Tuesday, July 31, 2012

Tax Court Finds Fraud Based, in Part, On Negative Inference from Fifth Amendment Assertion (7/31/12)

In Loren-Maltese v. Commissioner, T.C. Memo. 2012-214, here, the Tax Court introduces the legal issues as follows:
It's the facts that make this case interesting, but there are three issues of law that color its background: the general rules of tax fraud, the proper tax treatment of money taken by a politician from her campaign fund for personal use, and the effect of taking the Fifth Amendment in civil litigation. 
I address the first and third issues because they are within the scope of this blog.  The discussion of the requirements for fraud are probably familiar to most readers of this blog, but many may not know or fully appreciate the negative inference that may be drawn in a civil case from invoking the Fifth Amendment.

I highly summarize the facts the Court found "interesting," noting at the inception "The silence that shouts out" (see the third issue).  The taxpayer in the case was an elected local official with strong political tentacles of the Republican variety.  According to the findings, "her coiffure is legendary in Chicagoland." Her late husband was also, so he pled to criminal charges, "prominent Cicero politician who confessed to being a mob bookmaker and pleaded guilty to a federal gambling charge."  The taxpayer and her husband abused their positions for reasons of both animus and personal gain.  This got the attention of federal prosecutors.  So found the Tax Court:
In June 2001 a federal grand jury indicted her and several coconspirators for conspiracy to defraud the Town through a pattern of racketeering via multiple acts of bribery, money laundering, mail and wire fraud, official misconduct, and interstate transportation of stolen property. Her criminal trial lasted about three months, culminating in a conviction on August 23, 2002, on all but one count of the indictment (the criminal tax charge later tried separately). This put an end to her political career, and she was sentenced to eight years in prison. The government then tried her separately on the criminal-tax charges, but the jury hung, and the government decided not to try her again. See Gov't Motion to Dismiss Count 13 of the Above-Captioned Indictment, United States v. Spano, No. 1:01-cr-348 (N.D. Ill. Jan. 31, 2003), ECF No. 494. Ms. Loren-Maltese and the other conspirators appealed their convictions and sentences to the Seventh Circuit, which upheld the convictions but remanded for resentencing. See United States v. Spano, 421 F.3d 599 (7th Cir. 2005). The trial court then upheld the original sentence, and she remained imprisoned until 2010.
As often occurs after tax prosecutions (whether successful or unsuccessful), the IRS moved to assess alleged unpaid tax and penalties (interest comes along automatically), relying heavily on the evidence developed in the trials.  In the Tax Court, the parties made an interesting stipulation which the Tax Court discussed as follows (case citations omitted):
[W]e held a short trial in Chicago whose record was supplemented by the parties' stipulated admission -- "as testimony and exhibits in this proceeding" -- of slightly fewer than 10,000 pages of transcript and numerous exhibits from her criminal trials. n5
   n5 We therefore accept as testimony for purposes of this trial all of the testimony that took place in the criminal trials, and we (like the parties) used the documentary evidence extensively. * * * *
The Commissioner cut through the fog of this mass of evidence to focus on two transactions:
The Commissioner boiled down this sea of information into a very detailed analysis of two transactions: Ms. Loren-Maltese's purchase of a 1993 classic black Cadillac Allante convertible, and her investment in a luxury golf course and clubhouse. The Commissioner contends that her withdrawal of more than $350,000 from the Committeeman Fund to finance the car and investment created taxable income and that she fraudulently tried to evade the tax due on that income.
Essentially, the IRS had the evidence to support the inferences of fraud it alleged.  The taxpayer was "mostly silent during her trial in our Court, relying on her attorney's advice to take shelter under the Fifth Amendment."  The Court took great pains to note that the IRS had evidence to support the inferences of fraud it alleged, but also took great pains to note that the taxpayer's invocation of the Fifth Amendment hurt her.

