Saturday, August 8, 2015

Ninth Circuit Reverses Prejudicial Admission of "Bad Acts" Evidence in Tax Perjury Convictions (8/8/15)

In United States v. Martin, ___ F.3d ___, 2015 U.S. App. LEXIS 13828 (9th Cir. 2015), here, the Ninth Circuit (i) reversed a conviction for tax perjury, § 7206(1), for omitting certain income from her corporation's income tax returns but (ii) affirmed non-tax fraud-related and obstruction convictions for fraudulently obtaining government contracts.  I focus on the tax convictions which the Ninth Circuit reversed because the trial judge had impermissibly allowed the prosecutor to introduce evidence of earlier improper state tax deductions which were irrelevant to her alleged omission of income on the federal tax returns which was the basis for the tax perjury charges and convictions.

The Ninth Circuit summarized the relevant facts as follows:
To prove that Martin knew she had a duty to truthfully report her income on her tax returns, the government was allowed to introduce evidence that Idaho tax authorities had audited Martin and that in tax years 1996 and 1997 she had improperly claimed less than $3,000 as deductible farm expenses on her state tax returns. Martin was accused of incorrectly characterizing student loan payments for her children and expenses related to her divorce as farm expenses. Martin settled the issue without conceding liability. 
During closing arguments, the government reminded the jury in its rebuttal of the Idaho audits and argued that Martin knew what she was doing when she subscribed false tax returns because she had tried it before: 
The government is focused obviously on the used materials, but the same thing was brought up and Elaine Martin agreed it was wrong . . . when she tried to charge various things as a farm expense. Things like her divorce fees. Things like her children's health insurance and payment of student loans. Remember that. Remember how you were told that she tried this before. That she tried to say those were farm expenses. Now a farm needs fertilizer, it needs seed, it needs equipment, but does it really need to pay for student loans? Well, in Elaine Martin's book it does.
The evidence of the state tax improper deductions was introduced under FRE 404(b), here,  FRE 404(a), here, generally prohibits the introduction of "Evidence of a person’s character or character trait" to show that conduct in question on a particular time in controversy in the trial was consistent with the character or trait.  FRE(b) carries forward that concept to "crimes, wrongs or other acts" -- so-called "bad acts."  FRE 404(b)(1) says:  "Evidence of a crime, wrong, or other act is not admissible to prove a person’s character in order to show that on a particular occasion the person acted in accordance with the character."  FRE 404(b)(2) then says that such prior bad acts are admissible in a criminal case if for another purpose than merely showing bad character -- i.e. "such as proving motive, opportunity, intent, preparation, plan, knowledge, identity, absence of mistake, or lack of accident."  The Ninth Circuit explains this limited window of opportunity"
This general rule reflects our concern that a person charged with a crime be convicted only if its elements are proved beyond a reasonable doubt. A person should not be convicted merely because he or she has done prior bad acts. Rule 404(b) will not be violated if the prior bad acts are relevant on some issue in the current prosecution, such as "motive, opportunity, intent, preparation, plan, knowledge, identity, absence of mistake, or lack of accident." Fed. R. Evid. 404(b). But when bad acts are not relevant, they can only be viewed as being presented to inflame prejudice in the trier of fact, in which case they are at odds with our fundamental premises on the need for a fair trial. And even when relevant on some issue, evidence of prior bad acts should not, under Federal Rule of Evidence 403, be admitted when its "probative value is substantially outweighed by dangers of unfair prejudice, confusion on issues, waste of time, or needlessly presenting cumulative evidence." Fed. R. Evid. 403.
FRE 403 is here.

