Lesson for Students on the Civil Tax Collateral Consequences of a Criminal Case (4/16/13)

Last night in our Tax Fraud class at UH Law School, we covered a chapter on Civil Tax Considerations.  A Tax Court decision yesterday offers a good opportunity to reprise key points from the class.  The materials in this blog are directed to students rather than experienced practitioners.

In Laciny v. Commissioner, T.C. Memo. 2013-107, here, after pleading guilty to tax perjury (Section 7206(1), here), the IRS pursued the taxes for years of her counts of conviction and related years.  The Tax Court sustained the IRS's determination of additional taxes and the civil fraud penalty.  The following are key points from the opinion (and except for the student's curiosity, the reading the opinion is not necessary).

1.  The underlying tax misconduct was the diversion of corporate funds, thereby underreporting both corporate tax and individual tax.

2.  The wife had previously been indicted for multiple counts, including tax perjury for corporate and individual returns, conspiracy, and aiding and abetting.  She then pled guilty to two counts each of corporate and personal false returns (tax perjury).  The plea agreement had a schedule of total unreported diverted funds.  During her colloquy on plea, she admitted her misconduct including the intentional omission of income.

3.  The wife was sentenced to one year and one-day.  (Students will recall that the addition of one day over one year qualifies the defendant for the good time credit that will knock time off the sentence actually served,  provided, of course, the defendant behaves while incarcerated.)  She was also ordered to pay restitution in an amount not specified, although the respondent agreed that any payments of the restitution would be applied to reduce the tax liability (see fn. 9 on p. 13 of the slip opinion).

4.  The IRS issued a notice of deficiency to husband and wife relating to the tax liability involved and the civil fraud penalty.  (Students will recall that Congress recently enacted a provision that permits the IRS to assess amounts related to tax restitution immediately without having to issue a notice of deficiency; of course to the extent that the IRS seeks more than is included in an order of restitution (which typically would not include mere civil tax adjustments or penalties), the IRS will have to issue a notice of deficiency.)

5.  Husband and wife petitioned the Tax Court.

6.  The Tax Court first rejected the petitioners' threshold argument that the burden of proof had shifted to the IRS under Section 7491(a), here, so that "uncertainty on any issue in this case should be resolved in their favor."  Students will recall that the office of the burden of persuasion (a subset of the general burden of proof concept) is to determine who loses in the event of uncertainty or nonpersuasion on any fact.  Among the requirements for a Section 7491(a) is the requirement that the petitioners introduce credible evidence (a minimum of evidence which must be credible).  The Tax Court found the petitioners' evidence not to be credible.

7.  On the substantive issue of whether the diverted funds constituted dividends taxable to the petitioners, the Tax Court held that the petitioners had produced no evidence of the corporations' earnings & profits (E&P), a tax accounting concept somewhat akin to retained earnings designed to measure a corporation's ability to pay dividends taxed to the shareholder as dividends (as opposed to return of capital invested or, if in excess of return of capital invested, as capital gain).  The Court said curtly:

Petitioners' only evidence of Sta-Cool's earnings and profits is Sta-Cool's corporate income tax returns for the years at issue. But Mrs. Laciny admitted that she falsified Sta-Cool's corporate income tax returns, and petitioners offered no credible evidence to establish Sta-Cool's current or accumulated earnings and profits for the years at issue. Petitioners have failed to meet their burden of proving that there were insufficient earnings and profits to support respondent's determinations in the notice of deficiency. See Truesdell v. Commissioner, 89 T.C. at 1296. Petitioners also failed to prove that any of the constructive distributions represent nontaxable returns of capital.
We sustain respondent's determinations that petitioners' unreported income from Sta-Cool, their personal expenses reported on Sta-Cool's return, and Sta-Cool's overpayment of the Cobb Construction loan are taxable to petitioners as constructive dividends.

Students will recall a similar issue arising in the context of a criminal tax evasion case.  The question  in that context is whether, in order to prove beyond a reasonable doubt the element of tax due and owing, the Government must prove sufficient E&P on a corporate diversion to support the dividend.  The general solution to that issue is not to lessen the Governments required proof beyond a reasonable doubt that there is a taxable dividend, but to require that the defendant put the issue properly in play with some evidence, like a production burden, that the E&P may not have been sufficient.

