablers) is being punished by the unlimited statute of limitations.

In the case of abusive tax shelters, however, the Government's imagination is that the taxpayers may not be wholly innocent. Tax benefits were created from thin air in an environment (often the reports are that the taxpayer or the taxpayer's advisors and even some of the enablers said early on that the shelter was "too good to be true" or some variation of that notion). Hence, if Professor Camp is wrong on the law and the IRS does actually have the tremendous discretion in the application of this interpretation, the IRS may desire to exercise the power in some cases and not in other cases. Are abusive tax shelters a case in which the IRS should or will exercise its powers?

If the Government tries, taxpayers will surely assert vigorously, as has Professor Camp, that Allen is wrongly decided, both as a matter of statutory interpretation and of policy. I think there is a reasonable chance that the Camp interpretation will prevail. I just think that Congress intended the panoply of provisions addressing return preparer and enabler abuses to cover the ground (and prosecutors have plenty of weapons against bad-acting tax shelter enablers) and did not intend to punish innocent taxpayers (which for this purpose includes perhaps not so innocent taxpayers whose intentions were not fraudulent) with an unlimited statute of limitations.

But, if Allen does prevail, the question then, of course, is that the Government can prove by clear and convincing evidence of fraud as to one or more enablers in the tax shelter chain with reasonable nexus to the return reporting position. Even if the Government could not or could but did not prosecute the taxpayers, it could still sweep those taxpayers into an unlimited civil statute of limitations, and put a lot of enablers’ actions in the line of fire. Of course, those innocent and not-so-innocent taxpayers might be able to push all or some of the cost to the bad-acting enablers through malpractice or related fraud claims.

Finally, in such a proceeding involving the unlimited statute of limitations, any of the enablers' convictions will not give rise to res judicata or collateral estoppel because the taxpayers are not in privity with them. But obviously, their convictions will be bad facts and may go a long way to meeting the Government's burden to prove fraud by clear and convincing evidence.