Money Laundering Provisions of FERA

I have previously noted that, in enacting the Fraud Enforcement and Recovery Act of 2009 (FERA), Congress, in its wisdom, dropped the Senate proposal to include tax crimes (§§ 7201 and 7201) to transportion money laundering. Of course, the IRS still considers that money laundering is "tax evasion in progress." See IRS Web Page here; for other references to this statement, see the cites at the bottom of this blog. I also cautioned that Senator Grassley seems intent on giving Congress other opportunities to pass the proposal, so stay tuned.

In all events, given the real or perceived connection between money laundering and tax crimes, practictioners are well advised to stay abreast of money laundering developments. The following are the key points from FERA as enacted:

1. The legislation overrides the Supreme Court's restrictive interpretation of the term "proceeds" as meaning the profits rather than gross revenue of specified unlawful activity. For further discussion, see Ellen Podgor's discussion on the White Collar Crime Prof Blog here.

2. Congress stated a "Sense of Congress" [not intended as an oxymoron] and reporting requirement regarding the following subject:

It is the sense of the Congress that no prosecution of an offense under section 1956 or 1957 of title 18, United States Code, should be undertaken in combination with the prosecution of any other offense, without prior approval of the Attorney General, the Deputy Attorney General, the Assistant Attorney General in charge of the Criminal Division, a Deputy Assistant Attorney General in the Criminal Division, or the relevant United States Attorney, if the conduct to be charged as ‘‘specified unlawful activity’’ in connection with the offense under section 1956 or 1957 is so closely connected with the conduct to be charged as the other offense that there is no clear delineation between the two offenses.

I am not sure exactly what Congress perceives the problem to be. From the "sense" of the stated "Sense of Congress," Congress appears to believe that the underlying substantive crime (the SUA) might be so coterminous with the money laundering offense itself that charging both presents a problem. I know courts have expressed concern about that. This have overtones of the doctrine of merger dealing with conviction of a greater and lesser offense with overlapping elements of conviction, and its cousin, the lesser included offense concept. But even if that is the concern, of course, the prosecutors could simply charge the greater offense (here money laundering) without charging the lesser offense, so that merger is not presented and thereby avoid the lesser included offense problem by making sure that the contested elements are overlapping. I will try to find out more on this and fill in later.

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Other references to money laundering as tax evasion in progress. DOJ Press Release; see also TIGTA, The Criminal Investigation Function Provides Adequate Guidance to Field Offices for Money Laundering Investigations, Report No. 2002-10-150 (8/21/02). The IRS likes this catchy phrase and repeats it for emphasis, particularly when justifying its enforcement efforts against money laundering E.g., Richard Speier, IRS Civil and Criminal Enforcement Statement, reproduced at 2006 TNT 8-31 (1/11/06); see also Martin A. Sullivan, Sex, Drugs and Tax Evasion, 115 Tax Notes 1098 (June 18, 2007).

And while we are on catchy phrases, I throw out this one: "The only think to fear is FERA itself,' from this web site. The phrase is a play on FDR's famous line about the depression at the start of his presidency.

Offshore Tax Investigation Files Exempt from FOIA Disclosure

In a nonprecedential summary order in Radcliffe v. IRS & Geithner (2d Cir. 08-1513-cv), issued May 27, 2009, the Second Circuit affirmed the denial Radcliffe's FOIA request for documents related to the IRS's investigation of U.S. taxpayers using offshore credit card accounts. The credit card initiative was launched several years ago well in advance of the current offshore initiative focusing on UBS that we have discussed here which resulted in the current voluntary disclosure initiative which we discussed here. The earlier offshore credit card initiative also used the John Doe Summons to get information and documents and also resulted in a voluntary disclosure initiative (referred to by the initialism OVCI (Offshore Voluntary Compliance Initiative), which followed with another initialisim LCCI (Last Compliance Chance Iniatitive or some such)).

The reason the court summarily affirmed was the rather obvious reason:

We have no doubt that the documents retrieved pursuant to the government's search were exempt from production as "records or information compiled for law enforcement purposes" the production of which "could reasonably be expected to interfere with enforcement proceedings," 5 U.S.C. § 552(b)(7)(A); see also 26 U.S.C. § 6103(e)(7). Radcliffe has essentially conceded as much, asserting that this FOIA suit stems from the Internal Revenue Service's ongoing investigation of whether and to what extent Radcliffe has used undeclared offshore credit card accounts to shelter his income and avoid his federal tax obligations. By letter dated July 25, 2007, Radcliffe, through counsel, stated that his "FOIA suit became necessary due to the IRS' failure to provide [information relating to the tax audit] willingly." Letter from Frank Agostino to Gary A. Nichols, Internal Revenue Service (July 25, 2007).

Scoping the Conspiracy -- Upton Redux

I have previously written here about the First Circuit's decision in Upton. I subsequently refined those comments and publised them in a Tax Notes article, John A. Townsend, Scoping the Conspiracy, 123 Tax Notes 1047 (May 25, 2009), which may be viewed or downloaded here. This publication in Tax Notes, as well as the companion web publication Tax Notes Today, is part of a series that I and the other authors of Tax Crimes (LEXIS-NEXIS 2008) (see here) are publishing in Tax Notes. The other authors are Larry Campagna, Steve Johnson and Scott Schumacher. Articles in this series will come out about once a month and will be posted here as well as being available through Tax Notes or Tax Notes Today.

Get in Line Brother #7 -Further Factors / Incentives to Join the Voluntary Disclosure Program for Offshore Accounts / Entities

Tax practitioners advising taxpayers about the Voluntary Disclosure initiative for foreign accounts and entities in should be able to easily advise them of the immediate costs of entering the initiative as compared to worst case. (For facets of the matters that should be considered, see the past "Get in Line Brother" blogs here and for IRS documents related to the Voluntary Disclosure Initiative see here.) Practitioners should also consider the following (although this is by no means an exhaustive list):

1. The length that the civil and criminal statutes of limitation remain open if taxpayers decide to hunker down and not join the initiative. The criminal statutes of limitation are 6 years for the tax crimes and 5 years for the FBAR crimes. Thus, taxpayers not entering the program during this initiative (which expires 9/23/09) are not out of the woods for a significant time.

