Supreme Court Applies 40% Penalty to Bullshit Basis Enhancement Shelters (12/3/13)

In United States v. Woods, ___ U.S. ___ (12/3/13), here, the Court rejected procedural arguments and applied the special 40% accuracy related penalty for valuation and basis overstatements.  §§6662(a), (b)(3), (e)(1)(A), (h).  The unanimous opinion is written  by Justice Scalia, the plain language justice, who not surprisingly concludes:  "The penalty’s plain language makes it applicable here."

I am sure others and even I will have a lot to say about the opinion and its ramifications later. For now, this caught my eye as Justice Scalia jabs at the use of the Blue Book:

Woods contends, however, that a document known as the “Blue Book” compels a different result. See General Explanation of the Economic Recovery Tax Act of 1981 (Pub. L. 97–34), 97 Cong., 1st Sess., 333, and n. 2 (Jt.Comm. Print 1980). Blue Books are prepared by the staff of the Joint Committee on Taxation as commentaries on recently passed tax laws. They are “written after passage of the legislation and therefore d[o] not inform the decisions of the members of Congress who vot[e] in favor of the [law].” Flood v. United States, 33 F. 3d 1174, 1178 (CA9 1994). We have held that such “[p]ost-enactment legislative history (a contradiction in terms) is not a legitimatetool of statutory interpretation.” Bruesewitz v. Wyeth LLC, 562 U. S. ___, ___ (2011) (slip op., at 17–18); accord, Federal Nat. Mortgage Assn. v. United States, 379 F. 3d 1303, 1309 (CA Fed. 2004) (dismissing Blue Book as “a post-enactment explanation”). While we have relied on similar documents in the past, see FPC v. Memphis Light, Gas & Water Div., 411 U. S. 458, 471–472 (1973), our more recent precedents disapprove of that practice. Of course the Blue Book, like a law review article, may be relevant to the extent it is persuasive. But the passage at issue here does not persuade. It concerns a situation quite different from the one we confront: two separate, non­overlapping underpayments, only one of which is attributable to a valuation misstatement. 

Addendum 12/4/13 10:32am:

I have posted the foregoing, along with more discussion on the Blue Book on my Federal Tax Procedure Blog:   Supreme Court Applies 40% Penalty to Bullshit Basis Enhancement Shelters (Federal Tax Procedure Blog 12/3/13), here.

Also, I have extended and updated those comments on the following:  More on the Supreme Court's Opinion in Woods on TEFRA and the 40% Basis Overstatement Penalty (Federal Tax Procedure Blog 12/4/13), here.

Civil Collateral Estoppel Following Tax Evasion Conviction (12/3/13)

In Senyszyn v. Commissioner, T.C. Memo. 2013-274, here, the taxpayer, a former IRS agent, had earlier been convicted by plea of tax evasion.  The evasion count to which he pled was:

COUNT TWO

TAX EVASION

1. The allegations contained in paragraphs 1 through 10 of Count One of this Superseding Information are repeated, realleged, and incorporated by reference as though fully set forth herein.
2. During the calendar year 2003, defendant BOHDAN SENYSZYN embezzled taxable income from the sale of real estate owned by DH that was in addition to the income paid to him as salary and wages by the IRS. Specifically, defendant BOHDAN SENYSZYN embezzled approximately $252,726.00 from the November 19, 2003 sale of DH-owned property in Andover Township identified as Lot 72, which was sold for $351,000.00.
3. On or about January 29, 2004, defendant BOHDAN SENYSZYN prepared, co-signed, and filed a United States Individual Income Tax Return, Form 1040, for himself and his wife, who also signed the return. That joint return declared $78,115.80 in wages and salaries as their only income, and stated that the amount of tax due and owing was $0.
4. The return did not include about $252,726.00 in additional taxable income that defendant BOHDAN SENYSZYN embezzled in 2003 from the sale of Lot 72. Upon this additional income, an additional tax of about $85,016.27 was due and owing to the United States.
5. On or about January 29, 2004, in the District of New Jersey, and elsewhere, defendant BOHDAN SENYSZYN knowingly and willfully did attempt to evade and defeat a substantial part of the income tax due and owing by him to the United States for the calendar year 2003 in that he signed, filed and caused to be filed a false and [*6] fraudulent United States Individual Income Tax Return, Form 1040, as described in paragraph 3, knowing it to be false and fraudulent as described in paragraph 4. In violation of Title 26, United States Code, Section 7201.

In the ensuing civil proceeding, the IRS urged that the conviction was collateral estoppel as to the issue of fraud for purposes of the civil fraud penalty and for purposes of the statute of limitations.

As a result of the case, I have slightly revised the working draft of my Federal Tax crimes book discussion of collateral estoppel as it relates to the civil fraud penalty.  Here is the discussion (footnotes omitted):

Daugerdas Retrial Jury Instructions - Part 07 Tax Evasion Instructions Part 3 Economic Substance (11/27/13; 11/29/13)

I address in this blog the relationship to the defendants served as enablers and the taxpayers whose taxes were allegedly evaded.  In the prior cases, as I recall it, the Government conceded that the taxpayers themselves were innocent.  That would mean that the enabler defendants could not have aided and abetted the taxpayers' tax evasion.  It is not clear to me that the Government made that concession in this Daugerdas retrial.  So, I suppose, the jury could have applied an aiding and abetting construct to say that the enabler defendants aided and abetted some or all guilty taxpayers, but I think on the instructions given which did not develop the aiding and abetting concept, they would have had to find the defendants directly guilty of the crime of tax evasion which they could do because tax evasion can apply to enablers directly without the help of derivative liability provisions.

