Uncertainty in the Law As a Defense in Tax Cases

Recently, I posted a blog here on our firm’s sister site, Tax Controversy Update, which deals principally with the civil side of tax controversy practice. My partner, Larry Jones, takes the laboring oar for the Tax Controversy Update blog, but sometimes I make contributions. The topic of my recent blog was the Tax Court’s rebuff of a taxpayer’s request for discovery of the many MLTN opinions regarding Son-of-Boss shelters in the IRS’s possession. The taxpayer urged that this discovery was relevant to the taxpayer’s reasonable cause defense against the assertion of the accuracy related penalty. The taxpayer’s rationale for relevance was that the fact that there were many supposedly reputable law firms giving MLTN opinions for the Son-of-Boss transaction somehow supported the reasonableness of the taxpayer’s reliance on the particular MLTN opinion that the taxpayer allegedly relied upon. The Tax Court rejected the request for discovery based on relevance grounds and based on the general prohibition of Section 6103.

I would like in this Federal Tax Crimes Blog to expand that discussion into the criminal arena. I will try to be brief, but caution that it is a large subject and thus being brief necessarily entails painting in broad strokes.

The starting point is the seminal rule in tax crimes that, if the law is not certain, there can be no criminal conviction. This concept has developed from a line of Supreme Court cases from James to Cheek to a host of lower court cases (Dahlstrom, Critzer, Garber, Harris, Pirro). For a taxpayer to be convicted, the law must first be knowable (an objective standard) and the taxpayer must in fact know the law and intend to violate the law (a subjective standard).

The Son-of-Boss shelters exploited Helmer v. Commissioner, 34 T.C.M. (CCH) 727 (1975), a case in which the Tax Court adopted the IRS position as that contingent liability was not a liability. The precise parameters and potential scope of the Helmer holding (and cases with other similar holdings) was uncertain for years and became the basis for a number of shelter manipulations, including the Son-of-Boss shelters. The IRS finally began shutting down Son-of-Boss by a Notice in 2000 by making them listed transactions. The IRS thereafter adopted its position in regulations that, under Chevron, may adopt among competing positions and establish the law. But before that occurred, as several courts have noted, Helmer was a fair interpretation of the state of the law.

Prior to at least the 2000 Notice, Helmer was a fair interpretation of the law. I doubt that, under the knowable standard, shelters exploiting Helmer alone could be considered criminal on the notion that the world should know that Helmer was not the law. And, certainly, given the uncertainty in the law and its common use in shelters designed by prominent legal professionals, I am certain that many people participating in the shelters would have known that Helmer was not the law. I would think that the state of interpretation of the law among many practitioners should be considered by the Court in determining knowability and is relevant to the issue of whether the particular defendants knew that knowable law and intended to violate that known law.

The problem with these shelters, as I have noted earlier, is the lie. They, like many of the earlier shelters, had plausible – noncriminal – legal constructs; the problem was that the facts – often the economics – simply did not support the legal constructs. In Son-of-Boss, because of the economics of the shelter, the lie presented itself in the profit motive representation that was the infirm foundation for the whole superstructure. The Helmer legal foundation itself was criminal. Unless that distinction is made clear to the jury, the jury might convict simply because it believes that the defendant(s) criminally behaved by participating in a something too good to be true – artificial basis by a legal fiction of contingent liability. The lie may not be the reason the jury convicts or it may convict because of mixed legal reasons. Unless carefully instructed the jury could convict because the jury believes that the Helmer legal fiction was not true and the defendants knew it was not true. I think that the instruction should be something like (more artfully worded but the concept is here).

In determining whether the defendant(s) is guilty of the crime of tax evasion (or whatever crime is alleged), you must assume that the law does or should permit a taxpayer to create artificial basis by use of contingent liability of the type alleged in this case. You are only to convict if you find that the defendants knew that the purported factual basis supporting the use of the contingent liability here was in fact false.

Sure, the court should fluff it up and flesh it out, but that is the concept.

In this proposed instruction, the court pre-empts the issue of uncertainty in the law. Once the court finds the uncertainty in the law, then, as in James, any conviction based on the defendant’s intent to violate the law is irrelevant. (I will discuss this aspect of James in my next blog.)