This article reports a discussion at the ABA Tax Section Meeting in mid-May 2012 regarding the relationship between tax loss numbers, restitution, and civil tax numbers. For example, some courts hold that unclaimed deductions are not included in the sentencing tax loss so that, conceivably at least, the Court will calculate sentencing on a tax loss that exceeds the real tax due whereas for restitution purposes, it is the real tax loss and for civil tax purposes it is the real tax loss. The notion is that the Sentencing Guidelines defines the tax loss as the tax loss that was intended -- the object of the offense (USSG § 2T1.1(c)(1)); where the taxpayer does not claim the deductions he or she would have been otherwise entitled to, his object or intent, presumably, is to save the tax due without the benefit of the deductions. I certainly see the textual basis for that notion, but I personally think it is stupid.
I understand the sentencing courts and appellate courts do not want to get slowed down over tax computations. I suppose that, since most taxpayers claim deductions that they are entitled to, the odds are that, in the bulk of the cases, there are not really credible unclaimed deductions. But, a taxpayer desperate to lower the tax loss for the sentencing benefit will be tempted to throw marginal claims on the table and force the courts to deal with them. So, for courts buying into this notion, it is better just not to have to deal with them. But they thereby create the anomaly noted where the tax loss can materially exceed the restitution amount.
Even worse, at least conceptually, the tax loss can exceed the criminal tax number that the Government would have to prove in the first case in a tax evasion trial. Let me use an example: Say the real civil tax deficiency is $50 after all components entering the calculation (including unclaimed deductions) are considered, but that, if the unclaimed deductions are not considered, the sentencing tax loss is $100. At the guilt or innocence phase of the trial, the Government would have to allow real unclaimed deductions (and would probably tilt in doubt in favor of the taxpayer in making the tax calculation). The use of the real tax due is the Spies element of the offense. So the taxpayer would be found guilty on a tax loss of $50, but will be sentenced on a tax loss of $100 and, if restitution is imposed (usually not without consent in tax crimes), at $50.
The truth is that the taxpayer's intent is to evade all or some portion of the amount of tax that he or she actually owed, not an intent to evade a portion of a greater amount that he or she fictionally owed (by not claiming deductions). If he or she miscalculated, he or she certainly cannot be said to intend -- or have an object to -- to evade tax that he or she did not owe (even if he or she thought he or she owed it). So, if one must tie the object to the text of the Sentencing Guidelines, that is the object that seems the most fair.
And, finally, as hinted in the article, for those vast majority of tax crimes cases that plead, I suspect that the the line prosecutor and his IRS assistant will not be niggardly in allowing unclaimed deductions in the tax loss calculation that is put into the plea agreement. I would expect that they would insist the proof of the unclaimed deductions must be fair and reasonable and not fanciful or stretched. If so, at least in my experience, the parties can agree upon a tax loss number than then sails through the process without further ado. Probation Officers and Courts usually do not spend a whole lot of time recalculating the tax loss numbers that the parties have agreed upon. There is always the possibility that a zealous Probation Officer who insists upon the technicality of the law (through the lens of the court of appeals on this issue) rather than mercy or fairness and the agreement of the parties will go behind the numbers and deny the use of unclaimed deductions, but I doubt it will happen often.
Addendum 5/23/12 at 8:45pm: I revised the test of the blog to insert the word from the text -- object -- which is the equivalent in this context of intent. See USSG § 2T1.1(c)(1)):
If the offense involved tax evasion or a fraudulent or false return, statement, or other document, the tax loss is the total amount of loss that was the object of the offense (i.e., the loss that would have resulted had the offense been successfully completed).
As I noted also in an earlier blog, the Tenth Circuit split the baby by allowing related unclaimed deductions. See Tenth Circuit Decision on Unclaimed Deductions for Sentencing Tax Loss Calculations (8/16/11), here.