But, I want to focus on the taxpayers because it was their taxes that had to be evaded in all events for the crime of tax evasion as charged in Daugerdas.  What would it require for their taxes to have been evaded via the tax shelters promoted by the enabler defendants?  In the Tax Due and Owing instruction, Judge Pauley explained that the critical issue as to whether there was a tax due and owing was whether the shelters lacked economic substance.  (I have previously written on what I perceive as major difficulties in presenting the concept of economic substance to juries; they can be reviewed via the "Economic Substance" link.)  One uncertainty is whether the two component tests commonly applied to determine economic substance are in the disjunctive or the conjunctive.  That uncertainty has existed for a long time.  So, Judge Pauley asked the jury to apply the test in the conjunctive -- the most defendant-friendly application of the economic substance test.

Judge Pauley explained in explaining Tax Due and Owing:

The Government claims that the reason the taxpayers * * * * owed more taxes than they reported is that the losses they claimed on their tax returns as a result of the Short Sale, SOS, Swap, or HOMER tax shelters were not allowable. The Government contends that these losses were not allowable because they stemmed from transactions that lacked “economic substance.” 

A transaction that lacks economic substance cannot enter into tax computations. Any deduction claimed for a tax loss allegedly sustained in such a transaction is not properly claimed on a tax return. 

In order to establish that a transaction lacks economic substance, the Government must prove, beyond a reasonable doubt, two components. 

The first component is that the relevant taxpayer had no genuine business purpose for engaging in the transaction in question apart from the creation of the tax deduction.  

The second component is that there was no reasonable possibility that the transaction would result in a profit.

Daugerdas Retrial Jury Instructions - Part 07 Tax Evasion Instructions Part 3 Tax Evaded (11/25/13)

I address here what I now call the evaded element for the crime of tax evasion.  There has been loose jargon that has crept into this element.  I have used loose jargon, but I have recently seen the error of my ways.  

The key concept is that the taxpayer have evaded tax for the crime of tax evasion.  Simply because a taxpayer underpaid some or all of his tax liability, does not mean that he evaded some or all of his tax liability.  The Supreme Court and other courts, however, have described this element as a "tax deficiency" which is a tax term of art that normally means simply tax underpaid.  See Section 6211(a), here.

In his instruction, Judge Pauley describes this element as "tax due and owing."  Judge Pauley explains it to the jury as follows (again excluding the portion relevant only to Daugerdas' personal evasion):

First Element: Tax Due and Owing 

In order to establish the first element of tax evasion, the Government must prove beyond a reasonable doubt that the relevant taxpayer or the defendant Paul Daugerdas owed a substantial federal income tax for the tax year at issue.

This particular quote does not use the term tax due and owing, but rather just requires that there be a substantial federal income tax due.  Perhaps, though, the requirement of proof beyond a reasonable doubt captures the concept I want to discuss here.

There are more extensive instructions on tax due and owing and may be reviewed on a prior blog.  Daugerdas Retrial Jury Instructions - Part 06 Tax Evasion Instructions Part 1 Tax Evasion and Conspiracy to Commit Tax Evasion (Federal Tax Crimes Blog 11/25/13), here.

In the past, I have typically used the "tax due and owing" formulation of the element.  However, in preparing an article on sentencing, I concluded that perhaps the better concept would be "tax evaded."  Here is an except from the latest draft of that article which arises from the Villanova Symposium in which I recently participated (footnotes omitted):

E. Tax Liability Concepts in the Criminal Tax Universe. 

I stated earlier that tax evaded is the centerpiece of the sentencing in criminal tax cases and, hence, is at the forefront from the earliest steps in the criminal investigation and enforcement process where practitioners must anticipate and, if possible, shape what will happen at sentencing.  I will first state generally the varying concepts of tax liability as they play out in the criminal tax context and specifically at sentencing.  As with most financial crimes, the key determinant in the advisory Sentencing Guideline calculations is the financial loss to the victim.  For taxes, the victim is the IRS, and the tax loss is the measure of the financial loss that is considered. 

1. Civil Tax Liability / Tax Deficiency. 

A taxpayer may think of his tax liability as what he offers to the IRS.  In the case of a filed return, the return is the taxpayer’s offer.  In the case of an unfiled return, the taxpayer’s offer is nothing (except to the extent of prepayments such as withholding or estimated taxes).  In either case, the IRS may disagree and think the taxpayer owes more than he offered.  That is the context for IRS investigations into liability that may include both audits and criminal investigations. 

The taxpayer will have a civil tax liability which is imposed on the original due date of the return.  That liability is determined before application of payments.  To the extent that the liability exceeds the payments made or deemed as of the due date of the return, the taxpayer has an unpaid civil tax liability, often referred to in a civil context as a deficiency.  Taxpayers who fully pay their civil tax liability will usually not be at risk of criminal prosecution because of the phenomenon noted above that punishment is determined by evasion of the unpaid tax.  At least usually, in the tax crimes universe, if there is no tax underpaid, there is no crime – or at least no crime that the Government will have the incentive to prosecute. 