1.  The general rules of tax fraud (case citations omitted):
Tax fraud is important in this case because fraud stops the clock on the statute of limitations, and so much time has passed that proving fraud is the only way the Commissioner can win. See sec. 6501(a), (c). The question is: Can the Commissioner prove, by clear and convincing evidence, that Ms. Loren-Maltese intentionally evaded a tax that she believed was due? To do so, the Commissioner must establish that (1) an underpayment exists; and (2) some portion of the underpayment was due to fraud. See sec. 7454(a); Rule 142(b); * * * *. Fraud requires a state of mind -- it is commonly defined as an "intentional wrongdoing" on the part of the taxpayer with "the specific purpose to evade a tax believed to be owing." * * * * *
Because it's rare to have direct proof of someone's state of mind, we usually have to rely on circumstantial evidence. * * * * We consider the entire record. * * * * We may infer fraud from any conduct calculated to mislead or conceal. * * * * And we look for "badges of fraud" -- including the ones the Commissioner argues are present in this case:
  • inadequate records;
  • implausible or inconsistent explanations of behavior;
  • concealing assets;
  • engaging in illegal activities; and
  • attempting to conceal activities.
* * * *  We also look at the taxpayer's background, including her sophistication, experience, and education. * * * *

2.  The third issue - negative inferences from invocation of Fifth Amendment.

I just pull out a few snippets of the Court's opinion for flavor (case citations omitted):
The third and final legal issue in this case is the consequence of Ms. Loren-Maltese's taking the Fifth Amendment. Like the other legal issues, the law here is well settled, and Ms. Loren-Maltese's steadfast invocation of her right not to incriminate herself makes the Commissioner's job at least a bit easier. The parties took pains to argue about whether Ms. Loren-Maltese's invocation of the Fifth was justified -- but that doesn't matter much here because even a valid invocation of the Fifth Amendment allows us to draw a negative inference from her refusal to answer a question if the Commissioner produces some additional supporting evidence. * * * * 
We can also draw inferences from her silence if, under the circumstances, it would've been natural for her to object. * * * *. This later principle is not constitutional, just an acknowledgment of human nature. The original Cicero made the point 2,000 years ago in his oration exposing the plot of Lucius Catilina and his friends to plunder their government's treasury. n3 He observed that people have a natural tendency to defend their reputation, and that silence in the face of accusations suggests that there might be some merit to the charges. The Latin is more succinct: Cum tacent, clamant. M. Tullius Cicero, First Oration Against Lucius Catilina: Delivered in the Senate 21.
 n3 And, allegedly, to murder the Senate, overthrow the Republic, and set their city on fire. See Z. Yavetz, "The Failure of Catiline's Conspiracy", 12 Historia: Zeitschrift für Alte Geschichte 485, 485 n.1 (1963).
* * * * 
On this issue, the Commissioner points not just to the paper trail but to Ms. Loren-Maltese's silence at trial. She invoked the Fifth on virtually every question about the car, including its purchase and her use of it, and how she reported (or rather didn't report) on her 1994 tax return her use of Committeeman Fund money to buy it. 
Ms. Loren-Maltese, whose coiffure is legendary in Chicagoland, broke her Fifth Amendment silence on this subject only once -- to tell us that though the car was a convertible, she didn't go "cruising around" Town with the top down because she "wouldn't want to mess up [her] hair." On this narrow issue, we find her entirely credible, but the evidence that her use of the Cadillac was personal rather than political is overwhelming. Though she was a good-humored, engaging, and credible witness when actually answering questions, her silence on substantive questions severely injured her case -- not only because we specifically warned her that claiming the Fifth Amendment would allow us to draw a negative inference, but because the Commissioner's voluminous evidence against her strongly supported that inference.


  1. Jack

    And on these lines, I presume that advising a client to take the Fifth during a civil audit is a difficult and crucial decision for a practitioner. At the very least it might motivate the examiner to bring in CI, even if he/she was on the fence before. On the other hand, not invoking the fifth would mean that the civil agent would have obtained potentially incriminating information.

  2. You have pointed out a major dilemma that taxpayers and practitioners face in a so-called "egg-shell" audit, one that could turn criminal, particularly when the agent is aware of the core facts that could make it criminal.

    Jack Townsend


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