The Role of Unclaimed Deductions in Computing Tax Loss For Sentencing (3/1/13)

Steven Toscher, here, and Dennis Perez, here, have a new article titled Recently Proposed Amendment to the Federal Sentencing Guidelines Affect Criminal Tax Cases, J. Tax Prac. & Proc. 47 (2013), here.  As readers of this blog probably already know, the tax loss is the primary driver of sentencing under the Guidelines.

One of the proposed options would assure that unclaimed deductions are allowed in the sentencing calculation.  Courts have not consistent on that issue.  Courts that disallowed unclaimed deductions focused on the Guidelines' definition of the tax loss as the "intended" tax loss.  Reasoning that the taxpayer did not claim the deductions on the return; hence, hence the tax loss he or she intended was the tax loss without the unclaimed deductions.

Several points are worth noting.

First, as the authors noted, "deductions related to the fraudulently omitted income somehow seem to get left off the tax return."

Second, if the tax loss is relevant to the elements of the crime (most importantly for tax evasion, where an element is a tax due and owing), unclaimed deductions are in fact considered in reducing the tax due and owing during the guilt finding phase.  Often, that will not save the day in that phase because the unclaimed deductions will not be enough to eliminate the tax due and owing or reduce the tax due and owing to an amount that makes it sufficiently insubstantial that the element is lacking.  But, in either case, the sentencing is based on an amount that really exceeds the real tax due and owing if unclaimed deductions are not considered.

As the authors note:

A very strong argument can be made that if we are going to punish tax offenders based upon the harm or tax loss, we should look to the actual tax harm or loss to the Government. If a restaurant owner decides to omit income, but also omits legitimate food costs that would otherwise be deductible, isn’t the actual harm to the government the lesser amount?

The Sentencing Commission has asked comments on three options for change:

First, the tax loss would take into consideration any credit, deduction or exemption to which the defendant was entitled, whether or not originally claimed. Second, the tax loss should not account for any unclaimed items, unless originally claimed at the time the offense was committed. The third option is whether the unclaimed deductions will be considered if the defendant demonstrates by contemporaneous documentation that the defendant was entitled to the deduction or credit.

Readers with an interest on this subject might consider making their views known to the Commission.

Thanks to Steve and Dennis for this timely article.