8.  The Tax Court also held that the petitioners had failed to show that the IRS had not properly accounted for nontaxable loans.

9.  The Tax Court found for the petitioners on certain minor items ($100 and $759), and reduced income accordingly.

10.  Turning to the Section 6663, here, penalty, the Tax Court seems to have brushed with too broad a stroke in finding the necessary underpayment.  The Court said.

A taxpayer's conviction pursuant to section 7206(1) estops him or her from contesting that an underpayment exists for the years at issue in the criminal case. See Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), aff'g T.C. Memo. 1984-601; Kemp v. Commissioner, T.C. Memo. 2004-153. Mrs. Laciny's criminal conviction under section 7206(1) estops her from contesting that an underpayment exists for tax years 1998 and 1999. With regard to tax years 1996 and 1997, Mrs. Laciny acknowledged under oath and while represented by counsel that on their 1996 and 1997 returns petitioners did not report all of their income and that this unreported income was subject to significant Federal income tax. This acknowledgment establishes underpayments by petitioners. See Considine v. United States, 683 F.2d 1285, 1287 (9th Cir. 1982); Ford v. Commissioner, T.C. Memo. 2005-18. Further, respondent introduced evidence showing that during tax years 1996 and 1997 petitioners failed to report income from their rental properties, from the personal expenses paid by Sta-Cool, and from Sta-Cool directly.

Focusing just on the first sentence, students will recall that an understatement is not an element of the crime of tax perjury and, hence, a mere conviction for tax perjury estops the taxpayer neither as to the understatement issue nor the fraud with respect to the understatement issue.  (I note that the cited cases -- Bradford and Kemp -- do not seem to support the proposition for which they are cited.)  However, the tax perjury conviction, in conjunction with the plea agreement and the plea colloquy which admitted the corporate diversion, I suppose that the resulting conviction might and should require estoppel.

11.  Continuing on fraud, the Court held "Fraud is an intentional wrongdoing designed to evade tax believed to be owing."  Note how this parallels the Cheek standard -- intentional violation of a known legal duty -- but in the specific context of the legal duty to report and pay tax.  The Court went through the facts that showed that wife had committed fraud as claimed by the IRS.  The Court said (confirming the importance of the plea agreement and colloquy as opposed to just the counts of conviction):

Petitioners argue that Mrs. Laciny's conviction and plea agreement are not persuasive evidence of fraud because she never had a trial in her criminal case, had inadequate legal advice, felt pressured to sign the agreement, and did not and does not agree with the allegations in the agreement and the statement of facts attached to it. There is no material difference, however, between a judgment of conviction based on a guilty plea and one rendered after a trial on the merits. Arctic Ice Cream Co. v. Commissioner, 43 T.C. 68, 75 (1964); Smith v. Commissioner, T.C. Memo. 1995-402, aff'd without published opinion, 116 F.3d 492 (11th Cir. 1997). Mrs. Laciny voluntarily agreed to the plea agreement and confirmed under oath that the plea agreement and the statement of facts were accurate and truthful. She cannot credibly contest those admissions now. We find the plea agreement and the statement of facts to be highly persuasive evidence of fraud.

12.  Students will recall that the procedural steps in the application of the civil fraud penalty are that (i) the IRS must establish some fraudulent understatement by clear and convincing evidence and (2) then all of the understatement will be subject to the fraud penalty unless the taxpayer establishes by a preponderance of the evidence what portion, if any, of the understatement is not fraudulent.  The Court disposed of this issue as follows:

For the reasons explained above, we find and conclude that respondent has established by clear and convincing evidence that a portion of petitioners' underpayment was attributable to Mrs. Laciny's fraud for each of the years at issue.
Petitioners have failed to show that any portion of the underpayment was not attributable to fraud. Accordingly, we sustain respondent's determination that Mrs. Laciny is liable for the section 6663 penalty for each year at issue.

13.  For the same reason -- the presence of fraud -- the court sustained the IRS's assertion of the unlimited statute of limitations under Section 6501(c)(1), here.