Court Rejects No Harm (Tax Loss) No Criminal Foul for Defraud Conspiracy in Backdating to Allocate Partnership Losses to New Partners (10/27/22)

 In an Order in United States v. Fisher (N.D. Ga. No. 1:21-cr-231-TCB dkt entry # 311 10/13/22), TN here, the Court denied motions for bills of particulars and to dismiss.  This is all fairly standard stuff in this area, so I write only to point out the portion I found interesting.

The Court addressed (Slip Op. 30-34) Fisher’s claim that the indictment’s conspiracy charge did not allege criminal conduct.  Specifically, Fisher targeted claim in the indictment that “Fisher (and others) backdated partnership documents in order to receive tax deductions for years in which the clients were not in fact partners.”    What caught my attention was this at the beginning of the discussion:

First, Fisher argues that the backdating led to no harm to the Government because the amount of deduction remained the same. In other words, whether ten or twenty partners split $1,000,000 ends in the same result to the Government; therefore, he contends, there is a lack of harm necessary to prove a Klein conspiracy.

Of course, everyone (at least those everyones practicing tax law or white collar crime law) would recognize as suspect on its face (although Fisher and presumably his lawyer(s) did not recognize it).  More importantly for tax crimes geeks, actual pecuniary loss is not required for the conspiracy alleged–to defraud the IRS.  (See Count One of the Superseding Indictment, here.)  All that is required is a conspiracy to interfere with the lawful functioning of the IRS; allocating losses inappropriately can do that. 

Still the rest of the Court’s discussion on this claim might be useful for  students and even some practitioners:

            But as the Government notes, backdating partnership documents does lead to harm. This is because Fisher’s actions “caused clients to file [*31] false tax returns that claimed fraudulent deductions based upon backdated documents.” [276] at 23. The United States Code explicitly criminalizes this behavior in 26 U.S.C. § 7206, which forms the basis for many counts in the indictment. To argue that causing clients to file false tax returns is not a harm for purposes of the conspiracy charge, when the act itself is criminalized, is simply wrong. Accord, e.g., United States v. Daugerdas, 837 F.3d 212 (2d Cir. 2016) (affirming conviction for conspiracy in tax shelter case involving backdated documents).

            Second, Fisher argues that backdating was lawful (and if not lawful, he contends the law was unclear on this issue). He cites various cases and 26 U.S.C. § 761 for the proposition that partnerships may modify the partnership agreement after the close of the taxable year. But what Fisher omits is that modifications are permitted only with respect to already-existing partners. As the Government notes, the tax code permits reallocating partnership income and loss pursuant to the partnership agreement. See, e.g., 26 U.S.C. § 704(a) (allowing partnerships to allocate “income, gain, loss, deduction, or credit” by reference to the partnership agreement). Indeed, this is standard [*32] practice. But as the Ninth Circuit stated, backdating documents to add partners, and then allocating deductions to those partners, is illegal:

            Case law and relevant legislative history made plain that the retroactive allocation to a new partner of partnership losses attributable to periods prior to the new partner's entry into the partnership was impermissible. Appellants had fair notice of the law and they could have conformed their conduct to the requirements of the law. Thus, they could have had the requisite intent to violate the law. United States v. Little, 753 F.2d 1420, 1434 (9th Cir. 1984). n14
   n14 Accord Martin v. Comm’r, 43 T.C.M. (CCH) 1216, 1982 WL 11304 (T.C. Apr. 28, 1982) (stating that a modification to distributions of income and loss after the-fact is permissible unless it “does not result in the retroactive allocation of partnership income or losses to a new partner”); Williams v. United States, 680 F.2d 382, 384 (5th Cir. 1982) (“[L]osses accruing prior to a transfer of partnership interests cannot be assigned to the transferee.”); Snell v. United States, 680 F.2d 545, 549 (8th Cir. 1982) (stating that § 761 “has no relevance to an allocation of profit or loss to an individual who was not even a member of the partnership when that loss or profit was sustained”).

            Third, Fisher argues—notwithstanding case law to the contrary—that the Court must look only to 26 U.S.C. § 761(c), and its regulations, that purportedly allow a partnership agreement to add partners to past taxable years. He contends that this section makes clear that the entry of a new partner does not close the partnership’s taxable year.

[*33]

            Fisher’s arguments ask the Court to turn the tax code on its head. Section 761 sets forth the various definitions relevant to Subchapter K n15 and it states that partnership agreements may include modifications. But to contend that this definition gives partnerships leeway to modify the agreement to any end lacks legal and logical support. Indeed, none of the cases discussing limitations to partnership modifications turns on this definition. While Fisher contends that this fact makes the plethora of case law inapposite, it instead proves the Government’s point: backdating partnership agreements to give benefits to those nonexistent during the taxable year is prohibited. Cf. Williams, 680 F.2d at 383 (“[T]axpayers would like to play a game of musical chairs with partnership interests and losses, but the movements of the game do not conform to our contemporary Codal choreography.”).
   n15 Subchapter K is devoted exclusively to partnership tax.

            Therefore, the Court will deny Fisher’s motion to dismiss the indictment based on this argument.  n16|
   n16 Fisher, in a brief paragraph, also argues in the alternative that the indictment is unconstitutionally vague, repeating by reference his arguments for the motion to dismiss for uncertain law. He also argues in his reply that the rule of lenity should resolve this case in favor of the Defendants. Neither argument | changes the outcome. The Court’s above analysis applies equally to the unconstitutional vagueness argument, and the rule of lenity does not change the result. In sum, the indictment is neither uncertain nor vague, and the Court will not dismiss it on this basis.

JAT Comment:

On the initial claim of no harm/ no foul, the actual tax loss will come up at sentencing if Fisher is convicted.  My bet is that the Government will be able to show tax loss in the allocations to the new partners that are not offset by what the tax benefits the old partners cold have claimed.  Of course, this may be as a result of bogus valuations (which do not address the allocation issue).