Early Court Appellate Court Decision on New Sentencing Guideline Provision Regarding Unclaimed Deductions (11/19/13)

In United Sates v. Fawaz, 2013 U.S. App. LEXIS 23135 (6th Cir. 2013), here, the Sixth Circuit addressed the new Sentencing Guidelines provision, effective November 1, 2013, here, regarding unclaimed deductions.  See Further on U.S. Sentencing Commission Proposal for Unclaimed Credits, Deductions and Exemptions (Federal Tax Crimes Blog 8/10/13), here.  The new provision is in SG 2.T.1, Application Note 3, here, as follows :

3.      Unclaimed Credits, Deductions, and Exemptions.—In determining the tax loss, the court should account for the standard deduction and personal and dependent exemptions to which the defendant was entitled. In addition, the court should account for any unclaimed credit, deduction, or exemption that is needed to ensure a reasonable estimate of the tax loss, but only to the extent that (A) the credit, deduction, or exemption was related to the tax offense and could have been claimed at the time the tax offense was committed; (B) the credit, deduction, or exemption is reasonably and practicably ascertainable; and (C) the defendant presents information to support the credit, deduction, or exemption sufficiently in advance of sentencing to provide an adequate opportunity to evaluate whether it has sufficient indicia of reliability to support its probable accuracy (see §6A1.3 (Resolution of Disputed Factors) (Policy Statement)).

However, the court shall not account for payments to third parties made in a manner that encouraged or facilitated a separate violation of law (e.g., "under the table" payments to employees or expenses incurred to obstruct justice). 

The burden is on the defendant to establish any such credit, deduction, or exemption by a preponderance of the evidence. See §6A1.3, comment.

In summary, under the new Application Note, in order for a defendant to use unclaimed deductions to offset the income component of tax evasion, the unclaimed deductions must be related to the income in issue.  In Fawaz, the Court addressed the issue but remanded the issue for further consideration.  The Court said:

Sentencing Guidelines 

Sentencing Guideline § 2T1.9 applies to violations of § 371. The base offense level is the greater of the offense level as determined by § 2T1.1 or § 2T1.4, or offense level 10. U.S.S.G. § 2T1.9(a). Guideline § 2T1.1 calculates the base offense level through specified monetary ranges in Guideline § 2T4.1. U.S.S.G. § 2T1.1(a). For the purposes of Guideline § 2T1.1, "[i]f 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)." U.S.S.G. § 2T1.1(c)(1). "If the offense involved filing a tax return in which gross income was underreported, the tax loss shall be treated as equal to 28% of the unreported gross income . . . unless a more accurate determination of the tax loss can be made." U.S.S.G. § 2T1.1(c)(1)(n.(A)). 

At the sentencing hearing, Safiedine and Fawaz objected to the probation officer's conclusion that JSC underreported its income by $1,020,000 n4 and estimation of the tax loss as $285,600 pursuant to the 28% default tax rate included in Guideline § 2T1.1(c)(1)(n.(A)). The probation officer's conclusions led to her recommendation that the court determine the appropriate base offense level was 18. At the sentencing hearing, Fawaz and Safiedine presented expert testimony from Michael Washenko, a private forensic accountant who previously worked 34 years for the IRS, in part assisting in investigations similar to the investigation of Safiedine and Fawaz. Washenko testified that the government did not actually incur a tax loss as a result of the underreported income and sales price of the Joy Road station; rather, Washenko testified Safiedine actually overpaid his taxes because he did not claim business expense deductions related to the payments Safiedine made in signing the Sunoco checks over to third parties.
   n4This total includes $175,000 from the sale of the Joy Road station and $845,000 from unreported Sunoco upfront consideration payments.

The district court did not conclude the amount of the tax loss should be adjusted by the deductions to which Safiedine asserted he was entitled and, after concluding some of the income from the Sunoco payments had been reported on the tax return of another of Safiedine's businesses, applied the default 28% tax rate from Guideline § 2T1.1(c)(1)(n.(A)) to the unreported income and the 20% capital gains rate to the unreported balance of the Joy Road station sale price. After adding these estimates together, the district court determined the total loss was $193,200. Accordingly, the district court concluded the appropriate base offense level was 16, rather than 18 as the probation officer initially concluded, and that both defendants were Criminal History Category I. Therefore, the advisory guideline range for both defendants was 21 to 27 months. The district court then sentenced Safiedine to 21 months imprisonment and Fawaz to 12 months and 1 day imprisonment. 

On May 6, 2013, the United States Sentencing Commission submitted proposed amendments to the Application Notes in the Commentary for Guideline § 2T1.1 to Congress. Amendments to U.S.S.G. § 2T1.1 Application Notes, 78 Fed. Reg. 26, 429 (May 6, 2013). Those amendments instruct courts, in determining the tax loss, to "account for the standard deduction and personal and dependent exemptions to which the defendant [is] entitled . . . [as well as] account for any unclaimed credit, deduction, or exemption that is needed to ensure a reasonable estimate of the tax loss" within several specified restrictions. Id. The Sentencing Commission promulgated the amendment in response to a conflict among the federal courts of appeal "regarding whether a sentencing court, in calculating tax loss as defined in §2T1.1 . . . may consider previously unclaimed credits, deductions, and exemptions that the defendant legitimately could have claimed if he or she had filed an accurate tax return." Id. at 26, 430. 

Those amendments took effect on November 1, 2013. The parties dispute whether the amendments are clarifying and thus retroactively applicable or substantive and thus only prospectively applicable. "This court has consistently recognized that clarifying amendments may be applied retroactively to discern the Sentencing Commission's intent regarding the application of a pre-amendment guideline." United States v. Geerken, 506 F.3d 461, 465 (6th Cir. 2007). On remand, the district court should consider whether the amendment is clarifying or substantive and, if clarifying, determine whether the defendants have established any unclaimed credit, deduction, or exemption by a preponderance of the evidence. See 78 Fed. Reg. 26, 429-30 at 27.

I will not predict the outcome on this one, although the Sixth Circuit panel could have expressed its views.  However, it is not clear to me that, if the defendant clears the hurdles of (i) clarifying and thus retroactive and (ii) related, it will avoid the hurdle of the second paragraph that the manner of the payment not have contributed to violation of the law by the payees.