Daugerdas Retrial Jury Instructions - Part 07 Tax Evasion Instructions Part 2 Tax Evasion and Conspiracy to Commit Tax Evasion - Derivative Liabilities (11/25/13)

As I have previously blogged, where a defendant can be directly liable through his own conduct for the substantive crime (tax evasion under Section 7201, here), the derivative liabilities in this type of case are irrelevant and confusing.  The derivative liabilities are under 18 USC Section 2, here --  aiding and abetting under Section 2(a) and causer liability under Section 2(b) -- and under the Pinkerton concept for co-conspirators' crimes.  See particularly, Even More on Principals, Accomplices, Causers and Pinkerton Conspirators - the Daugerdas Case (Federal Tax Crimes Blog 5/10/11), here; for more extensive discussion of that concept, see John A. Townsend, Theories of Criminal Liability for Tax Evasion (May 15, 2012), here.  As I note in both pieces, at the first trial, because defendants' alleged conduct, if found by the jury, made them directly liable for the substantive crime of tax evasion, Judge Pauley was skeptical as to what these derivative liability provisions added to the jury's understanding of the case and thus either did not mention them or merged them into the direct substantive liability.  I was thus curious as to what Judge Pauley would say on this round.

I start with a key general observation about the derivative liabilities.  They function solely to make a person who is otherwise not a principal guilty of the substantive crime as a deemed principal of the substantive crime. Stated otherwise, the sole function of Section 2 is to create deemed principal status for defendants who are not otherwise direct principals in the substantive crime under general principles of principal status.  See particularly my article.  Section 2 serves no other purpose than that.  Similarly, while not invoking the deemed principal construct of Section 2, Pinkerton serves the same function of making a person who does not commit the substantive crime guilty for the crime committed by a co-conspirator -- effectively a deemed principal status similar to aiding and abetting.

This is critically important because, where a defendant's conduct could make him directly liable for the substantive crime, deemed principal status under these derivative liability concepts is irrelevant and instructing the jury on it is likely to be more confusing than helpful.  In the trilogy of major tax shelter cases in SDNY, the conduct alleged would have made the defendants directly guilty of the crime of tax evasion.  That is to say that enablers other than the taxpayer can be directly guilty of the crime, regardless of whether or not the taxpayers were guilty of the crime.

Aiding and Abetting under Section 2(a).

Judge Pauley's only instruction mentioning aiding and abetting either by name or theory is the following from the very general introduction to the substantive charges (p. 28)::

Counts 2 through 11 charge the Defendants with aiding and abetting the evasion 18 of income tax obligations of various clients who engaged in tax shelter transactions.

Then, when drilling down on the specific instructions about the tax evasion charge, Judge Pauley does not mention the words aiding and abetting or the concepts those words incorporate.  I am not sure the general instruction would have given the jury the notion that it could convict by finding that the defendants were not guilty of the substantive crime but could be guilty as principals by aiding and abetting the taxpayers in the taxpayers' evasion or other defendants who were directly guilty of the substantive crime in the taxpayers' evasion.  So, as presented, except for this fleeting reference to aiding and abetting, I think the instructions as presented required the jury to find the defendants directly guilty of the crime of tax evasion (and not as deemed principals under 18 USC Section 2(a), aiding and abetting).

Government May Enforce Restitution Despite the Defendant Taxpayers Installment Agreement with the IRS (11/26/13)

In United States v. Fisher, 2013 U.S. Dist. LEXIS 165473 (D. Mich. 11/21/2013), the Court held that, despite the taxpayer having reached an installment plan with the IRS regarding his unpaid taxes, DOJ could pursue restitution for those taxes independent of the IRS.  DOJ sought to garnish two retirement accounts with an aggregate value of $164,217.  Per the Court, "On September 30, 2013, Fisher moved to quash or modify these garnishments arguing that the garnishments violate his restitution agreement with the IRS, and that the garnishments are unfair and impose undue financial hardship on his family."

I include the full discussion from the case in order to alert practitioners that the restitution obligation is separate from the tax obligation which the restitution obligation is designed to pay.  That seems a bit circular but it is the case.  I include the following, constituting the bulk of the opinion (caption omitted):

OPINION AND ORDER DENYING DEFENDANT'S MOTION TO QUASH OR MODIFY GARNISHMENTS 

Following his conviction for conspiracy to defraud the United States, 18 U.S.C. § 371, the court ordered Defendant Edward Fisher to pay $10,000,000 in restitution to the Internal Revenue Service ("IRS"). Fisher has repaid approximately $6,012.44 of this obligation, and under his current financial circumstances, has agreed to pay the IRS $100 a month. On September 5, 2013, the government applied for and received writs of garnishment for funds in Fisher's retirement accounts at Virtus Partners, Inc., and Dodge & Cox. Together, these accounts hold approximately $164,217. On September 30, 2013, Fisher moved to quash or modify these garnishments arguing that the garnishments violate his restitution agreement with the IRS, and that the garnishments are unfair and impose undue financial hardship on his family. 

18 U.S.C. § 3612(c) vests the Attorney General with responsibility for collecting unpaid restitution and fines. This authority is broad: the government may use any of the "practices and procedures for the enforcement of a civil judgment under Federal law or State law." Id. at § 3613(a). This broad authority is circumscribed by the exceptions listed in 26 U.S.C. § 6334(a)(1)–(8), (10), and (12). 18 U.S.C. § 3613(a)(1). Notably, none of the listed exemptions include retirement accounts. Although Fisher argues that allowing the government to garnish retirement accounts discourages individuals from saving for retirement, this type of policy argument is better left to Congress. 

