Sunday, January 31, 2010

Germany May be Lowering Its Sights on Switzerland

The Wall Street Journal reports here that the German Government is considering paying for allegedly stolen Swiss Bank data regarding German tax cheats. The article is a good read, but here is a teaser:
A confrontation with Germany could represent the biggest challenge Switzerland has faced thus far. Though the Swiss clash with the U.S. drew much attention, Americans with offshore accounts in Switzerland represented no more than 5% of Switzerland's $1.8 trillion offshore-banking business, according to KPMG.

German officials say the country's taxpayers have about €175 billion in Swiss bank accounts, or more than 10% of the total. According to KPMG, as much as 80% of European Union account holders' money in Switzerland is undeclared, and experts say Germans are among the biggest groups of tax evaders in Switzerland.
I suppose that, in yielding -- or appearing to yield -- to the U.S., the Swiss were simply trying to mitigate the damage.  But with other countries standing in line with equal or larger stakes, the threat to the Swiss way of doing banking business may be irreparable.  I hope so.

Not surprisingly, the article reports that Swiss officials are crying foul that another sovereign would pay for and use data stolen in violation of Swiss law.  I must admit that I previously thought that business of using and even paying for stolen Swiss bank data would be unseemly and inappropriate. No more. And, in any event, just the thought that it could happen should give further incentive to U.S. and other country taxpayers to seek amnesty in whatever form it may come (in the U.S. via voluntary disclosure).  The old attitude of catch me if you can seems foolhardy. 

If this is happening to the Swiss banks, other countries' banks are also at play.

Of course, these countries and the banks they enable could behave, probably a startling concept to them.  More likely than behaving, though, they will try to mitigate the damage while keeping as much as they can of their franchise to enable raids on the fiscs of other countries.

Update on 2/2/10:  The Tax Prof Blog has a blog on this here with helpful links to a number of news sources.  I note that the source for the German Government is an IT specialist.  Think of all those people working in the bowels of the banking industry who are now trying to figure out what they can do to become as rich as some of the people they turn in.  My experience is that persons playing the game of using Swiss banks to cheat on taxes thought that they had controlled the flow of information, but we now find that there are lots and lots of on the books and off the books potential breaches in that dam.

Saturday, January 30, 2010

David Cay Johnston's Thoughts on Swiss Criminal Enablers

David Cay Johnston has an interesting column, titled Enabling Tax Thieves, in today’s Tax Notes Today. Johnston “is a former tax reporter for The New York Times. He teaches at Syracuse University College of Law and is the author of two books about taxes, Free Lunch and Perfectly Legal.”

Here are a few quotes to give readers the flavor of the column (my addition in brackets):

Recent developments are making it clear that rather than being a legitimate nation, Switzerland seems not that much different from a criminal enterprise -- a rogue state and a kleptocracy that is a threat to every honest taxpayer in the rest of the world. The Swiss government differs from the usual leader of a thieving gang in one respect: It is not ratting out its partners in crime.

Other than its techniques of enforcement, what makes the Swiss government any different from the mob -- Alabanian, Colombian, Israeli, Russian, Sicilian?

[After reviewing recent developments with his own usual spin on them]

The expectation was that UBS would disgorge names and behave like a civilized institution. It would give up the tax cheats it helped and stop soliciting cheats. Instead the Swiss government has run interference on behalf of UBS -- and arguably all Swiss banks.

* * * *

However, this agreement [between the U.S. and the Swiss] never anticipated that the Swiss would lack honor, that their word is unreliable. The reason for this shortcoming is obvious -- no one at the DOJ believed that they were dealing with a rogue government.

* * * *

The American government should begin shutting down Swiss access to the American economy. The first step would be to announce that a grand jury is being impaneled to indict UBS and every officer and employee suspected of involvement in the cheating.

* * * *

And there is a symbolic gesture that President Obama could make that would probably be just as effective in scaring the Swiss into being honest: Pardon Bradley Charles Birkenfeld, who blew the whistle but is now serving 40 months because he was not entirely candid with the DOJ.

The point of pardoning Birkenfeld would be entirely practical. It would send a signal that in the interests of justice, the American government will overlook conduct by those who bring in major tax criminals and their enablers.

* * * *

The American government has long taken action against rogue states that threaten its interests -- from a nearly half-century economic embargo against Cuba to overthrowing regimes that harbor threats physical and financial to seizing Iranian assets.

The U.S. government deals with extraordinary harshness when the working poor, especially single mothers, make errors on their tax returns. Congress has given the IRS authority to deny the earned income tax credit for 10 years, more than half of a child's formative years.

Why do we treat the Swiss differently? Why do we show any tolerance to calculated crimes facilitated by greedy Swiss bankers?

So here is the question I ask my readers. What is the difference between the Swiss bankers and the Somali pirates?

Further on Use of Sentencing Tax Loss Findings in Later Proceedings (1/10/10)

This blog addresses excellent comments by Anonymous to a prior blog here

I focus on Anonymous' comment as follows: "But that admission [of the sentencing tax loss stipulation] itself is very persuasive and direct evidence that could clearly support a much higher burden of proof." First, let me say that stipulations are simply the basis for findings that the judge would otherwise be required to make on the basis of other evidence. Hence, for this purpose, there should be no difference between findings based on stipulations and findings based on other evidence. Paraphrasing your comment, I think you are saying that the sentencing tax loss finding could alone support a finding in a later civil (including immigration proceeding) where the Government must prove fraud and / or an amount by clear and convincing evidence. (Notice that the amount is an element of the statute for immigration purposes.)

So stated, there is actually considerable authority in the civil tax area as to the limited effect of sentencing tax loss findings. Predicate to understanding this authority, we must first focus on what the tax loss number is. The tax loss number is that number that the defendant / taxpayer intended to defraud the Government of. It is not the civil tax loss number which, in criminal tax cases, can be and often is much larger than the sentencing tax loss number (i.e., the civil tax loss, typically called the deficiency, is never less but can be more than the sentencing tax loss number). Moreover, the tax loss number is often not a crisp easily determined finite amount. Particularly when the result of stipulations, there is considerable negotiation about what the tax loss is – with the defendant’s counsel and the Government negotiation over what really was the object of criminal intent. Frequently, the amounts the Government originally asserted are whittled down substantially, and the reason that happens is often not because the tax is not due but because the Government has doubt that it can prove even by a preponderance that the disputed amount was due to fraud.  So the Government's preponderance burden plays a critical role in determining the tax loss amount and, by the same token, if the Government's burden in the sentencing phase were to prove tax loss by clear and convincing evidence, the tax loss number would or at least could be whittled down even further.

Now, let’s turn to the civil fraud tax case where this issue could arise routinely. I will assume a criminal conviction for § 7206(1). In that civil tax fraud penalty case that usually follows criminal conviction, the mainstream and universal holding is that the conviction itself is not preclusive of fraud, because all the conviction determines is that the taxpayer lied on the return and does not determine that he intended to defraud the Government of tax. But, in the sentencing hearing, the sentencing judge is required to find the tax loss and does so by a preponderance of the evidence. The tax loss has two important elements -- (1) an amount and (2) a relationship between the amount and some related (aka relevant conduct) intent to defraud the IRS of tax. The question, as in the immigration proceeding, is whether the finding of the tax loss as the first step in the Guidelines calculations is preclusive or even persuasive evidence in the civil fraud penalty proceeding where the Government must prove civil fraud by clear and convincing evidence. The answer to that question is no; the Government may introduce the sentencing finding in order to present full context for its other clear and convincing evidence of crime, but the Government could not prevail by just introducing the sentencing tax loss finding to met its burden by clear and convincing evidence that (1) the taxpayer did intend to defraud the Government and (2) the amount he or she intended to defraud.