2. The criminal statutes of limitation can be extended in certain ways that may not be intuitive to taxpayers but should be to their practitioners. If more than one person is involved in hiding the money (as is usually the case (e.g., the foreign enablers, such as bankers)), their actions in furtherance of that conspiracy can refresh the original criminal statute of limitations. I have discussed a facet of this phenomenon here and, within the next few days should be able to post a more refined article being published in Tax Notes. Indeed, for foreign accounts containing the proceeds of "specified unlawful activity," ("SUA"), certain future actions including the mere failure to file the FBAR report could draw a whopping 20 year criminal penalty and a fine of $500,000. 18 U.S.C. § 1956(a)(1) (and the fine may be even more under 18 U.S.C. § 3571 (sometimes referred to as the Criminal Fine Enforcement Act of 1984 (P.L. 98-596) (“CFEA”)). Even worse, since most of the clients we represent would not be dealing with proceeds of SUA, Congress just this year considered a proposal that would have expanded § 1956(b)(1) -- transportation money laundering -- to include transfers into or out of the United States with the intent to promote SUA or "engage in conduct constituting a violation of section 7201 or 7206" of the Code. Those latter sections, of course, are tax evasion and tax perjury. This proposal, promoted by the Department of Justice and passed by the Senate, was apparently dropped out of the House version and thus out of the final enactment that was signed into law. I have not yet heard precisely why the House dropped the provision, since it passed the Senate easily. So, it may be just a deferral for further consideration. I have heard that Senator Grassley has said that he will promote the proposal "at every opportunity." The prospect of this type of legislation is scary indeed and could well make any movement or use of foreign bank account proceeds -- even from legal activity -- a separate money laundering act with draconian penalties. Taxpayers coming clean under the program now need not face this uncertain risk in the future and can make these funds "visible" and far more useful immediately.

Obama Legislative Proposal - Assessment of Restitution as Tax

I have previously blogged here a very brief summary of the President's tax related legislative agenda, presented in which is known as the "Greenbook" and is available here. I now discuss in more detail some of the proposals. Today, I discuss the following proposal (pp. 97-98 of the Greenbook):

ALLOW ASSESSMENT OF CRIMINAL RESTITUTION AS TAX

Current Law

In criminal tax cases, a District Court may issue an order requiring the defendant to pay restitution of existing tax liabilities. The District Court has authority to order restitution under the criminal provisions of Title 18, not the Internal Revenue Code (Code). Because the assessment procedures under the Code apply only to taxes imposed by the Code, those procedures do not apply to restitution orders issued under Title 18, even if the restitution order relates to an existing tax liability.

Reasons for Change

Because court-ordered restitution in criminal tax cases cannot be assessed as a tax, the IRS cannot use its existing assessment systems to collect and enforce the restitution obligation. This leads to unnecessary duplication of efforts, delays, and confusion in the administration of court-ordered restitution.

Proposal

The proposal would allow the IRS and the Treasury Department to immediately assess, without issuing a statutory notice of deficiency, and collect as a tax debt court-ordered restitution. The taxpayer would not be able to collaterally attack the amount of restitution ordered by the court, but would retain the ability to challenge the method of collection.

The proposal would be effective after December 31, 2010.

By way of background, and as noted in the cryptic statement of current law, restitution is not statutorily authorized for convictions of pure tax offenses. The reason is that the IRS has assessment and collection mechanisms for collecting taxes that are deemed quite effective for collecting taxes and hence Congress did not deem it appropriate to overlay the separate system for collecting restitution. Notwithstanding this general notion that restitution is not available in tax cases, many tax crimes are charged along with Title 18 offenses for which restitution is allowed. Thus, for example, the indictment in tax crimes often includes a defraud / Klein conspiracy (18 U.S.C. § 371) charge that is a separate crime under Title 18 and thus permits the Court to impose restitution. More importantly, the Department of Justice Tax Division requires that plea agreements contain a restitution provision for tax and some of the penalties regardless of whether, absent the plea agreement, the sentencing court could impose restitution. (For the DOJ Tax CTM discussion of Restitution in tax cases, see here., which among other things provides that the prosecutor cannot word the restitution agreement as a compromise of the underlying civil tax liability.) As best I understand DOJ Tax's policy decision to require restitution in tax cases, it is not to end-run the congressional judgment to not allow restitution in tax cases, but to force some monetary resolution in the criminal case in advance of the IRS using its collection enforcement tools.

Usually, the IRS is unable to marshall its collection enforcement tools right away because, most of the taxes involved in criminal cases, require a predicate notice of deficiency and then permit prepayment administrative review and litigation before the IRS can assess the tax. Assessment is the predicate act required to using the IRS enforcement tools. The proposal allows the immediate assessment of the amount of the restitution without any other applicable statutory or administrative predicates. Thus, the restitution amount can be assessed without a notice of deficiency and the remedies / delay opportunities it affords.

Of course, in many cases where restitution is agreed upon as part of the plea bargain, the defendant will have the incentive to fully pay the restitution amount in order to obtain sentencing benefits. The proposal thus affects only restitution amounts that are not paid at or before sentencing.

Finally, the proposal does not address the defendant upon whom restitution is not imposed. In tax cases, this could occur where the only crime(s) of conviction are tax crimes and the defendant does not agree to restitution or accept some benefit having a condition of restitution. The IRS will then have to issue a notice of deficiency for those taxes where one is required (income and estate and gift tax) and await the taxpayer's pursuit of administrative or judicial remedies before assessing. This will be true even if the sentencing court determines a tax loss number in the sentencing phase. (On a related topic, I have previously discussed here the application of collateral estoppel on the basis of events at the sentencing.)