Fisher also argues that the garnishments violate his payment agreement with the IRS. However, as the government explains, a payment schedule does not serve as a bar to further collection efforts by the government. United States v. Bancroft, No. 1:09-cr-101-02, 2010 WL 4536785, at *2 (W.D. Mich. Nov. 2, 2010) ("The government is free to pursue any authorized means of securing a restitution obligation, and it is clear that writs of garnishment are authorized by federal law.") (Bell, J.); United States v. Miller, 588 F. Supp. 2d 789, 797 (W.D. Mich. 2008) (holding that a periodic payment provision in a criminal judgment does not insulate a defendant from other collection efforts, including garnishment) (Lawson, J.). 

Lastly, Fisher argues that it would be inequitable to allow the government to garnish his retirement accounts because it would impose undue financial hardship on his family and saddle him with extreme tax liabilities. The government avers that Fisher has already liquidated two other retirement accounts that he possessed, and used the proceeds of these accounts to pay personal debt rather than his restitution obligation. At oral argument, Fisher concedes the point. The court certainly endorses the general proposition that people should save for retirement, but finds no basis presented here on which to grant the relief defendant seeks. Accordingly, 

IT IS ORDERED that Fisher's "Motion to Quash or to Modify Garnishments" [Dkt. # 13] is DENIED. 

/s/ Robert H. Cleland
ROBERT H. CLELAND
UNITED STATES DISTRICT JUDGE
Dated: November 21, 2013

18 USC Section 3621, titled Collection of unpaid fine or restitution, is here.

Daugerdas Retrial Jury Instructions - Part 06 Tax Evasion Instructions Part 1 Tax Evasion and Conspiracy to Commit Tax Evasion (11/25/13)

I provide here the instructions relevant to the Tax Evasion and the object element of the conspiracy to commit tax evasion.  The relevant instructions are quite long, so in this blog, I will just present the instructions.  In later blogs I will discuss key components in these instructions.

I will bold-face certain items, without further explanation in this blog, that I hope you will think about as you read the instructions.  I will probably discuss most of the bold-faced instructions in later blogs.  Keep in mind that the text headings are bold-face simply to show that they are headings.  The bold-face to which I particularly draw attention will be in the body of the text.  That bold-facing is mine and not Judge Pauley's.

I start with the discussion of the second object of the conspiracy, tax evasion.  The court gave this instruction before instructing as to what tax evasion was.  I think the court did that simply because the order of presentation in the indictment was with conspiracy as the first count.

Also, readers should be aware of that two types of tax evasion were charged.  First, there was tax evasion with respect to unindicted taxpayers, the notion being that the defendants allegedly conspired to commit and themselves did commit, under various derivative liability theories (that I will discuss in a later blog).  Second, there was Daugerdas' personal tax evasion with respect to his own returns.  In the following discussion, I omit the instructions relevant to this second type of evasion, since it is garden-variety (although he used exotic aggressive tax shelters of his own crafting).  I am much more interested in the first type of evasion -- evasion on the returns of unindicted and perhaps even nonculpable -- at least not criminally culpable -- taxpayers.  So, in order to make the instructions more readable as to the first type of tax evasion, I am omitting all references to Daugerdas' person alleged evasion.  I show those omissions with ellipses -- * * *.

Second Object: Tax Evasion  

The second object of the alleged conspiracy is the attempted evasion of income taxes of Jenkens & Gilchrist clients who participated in the Short Sale, SOS, Swaps, and HOMER tax shelters. To prove the second object of the conspiracy, the Government must prove beyond a reasonable doubt that the defendant you are considering and one or more co-conspirators unlawfully, willfully and knowingly agreed to commit the crime of tax evasion with respect to the clients who participated in the tax shelters. The elements of tax evasion are:  

First, that a substantial tax was due and owing to the United States by the relevant taxpayer client;  

Second, that the defendant you are considering committed, or caused to be committed, one or more affirmative acts of evasion described in the Indictment; and  

Third, that the defendant you are considering acted willfully and knowingly in attempting to evade the taxes owed by the taxpayer client.  

I will discuss the elements of tax evasion in more detail later in my charge, when I discuss Counts 2 through 11 * * * of the Indictment, which charge substantive counts of tax evasion. The law that I am going to explain in connection with those substantive counts should be applied by you when you are considering whether either of the defendants conspired to commit the tax evasion object of the conspiracy. 

I now offer the relevant instructions on the substantive crime of evasion:

Fourth Circuit Approves Statistical Sampling Technique for Sentencing Tax Loss (11/23/13)

In United States v. Ukwu, 2013 U.S. App. LEXIS 23513 (4th Cir. 2013), here, the Fourth Circuit affirmed a tax loss calculation based on what it viewed as a proper statistical inference from a sample of the population.  I want to address that issue in this blog.

The cases where this type of statistical inference is drawn as to the tax loss usually appear in tax return preparer prosecutions.  In these cases, the IRS discovers a pattern of errors in some number of returns prepared by the target of the investigation.  It will do some level of investigation and determine that some percentage of the errors -- usually a very high percentage -- represent the preparer's fraud. The IRS will then project that percentage over the universe of returns prepared by the preparer to determine, by statistical inference, the tax loss.  This type of inference is usually not presented in the trial to determine guilt or innocence because a more exacting standard of proof than mere inference is required but rather is presented at sentencing to determine the relevant conduct (which can include noncharged years or returns, acquitted years or returns, etc.).  From a statistical perspective, the initial inquiry is whether the sample size is adequate.  See generally the Wikipedia entry on Sampling (Statistics), here.  Let's say, for example, that the preparer prepared 1,000 returns, that the IRS audited 10 and that 9 out of 10 claimed fraudulent deductions or credits resulting in average underpaid tax of $1,000.  Can a fair inference be drawn that 90% of the remaining unaudited 990 returns not only contained fraudulent deductions but that their average amount of fraudulent deductions was $1,00?  What if the number audited were 100, with similar percentages and amounts?  What if the number audited were 200?  300? Would it be important that the taxpayers audited were randomly drawn?  And what does randomly drawn mean?