I have addressed related themes in my article John A. Townsend, Collateral Estoppel in Civil Cases Following Criminal Convictions, 2005 TNT 4-28. My points in the article, bottom line, were (i) I accepted the universal holdings that the Government must prove by clear and convincing evidence that the taxpayer intended to defraud the Government of tax and must do so by something other than the mere sentencing findings of tax loss amount and (ii) that, once the Government shows fraud, then the sentencing tax loss finding could -- and should be -- be preclusive as to the amount. In both the civil and criminal proceedings, the amount determination is by a preponderance of the evidence. Now, as to the latter point, there is a razor-thin difference in the preponderance determinations in these proceedings -- i.e., in the sentencing proceeding, the Government is required to prove the amount by a preponderance but in the civil proceeding, the taxpayer is required to prove the amount not attributable to fraud. In my article, I argued that this razor thin difference (i.e., the difference being the state of equipoise which almost never is outcome determinative in the real world) is not significant enough to justify further litigation on the amount of the tax loss attributable to fraud.

No court has accepted my arguments (in burden language, I have not met my burden), so the state of the law as I understand it now is that, in the subsequent civil tax proceeding after a § 7206(1) conviction, (i) the IRS must prove fraud by clear and convincing evidence, (ii) (and this is my reading of the tea leaves), the IRS cannot rely only on the sentencing tax loss finding (whether the result of stipulation or an evidentiary proceeding), but must put on evidence of that breathes some persuasive life into the fraud, and (iii) if the IRS does breathe life into the taxpayer’s alleged fraud by clear and convincing evidence, the taxpayer must then whittle down the amount of the total deficiency (or the amount the IRS asserts as fraud) by the preponderance of the evidence.

The point of all this is that the stipulated tax loss, although containing both necessary “prepnderance” holdings as to the amount and as to the taxpayer's fraud, is not considered evidence sufficient alone to meet the IRS burden to prove fraud by clear and convincing evidence.

Now, moving back to Kawashima, I think the Court mouthed the right words in saying that the amount could be in play in the immigration proceeding (i.e., no preclusive effect), but I disagree with the suggestion that the stipulation / sentencing finding could alone be clear and convincing evidence as to the fraudulent amount.  I could agree that the sentencing amount determinations should be preclusive or perhaps even evidence standing alone without rebuttal of the amount if the Government in the immigration proceeding otherwise proved fraud, but as I noted, in the related context of civil tax proceedings, that is not the way the law has developed.

Friday, January 29, 2010

Truly Offshore Solutions to Offshore Bank Accounts May Not Be So Good

In the latest highly publicized spate of IRS initiatives against the use of offshore accounts to mitigate U.S. tax liability (that sounds better than to cheat on U.S. tax liability, although it is semantics), some U.S. persons decided that they would just avoid the problem (including past problems) by leaving the U.S. There are some downsides to that U.S. tax mitigation strategy.  One was a topic of comment at the recent ABA tax section meeting in San Antonio.  Practitioners were cautioned to make sure those persons who are or become their clients are advised about the potential tax costs of leaving the U.S. See § 877A. So, I pass this tip on to my readers.

The IRS has recently provided guidance under Section 877A in Notice 2009-85. And, the ABA Tax Section Newsquarterly has a point to remember article discussing this new guidance - Michael A. Spielman, Service Issues Guidance on Section 877A Exit Tax. Here is some excerpts from the article to whet your appetites (I have cut and paste this out of order for readability purposes here, but it is all in the article except as I indicate in brackets).
Under new section 877A [enacted in June 2008], Tax Responsibilities of Expatriation, covered expatriates (generally, U.S. citizens or long-term residents with a five-year average income tax liability exceeding $124,000 as indexed for inflation ($145,000 in 2009 and 2010) (“tax liability test”) or net worth of $2 million or more (“net worth test”), are immediately taxed on the net unrealized gain in their property exceeding $600,000 ($626,000 in 2009 and $627,000 in 2010) as if they sold the property for fair market value the day before relinquishing U.S. citizenship or terminating their U.S. residency (“expatriating”). This mark-to-market tax regime applies to all property of the covered expatriate, other than deferred compensation items, specified tax deferred accounts, and interests in a nongrantor trust of which the covered expatriate was a beneficiary on the day before the expatriation date. Separate provisions apply with respect to these items.
In addition to section 877A, HEART also introduced a new succession tax under section 2801 that imposes a tax on U.S. persons who receive a gift or bequest from an expatriate who was subject to the rules of section 877A. Generally, the rules under section 2801 require the recipient of the gift or bequest to pay tax on the fair market value of the property received at the highest gift or estate tax in effect on the date of receipt. Gifts or bequests to a qualified charity or U.S. spouse are exempt from the tax if made in a form that would be eligible for a deduction under the relevant estate or gift tax Code section. Although Notice 2009-85 does not provide guidance on section 2801, it indicates that future guidance on section 2801 will be issued separately.

Prior to the enactment of HEART, covered expatriates were subject to a 10-year alternative tax regime (1) on their U. S. source income and gain under section 877 and (2) a modified estate and gift tax regime under sections 2107 and 2501. In its most recent incarnation, as modified by the American Jobs Creation Act of 2004 (“AJCA”), section 877 became applicable solely on the basis of objective tests that measured an expatriating individual’s net worth and net income tax liability, without regard to whether the individual had a tax avoidance purpose for expatriating. AJCA also added a third test, which caused expatriating individuals to become subject to the 10-year alternative tax regime if they failed to certify compliance with all U.S. federal tax obligations for the five preceding taxable years. In addition, AJCA added section 877(g), which caused covered expatriates to be treated as U.S. citizens for all federal tax purposes for any year during the 10-year period in which they spent 30 days or more in the U.S. This 30-day rule was not carried over to new section 877A.

Ninth Circuit Joins the Parade on 7206(1) as Deportable Crime

In Kawashima v. Holder, 615 F.3d 1043 (9th Cir. 2010), here, decided 1/27/10, the Court held that Section 7206(1), tax perjury, was a deportable crime and that, depending upon the circumstances, Section 7206(2), aiding and assisting, may be a deportable crime. [Note: Kawashima was affrirmed by the Supreme Court in Kawashima v. Holder, ___ U.S. ___, 132 S. Ct. 1166 (2012), which is discussed in a subsequent blog titled Supreme Court Rules Tax Perjury and Aiding & Assisting Are Deportable Aggravated Felonies (2/21/12), here.]

I have previously written here on a petition for certiorari that was filed on the tax perjury issue. That discussion gives more detail, so I will just be more summary on the general issue and develop a nuance that I find interesting.

The petitioners in Kawashima had pled guilty as follows: (1) the husband to tax perjury and (2) the wife to aiding and assisting. At sentencing, Mr. Kawashima stipulated that the "total actual tax loss" was $245,126.  Using this evidence, the Board of Immigration Appeals ordered deportation upon finding that the crimes were "aggravated felonies."  The petitioners appealed.

The Ninth Circuit crisply states the interpretational issue as follows (the words are the Ninth Circuit's but I divide the words into subparagraphs to highlight the issue):
We are faced with the task of determining whether Mr. Kawashima's conviction for willfully making and subscribing to a false statement on a tax return, in violation of § 7206(1), and Mrs. Kawashima's conviction for aiding and assisting in the preparation of a false tax return, in violation of § 7206(2), constitute aggravated felonies.

