Fourth Circuit says Factual Uncertainty Is Not Legal Uncertainty for James-Critzer-Mallas Defense (4/25/11)

I have written in other blogs about uncertainty in law and the legal principle, emanating from the seminal decision in James v. United States, 366 U.S. 213 (1961), here, that uncertainty as to the law's commands precludes criminal prosecution. (For my prior blog discussions, see here.)  There are two key Fourth Circuit cases on that issue -- United States v. Critzer, 498 F.2d 1160 (4th Cir. 1974) and United States v. Mallas, 762 F.2d 361 (4th Cir. 1985). The Fourth Circuit recently addressed the issue again in in United States v. Cole, 631 F.3d 146 (4th Cir. 2011). Unfortunately the facts were very bad for the defendant, so it was clear that the Court of Appeals was not inclined to want to help him.

The defendant, a real estate agent, received secret commissions by having the sellers pump up the sales price and remit the amount of the artificially inflated commissions to a corporation he owned. The defendant did not disclose these secret commissions to his partners, the buyers.  The corporation apparently did not report the "commissions" and neither did the defendant who was the actual earner of the commissions. Indeed the defendant did not even file tax returns until he learned that that he was being criminally investigated. He then filed tax returns for the years involved (2001-2003), reporting no taxable income for each year. He did this by characterizing the "commissions" as "assignment fees" which he treated as a sale of capital assets producing short term capital gains against which he applied carry forward losses. The Government did not agree with these shenanigans and indicted. As described by the Court:

A grand jury issued a superseding indictment in September 2008 charging Cole in six counts: three counts for willfully filing false tax returns for tax years 2001, 2002, and 2003, in violation of 26 U.S.C. § 7206(1), and three counts for evading income taxes in the same years in violation of 26 U.S.C. § 7201. The indictment charged that, inter alia, Cole falsely claimed $2 million of ordinary income as capital gains.

From the bare text, one might wonder why the Government was charging both 7206(1) and 7201 for the same three years. Rather than speculate at this time (maybe readers can provide the answer crisply), I just move on to address the issue of uncertainty in the law.

According to the Court, the jury convicted as follows:

In a special verdict form the jury largely adopted the Government's theory of the case, although it declined to find that Cole had fraudulently claimed charitable deductions and business expenses. Ultimately, the jury found Cole guilty on all six counts for willfully mischaracterizing the $2 million as capital gains each year and failing to report the $98,200 in income from the sale of the $1 million note.

Keep in mind that the delinquent original returns filed after the criminal investigation started is the one the Government and the jury found offensive (offensive in the sense of criminally offensive). As a side note, I find it incredible that returns -- whether delinquent or original -- filed during a criminal investigation would have taken a position that was so aggressive, indeed criminal at least ex post facto. But setting that aside, we now come to that aggressive position and the defendant's claim that the excess commissions remitted to his corporation were "assignment fees" which justified reporting as capital gains rather commissions reportable than ordinary income.

Obviously, the precise nature of the amounts remitted is a fact question; the legal treatment is clear once the factual nature of the remission is determined. The defendant was arguing, in effect, that, the factual characterization of the remissions was uncertain and that caused there to be uncertainty in the legal duty as to how to report the remissions. The Fourth Circuit, as did the jury, found the evidence overwhelming that, factually, the remissions were commissions rather than "assignment fees" and thus that the defendant had intentionally violated known legal duty. (The Court did not say it quite that crisply, but that is the gravamen.) In the course of reaching that holding the Court had this to say about the James-type uncertainty:

Having closely examined Cole's contentions, we conclude that because the two cases Cole relies on, United States v. Critzer, 498 F.2d 1160 (4th Cir. 1974), and Mallas, speak only to legal, not to factual, uncertainty in the treatment of income under federal tax law, they are wholly inapposite to this case and Cole's argument is wholly without merit.

Then addressing the fact that the trial court had permitted his accountant to testify about uncertainty and indeed that the remissions were properly characterized as "assignment fees," the Court says:

Accordingly, Cole argues, the opinion of a single accountant, hired by a defendant, should suffice to establish the sort of legal uncertainty we found adequate to defeat a finding of willfulness in Critzer and Mallas. Indeed, Cole boldly invites us to "take this opportunity to announce a general rule that admissible Rule 702 evidence of actual correctness [of a tax characterization] precludes a finding of willfulness in tax prosecutions." Br. of Appellant, at 45. We decline this invitation.

And, concluding:

Finally, asking us to blink at the evidence of the repeated contemporaneous descriptions of the disputed payments as commissions, Cole contends that if we look to "the objective economic realities of [the] transaction rather than . . . the particular form the parties employed," Boulware v. United States, 552 U.S. 421, 429 (2008) (quoting Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978)), we must find that the $2 million in payments were assignment fees, not commissions. We disagree. To excuse a party's attempted tax evasion by giving him the benefit of a different transactional structure he concocts post factum would be to turn Frank Lyon on its head. Here, where the jury could easily have found that Cole could not have structured these transactions as assignments because his partners did not know and would not have approved of Cole's inflating sales prices to capture solely for himself $2 million in income, this argument entirely lacks merit.

We readily conclude, therefore, that no complexity of tax law rendered Cole's prosecution untenable and that the jury's verdict finding beyond a reasonable doubt that Cole had willfully falsified the character of his income on his tax returns was amply supported by the evidence presented at trial. There was no error in the district court's denial of Cole's motion for judgment of acquittal.