I can't write a book on statistics, but there are any number of scholarly books and articles on the subject.  One popular book is Nate Silver, The Signal and the Noise (2012), here.  I will mention Silver again below, although I can't resist saying that Silver was the "gold standard" in projecting the outcome of the 2012 presidential elections.  See Nate Silver's Wikipedia entry here.  I mention also Charles Whelan, Naked Statistics: Stripping the Dread from the Data (2012), here.

Let's see what the Fourth Circuit did in its statistical exegesis in Ukwu.  I note at the outset that  opinion is an unpublished per curiam opinion.  I won't go into a rant about unpublished opinions, not to mention unattributed per curiam opinions.  I have done that elsewhere and, besides, nobody is or should be interested in my opinions on such opinions.  I do say that it is some type of "junior" opinion deemed to be of less significance than published opinions in terms of adding to the law.  (Perhaps this could be compared to the difference between Memorandum and Regular Tax Court Opinions.)  Let's get right to to opinion:

The Court gave us the key background (but not the details) as follows:

After Mr. Ukwu's jury conviction, the government estimated how much money Mr. Ukwu took from federal and state coffers. It concluded that Mr. Ukwu's criminal behavior created tax losses of $2.1 million, which corresponds to a base offense level of 22 under § 2T4.1 of the United States Sentencing Guidelines Manual. 

On appeal, Mr. Ukwu takes issue with the $2.1 million estimate, arguing that a preponderance of the evidence shows that his ill-gotten gains amounted to less than $1 million. Specifically, he argues that the district court's method of estimating the tax shortfall was unsound because it used a small, flawed sample of tax returns to make inferences about another 1000 returns that he prepared. Based in part on its estimate, the district court sentenced Mr. Ukwu to 51 months in prison. Mr. Ukwu filed a timely appeal.

Daugerdas Retrial Jury Instructions - Part 06 Conspiracy Instructions Part 2 - Defraud / Klein Conspiracy (11/16/13; revised 11/23/13)

Judge Pauley gives standard instructions on the elements of the crime of conspiracy - to summarize:

First: that an agreement existed between two or more persons to accomplish at least one of the unlawful objectives charged in the Indictment;  

Second: that the defendant you are considering knowingly and willfully became a member of, and joined in, the conspiracy; and  

Third: that a member of the conspiracy, not necessarily the defendant whom you are considering, knowingly committed at least one overt act in furtherance of the conspiracy

The Court then explains the elements, again in fairly standard instructions.  The Court then moves to the objects of the conspiracy.  I address in this blog the defraud / Klein conspiracy object.  The defraud conspiracy in a tax setting is commonly referred to as a Klein conspiracy.  See United States v. Klein, 247 F.2d 908 (2d Cir. 1957), here.  Here are Judge Pauley's instructions on the Klein conspiracy (I have added the bold face in the text (as opposed to the caption) to make a point that I shall discuss below):

First Object: To Defraud the United States and its agency, the IRS 

The first object of the conspiracy is to defraud the United States by impeding, impairing, defeating and obstructing the lawful functions of the Internal Revenue Service in the ascertainment, evaluation, assessment and collection of income taxes. To prove the first object of the conspiracy, the Government must prove beyond a reasonable doubt that the defendant you are considering and one or more co-conspirators unlawfully, willfully and knowingly agreed to defraud the United States by fraud, deceit or other dishonest means.

I instruct you that the Internal Revenue Service is an agency of the United States Government which is responsible for the collection of tax revenue. The term “conspiracy to defraud the United States” therefore means that the defendants and other co-conspirators are accused of conspiring to impede, impair, defeat, and obstruct the IRS’s lawful functions of ascertaining and collecting tax revenue owed to the United States. It is not necessary that the United States suffer a financial loss from the conspiracy. Indeed, even if the taxpayer’s ultimate legal position on some issue (such as a tax shelter loss) is correct, and he owes no additional taxes, that is not a defense to the crime charged. One cannot use deception and dishonest means—such as making false statements to the IRS—to impede, impair, obstruct, or defeat the 8 IRS, even to protect a legitimate tax position.  

A conspiracy to impede the functions of the IRS by fraud or dishonest means may include, by way of example, such things as agreements to destroy documentation of income, to destroy records, to transfer money or take other action in an attempt to conceal ownership of income or property, to create false documentation, to attempt to influence witnesses, or to engage in any other fraudulent or deceptive conduct that would have the effect of impairing the ability of the IRS to collect tax revenue. Such conduct can also include falsifying the date of a transaction for tax purposes. In this regard, I instruct you that the income tax laws are administered on the basis of an annual accounting system which prohibits the reopening of a prior year’s tax return to take account of events occurring in later years. By citing such examples, of course, I am not suggesting that these are the only actions that could impede the IRS by fraudulent or dishonest means. Nor am I expressing any view as to whether conduct similar to the examples I have mentioned took place here.  

