Tax Court Applies Willful Blindness to Find Civil Fraud by Clear and Convincing Evidence (1/19/13)

In Fiore v. Commissioner, T.C. Memo. 2013-21, here, the Tax Court (Judge Holmes) held the taxpayer liable for the civil fraud penalty.  Apparently critical to its holding was an application of the willful blindness concept that has rarely if ever been applied in a civil fraud context.  I have written often on willful blindness -- which goes by several different names, the one I usually use is conscious avoidance -- in a criminal context.  My blogs discussing the concept are here.  My criticism of the concept in a criminal context is that, when as in tax crimes the statute requires willfulness, which is definitively interpreted to mean intentional violation of known legal duty, ignorance is not intent to violate a known legal duty.  According to that intentional violation of a known legal duty interpretation (on its face), anything less than intentional conduct will not do.  And, in the context of tax crimes, it is intent to violate the tax law that is required.  Willful blindness or conscious avoidance or similar phrasings do not connote specific intent.

Now to the use of this concept in a civil context.  There are usually two consequence of "fraud" in a civil context -- (1) an unlimited statute of limitations under Section 6501(c)(1), here, and a civil fraud penalty under Section 6663, here.  Essentially, the type of conduct that invokes these consequences is the type that would be evasion in a criminal context under Section 7201, here.  The key differences relate to the nature of the proceeding.  In a criminal case, the Government must prove the elements -- including intentional violation of a known legal duty -- beyond a reasonable doubt.  In a civil cause, where fraud is at issue, the Government must prove the fraud by clear convincing evidence.

Some of the key facts are:

1.  The defendant was a tax lawyer.

2.  The defendant was indicted for four counts of tax evasion, Section 7201, for the years 1996 through 1999.  As is typical in such cases, the defendant pled to a single count of tax evasion for 1999.  However, he agreed that the tax losses for the other years were "relevant conduct," but agreed that the IRS could determine additional taxes for the year of conviction and the relevant conduct years.  He did attempt to mitigate the force of the relevant conduct agreement at the sentencing hearing where he claimed:  "I recognize that I brought this on myself relating to one year, 1999. I deny strongly as I can in this situation that the prior years, other than being relevant conduct for purposes of determining apparently the so-called tax loss, which I've fully paid, that the prior years have anything to do with or anywhere near the same conduct that I pled guilty to."  [There is a long discussion about this, but I don't develop it in this blog entry in order to focus on willful blindness.]

3.  The IRS issued a notice of deficiency asserting additional tax and civil fraud penalties for the year of conviction and the relevant conduct years.  The taxpayer petitioned for redetermination in the Tax Court.  As tried, the taxpayer claimed that the IRS had not satisfied its burden to prove fraud for 1996 and 1997 by clear and convincing evidence.

The Court's key analyses.

1.  Civil fraud is the "willful attempt to evade tax," a formulation of the conduct which is the same as the criminal evasion standard of intentional violation of a know legal duty."

2. The Court then proceeded to go through the types of factors the courts usually go through in determining whether the IRS has shown civil fraud by clear and convincing evidence.  Last on its list of these types was "Willful Blindness."  In entering this willful blindness discussion, it appears that the Court was not able to conclude that the IRS had shown willfulness by clear and convincing evidence.  In the Court's own words:  "So far, then, it's not clear whether Fiore had fraudulent intent. But underlying all the factors discussed above is another important question -- was Fiore willfully blind to the unreported income?"

3.  The Court said that "Willful blindness is a relatively underdeveloped area of law in Tax Court jurisprudence -- at least in fraud cases."  The Court cited one case where it had  been mentioned, Fields v. Commissioner, T.C. Memo. 1996-425.  In that case, the Tax Court said:

fraudulent intent can be found by reasonable inference drawn from proof that a taxpayer deliberately closed his or her eyes to what would otherwise have been obvious to him or her * * * a trier of fact may infer that an individual knew of his or her evasion of tax from his or her willful blindness to the existence of that fact.

I think this is a correct statement of the law.  The quote does not treat willful blindness as a substitute for intent to violate a known legal duty or even an intent to commit any actus reus; rather, as articulated -- and this is critical -- the concept merely permits the trier of fact to infer from the willful blindness that taxpayer (or defendant in a criminal case) had the required intent.  That is a critical distinction that is not often discussed even in the criminal cases where willful blindness is in issue.  I will come back to it.

4.  The Court then turns to the criminal cases which develop the concept of willful blindness.  It is here where the Court does not appear to really understand the concepts.  In the criminal tax law, the key statutory element of the crime is willfulness which the Supreme Court consistently interprets as intentional violation of a known legal duty -- i.e., specific intent.  Ignorance of the law is a defense; merely conducting actions -- the actus reus -- and even intentionally conduct those actions without the required specific intent to violate the law is a defense.  Ignorance of the law is a defense.  So, it would seem, ignorance -- whether willful or negligent -- is a defense to the key element of the crime requiring intentional violation of a legal duty.  As the Supreme Court has noted only for tax law crimes and certain other specific crimes, has Congress required this level of specific intent to violate the law mens rea.  For most crimes, even crimes where the statute defines the mens rea as acting knowingly, ignorance of the legal duty imposed by the acts is not required; all that is required is that the defendant have intended to commit the actus reus which the law defines as a crime. In the latter context, a defendant cannot plead ignorance of the law as a defense but can claim that he did not know or intend the actus reus because he did not know the facts.  Hence, the concept of willful blindness became important to deal with attempts to avoid knowing the facts.  Basically, understanding these differences between knowledge and willfulness (specific intent to violate the law), should equip the analysis of how it might apply -- if it even applies -- in a criminal or civil context.  But the Tax Court does not even hint that it understands or appreciates those differences.

5.  In that context, the Tax Court quotes favorably a proposed instruction framed by Judge Easterbrook, one of the leading appellate judges.

You may infer knowledge from a combination of suspicion and indifference to the truth. If you find that a person had a strong suspicion that things were not what they seemed or that someone had withheld some important facts, yet shut his eyes for fear of what he would learn, you may conclude that he acted knowingly, as I have used that word.

Note that here Judge Easterbrook does not treat willful ignorance as a substitute for even acting "knowingly" -- a lesser mens rea than "willfully" -- but treats it as allowing a permissive inference for the trier of fact to conclude that, despite the appearance of willful ignorance, the defendant really knew the required fact that constituted the actus reus.

6.  In discussing the use of willful blindness in a civil proceeding, the Court does not even mention the recent leading Supreme Court case of Global-Tech Appliances, Inc. v. SEB S.A., 131 S. Ct. 2060 (2011), here.  I am told that the case was briefed before Global-Tech was decided, but had willful blindness been briefed, I would have thought that the IRS would call it to the Court's attention.  I am not sure it was briefed and may have just been an adventure of the Tax Court Judge.  I have asked my Assistant to obtain the briefs and will supplement as appropriate.  (Also, for blogs discussing Global-Tech, see here; for the specific blog discussing the case, see here.)

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I could develop this further, but I think the key points are noted.  I go back to the Court's own introduction of the concept of willful blindness -- it stated that the evidence was inconclusive which would normally mean that the taxpayer wins inconclusive facts are not clear and convincing evidence of fraud.  I think the Court gave a superficial analysis of willful blindness.  I suspect that the Court would reach the same bottom-line holding -- fraud proved by clear and convincing evidence -- without the confusing (at least to me) discussion of willful blindness, but it may have boxed itself in by stated that it would not have reached that conclusion except for the discussion of willful blindness.