Tuesday, April 24, 2012

Trust Fund Tax Convictions Affirmed (4/24/12)

In United States v. DeMuro, 677 F.3d 550 (3d Cir. 2012), here, the Demuros, husband and wife, were convicted of "conspiracy to defraud the United States, in violation of 18 U.S.C. § 371, here,, and 21 counts of failure to account and pay over employment taxes (employee income tax and employee FICA withheld), in violation of 26 U.S.C. § 7202, here.  The facts for the DeMuros were bad, very bad.  Which is the reason that a civil tax matter turned into a criminal prosecution.  I want attempt a comprehensive review.  The  opinion lays the facts and law out well, and at length.

1.  By way of background, employers are required to withhold and pay over income tax and the employee's share of FICA from the pay otherwise due employees.  I am sure that, almost all readers from the U.S., have encountered this system where our paychecks were less because of these withholdings.  The withheld amount is sometimes referred to as a "trust fund" because the employer is deemed to have withheld it from the gross payments and must turn the withheld amounts over to the IRS according to schedules that time the turn to the IRS over depending upon amounts.  The funds so withheld, although described as trust funds, are not required to be segregated by the employer until they are turned over to the IRS.  Nevertheless, the amounts involved are often referred to as trust fund taxes.

2.  Often, particularly in a down economy or even in an up-economy where the employer (or its responsible officers) wants to divert the money to other purposes, employers may raid the withheld trust fund taxes in order to use the amounts to pay other creditors or, even, themselves.  In DeMuro, the employer -- the DeMuro's corporation -- withheld the trust fund taxes from the employees gross pay as the law requires, but they did not pay over to the IS.  It is unclear precisely why they did not pay over, but there was proof at trial of lavish personal expenditures by the DeMuros well beyond the amount of the trust fund withholdings the employer was required to pay over but did not.

3.  The civil enforcement mechanism to "encourage" employers to meet the obligation consists of audits of the trust fund obligation (as well as other potential tax related obligations of the employer).  This includes examination and marshaling the full resources of the IRS, including liens and levies.  Additional encouragements to discourage trust fund defaults are:  (1) so-called trust fund penalty liability under Section 6672, here, for persons in the employer power structure that have responsibility to ensure that the withholding and pay over occur; and (2) Section 7512, here, which authorizes the IRS to give notice to establish a special trust account for the employer to deposit the withheld amounts pending payment to the IRS.  In DeMuro, this latter trust was created.  The proof indicated that the DeMuros wrongfully disbursed some of the monies and shut down the account without the permission of the IRS.

4.  The criminal enforcement mechanisms consist of a felony for failure to withhold and pay over (Section 7202) and a misdemeanor for failure to honor the Section 7512 arrangement.  This latter misdemeanor provision seems to be rarely used.  Generally, DOJ Tax likes to fire felony bullets rather than misdemeanor bullets, but that is a broader discussion that I want to make here.  So most cases that are prosecuted and reported are prosecutions for the felony offense under Section 7202.

5.  After jacking the IRS around for a number of years, the IRS finally had enough and recommended the DeMuros for prosecutions.  As noted above, DOJ prosecuted and convicted them for one count of conspiracy (an oft charged count in tax prosecutions because of the prosecution strategic advances the charge of conspiracy permits) and 21 Section 7202 counts (for the 21 delinquent quarters).

6.  On appeal, the DeMuros first claimed reversible error in certain evidentiary rulings.  The standard the Court applied was that (i) as to errors for which proper objection was made at trial, the DeMuros must establish one or more evidentiary errors and, if so, reversal was required unless it is "highly probable" that the error(s) did not affect the result and  (ii) as to errors for which no proper objection was made, the error must be plain error, meaning that it was "clear and obvious" and that it "affected defendant's substantial rights."  In other words, a higher showing is required for unobjected errors.   I mention just two of the claimed evidentiary errors.

