Thursday, January 16, 2020

Criminal Tax Evasion and Civil Fraud–If Found by the Trier, Can There be a Reasonable Cause/Good faith Defense (1/16/20; 1/17/20)

I have blogged several times on my Federal Tax Crimes Blog about how the “good faith” defense is subsumed in the definition of willfulness for tax crimes.  Willful is the intentional violation of a known legal duty.  If a trier of fact determines that the defendant intentionally violated a known legal duty, then per se that person did not have a good faith defense.  Accordingly, if the trial court in a criminal case where willfulness is an element of a tax crime properly instructs the jury on the willful element, the fact that the judge did not separately instruct the jury that good faith (such as reliance on tax professional) is a “defense” is not error or, at least not reversible error.  Simply put, proof of willfulness negates the good faith defense.  The defendant cannot have intended to violate a known legal duty and then have reasonable cause/good faith in violating that known legal duty.  Accordingly, for example, consider the following:  "[T]o prove willfulness beyond a reasonable doubt, the Government would have to negate the taxpayer's claim that he relied in good faith on the advice of his accountant.”  United States v. Stadtmauer, 620 F3d 237, 257 n. 22 (3d Cir. 2010).

Now I want to move this concept to the civil arena.  Section 6663, here, imposes a civil fraud penalty.  The conduct penalized under § 6663 is “fraud.”  Basically, the conduct penalized under § 6663 is the same conduct that is tax evasion in the criminal context – intentional violation of a known legal duty.  (There may be different verbal formulations, but that is the essence of it in both the criminal and civil arenas.)  So, if proof of tax evasion negates a reasonable cause defense, one would think that proof of civil fraud negates a reasonable cause defense.

Although I think this logic is irrefutable, some courts nevertheless act like they believe otherwise.  For example, in Purvis v. Commissioner, T.C. Memo. 2020-13, at *33-*48, here, the Tax Court found that the taxpayers committed civil fraud subject to the penalty under § 6663.  The Court concluded after 15 pages analyzing the evidence (*48):   “Accordingly, we hold that petitioners are liable for the section 6663(a) fraud penalties for the years at issue.”

The Court then  (at *49-*50) considered the reasonable cause defense.  But why did the Court do that after the Court found that the taxpayer had intended to violate a known legal duty?

One reason is the way the statutory provisions are written.  Specifically, § 6663 imposes the penalty for fraud but then, § 6664(c)(1), here, states (emphasis supplied): “No penalty shall be imposed under section 6662 or 6663 with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.”  But, as established in the criminal context, the taxpayer (called defendant in a criminal context) cannot have intended to violate a known legal duty if he had a reasonable cause/good faith defense.  That surely must be true in the civil context as well.

I would appreciate readers view on this issue.  Specifically, is it possible for the Government (the IRS in a Tax Court case) to prove civil fraud by clear and convincing evidence and the taxpayer then establish a reasonable cause/good faith defense?

One other thought.  The regulations for the reasonable cause defense under § 6664 only address the accuracy related penalty under § 6662.  See Regs. § 1.6664-4, titled "Reasonable cause and good faith exception to section 6662 penalties." I suspect that this analysis is the reason.  The reasonable cause defense is an oxymoron if § 6663 civil fraud is proved.  But § 6664(c) is not the only time that Congress has legislated an oxymoron.

Addendum 1/17/20 12:00pm:
I add just a few bullet points without extended discussion:
  • The FBAR nonwillful civil penalty permits a reasonable cause defense but the FBAR willful civil penalty does not.  See § 5321(a)(5), here.  Although the comparison of the FBAR willful civil penalty to the § 6663 civil fraud penalty is not exact, I think genre of conduct penalized by both penalties is basically the same.  Of course, this invites the question of why Congress would have provided a reasonable cause defense to the § 6663 civil fraud penalty but not for the FBAR willful civil penalty.  I don't know the answer to that question, but I do assert above that the requirements for the civil fraud penalty will necessarily negate the reasonable cause defense.
  • In a criminal case, the defendant gets the reasonable cause "defense" (not a defense at all) before the jury if the record has some evidence of reasonable cause.  In that environment, the defendant might get a jury instruction on reasonable cause (such as good faith or reliance on tax professional), but courts hold that, given the definition of willful, the reasonable cause instruction is not necessary.  In such cases, whether or not the instruction is given, the defense can argue to the jury that the defendant's reasonable cause negates willfulness.  The Government's burden is to prove beyond a reasonable doubt that the defendant was willful, which necessarily negates reasonable cause.
  • In a civil case, to sustain the civil  fraud penalty, the Government must prove fraud (willfulness) by clear and convincing evidence.  However, in order to prove the accuracy related penalty in § 6662, the Government must only establish a production burden that the § 6662 penalty applies in cases subject to § 7491(c) and once it has done so, the taxpayer must prove that he is not liable for the accuracy related penalty described in § 6662 and that, even if he is liable, then he has reasonable cause which avoids the penalty.  E.g., Gustashaw v. Commissioner, 696 F.3d 1124, 1134 (11th Cir. 2012); Klamath Strategic Investment Fund v. United States, 568 F.3d 537, 548 (5th Cir. 2009);  and Montgomery v. Commissioner, 127 T.C. 43, 66 (2006).  But, since the § 6662 accuracy related penalty itself does not negate reasonable cause, § 6664(c)'s application to the § 6662 accuracy related penalty can be meaningful.
  • Also worth consideration is the fact that conviction of tax evasion can give rise to collateral estoppel in civil cases where fraud is in issue (such as the unlimited statute of limitations and, most prominently here, the § 6663 civil fraud penalty).  I am not aware that any court has considered the reasonable cause defense to the application of collateral estoppel to avoid the § 6663 civil fraud penalty, despite the fact that § 6664(c)(1) seems to permit the defense. Of course, as interpreted tax evasion negates reasonable cause in the criminal tax case and perhaps that nuance carries over to preclude the applicable of § 6664(c)(1) reasonable cause defense.
Note:  This is a duplicate of a posting on my Federal Tax Procedure Blog.

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