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:

Two Courts' Approaches to Taxpayer Culpability in the Son-of-Boss Bullshit Tax Shelter (3/26/15)

I write today on two recent cases that evidence different approaches to taxpayer culpability for tax underpayment from "investing" in bullshit tax shelters.  These cases are CNT Investors LLC et al. v. Commissioner, 144 T.C. No. 11 (2015), here, and Kerman v. Chenery Associates, Inc. (WD Ky NO. 3:06-CV-00338-CRS 3/23/15), here.

For context, readers will recall that the Son-of-Boss ("SOB") tax shelter and the Custom Adjustable Rate Debt Structure ("CARDS") tax shelter are variations on the theme of no-cost (except promoter fees and reams of paper and commotion) tax benefits from thin air.  They have been the basis for several  prominent criminal prosecutions.  Courts have routinely called them too good to be true.  Most courts have reached that conclusion with respect to the type of sophisticated taxpayers who entered these shelters.  All of these shelters not only involved sophisticated taxpayers but required that those sophisticated taxpayers represent to the promoter and the issuers of the legal opinions that they had a profit motive independent of the tax motive.  In the context of the tax adventure in which that representation was made (tax benefits created from nothing except paper shuffling and payment of large fees to the promoters), that representation was bullshit.  That's my opinion and probably the opinion of most courts that have dealt with the issue.  I am some readers will disagree and I welcome their comments/corrections.

So, let's turn to the cases.  First, I will discuss the Kerman case.

Kerman was a suit by a taxpayer - "investor" against promoters of the adventure.  The originally named defendants were prominent players in the bullshit shelter industry:  Chenery Associates, Inc., Chenery Management, Inc., Sussex Financial Enterprises, Inc, Sidley Austin Brown & Wood, LLP, R. J. Ruble, Roy Hahn, Bayerische Hypo-Und Vereinsbank, HVB U.S. Finance, Inc.   The HVB defendants moved for dismissal of the remaining claims against it.

The IRS had prevailed in the Kerman's Tax Court case. here, and appeal, here, which had, successively, imposed the tax and the 40% accuracy related penalty.  (I will discuss this in more detail in discussing CNT Investors.)  For my blog discussion of the appellate case, see A Self-Proclaimed "Simple Man," "Utterly Uneducated" in Tax and Finance, but Still a Self-Made Multi-Millionaire Loses his Bullshit Tax Shelter Case (Federal Tax Crimes Blog 4/13/13), here. As a result, the Kermans conceded in their suit against the HVB defendants that:  "[i]ndisputably, the[y] participated in the abusive tax-shelter in conjunction with HVB."  Seizing on that concession, "HVB now contends that this admission is fatal to the Kermans' remaining claims against it under the theory of in pari delicto."

The Kerman court opened its discussion as follows:

The common law docntrine in pari delicto is a phrase that is short for the maxim in pari delicto potior est condition defendent is, which means: "In a case of equal or mutual fault . . . the position of the [defending] party . . . is the better one." Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 306, 105 S. Ct. 2622, 2626, 86 L. Ed. 2d 215 (1985) (quoting Black's Law Dictionary 711 (5th ed. 1979) (alternation in original)). When applied, it serves as a defense that prevents two parties whose wrongdoing are found to be in pari delicto from recovering from one another for any damages that arose from that joint wrongdoing. Bateman Eichler, 472 U.S. at 306, 105 S.Ct. 2622 (footnotes omitted). Courts apply the doctrine based on "two premises: first, that courts should not lend their good offices to mediating disputes among wrongdoers; and second, that denying judicial relief to an admitted wrongdoer is an effective means of deterring illegality." See id.; see also In re Dublin Securities, Inc., 133 F.3d 377, 380 (6th Cir.1997) ("'No Court will lend its aid to a man who founds his cause of action upon an immoral or illegal act.'"). 

In one germane application of the doctrine, a Kentucky court found that when two parties participate in a tax evasion transaction, they are deemed to be in pari delicto. Eline Realty Co. v. Foeman, 252 S.W.2d 15, 19 (Ky. 1952)(citing Stacy v. Williams, 253 Ky. 353, 69 S.W.2d 697; Middlesboro Home Telephone Co., v. Louisville & N. R. Co., 214 Ky. 822, 284 S.W. 104). This is true even if the plaintiff was induced to enter the transaction. Id. Here, the Kermans' admit that "[i]ndisputably, [they] participated in the abusive CARDS tax-shelter with HVB and the other Defendants." DN 227, p. 5. Moreover, they do not even dispute that, as a result, they are in pari delicto with HVB. Id. Instead, they argue that, regardless of whether they are in pari delicto with the Defendants, the defense does not bar their claims for rescission or under KRS §446.070 in this instance. We address these arguments in turn.