Sentencing Guidelines - The Tax Loss from Timing Issues

The Sentencing Guidelines calculation required even post-Booker is principally driven by the tax loss number -- the amount of tax the defendant intended to evade. This can often be calculated exactly. Where it cannot be reasonably calculated, the Guidelines permit a presumptive rate -- for individuals, 28% of omitted income or claimed improper deductions. The question addressed here is how the tax loss is, or should be, calculated if there is simply a timing difference. To take an extreme case, assume that a defendant improperly claimed a $1,000 deduction in year 1 that he is entitled to take in year 2 but does not claim in year 2. Assume further that the tax saved by claiming the deduction focusing only on year 1 is $250 (actual) or $280 (presumptive). But is that the real loss to the Government because the Government will make that up in year 2 when the taxpayer does not claim the deduction? (Note that there is a real sweet civil mitigation issues that could be addressed here if the defendant were to attempt to deduct the same item in year 2, but let's not get bogged down in noncriminal matters here because I assume that he did not claim the deduction in year 2.) In the bare facts given, what is the real tax loss? It is not $250 (actual) or $280 (presumptive), but rather (assuming constant or materially the same marginal rates), it is zero except for, perhaps, the time value of money for that short one year timing period. (Normally, except in collection evasion cases, the time value of money is not considered in calculating the tax loss.)

In United States v. Stadtmauer, 2009 U.S. Dist. LEXIS 9945 (D. N.J. 2009), the timing issue was in the context of depreciation where a current deduction was claimed for items that could be depreciated over future years. The Government wanted to apply the 28% presumptive rate to the entire deduction claimed without any mitigation for the future tax revenue the Government did or would collect. The defendant cried foul and the Court listened. The Court opined:

Mr. Stadtmauer argues that since the issue is only one of timing there is no tax loss associated with these deductions. The Government disagrees, arguing that there is at a least a loss due to the time value of money. However, the Government does not argue that the loss is the time value of money, rather the Government argues that because there is some loss due to the time value of money the 28% presumptive rate should be used. This Court agrees with the Government that the time value of money should be considered as a tax loss, but disagrees that using the 28% rate is appropriate; the 28% rate does not "fit the circumstances" for these deductions. See USSG 2T1.1, Application Note 1.

The Court recognizes, and the Government conceded at the sentencing hearing, that as a general matter, tax loss under the Guidelines for the crimes at issue here does not include interest and penalties. Id. The Court also recognizes that interest calculations are meant to account for the time value of money, so arguably any interest based calculation [*46] should not be included under the Guidelines. But, the Court also finds that recognizing a time value of money effect for these deductions is completely different than the general case of calculating and adding interest, as addressed in Application Note 1. Under § 2T1.1(c), "the tax loss is the amount of loss that was the object of the offense." Here, the purpose of taking the deductions in full in the year incurred was to receive the time value of money benefit from paying less taxes now rather than spread over time; it was not merely some ancillary benefit to the primary object of avoiding taxes by taking a deduction that was not permissible at all, the time value of money benefit was the object of the offense.

The question, then, is what is a reasonable way to estimate this loss. As noted above, to accept the presumptive 28% rate as the Government argues would be unfair and drastically overstate the tax loss. The Court finds that the most reasonable way to account for this loss is by using the Government's own method for compensating itself for the time value of money related to underpayments of tax. Interest on underpayments is calculated by the IRS pursuant to 26 U.S.C. § 6621(a)(2). [*47] This rate is determined quarterly. Id. at § 6621(b). For the years 1997 to 2001, the IRS rate for non-corporate underpayments varied between 7% and 9%, with the rate declining in the years after 2001. See Rev. Rul. 2008-54. This Court finds that using a rate of 8%, a rate in the middle of the range, is reasonable. This approach is not perfect. It does not account for compounding, but it also does not account for the exact timing of the deductions. However, exact precision is not required. This Court finds that the other methods suggested either understate or overstate the intended loss and that this method is the most fair and reasonable estimate of the loss intended for these items. See Gricco, 277 F.3d at 356

Nice indeed.

Hat tip to Caroline Rule of Kostelanetz & Fink for calling this to my attention. Caroline and her partner, Bob Fink, were involved in the case.

Addition on 5/26/2009: See Alan Ellis' Article on Intended Loss here.

Economic Substance in Criminal Cases - Is It About the Lie? (5/19/09)

THIS BLOG WAS UPDATED AS OF 5/25/2009; IN REVISED LANGUAGE, I ATTEMPT TO CLARIFY MY ASSERTION THAT, IN APPLYING THE ECONOMIC SUBSTANCE DOTRINE IN CRIMINAL TAX SHELTER CASES, THE "OR" TEST MUST APPLY AND REQUIRES THAT THE GOVERNMENT PROVE FOR CONVICTION THAT (1) EACH OF THE TAX SHELER INVESTORS -- THE TAXPAYERS -- LIED (WHICH IS DIFFERENT THAN MERELY PROVING THAT A HYPOTHETICAL REASONABLE TAXPAYER COULD NOT HAVE MADE THE REPRESENTATION TRUTHFULLY) AND THAT (2) THE SHELTER ENABLERS MUST HAVE KNOWN THAT THE TAX SHELTER INVESTORS -- THE TAXPAYERS -- ACTUALLY LIED.

Yesterday, I blogged here about the decision in Klamath. In that case, the Fifth Circuit faced the conflict among the courts in the appolication of the economic substance doctrine in civil cases and held that the taxpayer must have both (i) objective economic sustance and (ii) a nontax business or profit motive. (Actually, the Fifth Circuit stated these two-prong requirements as three-prong requirements, but I conflate the second and third here.) I noted in that blog that the Government also trots out the economic substance doctrine issue in criminal cases involving tax shelters. On a related note, I previously blogged here about the claim by a federal prosecutor prominent in such criminal prosecutions that criminal tax shelter cases are about the lie. In this blog, I address these related themes.