Section 1101(a)(43)(M) defines an "aggravated felony" to include "an offense that

(i) involves fraud or deceit in which the loss to the victim or victims exceeds $ 10,000; or

(ii) is described in section 7201 of Title 26 (relating to tax evasion) in which the revenue loss to the Government exceeds $ 10,000." 8 U.S.C. § 1101(a)(43)(M)(i)-(ii).

Tuesday, January 26, 2010

The KPMG Enabler Convictions -- The Role of the Absent Taxpayers (1/26/10)

In the Larson/Pfaff/Ruble case, currently on appeal to the 2d Circuit, the trial Judge instructed the jury:
In order to establish that a transaction lacks economic substance, the government must prove beyond a reasonable doubt both of two factors. The first factor is that the relevant taxpayer had no business purpose for engaging in the transaction apart from creating the tax deduction. The second factor is that there was no reasonable possibility that the transaction would result in a profit.
(See here for the complete instruction.)

I want to focus again on the first element -- the proof beyond a reasonable doubt that the relevant taxpayer had no business purpose for engaging in the transaction apart from creating the tax deduction. (I refer in this blog to this purpose as just business purpose without repeating the formulaic words "apart from the tax deduction.") That instruction, in effect, tells the jury that the jury can convict the indicted enabler defendants of tax evasion if -- and only if -- the jury finds that the unindicted taxpayers were also guilty of tax evasion.

To some, that statement may not seem inevitable. Why can the enabler defendants in the case be convicted only if the unindicted taxpayers were guilty of tax evasion? Well, first off, no one could be convicted of tax evasion unless there is a tax due and owing. I have addressed concerns about tax due and owing in the case before, but I accept that, for purposes of this blog, the Government proved tax due and owing so as to be able to convict the indicted enablers for tax evasion. I now focus on the economic substance charge given above -- that the Government prove beyond a reasonable doubt that the taxpayers involved had no business purpose. Each of those taxpayers represented that they had such a business purpose. So, if the jury could make the finding that each of the taxpayers did not in fact have such a business purpose, they necessarily had to find beyond a reasonable doubt that they had committed tax evasion. They may not have brought back a guilty verdict against those taxpayers (who were not and never have been charged) but that is the inevitable conclusion of the jury's verdict under the instructions given by Judge Kaplan.

The question I now ask is whether the Government really proved a tax evasion case against each of those taxpayers as a necessary, but unstated, requirement to make the finding of guilt of tax evasion against the indicted enablers. I have previously suggested that, at least for some of the counts of conviction for evasion, the Government showed precious little about the subjective intent of the taxpayers and, in fact, only showed that, perhaps, a reasonable taxpayer could have had the intent.

One can fight over the fair inferences from the proof at that particular trial, but I ask you to assume with me now that the gravamen of the proof was as follows: (i) the underlying investment play wrapped into the BLIPS program was such that there was no objectively reasonable possibility of profit (let's not fight either about what reasonable is, or is is for that matter), so that it is fair to infer that a reasonable business-purpose motivated taxpayer would not enter the deal; (ii) Taxpayer B entered into the deal; (iii) Taxpayer B had a lot of income that was sheltered by the deal; (iv) Taxpayer B was a very successful businessman, at least in terms of his ability to earn lots of income as reflected on his returns; and (v) Taxpayer B represented in the deal documents that he did have a subjective business purpose apart from the tax benefit.

I think the question no those bare assumptions is whether there is a criminal jury issue on Taxpayer B's subjective business purpose. Stated otherwise, the question is whether there is sufficient evidence that a reasonable jury could find beyond a reasonable doubt that Taxpayer B did not have the subjective business purpose he represented he had in the deal documents. I think on the bare facts I have posited, the evidence would not be sufficient.

This point can best be made by adding an additional assumed fact -- that it is Taxpayer B who is charged with evasion.  I suggest that tax evasion trials require a whole lot more essential background and proof bearing upon the taxpayer's subjective intent before the jury is permitted to determine whether a taxpayer is guilty of tax evasion. Ultimately, the Government will have to prove that the taxpayer knowingly lied in making the business purpose representation, from which the jury could infer that he intentionally violated a known legal duty. And in order to do that the Government would have to make an individualized showing about the particular taxpayer involved, his education, his business savvy, his advisors on the deal, and other facts from which, in the context of a complete picture about that taxpayer, the jury could infer the lie and the corresponding intent to violate a known legal duty. If all the jury had was the spare facts I have assumed, I doubt that the case would survive a motion for acquittal.

Moreover, there is at least a risk of great unfairness to making an unindicted taxpayer's subjective motives essential to a conviction of other parties.  The indicted parties have little ability to mount an effective defense -- particularly as to charges of tax evasion which required a host of detailed knowledge and proof about a particular taxpayer's motivations.  The Government can get its view of the proof by hauling those unindicted taxpayers into proffer sessions and grand juries and otherwise browbeating them into submission with threat of prosecutions and even inducement -- ultimately promises or, wink-wink, suggestions of nonprosecution -- to admit their culpability and convict others based on the taxpayers' alleged subjective beliefs which might be very malleable with the right inducements / or threats.  The indicted parties, however, can provide no such inducements for the taxpayers' cooperation nor even effectively pursue any discovery from them to make a defense to the essential claim that the taxpayers, by lieing about their business purpose, committed tax evasion.
What do the readers of this blog think about these concerns?

Monday, January 25, 2010

Developments on the Swiss Tax Cheat Front

I suppose all readers of this blog probably already know about last Friday's decision by a Swiss court that holds illegal under Swiss law the agreement between the U.S. and Switzerland to turn over account information for a key category of U.S. taxpayers. For those who have not, I just point them to a some articles (see here and here) and make a few comments below.


I find it interesting the hyperbole that is surrounding this topic. For example, this posting on swissinfo.ch says that the president of Switzerland's Federal Administrative Court is looking to Parliament to resovle the issue of "whether tax evasion was a criminal offence." The reference is the interface of the Swiss law with the exchange of information provision in the double tax treaty with the U.S. The interesting quote is:
Bandli stressed that the cabinet was not the proper body to make that decision, which would effectively quash the principle of banking secrecy.
As I read this, the startling claim is that Swiss bank secrecy is all about enabling depositors to evade tax in other countries. I would have thought that there are plenty of rogues and brigands who have nontax reasons to hide assets (people do find other ways than tax to cheat and steal) and that Switzerland would continue to be a safe haven for them. But, of course, enabling depositors to cheat the fiscs of other countries is a major part of Swiss banks business. So, opening the kimono for tax cheats could have a major economic effect on Switzerland's ability to charge more for services than they are worth without the value added service of assisting them to cheat on their taxes.

Tuesday, January 19, 2010

More on Legal Uncertainty and, More Importantly, the Subjective Prong of the Economic Substance Test (1/19/10)

I have previously discussed here the economic substance instruction that Judge Kaplan gave in the skinnied down KPMG trial that resulted convicted three defendants of multiple tax evasion crimes and is currently on appeal to the Second Circuit. I blogged about the Government’s outsized brief filed last Friday (see the brief here). My topic of focus was the effect of legal uncertainty in the law.

Today, I carry that discussion further in the context of the Government’s claims about the role of the economic substance doctrine in a criminal tax case. To set the stage, there clearly is some uncertainty in the civil cases about the economic substance doctrine. Two tests have been developed, which the Government calls (Br. 55) and most practitioners call a subjective prong and an objective prong. The subjective prong is whether the taxpayer engaging in the transaction had a nontax profit or business objective. Under this test, tax can be a consideration but the taxpayer must have an actual business or profit object or intent; further, there is no requirement that the taxpayer's objective be reasonable. The objective prong is whether the transaction has some – perhaps limited to some reasonable – possibility of profit. The major uncertainty from the civil cases is whether the tests are in the conjunctive or disjunctive. That is, whether a taxpayer desiring to sustain his claim of tax benefits must prove (i) both that he had the profit objective (however unreasonable) and that it was a reasonable profit or business objective or (ii) either of those prongs. (For tax coneheads (among whom I number myself), this objective / subjective inquiry, if indeed conjunctive, may be analogized to the relief from the substantial understatement penalty for tax shelter transactions if the taxpayer had a belief that the transaction will more likely prevail and the belief is objectively reasonable.) The courts in the civil cases are split on that conjunctive / disjunctive issue for the economic substance test.

