Economic Substance Doctrine Tax Felonies (6/1/11)

I write today to provide viewers access to Jasper Cummings' article, Jasper L. Cummings, Jr., Economic Substance Doctrine Felonies, 131 Tax Notes 977 (May 30, 2011) and 2011 TNT 104-10 (5/31/11). (This article is provided with the permission of Tax Analysts.)  Mr. Cummings writes on the use of the economic substance doctrine in criminal tax cases. Most particularly, he writes about Mr. R. J. Ruble who was convicted in the first round of Son-of-Boss criminal prosecutions. In that case, Ruble, a tax lawyer, was convicted along with John Larson and Bob Pfaff who provided financial services in the conceptualization and implementation of the shelters. Two prominent subsequent shelter prosecutions have also used the economic substance doctrine in the charges to the jury.

First, let me disclose that I represented one of the dismissed defendants in the sprawling prosecution that ended up in the conviction of Messrs. Ruble, Larson and Pfaff. Once my client was dismissed along with 12 others before trial, I no longer had an immediate interest in the case but I did observe the progress of the proceedings through conviction and appeal and now pending petition for certiorari in the Supreme Court. I was particularly interested in whether and how the economic substance doctrine would be presented to the jury.

I, like Mr. Cummings, believe that the submission of the economic substance concept to the jury was inappropriate. My reasoning for that included the arguments that Mr. Cummings presents, although I articulate them a little differently. I won’t articulate those differences here because I am not prepared to write an article nor, I suspect, are the readers prepared to read such an article.

I will just summarize. Economic substance is a guide to interpretation of the law; it is not a guide to determining facts. Juries determine facts and should not be given uncertain guides to interpreting the law. Now, as presented to the juries, the judges did try to slice the concepts into factual components -- did the Government prove beyond a reasonable doubt that there was no profit motive or no reasonable profit motive (which is itself imbued with interpretive issues) and did the relevant taxpayer (most of whom did not appear in court) have a profit motive?

As I have argued before in earlier blogs, these cases are about the big lie. The big lie, if there was one, that overarched the prosecution for tax evasion and conspiracy to commit tax evasion (as well, in my mind, in the defraud Klein conspiracy) was the taxpayer's representations as to their profit motive for entering the shelters. Without that representation, they would have received no favorable tax opinions that gave them the comfort they needed to claim the benefits on the tax returns. Tax evasion is about lying; conspiracy (whether to commit evasion or to defraud) is about lying. Willfulness is about that lie. The lie is what the jury understands -- not whether some tax shelter had economic substance. As the prosecutor forcefully opened in Daugerdas: "This is a case about greed and lies." Greed is not a crime, although it can be the motive for crime. Tax evasion is about lying; conspiracy (whether to commit evasion or to defraud) is about lying. Willfulness is about that lie. The lie is what the jury understands -- not whether some tax shelter had economic substance.

So, that raises the question of whether the taxpayers were lying in making the representations and then whether the defendants -- exemplified by Ruble in Mr. Cummings' article -- knew the taxpayers were lying. In each case, the prosecutors conceded that the taxpayers were not guilty of tax evasion -- a concession that necessarily concedes that the taxpayers had not lied in their representations. With that concession, it seems to me the Government took the big lie out of the case.  If the taxpayers were not lying in their representations, how could the defendants have known that the taxpayers were lying and therefore relied on the taxpayer's false representations -- which, according to the Government's concession, were not false.

But, more subtly, virtually all of the taxpayers involved considered these shelters with the focused advice of some of the best tax professionals in the country who were engaged solely by them and were in no way related to any of the tax shelter professionals. If the shelters were bogus and required the big lie from their clients (the taxpayers), why did they not warn the clients that what they were making false representations and committing one or more crimes (depending on how the Government chose to charge)? Knowing the quality of at least some of the professionals representing the clients, I extrapolate that they believed that the law was sufficiently uncertain that their participation could not be said to be criminal and that is why, apparently, they did not forcefully object to the clients (the taxpayers) entering the shelters.

At any rate, that is my belief / argument. Take it for what it is worth.