In the criminal case from the monster indictment of 19 KPMG-related individuals, 13 of the original 19 defendants were dismissed for prosecutorial misconduct. Only six of the original 19 thus were left. Two of those pled. The Government tried the remaining 4 defendants in late 2008. As to the BLIPS shelter (the same type of shelter involved in Klamath), the Government claimed in the case that the defendants criminally crossed the line established by the economic substance doctrine. Recognizing that there is a conflict among the courts as to the interpretation of the economic substance doctrine and that a criminal tax violation requires a clearly defined line that must be crossed, Judge Kaplan submitted the most defendant-friendly iteration of the economic substance doctrine to the jury. After charging the jury on Cheek willfulness, Judge Kaplan instructed as follows (United States v. Ruble, 2009 U.S. Dist. LEXIS 34908 (S.D.N.Y. 2009)):

[Y]ou may find that a defendant acted willfully in this respect only if the government has persuaded you beyond a reasonable doubt that the defendant, first of all, knew that the relevant taxpayer was motivated by no business purpose apart from the creation of a tax deduction. Secondly, knew that the strategy in question had no reasonable possibility of making a profit, in excess of the costs incurred without regard to tax benefits. And, thirdly, knew that the tax due and owing absent the deduction attributable to the strategy in question, would have been substantially greater than the tax reported on the taxpayer's tax return.

Note that, as presented to the jury, the jury could and should have acquitted if either of the key elements -- no nontax business purpose or no reasonable possibility of profit (a variation on objective economic substance) -- was not proven beyond a reasonable doubt. In other words, for purposes of the criminal case, the test is in the disjunctive rather than the conjunctive. The failure to prove either element would cause the criminal case to fail. And this is as it should be given the fact that there is some remaining uncertainty, even after Klamath, as to whether the test is conjunctive or disjunctive in civil cases. So, Judge Kaplan presented the most defendant-friendly application of the test, as he should do given the fact that a clear line is required both for Cheek willfulness and the rule of lenity. The jury then convicted the defendants for the BLIPS shelters.

Now, what has that got to do with the lie which, as noted in the previous post, is asserted to be the bedrock of criminal cases in the tax shelter area? In the BLIPS tax shelter, the Government claimed and the proof suggested, that the investment strategy independent of the "borrowing" transaction giving rise to the tax play had only a highly speculative possiblity of returning proceeds in excess of the all-in costs of the combined transaction (those costs consisting principally upon the promoters fees based ad valorem on the touted tax benefits alleged to be derived). (I note that the instructions did not surgically separate the investment play from the borrowing play which gave rise to the tax benefit, as the court did in Klamath but which the court did not do in Sala which is currently on appeal to the Tenth Circuit.) Hence, when the investors made the obligatory nontax profit motive representation to KPMG and to Ruble, given the marginality of the possibility of profit on the invesment play, they lied. Although it is impossible to know precisely why a jury convicts, at least the notion or speculation would be that the jury believed the taxpayers lied in making that key representation and that the defendant-enablers who received and relied upon that "representation" knew that the taxpayers were lieing. This would mean that the taxpayer-friendly application of the economic substance doctrine would deny the taxpayers the benefit they claimed on their returns and the defendants thus would be guilty because the taxpayers' taxes then would have been underpaid.

That may be a bit confusing, so let's approach it another way. Focusing on the taxpayers (i.e., the shelter investors), at least for criminal purposes, they could have underpaid their taxes (a requirement for anyone to be convicted of tax evasion) only if, under the most taxpayer-friendly application of the economic substance doctrine, their taxes were actually underpaid. Under a taxpayer friendly version of the economic substance doctrine, the taxpayer does not underpay the tax if either the transaction has objective economic substance or the taxpayer had a profit motive. (The Court in Klamath, discussed here, said that expressly in adopting the majority approach to require both economic substance and a taxpayer nontax business or profit motive ("This particular situation highlights the logic of following the majority approach to the economic substance doctrine, because the minority approach would allow tax benefits to flow from transactions totally lacking in economic substance as long as the taxpayers offered some conceivable profit motive,")) But, all the courts have not adopted the "both" test approved in Klamath, and thus whether the test is both or or is still uncertain as to its ultimate resolution in the federal courts. Certainty in the law is required for criminal prosecution (a la James, Garber, Dahlstrom, Pirro), so the taxes should be deemed due for criminal purposes only under the more lenient "or" test. Assuming arguendo that the transaction has no objective economic substance, the tax is due for criminal purposes only if the taxpayer had no nontax business or profit purpose. But, the taxpayers represented that they did have a nontax business or profit purpose. So, correct instructions would require that the jury find that the taxpayers actually lied as to profit motive (a subjective determination as to what was in their minds) and that the defendant-enablers must have known they were lieing.

But, wait a minute, you might say, did the Government really prove in the case that each of the taxpayers involved in the counts of conviction lied (And, you might ask, if those taxpayers were lieing, why were they not also indicted?) While I did not attend the trial, I did review the daily transcripts. I don't think the Government made any serious attempt to prove beyond a reasonable doubt that each of those taxpayers lied other than from an inference that no reasonable taxpayer could have made the representation. That inference turns a subjective test (the taxpayer's profit motive) into an objective test (a reasonable taxpayer's profit motive). The test, however, is not objective, it is subjective. Many of those taxpayers did not even testify, and there was no other real evidence as to their states of mind in making the representation. Maybe at least some of those taxpayers really believed that the investment strategy would produce a profit (and made no attempt to distinguish the loan play from the investment play (see Sala)). In that case, the taxpayers did not lie, regardless of whether some hypothetical reasonable taxpayer might not have reached that same belief under the circumstances. And, if the taxpayers themselves really did not lie, then under the lenient "or" test which must be used for criminal purposes, they did not owe the tax.