Jack-
ReplyDeleteThanks for posting this. We are stuck with the "stupid" interpretation of the Sentencing Guidelines here in the 9th Circuit. It is sheer insanity for a taxpayer to be punished criminally based on tax numbers that can be essentially fictional due to the fact that legitimate deductions were not claimed on the riginal return. In a straight unreported income case, if a taxpayer is going to face a civil fraud penalty based on a deficiency of $500K, they should not be punished criminally based on a fictional deficiency of $1 million. That is just patently unfair. If I looked long enough, maybe I could find a Constitutional issue lurking here. Certainly there could be a Constitutional issue if Cost of Goods Sold have bee omitted. ( See Sobel Wholesale Liquor.)
Consider the following. It is early on in an eggshell audit. You discover that the taxpayer's received cash business receipts, some of which taxpayer used to pay business expenses in cash. Neither the cash receipts nor the cash expenses show up on the return. Is there anything you can do at that point, or subsequent to formal criminal charges being brought, to "claim" the expenses for purposes of the sentencing guidelines so that you don't have to worry about the largess of an AUSA if the case is referred to CI and DOJ? File an amended return? Send the revenue agent a letter "claiming" additional expenses? How do you broach the issue without fessing up to the unreported income? At what point in time does it become "too late" to "claim the expenses" for purposes of the Sentencing Guidelines? Practitioners should not have to deal with these types of issues. If the deductions are legit, the taxpayer should get them, on the criminal side and on the civil side.
The "stupid" interpretation also gives the government additional bargaining leverage. Cooperate, and we will give you the expenses. Don't cooperate, and you don't get the expenses if convicted. If the expenses are legit, that type of bargaining is offensive to me. The government's job is to ensure compliance with the tax laws. When the government does not respect the tax laws, it is counterproductive.
Best regards,
Anonymous who commented previously on bankruptcy issues
Anonymous, your comments as always are excellent. Your example did remind me of the following post
ReplyDeleteSee Tenth Circuit Decision on Unclaimed Deductions for Sentencing Tax Loss Calculations (8/16/11), here. I have revised the blog to include this reference in the body of the blog. But the Tenth Circuit split the baby by permitting related deductions to be claimed.
Thanks again for both your interest in the blog and your excellent comments.
Jack Townsend
On the civil side, if taxpayer does not file a tax return, the IRS can file tax returns for the the taxpayer pursuant to section 6020(b). Those returns, of course, are known as substitute for returns or SFRs.
ReplyDeleteWhen the SFR is filed by IRS, IRS sends notice of deficiency to taxpayer who has 90 days to file petition with Tax Court. Taxpayer then offers miscellaneous itemized deductions that he would be entitled to had he filed a return. The IRS and Tax Court and at least 3rd Circuit Court of Appeals deny the taxpayer these deductions because they argue, they are only allowed if the taxpayer actually files a return pursuant to section 63(e)(2). This is stupid as well, in my opinion.
The case is David R. Jahn TC Memo. 2008-141 aff'd 392 Fed Appx. 949 (3d Cir. 2010)
Great blog and post as always.
John
My experience is that, before the IRS does an SFR, it first asks the taxpayer to file a delinquent return but that does not directly address the issue of whether, once an SFR is issued, the taxpayer should be denied legitimate deductions.
ReplyDeleteI am less exercised about this result.
I would note that the taxpayer in Jahn represented himself and did not develop some of his arguments (see the Third Circuit cryptic opinion).
Also, I am not sure that the result would hold true in a criminal case. Jahn was a civil case. Had, for example, the same fact pattern been encountered in a criminal failure to file case and the tax loss was in issue, I think the tax loss would be the actual tax loss after considering real deductions. The Guidelines provide a presumption of 20% of gross unless a more accurate determination can be made. Assume that a more accurate determination can be made and that there is no doubt about the deductions. I think the same analysis to deny the "unclaimed deductions" would not apply. The object of the offense would be the tax the taxpayer would owe had he filed the return and claimed the deductions he was entitled to.
Jack Townsend