Moreover, it is critical for you to recognize that not all conduct that impedes the lawful functions of a Government agency is illegal. To be unlawful, the conduct must entail fraud, deceit, or other dishonest means. It is not illegal simply to make the IRS’s job harder. Only an agreement to engage in conduct that tends to impede the IRS and that also involves fraudulent, deceitful, or dishonest means, constitutes an illegal agreement to defraud the United States.

Fourth Circuit Reverse Tax Obstruction Conviction Because of Bad Instruction and Affirms Denial of Good Faith Instruction for False Claim Conviction (11/20/13)

In United States v. Jaensch, 2013 U.S. App. LEXIS 22977 (4th Cir. 2013), here, an unpublished decision, the Fourth reversed a conviction for tax obstruction, Section 7212, here, because of an erroneous instruction that did not adequately present the specific intent required for the crime.

The facts are of the tax protestor type -- failing to file returns based on tax protestor notions.  The defendant did file a return for one year -- extending his protest -- by claiming a refund of $774,052.  The IRS rejected the claim and notified him that he was required to file a return in 30 days to avoid a civil penalty.  The defendant then filed a return reporting $113 taxable income and, obviously, no tax due.

He was convicted for "one count of corruptly endeavoring to impede the due administration of the tax laws under 18 U.S.C. § 7212(a), ("Count 1"), one count of filing a false claim for a refund under 18 U.S.C. § 287, ("Count 2"), and four counts of willful failure to file a tax return under 26 U.S.C. § 7203, ("Counts 3-6")."   He appealed on several grounds.  Here are the parts of the opinion I find interesting:

Tax Obstruction / Section 7212

As noted, the court reversed this conviction because of a defect in the instructions.  Here is the Court's discussion:

In this case, the district court's instruction on Count 1 misled the jury as to the controlling law and we cannot say that the error was harmless. To prove a violation of § 7212(a), "the government must prove that the defendant: 1) corruptly; 2) endeavored; 3) to obstruct or impede the administration of the Internal Revenue Code." United States v. Wilson, 118 F.3d 228, 234 (4th Cir. 1997). To act corruptly is to act "with the intent to secure an unlawful benefit either for oneself or for another." Id.\ 

The district court's instructions do not properly explain the Government's burden to the jury. Violation of § 7212(a) is a crime of specific intent. A defendant must not only endeavor to impede due administration but must do so with the specific intent to secure an unlawful benefit. See Wilson, 118 F.3d at 234. Although the district court correctly defined "due administration," "obstruct or impede," and "corruptly," it instructed the jury that it could convict Jaensch by finding that he committed acts listed in the indictment without finding that he committed those acts with the requisite intent to secure an unlawful benefit. 

The jury instructions state, in relevant part, that: 

If the jury concludes that the government did prove beyond a reasonable doubt that one, the defendant employed at least one act set forth in Section 1-M through U of the indictment and that the defendant did commit an act identified in Section 1-V through Y of the indictment, and two, that the defendant acted knowingly and intentionally, then the jury must find the government [sic] guilty of the offenses in Count 1 of the indictment. 

J.A. 608.

Early Court Appellate Court Decision on New Sentencing Guideline Provision Regarding Unclaimed Deductions (11/19/13)

In United Sates v. Fawaz, 2013 U.S. App. LEXIS 23135 (6th Cir. 2013), here, the Sixth Circuit addressed the new Sentencing Guidelines provision, effective November 1, 2013, here, regarding unclaimed deductions.  See Further on U.S. Sentencing Commission Proposal for Unclaimed Credits, Deductions and Exemptions (Federal Tax Crimes Blog 8/10/13), here.  The new provision is in SG 2.T.1, Application Note 3, here, as follows :

3.      Unclaimed Credits, Deductions, and Exemptions.—In determining the tax loss, the court should account for the standard deduction and personal and dependent exemptions to which the defendant was entitled. In addition, the court should account for any unclaimed credit, deduction, or exemption that is needed to ensure a reasonable estimate of the tax loss, but only to the extent that (A) the credit, deduction, or exemption was related to the tax offense and could have been claimed at the time the tax offense was committed; (B) the credit, deduction, or exemption is reasonably and practicably ascertainable; and (C) the defendant presents information to support the credit, deduction, or exemption sufficiently in advance of sentencing to provide an adequate opportunity to evaluate whether it has sufficient indicia of reliability to support its probable accuracy (see §6A1.3 (Resolution of Disputed Factors) (Policy Statement)).

However, the court shall not account for payments to third parties made in a manner that encouraged or facilitated a separate violation of law (e.g., "under the table" payments to employees or expenses incurred to obstruct justice). 

The burden is on the defendant to establish any such credit, deduction, or exemption by a preponderance of the evidence. See §6A1.3, comment.

In summary, under the new Application Note, in order for a defendant to use unclaimed deductions to offset the income component of tax evasion, the unclaimed deductions must be related to the income in issue.  In Fawaz, the Court addressed the issue but remanded the issue for further consideration.  The Court said:

Sentencing Guidelines 

Sentencing Guideline § 2T1.9 applies to violations of § 371. The base offense level is the greater of the offense level as determined by § 2T1.1 or § 2T1.4, or offense level 10. U.S.S.G. § 2T1.9(a). Guideline § 2T1.1 calculates the base offense level through specified monetary ranges in Guideline § 2T4.1. U.S.S.G. § 2T1.1(a). For the purposes of Guideline § 2T1.1, "[i]f the offense involved tax evasion or a fraudulent or false return, statement, or other document, the tax loss is the total amount of loss that was the object of the offense (i.e., the loss that would have resulted had the offense been successfully completed)." U.S.S.G. § 2T1.1(c)(1). "If the offense involved filing a tax return in which gross income was underreported, the tax loss shall be treated as equal to 28% of the unreported gross income . . . unless a more accurate determination of the tax loss can be made." U.S.S.G. § 2T1.1(c)(1)(n.(A)). 