In other words, even if the tax shelter enablers knew that no reasonable taxpayer could make the representation, since taxes for criminal purposes would be due only if in fact the taxpayers lied -- i.e., they had no actual profit motive, even an unreasonable one -- the tax due and owing element could not be established without proving the lie for each of the taxpayers involved in the counts of conviction.

I have discussed in a previous blog (see here) the heavy burden of proof on the Government for tax evasion convictions as a result of the required element of proof of tax due and owing by the taxpayer. The issue discussed here is just a variation of that theme, although in an important but different context.

So, are the convictions flawed? We'll see on appeal.

Fifth Circuit Decides Klamath on Economic Substance for Tax Shelters

The Fifth Circuit has rendered its long-awaited decision in Klamath Strategic Investment Fund v. United States, ___ F.3d ___ (5th Cir. 2009). By way of background, Klamath involved the BLIPS tax shelter that was involved in the star-crossed KPMG individual defendants criminal indictment way back in 2004 (as well as the related KPMG deferred prosecution agreement). After slapping the Government for prosecutorial abuse in that case and dismissing most of the defendants (dismissal sustained in United States v. Stein, 541 F.3d 130 (2d Cir. 2008)), the Government finally took four of the defendants to trial and obtained a conviction on the BLIPS shelters in December 2008. During the winding journey that started at least by 2004 and ended in those convictions in December 2008, the Government had pulled out all the stops to prevent the issue of viability of the BLIPS shelter from being decided in a civil case. Obviously, the reason was that, if a taxpayer prevailed in a civil case or even avoided penalties in a civil case, the Government's charges in the criminal case might not pass the requirement that the legal duty be certain in order to support criminal charges (as established by the Supreme Court in James and in a number of cases from the courts of appeals, including Garber (5th Circuit), Dahlstrom (9th Circuit) and Pirro (2d Circuit).

Notwithstanding the Government's determined attempt to avoid a civil test of its claims about BLIPS, the district court in Klamath refused to stay the case and took it to resolution, hence the court of appeals case. In the district court, the court made a critical pre-trial ruling sustaining the legal superstructure employed in BLIPS (and many other tax shelters) which centered on an application of the Helmer case to allow, in effect, a cost-free basis in a partnership interest from a conditional obligation. At trial, however, the court held that (1) notwithstanding its previous holding that Helmer works (or at least worked at the time the shelter was implemented), the BLIPS transaction in the case failed the economic substance test and thus the IRS adjustments at the partnership level were correct but (2) (a) the accuracy related penalty did not apply and (b) in any event, partnership established the defense of reasonable cause and good faith defense precluded the IRS's claim for the accuracy related penalties. The partnership appealed the first holding (on the economic substance test), and the Government appealed the holdings on (1) that the penalty did not apply and (2) the predicate holding that the Helmer gambit in the case worked.

Obama's Tax Proposals Relating to Tax Crimes

I have briefly reviewed the so-called "Greenbook," which is the common name for a tome titled "General Explanations of the Administration’s Fiscal Year 2010 Revenue Proposals" dated May 2009. Based on my limited review, here are the items that are most relevant to the general topic of federal tax crimes (including civil penalties that often accompany tax crimes). I present here the proposals themselves without discussion of the current law or reasons for the change. Most practitioners reading this blog will already know the current law and can easily imagine reasons for the change. Perhaps in subsequent blogs where I address the proposals in more detail. In this blog, however, I just alert practitioners to the proposals.

1. FBAR and Related Foreign Account Provisions

This blog's readers certainly know by now what the FBAR is, but as a reminder it is the form due by June 30 of each year with respect to foreign financial accounts over which a U.S. taxpayer had certain powers during the preceding year (the year for which the report is made). (For the FBAR form, click here and for IRS FAQs on the FBAR, click here.) Suffice it to say significant numbers of U.S. taxpayers do not comply with the FBAR requirement or answer properly the related questions on Form 1040 Schedule B about foreign bank accounts. Taxpayers failing to file the FBAR also often -- indeed generally -- do not pay U.S. tax (income or estate and gift tax with respect to such accounts). The IRS has a major enforcement initiative with respect to foreign accounts and these obligations for FBARs and income tax return reporting. The Obama proposal is to require U.S. individual taxpayers to disclose on their 1040s information paralleling the disclosures on the FBAR.

As a backup to the foregoing obligations, the Obama proposal will require U.S. financial intermediary firms to report (i) transfers with a value of more than $10,000 to a foreign bank, brokerage, or other financial account on behalf of a U.S. person and (ii) receipts with a value of more than $10,000 from a from a foreign bank, brokerage, or other financial account on behalf of a U.S. person. A U.S. financial intermediary that opens a foreign account for a U.S. person will be required to report regarding the account and transfers to the account. Treasury would be given regulatory authority to promulgate rules and exemptions.

A negative presumption will apply in civil cases that a person having a foreign account had the amount required to have an FBAR obligation. A related negative presumption would treat the taxpayer's failure to report foreign accounts with over $200,000 as willful, thus attracting the more draconian FBAR penalties unless the taxpayer rebuts the negative presumption. A related provision extends the statute of limitations for failure to report until 6 years after the taxpayer reports the information required to be reported.

The accuracy related penalty for failure to report income for accounts required to be reported would be doubled from 20% to 40%.

2. Tax Restitution

Restitution is not permitted (absent the defendant's agreement or in exchange for a benefit given by the sentencing court) for Title 26 (Internal Revenue Code) offenses. Restitution is permitted for tax flavored crimes charged under Title 18 (e.g., defraud conspiracy). But, the IRS has no authority to assess the amounts in the restitution obligation and thus cannot use its substantial collection powers with respect to such amounts because restitution amounts have not been assessed as a tax. The proposal is (i) to give the IRS authority to assess immediately the amount of the restitution (without a notice of deficiency) and (ii) to deny the defendant taxpayer the right to collaterally attack liability for the restitution as tax in a civil tax proceeding.