To state the obvious, criminal cases are not civil cases and different policies are implicated that requires some role reversal. The criminal case asks whether the Government has proved beyond a reasonable doubt that the civil tax result is certain and was willfully violated. Accordingly, in instructing the jury, as he should in a criminal case, Judge Kaplan adopted the most defendant friendly version of the split – that is, he advised the jury that the Government had to both that there was no taxpayer profit or business objective and no reasonable profit or business objective. I have doubts about turning over the economic substance test under either formulation to a jury in a criminal case, but if it must be turned over (and Second Circuit authority says it must), I think Judge Kaplan made the right choice by requiring the conjunctive application of the test. (It is important at this stage to note that the Government argued to Judge Kaplan that the jury should be instructed in the disjunctive – i.e., the jury can convict if either (i) under the subjective prong, the Government proved beyond a reasonable doubt that the taxpayers involved had no profit or business motive, or (ii) under the objective prong, the Government proved beyond a reasonable doubt that there was no possibility – or, in the Government’s mind reasonable possibility -- of profit; that notion is just goofy in a criminal case, but I won't digress further here.)

Monday, January 18, 2010

Epic Tales - the Government Brief in KPMG Criminal Case and Uncertainty in the Law

The Government's long awaited epic (209 pages to conclusion) brief to the Second Circuit in the KPMG criminal case is now out. Readers of the blog may review and download it here.

There is a lot in the brief. I quickly spotted length and healthy doses of what appears to be both wheat and chaff. I also found many rhetorical flourishes (probably chaff, but making for a good read to grab interest).  I am not yet certain whether the rhetorical flourishes have much substance, but that is beyond my pay grade anyway.

I did find one Government claim in the brief with hyperbole and error. The claim is (pp. 103-104):
Larson concedes that the trial evidence sufficed to demonstrate that he “subjectively did not believe that the BLIPS transaction had a ‘reasonable possibility of profit.’” (Larson Br. 16). He contends, however, that this concession is of no moment — that the jury, instructed as it was on “willfulness,” was nonetheless not entitled to find that he intentionally evaded taxes because his subjective intent to intentionally violate the tax laws was irrelevant. Larson asks this Court to hold that “as a matter of law. . . a defendant cannot intentionally violate a known legal duty if the substance of that duty would have been objectively unclear to a fully informed lawyer or judge at the time.” (Larson Br. 16, 38 emphasis added); see also Pfaff Br. 29-30; Ruble Br. 25-26). According to the defendants, the economic substance doctrine was sufficiently murky at the time of their conduct, objectively speaking, to foreclose willfulness.

Put simply, the defendants argue that the fact that they intentionally broke the law and knew that they were intentionally breaking the law — facts that the jury found beyond a reasonable doubt — are irrelevant, because in 1999 other people might not have known that their conduct was against the law. This breathtaking argument confounds law and common sense. This precise claim has been rejected by this Court and is hence foreclosed.
 I think that Government's claim is just flat out wrong. I have previously discussed this issue both in my book (pertinent portions here) and in some blogs here, so will not repeat the details. I just summarize my claim of hyperbole and error.

In James v. United States, 366 U.S. 213 (1961), here, the Supreme Court held that legal uncertainty -- i.e., actual uncertainty in the state of the law -- is a bar to prosecution for a tax crime which requires willfulness. In James, the defendant had been prosecuted and convicted, meaning that the jury had determined that he had intended to violate a known legal duty. The problem was that he only thought he knew the law he intended to violate. The Supreme Court held that, regardless of his intent to violate the law, the law in question was legal sufficiently uncertain that James could not be convicted regardless of his intent. 

That is pretty much it.  (The summary is heavily dependent upon understanding the intramural dispute among the Justices evidenced in the various opinions in James, so that is the best place to start.)

The Government's only reference to James is on page 109 to the fact that defendants cite the case and some notion that it is "nothing like this case" because it involved ambiguity "from dueling Supreme Court opinions, which were directly in conflict on the specific tax question at issue in that case."  The Government does not explain and I cannot fathom how the principle of James that uncertainty in the law is a legal barrier to prosecution and conviction is a special rule requiring uncertainty caused by the Supreme Court.  The issue is one of certainty in the law such that a citizen can be criminally prosecuted and proper notice to all citizens; that not dependent upon the Supreme Court's failings or timidity.

Saturday, January 16, 2010

Fourth Circuit Cites S.G. Tax Sentencing Policy in Reversing Sentencing Variance (1/16/10)

In United States v. Engle, 592 F.3d 495 (4th Cir. 2010), here, decided 1/13/10, cert. den. 131 S. Ct. 165 (2010), the Fourth Circuit remanded an exceptional sentencing variance emphasizing the Sentencing Commission's introductory comment in S.G. Ch. 2, Pt. T:
The criminal tax laws are designed to protect the public interest in preserving the integrity of the nation's tax system. Criminal tax prosecutions serve to punish the violator and promote respect for the tax laws. Because of the limited number of criminal tax prosecutions relative to the estimated incidence of such violations, deterring others from violating the tax laws is a primary consideration underlying these guidelines. Recognition that the sentence for a criminal tax case will be commensurate with the gravity of the offense should act as a deterrent to would-be violators.
The Court also noted the following policy statement that the Guidelines
classify as serious many offenses for which probation was frequently given and provide for at least a short period of imprisonment in such cases. The Commission concluded that the definite prospect of prison, even though the term may be short, will serve as a significant deterrent, particularly when compared with pre-guidelines practice where probation, not prison, was the norm.
The factual background was this (at least the parts I feel most material):
The criminal information charged Engle with tax evasion for the 1998 tax year only, although the information alleged that Engle had evaded taxes for sixteen years between 1984 and 2002 and owed taxes of more than $600,000. With interest and penalties included, Engle's total tax liability exceeded $2 million. Engle's actions to avoid taxes included providing false information to the Internal Revenue Service, placing assets in others' names, and funneling income through shell corporations that he controlled.

Engle pleaded guilty to the information in 2004 and proceeded to sentencing almost two years later, in February 2006. Based on a total offense level of 17 and a category II criminal history, the presentence report calculated Engle's advisory sentencing range as 27-33 months. The district court concluded that Engle's criminal history was overstated and therefore reduced Engle's criminal history to category I, yielding an advisory sentencing range of 24-30 months.
The sentencing court clearly wanted a variance -- granting it not once but twice and chastising the Government attorney for wanting blood rather than money. The second time the sentencing court said:

Tenth Circuit Summarizes Double Jeopardy in Rejecting the Argument (1/16/10)

In United States v. Farr, 591 F.3d 1322 (10th Cir. 2010), decided 1/11/10), the Tenth Circuit rejected a double jeopardy argument under the following facts:
Skoshi Thedford Farr was convicted by a jury of evading taxes in violation of 26 U.S.C. § 7201. We reversed her conviction on appeal because the proof presented at trial and the district court's jury instructions constructively amended the indictment. She was subsequently indicted for violating the same statute based on the same conduct. The district court denied her motion to dismiss on double jeopardy grounds. For the reasons that follow, we AFFIRM the district court's decision.
The Court's discussion of double jeopardy is short and sweet (p. 1325, case citations and quotation marks omitted for readability):
The [double jeopardy] clause only creates an impediment to subsequent prosecution when there was previously a judgment of acquittal on the charge.

