Attacking the Tax Due and Owing Element of Tax Evasion and Tax Loss for Sentencing (11/18/11)

I write today on what I think is a significant new case, United States v. Tilga, 824 F. Supp. 2d 1295 133725 (D. N.M. 2011), here (for full opinion) and here (for excerpts including only the topic of this blog). The case deals with calculating the tax loss for sentencing purposes. The tax loss is the principal driver for Sentencing Guidelines calculations even if not controlling under Booker. The bottom-line in the case is that, for tax loss purposes, the defendant was entitled to accrue a foreign tax credit that she had neither claimed on the original return and, in the final analysis, did not pay. I think the way the court reached that conclusion has implications on the issue of the required tax due and owing element for the crime of tax evasion. Let me just say that the decision is rich in various facets of its holding and analysis. By way of background to the main issues discussed here, I provide the pertinent discussion from my Federal Tax Crimes book, here.

The substantive issue relates to the Code's prescription that a taxpayer can elect to claim a foreign tax credit on an accrual basis even if the foreign tax has not been paid. The construct is that, if the election is made, there is an actual reduction in the tax owing for the year. (This is unlike the net operating loss deduction which may be carried back to an earlier year, reducing the tax otherwise due for the year; rather, the foreign tax credit is a direct credit that “relates back” retroactively to the earlier year in which the income was earned to reduce the tax liability for the year.) To use a simple example, say that the same quantum of income is subject to both U.S. tax and to foreign country X tax and both have the same effective rate. If, for any reason, the foreign country X tax is subject to a U.S. foreign tax credit, the tax will (more precisely, should) be paid to the foreign country and the U.S. foreign tax credit will eliminate the U.S. tax otherwise due. The foreign tax credit permits the taxpayer to elect to claim the foreign tax credit even in advance of it being paid.

The potential use of the foreign tax credit to mitigate criminal tax consequences arose most prominently in the case of United States v. Cruz, 698 F.2d 1148 (11th Cir. 1983), cert. denied, 464 U.S. 960 (1983), where the taxpayer urged that he could, after indictment, claim the foreign tax credit for foreign tax due to eliminate the element of tax due and owing for the charged crime of tax evasion. The Court of Appeals for the Eleventh Circuit rejected the attempt, expressing concern that the taxpayer was playing games and could ex post facto defeat an evasion charge. For further discussion of Cruz, please see my attachment from my book.

Until Tilga, there were no material intervening developments with regard to the use of the foreign tax credit in criminal tax cases. In Tilga, the issue arose in computing the tax loss which, as noted above is a key factor for sentencing purposes. It really is the same issue -- tax due and owing as an element of the crime of evasion is the same as tax loss for sentencing purposes . As in Cruz, but at at a later stage, the taxpayer sought ex post facto to claim the credit so as to eliminate the element of tax due and owing for the crime of tax evasion. In Tilga, the issue arose in computing the tax loss for sentencing.  The claimed foreign tax credit did not wipe out the entire tax loss (and perhaps that is why the issue did not surface in a written opinion until the sentencing phase; but it did surface in the plea negotiations). The taxpayer pled guilty to the crime of conspiracy (one count) and the counts of tax evasion (6 counts) were dropped. (The dismissal of the counts of evasion would not necessarily mean that the Government accepted the taxpayer's foreign tax credit claims for purposes of the substantive crime because, under the major count policy, it likely would have accepted a plea to a single count of conspiracy anyway.) But, in the plea agreement, the prosecutors agreed to a tax loss net of the foreign tax credit. Here is how that plea agreement was worded:

10. The United States and the Defendant stipulate as follows:

a. For purposes of the advisory United States Sentencing Guidelines, the tax loss for the tax year ending on December 31, 1998, was $23,200.00.

b. The Defendant believes in good faith, relying on the advice of experienced and skilled tax counsel, that she has a foreign tax credit available to her under Title 26, United States Code, Sections 901 and 6511 and applicable regulations, for taxes accrued or actually paid to a foreign country, and that such foreign tax credit would eliminate her liability for federal income taxes in the United States of America for the remaining years of the conspiracy to which she is pleading guilty, that is, the tax years ending on December 31, 1999, through December 31, 2004, inclusive. The Defendant has elected to forego pursuit of the foreign tax credit and instead pay federal income taxes that may be due and owing in the United States of America. The government does not agree with the Defendant concerning the availability and/or applicability of such foreign tax credit on the facts of the present case, as the Defendant has not actually paid the foreign taxes. The government agrees, however, that the Defendant’s decision to pay the United States income taxes should not put her in a worse position for purposes of calculating her relevant conduct under the advisory United States Sentencing Guidelines than had she paid the foreign taxes. The parties accordingly stipulate, for relevant conduct purposes, that the tax loss from the conspiracy to which the Defendant is pleading guilty is limited to the $23,200.00 set out in ¶ 10(a), above.

Usually, an agreement between the prosecutors and the defendant as to the amount of the tax loss just sails through without further consideration. But not here. The Probation Office (PO) was aware of the claimed tax loss without consideration of the foreign tax credit. The tax loss without consideration of the foreign tax credit was $1,973,272. (The PO will often become aware of such discrepancies because of the claims made in the indictment or the RAR to which it may have access; but the PO, in my experience, will not engage in a redetermination of whether the parties' agreement as to the tax loss is correct and why it may be less than originally asserted.) In the PSR, however, the PO recommended to the sentencing judge that he find a tax loss of $1,973,272, notwithstanding the parties stipulation of the far lesser amount of $23,200. The extra amount would have made a huge difference in the Guidelines calculations.

As a result, although the parties urged the sentencing judge to just find $23,200 as a reasonable compromise of the tax loss issues, the sentencing judge felt compelled to decide the issue of whether the foreign tax credit could be used in computing the tax loss. The sentencing judge ultimately agreed with the parties that $23,200 (net of the foreign tax credit) was correct. Suffice it to say, in the course of the decision, the sentencing judge distinguished and questioned the Cruz opinion, although the issue was there decided in a different context. The sentencing judge found support for its conclusion, not only in the structure of the statutory allowance of the foreign tax credit, but also in the Tenth Circuit's recent precedential decision in United States v. Hoskins, 654 F.3d 1086 (10th Cir. 2011) which allowed unclaimed related deductions to be claimed in calculating the tax loss. See my prior blog Tenth Circuit Decision on Unclaimed Deductions for Sentencing Tax Loss Calculations (8/16/11), here.

I should note that, while the prosecutors were willing to not press the issue for purposes of the agreement and before the court, the prosecutors insisted that the Cruz result was proper. (That seeming non sequitur is perhaps why the Court felt the need to resolve the issue.) The Government relied upon United States v. Helmsley, 941 F.2d 71 (1991), cert denied, 502 U.S. 1091 (1991), and certain similar cases for a broad proposition, arising from the same concerns in Cruz, that the taxpayer should not be able ex post facto to defeat tax evasion charges by eliminating the tax due and owing element. I address that Government claim in the excerpts to my Federal Tax Crimes book that can be downloaded above. Suffice it to say that I think that claim is just wrong -- at least when it goes beyond the specific circumstances in Helmsley where the taxpayer sought to change her accounting method to accelerate deductions.

All in all, a great analysis in the decision. I recommend it. There is more in the decision than I discuss here, so I highly recommend it to those with particular interests in this area.