3. Make repeated Failure to File a Tax Felony.

A U.S. taxpayer failing to file for 3 out of 5 years involving an aggregate tax liability of $50,000 or more could be charged as a felony rather than the normal misdemeanor attaching to failure to file. This enhanced felony status would be called an aggravated failure to file. The maximum incarceration period would be five years and the maximum fine would be $250,000 ($500,000 in the case of a corporation).

4. Investigative disclosures

The proposal will give IRS agents authority to identify themselves, their organizational affiliation, and the nature and subject of an investigation, when contacting third parties in connection with a civil or criminal tax investigation.

Tax Shelter Enablers as Targets

At the Civil and Criminal Penalties Section meeting (at the larger ABA Tax Section May Meeting), a panel discussed tax crimes in a tax shelter context. Kevin Downing, a DOJ Tax attorney heavily involved in these prosecutions, announced that the Government is intent on prosecuting tax professionals serving as "enablers" (my word, not his) for tax cheating. Of course, clients who have been thus enabled are targets too. But, the Government gets maximum bang for its prosecution buck by targeting enablers because those prosecutions send a strong message to other potential enablers who might otherwise be tempted to enable beyond the confines of the law.

Mr. Downing also suggested that some clients might find it to their benefit to turn on their professional enablers. Assuming that the attorney or accountant is like the hub of a wheel having many spokes (clients), the clients by turning on the enabler could actually become very rich -- or richer -- from the whistleblower rewards on the taxes collected from all the other clients (the other spokes) who will get into the IRS's sights through the professional enablers. Of course, I would suspect that some special negotiation will be required with the Whisteblower Office because the client may not know the names of the other participating clients.

Tax Shelter Crimes Are About Lies (5/10/09)

At the Civil and Criminal Penalties Section meeting (at the larger ABA Tax Section May Meeting), a panel discussed tax crimes in a tax shelter context. Kevin Downing, a DOJ attorney heavily involved in these prosecutions, pronounced that tax shelter prosecutions are not about complex tax interpretations; rather, those prosecutions are about the "lie." The lie may appear in the context of complex tax interpretations, but it is still the lie that is the criminal problem. Of course a lie may be a flat out falsehood as to the law, but these shelters often appear in contexts that, even when they approach the too good to be true category, they have some semblance of tax superstructure to avoid being a flat out lie. Usually, in this context, it is the assumptions of the factual underpinnings for the legal interpretation superstructure that is the problem. Prominently mentioned in this context are factual representations from the taxpayer that he or she has a business or profit motive independent of the tax benefits sought and has a reasonable prospect of making a profit in excess of the transaction costs.

Noise about noisy and quiet voluntary disclosures

Historically, practitioners have recommended to clients two types of voluntary disclosures designed to meet the IRS voluntary disclosure practice at IRM 9.5.11.9 (09-09-2004). First, a "noisy" disclosure which means a disclosure to the IRS CI (often preceded by advance testing of the water to see if, under a "hypotherical" set of facts, the IRS will be inclined to pronouncement the disclosure a qualifying voluntary disclosure (meaning no civil prosecution of the taxpayer). Second, a "quiet" disclosure effected by filing true and complete amended or delinquent returns with the Service Center. (There is some discussion in the tax community as to whether the amended or delinquent returns must also have some type of narrative of the underlying problem being solved, but let's set that aside for purposes of this discussion.)

At the Civil and Criminal Penalties Section meeting (at the larger ABA Tax Section May Meeting), a panel discussed voluntary disclosure both the continuing historic voluntary disclosure practice and the special version most recently pronounced for offshore accounts. (IRS documents describing the special version for offshore accounts may be viewed here.) I will deal in a later blog about further nuances of the special initiative, but now turn to the historic practice. IRS CI Chief Eileen Mayer initially pronounced that the only voluntary disclosure qualifying for the IRS' voluntary disclosure practice was a noisy disclosure effected by opening the kimona to IRS CI. Later, a practitioner noted that the IRS IRM on voluntary disclosure policy was far from crystal clear on limiting the practice to noisy disclosures. And, another practitioner then asked the panel (including Ms. Mayer) to clarify a key point in the discussion -- as he stated it, the difference between the noisy disclosure and the quiet disclosure is that the noisy disclosure would draw a IRS letter -- let's call it a comfort or at least comforting letter -- giving the assurance of qualifying, whereas the quiet disclosure will not draw such a comfort or comforting letter. (This is my paraphrase of the clarification he requested). The panel consensus seemed to be that that was correct. If I read the events correctly, it thus appears that at least this panel thought that a true quiet voluntary disclosure would work.

One of the panelists (I can't recall which) said, in effect, he would be stunned if the IRS would recommend or DOJ would prosecute someone who made a true quiet voluntary disclosure. I think that, from a policy perspective, that has to be the right answer. But I doubt that the IRS will say that publicly in an unequivocal fashion. Morever, that merely invites the question as to whether the quiet disclosure, in order to be consider true and correct and complete (i.e., as a reasonable noisy disclosure substitute), must disclose considerably more information than normally disclosed on an amended or delinquent returns reporting additional or a new tax liability. I don't have an answer for that one, and just make the judgment as to how much disclosure is required based upon particular facts and circumstances. Obviously, the most risk averse of clients considering a voluntary disclosure will want to take the noisy route in any event. But more risk tolerant clients might pursue a quiet disclosure with the degree of "disclosure" in the amended or delinquent return(s) being determined by their tolerance for risk. Of course, they will have to fully and completely report their true and correct tax liabilities; the only question is what and how much to say about the reason they did not do that earlier.