The successful appeal of a judgment of conviction, on any ground other than the insufficiency of the evidence to support the verdict, poses no bar to further prosecution on the same charge, but a judgment of acquittal, whether based on a jury verdict of not guilty or on a ruling by the court that the evidence is insufficient to convict does bar future prosecution on the same charge. Whether a judgment or reversal constitutes an acquittal is not controlled by the form of the court's decision. Instead, `we must determine whether the ruling of the judge, whatever its label, actually represents a resolution, correct or not, of some or all of the factual elements of the offense charged.

Neither the district court nor this court made factual findings tantamount to a judgment of acquittal.

Friday, January 15, 2010

Criminal Statute of Limitations and the Timely-Mailing, Timely-Filing Rule

In Luparella v. United States, 335 Fed. Appx. 212, 2009 U.S. App. LEXIS 12440 (3d Cir. 2009) (unpublished), the defendant was convicted of tax crimes (conspiracy, aiding and assisting and, apparently, tax perjury). In relevant part, defendant signed his tax return on 9/24/96. Defendant alleged that he mailed the return on 9/25/96. The IRS received the return by mail on 10/2/96, "six postal days after Luparella allegedly mailed the return." The indictment was returned on 9/25/02, There are no other relevant facts recounted in the opinion. The issue in this habeas corpus case was whether the indictment was untimely.

Defendant argued that, under the timely mailing, timely filing rule in Section 7502, since he filed the return on 9/25/96, the indictment on 9/25/02 was one day short of the 6 year statute of limitations. Here's how the court handled / mishandled the argument:
Luparella argues that a tax return is "filed" on the date it is mailed, and insists that his tax return was mailed on the date it was signed, September 25, 1996. Since the Indictment was not returned until September 25, 2002, he contends that it is untimely by one day, and that his counsel was ineffective for failing to object to the admissibility of the tax return and for failing to move to strike Count 2 as untimely.

We are not persuaded. This is because Luparella has offered no relevant support for his assertion that a tax return is considered "filed" for statute of limitations purposes on the date it is mailed. He cites to 26 U.S.C. § 7502, which states that "[t]imely mailing [is] treated as timely filing and paying" for the purposes of processing a tax return. This provision does not speak to when the statute of limitations begins to run for a charge of criminal tax fraud. n5

n5 Although we do not reach the merits of this issue, we note that the Government's position -- that the statute of limitations begins to run on the date the return is filed with the IRS (which is also the date of receipt by the IRS service center) -- finds support in caselaw. See United States v. Matis, 476 F.Supp. 1287, 1293 (S.D.N.Y. 1979) (noting that the statute of limitations began to run in a tax fraud case on the date the return was received by the IRS); United States v. Stella, 745 F. Supp. 195, 197 (S.D.N.Y. 1990) (stating that the date of the "receipt" stamp by the IRS indicates the date at which the receipt was filed, and begins the statute of limitations for a tax fraud prosecution).

Further, even if Luparella's legal argument had legal support, he has provided no evidentiary support for the assertion that his return was mailed on the date it was signed. In the absence of such support, his assertion is unconvincing, particularly since the IRS did not receive the tax return until October 2, 1996 -- six postal days after Luparella allegedly mailed the return.
The Court got the right result -- timely indictment -- but for the wrong reasons. Section 7502(a), the timely-mailing, timely-filing rule, provides in pertinent part:
If any return * * * required to be filed * * * on or before a prescribed date * * * is, after such period or such date, delivered by United States mail to the agency * * * with which such return, claim, statement, or other document is required to be filed, * * * the date of the United States postmark stamped on the cover in which such return * * * is mailed shall be deemed to be the date of delivery* * * *.
The provision is a relief provision designed to treat a return that is otherwise untimely when filed (i.e., the date received by the IRS) as timely filed. Stated otherwise, this provision applies only if the return is untimely filed (for this purpose, received by the IRS) but timely mailed, in which case it is deemed timely filed. If the return is timely filed (i.e., received by the IRS during the period that it is required to be filed), then it is filed on the date that it is received and 7502 does not apply. For example, if the taxpayer mails his 01 return to the IRS on 4/1/02 and it is received and filed 4/4/02, then it is actually filed 4/4/02. (There is another rule that says that a return received before the original due date for the return, in this case 4/15/02, is deemed filed on the original due date (4/15/02); this rule does not apply during extensions.) So for all purposes, including criminal prosecution purposes, the starting due date in this example is 4/15/02. But the taxpayer in Luparella did not mail or file by the original due date (4/15/02 in the example and 4/15/96 in the actual case).

So we now look to the rules that apply to returns filed after the original due date. Keep in mind that the actual filing date is the date the IRS receives it. In Luparella, the taxpayer could benefit only if the timely-mailing, timely-filing rule permitted an earlier filing date. We have two possible scenarios.

1. If the taxpayer applied for and obtained an extension (let's say the usual one through 10/15/02 in the example and 10/15/96 in the case), then the IRS would have received the return within the filing date as extended and 7502 would not apply. (When teaching this, I encourage my students to think about why that is the case -- that taxpayer, having timely filed, does not need timely-mailing, timely-filing relief and the statute thus does not provide the relief.)

2. If the taxpayer did not file for the extension and thus was not timely when he mailed the return or it was received by the IRS, § 7502 simply does not apply because it requires a timely mailing in any event.

Under either of these scenarios (the only two possible), the taxpayer loses on a straight-forward application of the statute. The Court just did not get it. (I have not read the briefs, so do not know whether the Government served it up to the Court.) For more reading on this, I offer my current draft of the relevant portion of my Tax Procedure book here (note that in my book materials I discuss the § 7502 timely-mailing, timely-filing rule and the common law mailbox rule (which also would not apply in the Luperella facts) and provide extended examples).

Thursday, January 14, 2010

Notable Decision in SDNY Criminal Tax Shelter Case (1/14/10)

I have previously blogged that John B. Ohle was an unindictead alleged co-conspirator in the Daugerdas et al. indictment.  See here.  Ohle was indicted apart from that indictment.  He was indicted along with a guy named Bradley.  That indictment generated a significant decision from Judge Leonard Sand in United States v. Ohle, 2010 U.S. Dist. LEXIS 2150 (SDNY No. S2 08 Cr. 1109 (LBS)).  The following are the points that attracted my particular attention:

1. The Court rejected a challenge to the wire fraud count (Count One). Ohle argued that "Count One of the indictment impermissibly uses the wire fraud statute to reach an alleged criminal tax conspiracy, citing United States v. Henderson, 386 F. Supp. 1048 (S.D.N.Y. 1974)." The Court essentially took the life out of Henderson. Prosecutors have their choice of how to charge tax conspiracies. Why does it matter if a conspiracy is a conspiracy and there is a single punishment scheme in 18 U.S.C. § 371? Ah, but there are other potential consequences of wire and mail fraud -- forfeiture and even ramping up to money laundering or RICO -- which are not available for tax crimes and tax conspiracy (either offense or Klein defraud conspiracy). See fn. __ on page __. For the DOJ Tax Division policy for prosecutors to make the choice, see Directive No. 128 here (noting that virtually all tax crimes can be charged as mail or wire fraud, and attempting to provide guidance and preclearance directives so the mine-run tax cases are not willy-nilly charged as mail or wire fraud). Thus, these charging decisions are not tweedle dum / tweedle dee from the defendant's perspective.