The Ninth Circuit then repeated its requirements for bad acts evidence under FRE 404(b) (quoting United States v. Bailey, 696 F.3d 794 (9th Cir. 2012)):
"(1) the evidence tends to prove a material point; (2) the other act is not too remote in time; (3) the evidence is sufficient to support a finding that defendant committed the other act; and (4) (in certain cases) the act is similar to the offense charged." Id. at 799 (quotations omitted). "If the evidence meets this test under Rule 404(b), the court must then decide whether the probative value is substantially outweighed by the prejudicial impact under Rule 403."
Applying these requirements, the Court then found that the trial court committed serious error with respect to the proof of the state tax audit:
Under these standards, admitting evidence of the prior state tax audit for a prosecution of federal tax violations was serious error. Here, the state tax auditors described their investigation and the settlement agreement that Martin had signed, providing more information than merely the civil complaint introduced in Bailey. But this is a distinction that makes no substantive difference. The government introduced evidence that Martin was accused of incorrectly deducting farm expenses on a state tax form in 1996 and 1997, apparently to show her knowledge of federal tax laws related to reporting income in the mid-2000s. But we can perceive no relevant connection between Martin's awareness of rules about the characterization of farm expenses under Idaho tax law, and whether she had knowledge of federal tax law governing the reporting of income. Moreover, there is a substantial probability that the jury took this evidence as proof that Martin is a liar who does not want to pay taxes and will cheat to avoid them—a theme the government emphasized at closing, and a line of thinking the evidence rules are meant to discourage. The government has failed to meet its burden under our normal four-part test for admitting evidence under Rule 404(b). Also, even if relevant, introducing this evidence fails the Rule 403 balancing test. 
The government argues that unlike the securities violation in Bailey, the government in criminal tax cases must prove that the defendant knew the tax laws, and that extending Bailey to prohibit evidence of prior audits in criminal tax cases would impair the government's ability circumstantially to prove a defendant's knowledge of the tax laws. We disagree. When the government seeks to admit evidence of a defendant's knowledge, we have "emphasized that the government must prove a logical connection between the knowledge gained as a result of the commission of the prior act and the knowledge at issue in the charged act." United States v. Mayans, 17 F.3d 1174, 1181-82 (9th Cir. 1994). Mayans instructs that in cases such as this one, the materiality and similarity prongs of the four-part test merge essentially into one: "similarity is necessary to indicate knowledge and intent because it can furnish the link between knowledge gained in the prior act and the claimed ignorance of some fact in the offense charged." Id. at 1182 (internal quotation marks omitted). 
Evidence of an audit by, or settlement with, state authorities for unrelated conduct is only minimally—if at all—probative of Martin's knowledge of the federal tax laws at issue in this case, and there is "an insufficient connection, for Rule 404(b) purposes, between [the prior audit] and the knowledge, in the context of the crime charged," of federal tax laws governing the reporting of income. Id. 
To show that the admission of the evidence here was not an abuse of discretion, the government cites several criminal tax cases where evidence of prior encounters with tax officials was used. But all of the cases the government cites involve prior run-ins with the IRS, not state authorities. See United States v. Jackson, 565 Fed. App'x 662, 662 (9th Cir. 2014) (evidence that defendant continued filing false returns after IRS instructed him that his conduct was illegal used to show willfulness); United States v. Matthies, 319 Fed. App'x 554, 557 (9th Cir. 2009) (introduction of IRS publication related to tax protestor arguments used to show defendant was on notice of legal duty to pay income taxes); United States v. Voorhies, 658 F.2d 710, 715 (9th Cir. 1981) (evidence that defendant was put on notice of tentative tax deficiencies by IRS audit used to prove willfulness when defendant moved assets overseas the next year). None suggests that learning about obligations related to claiming personal expense deductions for state tax purposes shows knowledge of federal tax laws barring the under-reporting of income. We conclude that the state tax audit evidence was not relevant on the federal tax claims and so should have been excluded under Rule 404(b). But even if relevant, it was unduly prejudicial and not admissible under Rule 403. The government in substance told the jury that Martin had lied on her taxes before and should be convicted of doing so again—an argument not supported by the facts and barred under the rules of evidence. 
Was this mistake harmful or harmless? The evidence about the audit was introduced through the testimony of two witnesses and several documents and the government emphasized its importance in closing. Rather than merely arguing that the evidence showed Martin's knowledge of federal tax laws, the government also insinuated, impermissibly, that it showed Martin to be a dishonest person: "[D]oes [a farm] really need to pay for student loans? Well, in Elaine Martin's book it does." Cf. United States v. Brooke, 4 F.3d 1480, 1488 (9th Cir. 1993) (stating that evidentiary ruling was not harmless in light of the volume of testimony and references to it in the government's closing argument). The government was permitted to argue at closing that Martin knew what she was doing when she under-reported her income because "she had been there before," and "she tried this before." The government incorrectly used the state audit to make a propensity argument that more likely than not affected the verdict on the false tax return charges. Cf. Bailey, 696 F.3d at 805 (noting government's numerous references to the prior SEC civil complaint at closing); United States v. Brown, 880 F.2d 1012, 1016 (9th Cir. 1989) (stating that "continued references to [defendant's] prior bad acts at the Government's closing arguments make it impossible . . . to say" the error was harmless). n4 Martin's convictions for subscribing false tax returns must be vacated.
   n4 The absence of a limiting instruction that the jury should only consider the evidence for its tendency to show Martin's knowledge, see Mayans, 17 F.3d at 1183-84, bolsters our conclusion that the error more likely than not affected the verdict.
Of course, the prosecutor's exuberant attempt to exploit the bad acts evidence in the closing argument exacerbated the problem of its erroneous admission in the first case.  One can only speculate as to whether the Ninth Circuit would have reversed had it not been so exuberant in the closing arguments.

The Ninth Circuit then had to address what effect the erroneous admission and exuberant closing argument might have had on the other convictions.  It concluded that the erroneous admission of the "bad acts" evidence did not infect the fraud and obstruction of justice convictions.  The Court reasoned:
Considering the totality of the circumstances, however, we reach a different conclusion on the fraud and obstruction of justice convictions. There are several reasons for this. First, except for a brief reminder that income and net worth matter with regard to the DBE and SBA programs at the close of the discussion of the Idaho audit, the government's remarks at closing about the audit related only to the charges of subscribing false tax returns. Second, this propensity [16]  evidence likely affected the jury's decision differently on the tax charges than on the other charges. If jurors think that a person cheats on state taxes, they are likelier to infer that such a person cheats on federal taxes than to infer that the person is guilty of a more complex fraud scheme. Third, during a trial that lasted twenty-seven days, there was overwhelming evidence presented that Martin had fraudulently qualified her business for the DBE and SBA programs and had obstructed justice by concealing her true net worth. We see no realistic possibility that a jury would have reached a different conclusion on the fraud and obstruction charges if the state audit had not been mentioned. We conclude that unlike Martin's tax convictions, it was not more likely than not that the evidence of the Idaho tax audit affected the jury's decision on Martin's other charges.
Finally, the Court addressed certain Sentencing Guideline issues related to the nontax convictions that it affirmed, even though the reversal and remand for retrial meant that the trial court would have to address those issues afresh after retrial of the tax charges.

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