Obama's International Tax Legislative Proposals

The Obama Administration has announced a major legislative proposal related to international tax. The press release may be viewed here. In the area of tax crimes, the significant proposals are:

1. Strengthen the Qualified Intermediary ("QI") program by taking a tough stance with U.S. taxpayers who use offshore accounts that are not with a QI. The QI is supposed to know the customer and report to the U.S. with respect to U.S. taxpayers. Offshore financial institutions that are not QI's do not report, which, of course, is often why U.S. taxpayers use those non-QI offshore financial institutions. The proposal therefore is:

Impose Significant Tax Withholding On Transactions Involving Non-Qualifying Intermediaries: The Administration's plan would require U.S. financial institutions to withhold 20 percent to 30 percent of U.S. payments to individuals who use non-QIs. To get a refund for the amount withheld, investors must disclose their identities and demonstrate that they're obeying the law.

2. Create new proof mechanisms for applying the penalties. The proposal is to "create rebuttable evidentiary presumptions that any foreign bank, brokerage, or other financial account held by a U.S. citizen at a non-QI contains enough funds to require that an FBAR be filed, and that any failure to file an FBAR is willful if an account at a non-QI has a balance of greater than $200,000 at any point during the calendar year." The press release notes that these presumptions will make the IRS's job easier and are consistent with Senator Levin's proposals. Note in this regard that, although Section 7491(c) imposes a production burden on the IRS for penalties under the IRC (thus leaving the ultimate burden of persuasion with the taxpayer, the draconian FBAR penalties are not imposed under the IRC.

3. Increase penalties. The proposal is to double certain penalties (the press release does not say which penalties, but presumably the penalties include the FBAR penalty).

4. Extend the civil statute of Limitations until six years after the taxpayer submits the required documentation.

5. Enhanced information reporting. I will perhaps have more about this later.

6. Enhanced IRS Staff in International Enforcement. The proposal is to hire nearly 800 "new agents, economists, lawyers and specialists, increasing the IRS' ability to crack down on offshore tax avoidance and evasion, including through transfer pricing and financial products and transactions such as purported securities loans."

Get in Line Brother #6 - New IRS FAQs on Details of Voluntary Disclosure re Offshore (5/7/09)

The IRS has fleshed out many of the details of its voluntary disclosure initiative for foreign accounts in a new Frequently Asked Questions document dated 5/6/09. The FAQx document may be reviewed or downloaded here; other IRS documents related to the initiative may be viewed here. Upon the original posting, I will give a few initial comments on the FAQ, but will update this blog posting from time to time with more details. I note particularly that this weekend is the ABA Tax Section's May Meeting in Washington and this will be a significant topic of discussion at the meeting, so I will likely have more details early next week.

Subject to further refinement, these are my comments:

1. The FAQs are addressed to tax problems with offshore accounts and offshore entities.

2. Voluntary Disclosure requires a "noisy" disclosure. Simply sending in amended or delinquent returns or forms ("quiet disclosures") does not qualify for the program. For those who have made quiet disclosures prior to the issuance of the FAQs may get in the program by sending previously filed documents to the local CI office.

3. A taxpayer does not qualify if the taxpayer is already under civil examination (regardless of whether that exam relates to offshore accounts or entities).

4. Taxpayers who properly reported all their income from foreign accounts must file delinquent FBARs. The IRS will not impose the delinquent FBAR penalty.

5. Taxpayers under the program must file 6 years amended or delinquent returns.

6. Penalties asserted under the program are: (1) income tax for six years; (2) an accuracy related penatly of 20% of the tax due; (3) an additional penalty in lieu of the FBAR and all other penalties of 20% of the highest amount in the account; and (4) interest on the tax and accuracy related penalty.

7. The FAQs notes the truly draconian civil and criminal penalties that could apply if the taxpayer does not join the program.

8. The program lasts only 6 months fromf 3/23/09, the date a memorandum was issued outlining the penalty framework for resolution of the cases.

Collateral Estoppel to Corporation After Conviction of President and Sole Shareholder

In Hi-Q Personnel Inc. v. Commissioner; 132 T.C. No. 13 (5/4/09), the Tax Court applied the doctrine of collateral estoppel from the conviction of the president and sole shareholder under Section 7202 (failure to withhold and pay over) to the corporation. Since collateral estoppel usually applies only to the same shareholder, the Tax Court found that there was sufficient privity between the president and sole shareholder on the one hand and the corporation on the other. The Tax Court noted the truism that corporations act through their officers and, given his relationship, the president's actions were the corporation's actions. The Tax Court alternatively made an affirmative finding independent of collateral estoppel that the corporation was guilty of fraud with respect to the failure to withhold and pay over. As a result of those alternative holdings:

1. The corporation was liable for the payroll taxes.

2. The corporation was liable for the civil fraud penalty.

3. The unlimited statute of limitations applies.

Professional Prohibitions to Disclosing Client Information in Grand Jury Investigations

State-related agencies regulate professional practice of lawyers and CPAs. Among the obligations imposed upon these professions is an obligation to protect client information. This blog deals with the CPAs obligations to protect client information, although much of the analysis applies to lawyers as well.

A state agency related obligation to protect client information does not make that information privileged in the federal system. The federal system recognizes the attorney-client privilege, but that privilege is narrower than the obligation of a lawyer to protect client information. And, most importantly for this blog's purpose, the federal system recognizes no CPA client privilege. The federal system does have a modified privilege in Section 7525 that are applicable in noncriminal cases.

In Texas, the CPA obligation to protect client information is found in Tex. Occ. Code Ann. § 901.457 (West 2004); 34 Tex. Reg. 428 (2009) (to be codified as amendment to 22 Tex. Admin. Code § 501.75, effective January 28, 2009) (Tex. Bd. of Pub. Accountancy, Confidential Client Communications). These provisions permit disclosure in relevant part (i) if the client authorizes it and (ii) under legal compulsion defined to mean an IRS summons, an SEC summons, or under a court order (the actual provision is a bit awkwardly worded, but that is the gist). The federal grand jury subpoena is not within the exceptions. In practice, however, the Texas Board of Public Accountancy has interpreted and applied the provisions to permit disclosure pursuant to a grand jury subpoena.