2. The Court rejected a challenge to another conspiracy (Count Five) as duplicitous. The indictment contained a "boilerplate" allegation that appeared to allege a single conspiracy. The overt acts, however, seemed to suggest multiple conspiracies. Yet, because the apparent multiple conspiracies were related and involved players not acting in a vacuum, with compensation flowing around, the Court concluded that the allegation is of a single conspiracy and not multiple conspiracies so as to implicate duplicity concerns. In the process of getting to that holding, the Court had a nice discussion of the concerns that are implicated by duplicity in counts (case names and quotation marks omitted to easier see the logical flow):
An indictment is duplicitous if it joins two or more distinct crimes in a single count. Duplicitous pleading is not presumptively invalid; rather, it is impermissible only if it prejudices the defendant. Duplicity is only properly invoked when a challenged indictment affects one of the doctrine's underlying policy concerns: (1) avoiding the uncertainty of a general guilty verdict, which may conceal a finding of guilty as to one crime and not guilty as to other, (2) avoiding the risk that jurors may not have been unanimous as to any one of the crimes charged, (3) assuring the defendant has adequate notice of charged crimes, (4) providing the basis for appropriate sentencing, and (5) providing the adequate protection against double jeopardy in subsequent prosecution.

The Court of Appeals for the Second Circuit has recognized that application of the duplicity doctrine to conspiracy indictments presents "unique issues." In this Circuit, it is well established that [t]he allegation in a single count of a conspiracy to commit several crimes is not duplicitous, for the conspiracy is the crime and that is one, however diverse its objects. A single conspiracy may be found where there is mutual dependence among the participants, a common aim or purpose or a permissible inference from the nature and scope of the operation, that each actor was aware of his part in a larger organization where others performed similar roles equally important to the success of the venture. Each member of the conspiracy is not required to have conspired directly with every other member of the conspiracy; a member need only have participated in the alleged enterprise with a consciousness of its general nature and extent. If the Indictment on its face sufficiently alleges a single conspiracy, the question of whether a single conspiracy or multiple conspiracies exists is a question of fact for the jury. Accordingly, courts in this Circuit have repeatedly denied motions to dismiss a count as duplicitous.

9th Circuit Imposes a Sentencing Double Whammy for State Tax Loss Relevant Conduct

In United States v. Yip, ___ F.3d ___ (9th Cir. 2010), decided 1/13/10, the Ninth Circuit held, consistently with most other circuits, that relevant conduct for sentencing purposes includes relevant state tax loss in determining the tax loss for the first step of the tax crimes sentencing calculation. See my prior blog here discussing United States v. McElroy, 587 F.3d 73, 88-89 (1st Cir. 2009). The Ninth Circuit also held that the relevant conduct factored into this tax loss calculation is not concerned with expiration of the statute of limitations for criminal prosecution. Finally, the Ninth Circuit, having just required the state tax relevant conduct to be included in the tax loss, said that the defendant is not entitled to factor in the appropriate federal tax deduction for state taxes. This is the holding I discuss in this blog.

The unclaimed deductions issue may present itself at two stages of a criminal case -- (i) at trial in addressing the tax due and owing element that the Government must prove (see my prior blog here; see also United States v. Helmsley, 941 F.2d 71, 83- 89 (1991), cert denied, 502 U.S. 1091 (1991).); and (ii) at sentencing in determining the offense level under S.G. 2T1.1. The holding in Yip addresses only the second stage. I quote from the opinion so the reader can understand the Ninth Circuit's reasoning (case citations and one footnote omitted):
Relying on the latter clause, the Second Circuit has concluded that, under the amended Guidelines, tax loss should be adjusted for "'legitimate but unclaimed deductions.' " Several other circuits, however, disagree. These sister circuits have offered three reasons to refuse to allow a defendant to reduce tax loss by the amount of unclaimed deductions. First, deductions are not permissible if they are unintentionally created or are unrelated to the tax violation, because such deductions are not part of the "object of the offense" or intended loss. Second, the revisions of Amendment 491 [to the Sentencing Guidlines] were so extensive that the mere fact that the revised § 2T1.1 does not include the former "offsetting adjustments" reference fails to demonstrate that deductions are now permissible. Finally, our sister circuits reject the nebulous and potentially complex exercise of speculating about unclaimed deductions. The Tenth Circuit observed that it does not interpret the Guidelines "as giving taxpayers a second opportunity to claim deductions after having been convicted of tax fraud. . . . Rather, we are merely assessing the tax loss resulting from the manner in which the defendant chose to complete his income tax returns."

We are persuaded by the Fourth, Fifth, Seventh, Tenth, and Eleventh Circuits. The amendment to § 2T1.1's application notes is irrelevant to our analysis. It is true that the notes no longer state that § 2T1.3's alternative minimum standard "may be easier to determine, and should make irrelevant the issue of whether the taxpayer was entitled to offsetting adjustments that he failed to claim." But this sentence was deleted when § 2T1.3 was deleted in its entirety from the Guidelines. As a reference to § 2T1.3 was no longer logical, such a change does not show an intent to allow unclaimed deductions sufficient to undercut our decision in Valentino.

Section 2T1.1 does permit "a more accurate determination" of tax loss than the 28% approximation. A more accurate determination might involve applying a different tax rate or incorporating exemptions and deductions legitimately claimed by the taxpayer on a tax return. But that section does not require a court to speculate about tax deductions that the taxpayer chose not to claim. n3 We hold that § 2T1.1 does not entitle a defendant to reduce the tax loss charged to him by the amount of potentially legitimate, but unclaimed, deductions even if those deductions are related to the offense.

n3 We note, for instance, that a taxpayer is entitled to deduct either state income tax or state sales tax, but not both. 26 U.S.C. § 164(b)(5)(A). Some of the states in our circuit impose both an income tax and a sales tax. Reconstructing a hypothetical federal tax return for a resident of one of these states would require selecting between these potential deductions.

In Defendant's case, he cannot even argue that the state taxes are legitimate, but unclaimed, deductions. The state taxes are not legitimate deductions because he did not pay them. A cash-basis taxpayer may deduct state and local taxes "for the taxable year within which paid." 26 C.F.R. § 1.1641(a). The district court properly refused to reduce the tax loss attributed to Defendant to account for an imputed deduction from his unpaid state taxes.
The court ultimately held that the defendant was not entitled to the deductions because he had not paid the state tax. It is not at all clear that the Ninth Circuit would allow the deductions even for an accrual method taxpayer. In apparent dicta (not necessary because of the "not paid / cash method" final holding), the Court sweeps very broadly on the issue of unclaimed deductions.

I am troubled by the Ninth Circuit's refusal to allow the state tax deduction after it required, properly I think, that the state tax loss be included in the calculation. The purpose of the tax loss calculation is to determine the loss by reference to what the taxpayer would have paid if he had done it right. If the had done it right, the state tax would have been paid (hence failure to pay is properly included in the sentencing tax loss) and the state tax deduction would have been taken in calculating the federal tax loss (hence federal tax would have been less). That should, in my mind, set the appropriate tax loss for sentencing purposes.  But I am not the judge (or judges in this case).

I am also unpersuaded about the perceived difficulty or uncertainty in making the calculation.  We require citizens to make this type of calculation routinely in filing their tax returns.  This is not beyond the capacity of the courts, the Probation Office and counsel for the parties (and their experts) to calculate or make a reasonable estimate of what the effect of these unclaimed deductions should be.

