Tenth Circuit Decision on Unclaimed Deductions for Sentencing Tax Loss Calculations (8/16/11)

The Tenth Circuit recently rendered a very good decision on the issue of a convicted defendant using unclaimed deductions to reduce the tax loss for sentencing purposes. The decision is United States v. Hoskins, 654 F.3d 1086 (10th Cir. 2011) and may be viewed or downloaded here.  First a little background.

Tax crimes afficionados know, that the tax loss is the principal determinant in sentencing for tax crimes and the drill for the defendant and his or her lawyer is to get that number down.  But there is another key context in which a similar concept is used in tax crimes.  Tax evasion is the key tax crime where tax loss -- called tax due and owing -- is an element of the crime. The Government must actually prove a tax due and owing, basically the same as a sentencing tax loss. (I have discussed previously in this blog the issue of whether that tax due and owing must be substantial, but that is not the issue here; in all events there must be a tax due and owing.) In the case of an allegedly false return, the Government will usually make its proof usually by showing omitted income, falsely claimed deductions or falsely claimed credits, and make the resulting adjustments to the return to determine the tax allegedly due and owing. But the taxpayer may want to put in play unclaimed deductions, overreported income or unclaimed credits to offset the Government claims. The taxpayer can do that in the tax evasion case in chief as bearing on the issue of whether the Government has proved a tax due and owing. (There are some interesting burden of proof issues as to the unclaimed tax benefits, but I forego them for now.)  For example, in her now infamous criminal trial, Leona Helmsley (“only little people pay taxes”) asserted this defense by claiming that her husband's real estate empire generated far more depreciation deductions than they had claimed on their returns that so offended the Government. Indeed, she urged, the unclaimed deductions were more than sufficient to eliminate this element despite omission of large sums of income. It did not work for her, but it is an avenue that the experienced practitioner will explore. See United States v. Helmsley, 941 F.2d 71 (1991), cert denied, 502 U.S. 1091 (1991).

So, at least in terms of establishing a tax due and owing as an element of the crime of tax evasion, the taxpayer is entitled to assert anything that would lessen unclaimed deductions (or credits or even incorrectly reported income) to offset any claims that the Government makes that might indicate a tax due and owing (omitted income or falsely claimed deductions or credits).

But, when it comes to sentencing, the Courts are split as to whether the taxpayer can claim unclaimed deductions (or logically any other component that would mitigate the "tax loss"). This is where the new case comes in.

In Hoskins, the Tenth Circuit brought consider nuance to the discussion of the issue.

The key Sentencing Guidelines provision is this (USSG § 2T1.1(c)(1))

If 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).

Perhaps to oversimplify (but not much), some courts have reasoned that, if a taxpayer omitted $100 of income while failing to claim $100 in deductions, the taxpayer's object was to evade the tax increased by the omitted income but not reduced by the unclaimed deductions. The taxpayer did not claim the deductions originally and thus did not have the object to evade taxes reduced by those unclaimed deductions.

The majority in Hoskins held otherwise, interpreting the quoted Guidelines in light of USSG § 2T1.1(c)(1), Note (A)'s command that a more accurate determination of the tax loss could govern when the unclaimed deductions are in some way related to the offense. There, the Government computed the tax loss on omitted income from escort services but sought to deny the expenses related to the omitted income. The Court gave this example:

A hypothetical helps explain why consideration of unclaimed deductions may be appropriate, even if § 2T1.1 addresses only intended tax loss. Assume a restaurant owner is convicted of criminal tax evasion for failing to report or pay taxes on $100,000 income earned from his cash-only business. Let us also assume the restaurant paid $80,000 in tax-deductible business expenses, all in cash. And finally, let us assume the restaurant owner, despite evading his tax-filing responsibilities, maintained immaculate business records documenting every business expense. Assuming a 30% tax rate, if a court refused to consider the deductions under § 2T1.1, the restaurant owner would have caused a $30,000 tax loss. If the court did consider the deductions, the government's tax loss would have been only $6,000. We then ask, which of these two tax losses did the defendant intend?

The most logical conclusion is that the defendant sought to avoid paying what he legally owed in taxes: $6,000. It would never have occurred to the hypothetical defendant or his accountant that he would be cheating the government out of $30,000. Indeed, it is somewhat odd to frame the § 2T1.1 analysis in terms of intended tax loss—when in reality, a tax-evading individual seeks only to avoid paying taxes, not cause any specific loss to the government. Thus, if our hypothetical defendant presented his meticulously kept business records to the sentencing court, we believe the court could conclude reasonably that he "intended" a tax loss of only $6,000. This conclusion is bolstered by the notes to § 2T1.1, which explain that when the offense involves "failure to file a tax return, the tax loss is the amount of tax that the taxpayer owed and did not pay." USSG § 2T1.1 Note (2).

Moreover, the government is not supposed to reap windfall gains as a result of tax evasion. See United States v. Gordon, 291 F.3d 181, 187 (2d Cir. 2002) ("Tax loss under § 2T1.1 is intended to reflect the revenue loss to the government from the defendant's behavior."); USSG § 2T1.1 Application Notes ("[A] greater tax loss is obviously more harmful to the treasury . . . ."). Indeed, the government cannot claim to have lost revenue it never would have collected had the defendant not evaded his taxes. For the purposes of calculating sentencing and restitution, courts consider "the loss that would have resulted had the offense been successfully completed." USSG § 2T1.1. Had our hypothetical defendant's offense been completed successfully, he would have avoided $6,000 in taxes, and the government would have suffered a $6,000 tax loss. The government would of course be permitted to present evidence showing that it in fact suffered a greater tax loss. Under § 2T1.1, it is firmly within the court's discretion to decide which party is correct. But the Guidelines do not require courts to base their sentencing analysis on unadjusted gross receipts figures untethered to actual taxes to which the government was entitled, but did not receive as a result of tax evasion.

The dissent read the Guidelines, like tea leaves, differently than the majority.

My only point of concern is the limitation to related deductions. Once it is conceded that a taxpayer should be able to claim any deductions, I think it is logically a nonsequitur, on the reasoning given, to allow only related deductions. But full resolution of that issue will necessarily await further developments.  The dissent makes the point as follows: 

I fail to see why it should matter whether the unclaimed deductions are related to the offense or not.4 In fact, it might make more sense to permit unrelated deductions precisely because they are unrelated to the offense and, thus, not part of the tax evasion scheme to be addressed at sentencing. Cf. Clark v. United States, 211 F.2d 100, 103 (8th Cir. 1954) ("Some times the failure to claim deductions in a return may well be part of the taxpayer's scheme to cover up his unreported income as a matter of not creating suspicion on the face of his return."). Once a district court begins entertaining hypothetical unclaimed deductions, it must inevitably attempt to calculate the government's actual revenue loss. Why stop at unclaimed deductions relating to the specific offense? If the goal is to determine what an honest, tax-minimizing taxpayer would have done to determine what tax was legally owed (which becomes the goal when the court entertains unclaimed deductions), I would think that courts would be compelled to consider all possible exemptions, deductions and tax credits.

I don't think this point cuts in favor of either the majority's or dissenter's bottom-line result.  But I do think that, if deductions are allowed, allowing some and not all makes little logical sense.