At the sentencing hearing, Safiedine and Fawaz objected to the probation officer's conclusion that JSC underreported its income by $1,020,000 n4 and estimation of the tax loss as $285,600 pursuant to the 28% default tax rate included in Guideline § 2T1.1(c)(1)(n.(A)). The probation officer's conclusions led to her recommendation that the court determine the appropriate base offense level was 18. At the sentencing hearing, Fawaz and Safiedine presented expert testimony from Michael Washenko, a private forensic accountant who previously worked 34 years for the IRS, in part assisting in investigations similar to the investigation of Safiedine and Fawaz. Washenko testified that the government did not actually incur a tax loss as a result of the underreported income and sales price of the Joy Road station; rather, Washenko testified Safiedine actually overpaid his taxes because he did not claim business expense deductions related to the payments Safiedine made in signing the Sunoco checks over to third parties.
   n4This total includes $175,000 from the sale of the Joy Road station and $845,000 from unreported Sunoco upfront consideration payments. 

Watch the Refund Statute of Limitations on OVDP Payments Related to Income Tax (11/16/13)

The 2012 OVDP FAQ 25, here, requires that the full package include various documents (amended returns for the 8-year period, etc.).  Contemporaneously (or before) the taxpayer should send the following to a separate address (from  the 2012 OVDP FAQ):

A check payable to the Department of Treasury in the total amount of tax, interest, accuracy-related penalty, and, if applicable, the failure to file and failure to pay penalties, for the voluntary disclosure period must be sent along with information identifying the taxpayer name, taxpayer identification number, and years to which the payment relates to the following address.

If the taxpayer does not opt out of the OVDP penalty structure, there are no glitches in this payment system that I am aware of.  If the taxpayer opts out, however, and the IRS has posted the remittances as payments to years that, by the time of the resolution of the opt out, are closed for refund claims, the IRS takes the position that it cannot refund any tax, penalty or interest overpaid -- either overpaid with the original return or the payment under FAQ 35.

The reason for this position is that Section 6511(a) and (b), here, preclude the refund.  Readers can read the statute itself at the link.  The following is my explanation of the two statutes of limitations on refunds from the current draft of  my Federal Tax Procedure Book (footnotes omitted):

First, there is a statute of limitations for filing the claim for refund.  A claim for refund must be filed within three years from the date the return was filed or two years from the date the tax was paid, whichever is later, and, if no return is filed, within two years from the date of payment.  § 6511(a).  Read literally, this means that a taxpayer can file a return 40 years late and qualify under this first rule. I hope readers will instinctively say something must be missing here, for statutes of limitations do not normally allowing such lengthy lapses before the claim must be pursued.  The answer to that concern is in the second rule to which I now turn. 

Second, there is a statute of limitations on the amount of tax that can be refunded if the claim is timely under the first rule.  The IRS may only refund the amount of tax paid within three years  plus the period of any extension and, if the foregoing rule does not apply, then it may only refund the tax paid within two years of the date of the claim.  § 6511(b)(2).  This is called the “lookback” rule. 

The key for OVDP purposes is the second rule relating to possible refunds on the opt out arising from the FAQ 35 payments.  Taxpayers and practitioners should be alert to protect the refund statute of limitations for those payments and must act within the two year period from the date of payment.

DOJ Tax Memo Clarifying Points of Swiss Bank Initiative (11/16/13)

DOJ Tax has issued comments on its Swiss bank initiative.  See Memo of 11/5/13, here.  Excerpts I think may most interest readers are (highlighting provided by JAT):

Choosing a category. Each eligible Swiss bank should carefully analyze whether it is a category 2, 3 or 4 bank. While it may appear more desirable for a bank to attempt to position itself as a category 3 or 4 bank to receive a non-target letter, no non-target letter will be issued to any bank as to which the Department has information of criminal culpability. If the Department learns of criminal conduct by the bank after a non-target letter has been issued, the bank is not protected from prosecution for that conduct. If the bank has hidden or misrepresented its activities to obtain a non-target letter, it is exposed to increased criminal liability.

Changing from Category 3 to 2 (or 2 to 3).The Program provides that changes from category 3 to category 2 will be approved by the Tax Division only in extraordinary circumstances, and subject to the limitations set out in the Program. (Program III.C.) If a bank has submitted a letter of intent under category 2 of the Program and belatedly determines that it should have applied under category 3, a bank may withdraw its letter of intent. If the bank later submits a timely letter of intent under category 3, it should expect to be asked to describe why it initially believed that it may have committed tax-related or monetary transaction offenses as described in the Program. 

* * * 

Penalty calculation -- permitted reductions. The Program allows for the reduction of penalties with respect to three categories of U.S. related accounts. The first category -- accounts that are not undeclared -- is intended to address issues concerning lines of business that by their nature did not facilitate the evasion of U.S. taxes and reporting requirements. For example, a corporate account that was declared but had U.S. signatories who did not file FBARs is included in the definition of U.S. related accounts under the Program, but may be excluded for the penalty calculation. The second category -- accounts that were disclosed by the bank to the Internal Revenue Service -- refers only to accounts that were timely disclosed, not accounts that are disclosed under FATCA, as part of the Program, pursuant to treaty requests, as a result of other law enforcement efforts, or similar forms of later disclosure. The third category -- accounts as to which the bank notified its account holders of an announced offshore voluntary disclosure program and can establish that its account holder made a voluntary disclosure under that program -- includes only those accounts that were reported subsequent to notification by the bank. All forms of voluntary disclosure acceptable to the IRS will meet the voluntary disclosure standard of the Program, including the OVDI/OVDP procedures, the Streamlined Filing Compliance Program, and FBAR compliance under FAQs 9 and 17 of the respective IRS programs. The burden to show the application of penalty reductions rests with the bank. (Program II.H.) 