Monday, January 11, 2010

Court Finds Tax Motivated Transactions are Bullshit (1/11/10)

In Wells Fargo & Company v. United States, 91 Fed. Cl. 35 (2010), the Court of Federal Claims shot down another SILO transaction. In the smoke and mirrors scheme, the Court denied depreciation and interest deductions. In lay terms, the court found that the transaction was just bullshit, meaning also, I guess, that the arguments to sustain the transaction were also bullshit. (Sort of like Vincent LaGuardia Gambini's (aka Vinny) pithy argument in My Cousin Vinny - "Uh... everything that guy just said is bullshit... Thank you.") For the audio, click here.

Now, the Court of Federal Claims could not dispense of the case on that articulated basis, but it did the legal equivalent in more legalese (and words). The legalease is that the transaction lacks economic substance (the recognized way to say that transactions are bullshit). So that is what the court did.

I don't think that these transactions are materially different than the transactions involved in the KPMG prosecutions; indeed at some level they may be worse. As I have said, criminal tax cases are all about the lie. And, there appears to have been lies in these transactions. As the Wells Fargo Court said in concluding its analysis of the depreciation deductions denying the depreciation (quoting the Fourth Circuit in BB&T Corp. v. United States, 523 F.3d 461, 477 (4th Cir. 2008).):

The IRS was entitled to view these SILO transactions for what they are, not what they purport to be. As the Fourth Circuit observed in BB&T, citing an Abraham Lincoln riddle from Rogers v. United States, 281 F.3d 1108, 1118 (10th Cir. 2002), "How many legs does a dog have if you call a tail a leg?"

The answer is 'four,' because 'calling a tail a leg does not make it one.' Id. Here, BB&T styled the LILO as a lease financed by a loan, but did not in substance acquire a genuine leasehold interest or incur genuine indebtedness. Accordingly, . . . whether it has 'reached the point where the tax tail began to wag the dog,' Hines, 912 F.2d at 741, we conclude that the Government was entitled to recognize that tail for what it was, not what BB&T professed it to be.
BB&T, 523 F.3d at 477. The Court agrees fully with the Fourth Circuit's analysis in BB&T, and concludes that, looking at the substance of the SILO transactions, Wells Fargo did not become the owner for tax purposes of the SILO equipment, and is not entitled to the depreciation amounts claimed.
The Court also registered its disgust for this attempted stealth raid on the Treasury:

The SILO transactions here are offensive to the Court on many levels. A cadre of company executives, in concert with teams of well known legal and accounting firms and other consultants, regularly constructed and participated in these tax schemes for Wells Fargo, apparently blind to professional standards of care. Representatives from the Federal Transit Administration ("FTA") encouraged transit agencies to participate in SILO transactions as a way to raise additional funds, without seriously considering the probable adverse tax treatment of the transactions. Even when the IRS issued a 1999 Revenue Ruling disallowing tax deductions from LILO transactions, the participants continued on with only slight adjustments to create the SILO transactions. The Court has little sympathy for those who have lost out as a result of this decision.
Update on 1/12/10 at 11:50am:  I have corrected this blog to make bullshit a single word rather than two.  (I should note that I had it right in the quote from Vinny; that guy knows how to spell.)  For more on bullshit, there are two good Wikipedia entries -- one is general on bullshit here and the other is on Harry Frankfurt's "On Bullshit" here.  For the published version of Franfurt's landmark thoughts, see here; for the earlier non-published version of Frankfurt's landmark essay on bullshit, see here.

Update on 8/20/11:  The trial court's decision was affirmed in Wells Fargo & Company v. United States, 641 F.3d 1319 (Fed. Cir. 2011).

Friday, January 8, 2010

Swiss Court Holds Swiss Finma Ruling for UBS to Disclose Names Illegal

Bloomberg reports today that:
The Swiss Financial Market Supervisory Authority, known as Finma, exceeded its authority when it told the bank [UBS] Feb. 18 to deliver the information to the U.S., the Federal Administrative Court in Bern ruled today.
This ruling deals only with the approximately 255 names delivered before the Swiss and the U.S. agreed upon an interpretation and application of the double tax treaty exchange of information provision that permitted the rolling turnover of about 4,450 names.  The validity of the larger treaty exchange has yet to be determined.

For the complete article see here.

Thanks to a commenter, Anonymous, for reporting this breaking news.  For Anonymous' comment and others related to whether the U.S. can or should use for criminal prosecution - and perhaps for civil tax purposes -- information illegally obtained from foreign sources, see here.

I will post updates to this blog as I obtain details.  Any significant developments may be presented in a separate blog.

Wednesday, January 6, 2010

Tax Court Decides that Restitution Payments Related to a Trade or Business are Deductible

In Cavaretta v. Commissioner, T.C. Memo. 2010-4, the Tax Court held that contractual restitution paid by a Dentist to an insurance company to compensate for overcharges are deductible as ordinary and necessary business expenses rather than losses. This resolution permitted the taxpayer (the Dentist) to carry the current year losses generated by the deduction of the restitution payments back to an earlier tax year to obtain a refund.

The holding is not a broad holding that restitution payments are ordinary and necessary business expenses or are always deductible in some manner under the Code. Let's address the holding in the context of the facts.

The taxpayer was a dentist. His wife worked in his dental office. His wife began charging an insurance company for services that were not rendered to the insured patients. Under the contract between the dentist and the insurance company, the dentist was obligated to repay overpayments for services rendered. The wife was prosecuted and pled to one count of health-care fraud. The husband contractually agreed to restitution with the insurance company, and the wife asserted that restitution in seeking leniency in the sentence. At sentencing, the judge referred to the contractual restitution commitment, but did not impose any fine or restitution.

The taxpayer / dentist, who had included the wrongful charges in income in the years he received it, then paid the restitution and sought to deduct it as an ordinary and necessary business expense. The key points in the Tax Court's holding that the restitution payments to the insurance company were ordinary income were:

1. The parties agreed that the payments were deductible. The taxpayer argued they were deductible as ordinary and necessary business expenses, thus permitting carryback to an earlier year. The IRS argued that they were section 165(c)(1) losses incurred in a trade or business which could not be carried back. (Note that this key nexus between the trade or business and the payment or loss often is not present; most prominently in the context of federal tax crimes, although restitution to the IRS in tax cases is not permitted, plea agreements often contain contractual restitution to the IRS (and, of course, is a count of conviction is outside Title 26, court imposed restitution to the IRS may be permitted); there is usually, however, no nexus between the restitution payments and a trade or business.)

2. The payments were, in fact, restitution although the sentencing court did not award restitution.  The court thus would appear likely to reach the same result with court imposed restitution.  Note that, since the offense was not a tax offense and the victim had been defrauded, the court could have incorporated the agreement into a court ordered restitution.

3. Restitution payments with the required nexus to a trade or business are deductible. Often when a defendant defrauds another, it may not be in connection with a trade or business. For example, an embezzler is usually not considered to be in a trade or business, and thus restitution of embezzlement proceeds would not be a trade or business expense. (Thus, the wife could not have claimed the expenses as ordinary and necessary expenses related to her fraudulent conduct of overcharging; but the taxpayer / dentist could claim them as related to his trade or business of a dental practice.)

4. The court distinguished cases which held that payments that are punitive might be nondeductible as business expenses under § 162(f). The court noted most immediately that these particular restitution payments were not punitive but compensatory. ("[W]we have little trouble concluding that the payments are noncriminal, compensatory restitution.") The court reached this conclusion without necessarily relying on the taxpayer's contractual commitment to repay in the operative agreements with the insurance company over the period of the false charges. They still had the required nexus to the taxpayer's trade or business.

5. Finally, the court held that, given the novelty of the particular issue in the context presented and uncertainty in the law, even if the court were wrong in the ordinary and necessary business expense holding, it would not impose an accuracy related negligence penalty.