a.  The DeMuros urged error in the evidence of their lavish "personal spending habits, including their luxury vacations, nice homes, and Theresa's substantial home shopping network expenditures."  The Third Circuit adopted the holdings of two to her circuits "insofar as they stand for the proposition that evidence of personal spending can be relevant to rebut a defendant's defense that he has not acted willfully."  The Third Circuit found the patter in this case relevant, concluding "the District Court did not abuse its discretion in finding the evidence of the DeMuros' personal spending to be relevant to the jury's assessment of willfulness in light of the DeMuros' defensive arguments at trial."  In addition, that evidence bore on the conspiracy charge as it was relevant to the conspiratorial purpose, saying
The Government's theory at trial was that the DeMuros failed to pay their taxes because they wanted to live a comfortable lifestyle and, thus, they agreed to evade the tax laws so that they would have money to spend on themselves. Given this theory, the evidence that they did live a relatively lavish lifestyle, and how much money they spent on that lifestyle, was relevant.
The Court finally rejected the argument that, even if relevant, this evidence of lavish lifestyle was unfairly prejudicial which should be excluded under FRE 403.  The Court had this nice quote from another case:
Rule 403 does not provide a shield for defendants who engage in outrageous acts, permitting only the crimes of Caspar Milquetoasts to be described fully to a jury. It does not generally require the government to sanitize its case, to deflate its witnesses' testimony, or to tell its story in a monotone.
The Court concluded:
While we are sensitive to the effect that evidence of a defendant's liberal spending habits can have on a jury, particularly in these lean economic times, the evidence admitted in this case, i.e., evidence of vacations, jewelry, cars, and parties, was not so inflammatory as to carry a great risk of prejudice. It certainly was not so prejudicial as to substantially outweigh its very significant probative value. 
b.  The Court also rejected the DeMuros' objection to admission of evidence that she, acting under a power of attorney for her ailing father, mortgaged his residence for $300,000 and used some of that money for some of her lavish expenditures.

7.  The DeMuros complained about the introduction of FRE 404(b) so-called "bad acts" evidence.  I have previously discussed FRE 404(b) (prior discussions can be viewed at the link below), so do not provide a general discussion here.  The particular evidence in question was that the DeMuros had withheld not only the income tax and FICA, but other amounts that should have been but were not paid over to third parties for the benefit of the employees -- employees' health insurance, retirement and child support payments.  In effect, they not only stole from the IRS but through a similar pattern of withholding and failure to pay over, they stole from the employees.  (Note that as  to the withheld income tax and employee share of FICA, the only reason this was not stealing from the affected employees was that the employees get credit against their tax liabilities, so the theft was from the U.S. Government via the IRS.  In a step-by-step analysis, the Court found that the trial court did not abuse its discretion in admitting this evidence and then in the prosecutors arguments about this evidence.

8.  The DeMuros also complained that certain events from their dealings with the IRS agents should have been admissible to show their lack of willfulness required for the Section 7202 counts.  The Court again found no abuse of discretion.

9.  Ms. DeMuro also complained about admitting evidence that, she believed, supported her defense that, even if her husband was liable, she was not.  The court referred to this as an "innocent spouse defense."  (This defense is not the innocent spouse defense to civil income tax liability in Section 6015, although some of the same resonances are there; in effect, in this criminal setting, it is simply a defense that the putative innocent spouse -- Ms. DeMuro -- was not willful and I have not encountered a description of this defense as an innocent spouse defense.)  The evidence in question was that, when a similar pattern of failures to pay over trust fund taxes in prior years for a prior corporation, Mr. DeMuro had signed a statement saying that he was the responsible person and that his wife was not.  The trial court excluded the proffered evidence "on the grounds that 1) it was irrelevant to whether Theresa was responsible for paying TAD's taxes, 2) it had the potential to confuse the jury, and 3) James' statement was inadmissible hearsay."  The Court on appeal sustained the exclusion.

10.  The DeMuros finally complained that the trial court improperly applied a 2-level enhancement for abuse of position of trust, pursuant to Guidelines § 3B1.3.  That enhancement was based only on the DeMuros failure to meet the obligation imposed under Section 7512 for the special trust account.  The Court said:  "Our inquiry is whether the DeMuros were in positions of trust vis-a-vis the IRS based on their positions as signatories of the trust fund account set up to benefit the IRS."  The Court applied factors from United States v. Pardo, 25 F.3d 1187, 1192 (3d Cir. 1994) to conclude that, relative to the purposes of the enhancement and the particular special trust fund involved, the enhancement should not have been applied.  The factors in context were:  (i) the special trust fund did not have the factor of difficulty to detect the breach of trust; (ii) the DeMuros had little authority (they had power, but not authority) over the trust fund; and (iii) the IRS did not rely upon the integrity of the DeMuros, having established the special trust fund because it did not rely upon their integrity.  Based on this holding, the Court reversed for resentencing without the enhancement.

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