Liechtenstein Will / May End Its More Blatant Forms of Tax Cheating (11/16/13)

So speaketh this report from Reuters.  Tom Bergin, Liechtenstein to end bank secrecy (Reuters 11/14/13), here.  Here are the excepts.

Liechtenstein, whose banks have been accused by the United States and other countries of facilitating tax evasion, said on Thursday it would end its practice of helping foreigners hide money from their tax authorities. 

The move highlights how Liechtenstein has moved more quickly than neighboring Switzerland, possibly the world's most important offshore financial center, in reacting to international pressure for greater transparency. 

* * * *  

The government of the tiny country of 36,000 inhabitants said in a statement that it would sign up to the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, an international forum that allows tax authorities to ask their counterparts in other countries for information on taxpayers. 

The Alpine nation said it would also join up to a system of automatic information exchange being developed by the Organisation for Economic Co-operation and Development (OECD), which is expected to come into force in late 2015 or early 2016. 

Under automatic information exchange, if an individual opens a bank account in a foreign country, that country will automatically inform the tax authority in the individual's country of origin. 

Tax advisers say the automatic exchange of information will make the most common forms of tax evasion difficult, if not impossible, in those countries that agree to it.

Daugerdas Retrial Jury Instructions - Part 06 Conspiracy Instructions Part 1 (11/16/13)

I begin today the first of several blog entries on Judge Pauley's conspiracy instructions.  The complete set of the instructions is here.

Judge Pauly instructs the jury on the general concept of Conspiracy as follows:

Count 1: Conspiracy  

As mentioned earlier, Count 1 of the Indictment charges both Defendants, Paul Daugerdas and Denis Field, with a conspiracy that had three objectives: First, to defraud the United States and the Internal Revenue Service by obstructing the IRS’s ascertainment and collection of income taxes. Second, to attempt to evade income taxes allegedly owed by various tax shelter clients. And third, to defraud the IRS by committing wire and mail fraud.  

A conspiracy is a kind of criminal partnership—an agreement of two or more persons to join together to accomplish some unlawful purpose. It is an entirely separate and different offense from the substantive crime which may be the objective of the conspiracy. Indeed, you may find a defendant guilty of the crime of conspiracy, even if you find that the substantive crime which was the object of the conspiracy was never actually committed. Of course, if a defendant participates in a conspiracy and the crime or crimes which were the object of the conspiracy were committed, the defendant may be guilty of both the conspiracy and the substantive crime. The point simply is that the crime or crimes that were the objective of the conspiracy need not have been actually committed for a conspiracy to exist. 

JAT Comments:

Daugerdas Retrial Jury Instructions - Part 05 General Criminal Tax Instructions (11/14/13)

Judge Pauley's general criminal tax law instruction is:

General Instructions on Criminal Tax Law 

I will now turn to the charges in this case. The charges all relate to the federal tax laws and to the defendants’ design, marketing and implementation of the tax shelters that you have heard about at trial.  

I instruct you first that the income tax laws are constitutional and valid and everyone has a legal obligation to pay income taxes. However, as I told you at the outset, a taxpayer is entitled to arrange his or her affairs in any lawful manner to minimize the payment of taxes. One of the ways that people minimize the payment of taxes is through a tax shelter. The term “tax shelter” simply refers to a series of financial and related transactions that offer substantial tax savings as one of its main benefits. Some tax shelters are legal; others are not. It all depends on the facts about the individual taxpayer and the tax shelter involved. It is perfectly proper for a taxpayer to file his or her returns based on an aggressive or debatable tax position. If that position turns out to be incorrect, the taxpayer may be required to pay certain penalties. But this case is not about the actual collection of any income taxes that may be due to the United States or penalties imposed on any of the tax shelter clients. This is a criminal case.  

The Government brings this case to enforce laws that make it a crime to attempt to defeat or evade the payment of income taxes or to conspire to commit tax evasion or other related crimes. In a little while, I will instruct you in detail on the elements of a criminal violation of the tax laws. Overall, what you should keep in mind is that a person cannot be guilty of violating the federal tax laws if he believed that his conduct was lawful, even if it turns out that he was wrong about the law. 

JAT Comment:  The following key points are made:

1. Taxpayer can arrange his affairs to pay the minimum tax.
2. Tax shelters are defined as "simply" referring "to a series of financial and related transactions that offer substantial tax savings as one of its main benefits."
3. The jury is told that some tax shelters are legal, some are not -- with the distinction being dependent "on the facts about the individual taxpayer and the tax shelter involved."
4. The Court says that it will instruct as to the "criminal violation of the tax laws," which is presumably how the jury will distinguish between a legal tax shelter and an illegal tax shelter.
5. The Court ends with the short-form Cheek instruction.  The Court does have a Cheek "good faith" defense instruction later, after instructing about the crimes charged.  I will present a separate blog on that instruction.

The full set of jury instructions is linked here.