So, that is the guts of the opinion.

My comments are:

1. From a technical tax perspective, I would have thought that the concepts of Arrowsmith v. Commissioner, 344 U.S. 6 (1952) and its progeny might have played some role in the court's exegesis. In very broad strokes, the holding of Arrowsmith and its progeny is that expenses related to income take on the character of the income. The Arrowsmith fight is often about whether the character of the expense is ordinary or capital, but I am not aware that those concepts cannot be used in further characterizing the nature of the ordinary expense. That type of inquiry seems to the what the court actually did without citing Arrowsmith and its progeny. The related income here was clearly trade or business ordinary income and, at a gut level, denying a trade or business offsetting loss (albeit in a later year) just does not strike the gut -- at least my gut -- as wrong. Apparently, it did not strike Judge Holmes' gut as wrong either.

2. The court discussed an earlier case, Stephens v. Commissioner, 905 F.2d 667 (2d Cir. 1990), distinguishing between punitive and compensatory restitution. I had generally thought that restitution is compensatory rather than punitive even when imposed at sentencing.  I did a quick LEXIS-NEXIS search and located perhaps some differences, which I think may be semantical, over this the distinction between punitive and compensatory restitution. See United States v. Leahy, 438 F.3d 328, 334 (3d Cir. 2006) (citing the opposing holdings on the issue, which I think may be reconciled by context; it just goes to show that what appear to be sweeping holdings in cases need to be filtered through the context in which they are made); see also Brian Kleinhaus, Serving Two Masters: Evaluating the Criminal or Civil Nature of the VWPA and MVRA Through the Lens of the ex Post Facto Clause, the Abatement Doctrine, and the Sixth Amendment, 73 Fordham L. Rev. 2711 (2005) (arguing for a general rule that restitution is criminal in nature, but again I think that a more refined approach evidenced by Judge Holmes in Cavaretta gets the right tax result rather than glittering generalities about criminal v. civil or compensatory).

Harvard Business Review Article on KPMG Near Death Experience

Robert G. Eccles and Eliot Sherman, KPMG (A): A Near-Death Experience, Harvard Business School (9-408-073 rev. 6/2/09)

Here's the description:
Describes the way in which "Big Four" auditor KPMG dealt with an indictment stemming from the firm's sale of tax shelters. In 2005 Tim Flynn has been KPMG Chairman for a matter of days when he learns that the government is preparing to indict the firm on charges of selling illegal tax shelters. Flynn has to decide whether to fight the charges and risk the dissolution of his firm, or cooperate with investigators, effectively keeping the firm safe but sacrificing the tax partners involved in the shelter sales. Further, the case describes the government's prosecution of former KPMG tax partners and asks students to determine whether prosecutorial tactics during the government's investigation were warranted or represented a case of overreaching.
And, here's the footnote description of the authors and the caveat:
Senior Lecturer Robert G. Eccles and Research Associate Eliot Sherman of the Global Research Group prepared this case. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.
The authors conclude:
The results of the KPMG tax shelter fraud case had significant ramifications for the way the government would be able to prosecute white-collar crime going forward. For industry observers, it also left several questions. In the case of KPMG partners’ trial, had justice been served, or violated? For KPMG, responding to the tax shelter fraud case involved many difficult decisions about how best to move past its former partners’ wrongful conduct.
I think it is important to note that none of the former KPMG partners who were with KPMG when the allegedly fraudulent shelters were conceived and marketed were convicted of any crime.  Two of the defendants ultimately convicted on the much diminished trial had been with KPMG prior to the date the tax shelters conceived and marketed, but KPMG successfully disavowed their connection to KPMG for purposes of imputing wrongful conduct to KPMG.  So, I think it is a bit extravagant for the authors to assert without qualificaiton that the KPMG partners engaged in wrongful conduct.

Monday, January 4, 2010

Birkenfeld's Gambit for Lighter Sentence Fails

As previously reported in this blog and elsewhere, Bradley Birkenfeld has made a full court press both in court and out to get his 40 month sentence reduced.  The reports out today is that he failed; the sentencing judge denied his request for reconsideration.  Here is the Wall Street Journal report, and here is the Tax Prof Blog report.  Oh, well, at least he still has some possibility for a whistleblower claim in the mega-millions.

Sunday, January 3, 2010

More on Birkenfeld - 60 Minutes Segment

CBS 60 Minutes had a segment this evening on Bradley Birkenfeld here.

This is basically more of the same, but one interesting aspect is that Birkenfeld's attorney's claim that Birkenfeld's prosecution, conviction and sentencing sends the wrong message to others deep in the bowels of the Swiss banking system.  Instead of prosecuting, convicting and imprisoning Birkenfeld, so the claim goes, he should be rewarded.  But, after all, Birkenfeld did commit crimes, and he did not really come fully clean.

According the the DOJ official interviewed, Birkenfeld probably would not have been prosecuted had he come clean about his own nefarious activity.  The message to others in the bowels of the Swiss banking system (and there are many of them) is that you can come to the U.S., avoid prosecution in the U.S. by coming clean, and perhaps get in line for whistelblower rewards that can make you rich and thus assuage your self-imposed exile from Switzerland.

That is good news for potential whistleblowers and bad news for those persons who, so far, have not done a voluntary disclosure with the IRS.  And, of the course, the other bad news for those not doing a voluntary disclosure with the IRS is that the settlement with UBS, although perhaps only half a loaf (or less) with UBS, can still prove to be half a loaf (or less) for the many other banks in Switzerland (it is an interpretation of the treaty whose language is hardly UBS-specific).  Half a loaf (or less) across the system is certainly better than nothing. 

And the damage to the sophisticated piracy we call the Swiss banking system is probably irreparable, although it still has some life in it because all sorts of rogues, villains, despots, mobsters, desparados, corrupt officials, sheiks and other accidents of birth, and others may have few attractive alternatives.  But, once the tax dam is breached, they too have to know the secrecy they value and for which they pay the Swiss dearly may not be as impenetrable as they imagined it was before.

Friday, January 1, 2010

Birkenfeld is Tax Analysts Person of the Year

It is common on New Year's Day to review significant events of the prior year. Today, Tax Analysts joins the crowd and names Bradley Birkenfeld its inaugural annual "Person of the Year."

Hear are some brief excerpts from the award after noting the seismic events he unleashed (notably high diplomatic drama between the U.S. and the Swiss and a big breach in Swiss secrecy dam after both sides found some common ground (or equally painful ground)):
In October 2005 Birkenfeld resigned from UBS. The specific reasons for his departure remain private. On leaving UBS, he provided senior management with written complaints that documented the private banking group's illegal practices. A subsequent internal review by UBS in 2006, predictably, found no wrongdoing.

Frustrated by the results, Birkenfeld traveled to the United States in 2007 and voluntarily registered as an IRS whistle-blower with the intention of exposing UBS's complicity with illegal tax evaders. For over a year Birkenfeld provided a treasure trove of inside information to U.S. authorities. He held frequent meetings with officials from the IRS, the Justice Department, and the SEC. The information he provided was the foundation for the UBS debacle and everything that followed. Significantly, Birkenfeld did not obtain immunity from prosecution in exchange for his disclosures.

On numerous occasions the U.S. government has acknowledged Birkenfeld's role as the source who made the UBS probe possible. A DOJ court pleading described his assistance as "timely, significant, useful, truthful, complete, and reliable." Kevin Downing, the prosecutor in charge of the UBS case, said that "without Mr. Birkenfeld walking through the doors of the Justice Department in the summer of 2007, I doubt this massive fraud scheme would have been discovered by the United States government." In short, there would have been no UBS scandal without him.