In In re Grand Jury Proceedings, Grand Jury No. 08-4, 2009 U.S. Dist. LEXIS 36066 (WD TX 2009), a CPA -- anonymously identified as John Doe ("Doe") -- received a grand jury subpoena for documents within the scope of the state prohibition. Doe moved to quash the subpoena on the basis that the actual language of the Texas prohibitions on disclosure did not cover a grand jury subpoena and that a court order is required. The Texas Board filed a letter brief agreeing that federal pre-emption required that the grand jury subpoena pre-empt the Texas rules so that the grand jury subpoena was a compulsory process that required disclosure without a court order. The court so held.

Practitioners in other jurisdictions should be aware that analogous anomalies may exist in their CPA rules and consider this case in shaping response on behalf of CPAs. But beyond determining what to do upon receipt of a grand jury subpoena, I think the more important lesson is that in the context of federal tax crimes, at a minimum compulsory process is required. Thus, the Texas rules cover IRS summonses in particular and now this decision (as well as the Board's own interpretation) cover grand jury subpoenas. But, it is clear that, short of those compulsory processes the CPA may not disclose.

In representing one of the defendants in the KPMG grand jury investigation, this issue came up. The prosecutors leading the grand jury investigation wanted my client to disclose the information otherwise covered by these Texas prohibitions in a proffer session without issuing a grand jury subpoena. (An IRS summons could not be issued because the matter had been referred to DOJ.) My client refused, citing the prohibition of state law. The prosecutors persisted in their demands, and accused my client of wrongfully impairing the investigation by my client's insistence upon complying with these prohibitions. I had confirmed with the Texas Board that my client's interpretation of their rules was correct and that a grand jury subpoena was required. I urged the prosecutors to discuss the issue with the Texas Board; the prosecutors refused to do so, saying that they did not care what the Texas Board thought. This impasse was never resolved, but the most amazing point was that the prosecutors absolutely and strongly insisted that my client violate the law and abused my client for not doing so.

And, not only did the prosecutors insist that my client violate the state law, the prosecutors seemed to be insist that my client violate a parallel federal prohibition in Section 7216 of the Code. That provision prohibits tax return preparers from disclosing information without compulsory process. Since the prosecutors refused to issue a grand jury subpoena, my client had no compulsory process allowing disclosure under Section 7216. The Regulations under Section 7216 permit disclosure to an "officer" of the grand jury and, of course, the prosecutors' only role was as representatives of the grand jury investigation that they were conducting. So, Section 7216 did not appear to be an insuperable barrier, but I did ask the prosecutors to confirm in writing that they were acting in their roles as prosecutors for the grand jury investigation. Although that was fairly obvious (at least to me), the prosecutors refused to so state in writing, and chose instead to heap abuse on me for asking for that representation in writing. (One of the prosecutors actually accused me of "fabricating" the position.)

Finally, one may ask about this episode with the prosecutors why they would not have issued a grand jury subpoena at the beginning. I was told that they wanted their proffer session to be free of the strictures of FRCrP Rule 6(e) which mandates the secrecy of grand jury matters. The prosecutors wanted to be free to deliver to the IRS the fruits of their efforts without being bound by Rule 6(e). I told the prosecutor with whom I dealt that I did not think that mere failure to use the grand jury subpoena would solve the 6(e) problem, because their role was as attorneys for the grand jury and 6(e) was thus implicated and governing. That is another issue so I will leave it for another day.

Onshore Conference on Offshore "Opportunities"

The Wall Street Journal today has an article titled "Under Florida Sun, Tax Avoiders, Enforcers Trade Notes, Schmooze" which may be viewed here. The article discusses an annual conference run by one David Marchant. The teaser in the introduction is:

Mr. Marchant runs one of the country's more unusual annual trade gatherings. The OffshoreAlert Conference since 2002 has brought together a diverse collection of the hunters and the hunted: tax avoiders, convicted fraudsters, and their advisers -- as well as the regulators and law-enforcement officials who try to catch them. This week, they sat side by side on conference panels, and sipped cocktails a few yards from the beach outside the swank Eden Roc hotel.

This year's conference drew about 250 attendees from 29 countries, including financial officials from Caribbean nations as well as agents from the Internal Revenue Service, former Securities and Exchange Commission officials and numerous liquidators, white-collar defense lawyers and bankruptcy attorneys, who paid between $1,295 to $1,695 to attend the gathering.

The article is worth a read for those playing in the tax haven arena.

Townsend Publication on Tax Obstruction

The Tax Prof Blog here reports that an appendix to my article, John A. Townsend, Tax Obstruction Crimes: Is Making the IRS's Job Harder Enough? (article to be published later by the Houston Business and Tax Journal), has been put online here. The article addresses the Government's expansive claim as to the two principal tax obstruction crimes -- 26 U.S.C. (IRC) § 7212(a) and the Klein / defraud conspiracy under 18 U.S.C. § 371. The Government claim is that even legal actions undertaken to impair or impede the IRS may be prosecuted under these provisions. Sometimes, although often not in outcome determinative context, courts rotely say that also. In the article (to be published), I address the Government's claim in the context of audit avoidance, a common feature of tax practice. The article argues that something more than mere legal action to impair or impede or influence an audit is required for the obstruction crimes. There must be a false component of the action in order to sustain a prosecution. The Supreme Court so held in the defraud conspiracy context in Hammerschmidt v. United States, 265 U.S. 182 (1924), but the Government continues to attempt to end-run that holding. It is that end-run that is the focus of the article. As noted, the article is not yet published (indeed, I am making my final changes after receiving back the edited draft as we speak). I will post here later when the article is published.