Tax Fraud and Money Laundering Examination (6/9/13)

Larry Campagna, here, and I recently concluded our Tax Fraud and Money Laundering Class at the University of Houston School of Law.  (See our course web site, here.)  I thought that some readers of this blog might be interested in the examination we gave.  The examination in pdf format (with all attachments) is here'.  For those desiring to take the examination, please do so and send your answers to me so that I can grade them.  (Be sure and read the pdf with the instructions and attachments if you do desire to take the examination.)

The following is a cut and paste of the examination :

1. (50% of total exam grade)  

You have entered private practice in Houston, specializing in tax controversy matters.  A new client, Chris Cash, comes to your office for an initial visit.  He asks whether the information that he will tell you is subject to the attorney/client privilege, and you assure him that it is.  Chris then advises you that for the past few years, he failed to include interest income from a Swiss bank account on his individual income tax returns.  The first year of the Swiss account income was 2007, and the income was at least $200,000 per year in every year since then.  His income tax returns were filed as joint returns, signed by both Chris and his wife.  Each return was timely filed on or before October 15 of the following year, pursuant to a timely filed extension.  The certified public accountant who prepared the returns also prepared the joint returns that were filed by Chris and his wife for the ten years prior to the six years during which Chris has had the Swiss account income.  The CPA/preparer also happened to be Chris’ son, who knew that Chris had invested a significant sum of money in a Swiss account, but did not know how much money or the amount of the income that was left off of the income tax returns.  Yesterday, however, Chris visited a new CPA and confessed to having a foreign account, having left the $200,000+ of Swiss interest income off of each year's return, and asked the CPA what to do.  The CPA immediately stopped the conversation and advised Chris to make an appointment with you.  Chris provides you with a copy of his joint returns for 2007 through 2011, each of which shows income of his salary of $300,000 and his wife's salary of $500,000.  Chris tells you that his wife knew that he had made a significant amount of money offshore in 2007, and that he had left the money in an offshore bank account, and she signed some of the account opening documents for the Swiss bank account.  But his wife had no idea of the amount of the money he had made and hidden offshore that produced the interest in the foreign account.  Chris asks you the following specific questions:

a. (15% of total exam grade)  What potential crimes could be charged against Chris?  You may limit your answer to the Title 26 crimes, financial reporting crimes, and the conspiracy statute identified in our class materials.  No explanation of the crime is necessary.  Just identify each potentially applicable crime by Code section; state the elements of the crime; and the prescribed punishment for the crime as set forth in the United States Code (without regard to the punishment that would be determined under the sentencing guidelines).  Then state which crimes are most likely to be charged.


b. (15% of total exam grade)  Assuming Chris is investigated criminally and then prosecuted regarding the 2007 through 2011 income tax returns, what can he expect as far as the procedure that the government will follow?  Assume an administrative investigation conducted by the IRS rather than a grand jury.  Discuss briefly the governmental agencies and offices that would be involved, the order in which the matter is likely to proceed, and the role of each government agent and lawyer who ordinarily would be involved.

c. (10% of total exam grade)  Chris wants to amend the 2007-2011 returns, and to pay all the tax, civil penalties and interest that may apply.  He has had no contact from the Internal Revenue Service about the matter, nor is he under investigation or examination by any agency.  Advise Chris on whether an amended return should be filed and what effect the amended return would have on the potential criminal exposure.

d. (5% of total exam grade)  Would your answer to the previous question change if Chris' wife filed for divorce and threatened in her deposition to tell the IRS that she recently discovered the Swiss account income?

e. (5% of total exam grade)  Chris asks if he should just have his son amend the return.  Advise Chris regarding what precautions should be taken, if any, with regard to the accounting work and the preparation of the amended return.

2. (50% of total exam grade)

NOTE TO STUDENTS: THE QUESTIONS ARE ASKED IN SUBPARTS - E.G., 2a, 2b, etc.  EACH SUBPART SHOULD BE ANSWERED ONLY CONSIDERING THE INFORMATION BEFORE THE SUBPART; IN OTHER WORDS, QUESTION 2a SHOULD BE ANSWERED CONSIDERING ONLY THE INFORMATION BEFORE Q2a AND NOT ANY OF THE INFORMATION AFTER Q2a.

At all times, the taxpayer operated a business through a regular C Corporation (tax at the corporate and shareholder levels) which generated significant revenue in cash.  When the business received payment (whether by cash, check, credit card or otherwise), it would give the customer a receipt acknowledging the amount of the receipt and the payment medium (check, cash, etc.).  The taxpayer separated the retained copies of cash receipts from the other receipts.  The business receipts given to customers were numerically ordered; hence, by separating out the cash receipts, the business’ retained copies of receipts would have “holes” where the cash receipts would have otherwise appeared (i.e.,  the receipt number might go from 1101 to 1105, with 1102-1104 missing, etc.)   The taxpayer would then bundle the cash business receipts along with the cash and stores them in a highly secure gun safe in a house the taxpayer has in another state for deer hunting purposes.  The business deposited the noncash receipts in its regular business operating account at a bank located a block away from its offices.

Shortly after the end of each month, the taxpayer delivered to the accountant the retained copies of noncash receipts (not including the cash receipts stored with the cash in the gun safe).  The accountant included as the businesses gross revenue only the receipts he was given -- representing the noncash receipts, or in accountant’s lingo, noncash gross revenue.  The gross revenue thus calculated (i.e., not including cash) was used for all purposes (including federal tax on the Form 1120 filed by the Corporation and state franchise tax and sales tax reported by Corporation).  Furthermore, in preparing the individual form 1040 for that taxpayer, the preparer did not include the cash receipts.  The taxpayer had this pattern of conduct of spiriting away cash receipts for the entire years 01 through 06.  For each of the years 01 through 05, the Corporation and the taxpayer filed returns timely – the Corporation, a calendar year taxpayer, by March 15 of the year following, and the taxpayer, also a calendar year taxpayer, by April 15 of the year following.

In January 07, two IRS agents make a surprise visit to taxpayer's home at 8am to “interview” him.  The taxpayer is caught off-guard by this IRS expression of interest in him (i.e., he did not know the IRS was interested before).  The taxpayer fortunately had the good sense to decline to answer questions once the CI Agents read him his modified Miranda warnings.  The taxpayer terminates the interview and He immediately consults you, a tax controversy specialist.

Question 2a (10% of total grade):  Explain to the taxpayer whether he should file a year 06 Form 1120 and/or a year 06 1040.  Assume that CI investigation is still continuing at the time of the normal due dates for the 06 return (March 15 of year 07 and April 15 of year 07, respectively) and the extended due dates, if an extension is sought (September 15 of year 07 and October 15 of year 07).  Explain your answer to the taxpayer.  END OF QUESTION 2a.

On March 15 (the Ides of March) of year 09, the grand jury indicts the taxpayer for tax perjury (Section 7206(1)) with respect to the Forms 1120 and 1040 for the years 02 through 05.  The following summarizes the Counts in the indictment:


Indict
ment
Count # Crime Charged Gross Revenue
Understated Tax Understated
1 § 7206(1), Tax Perjury for year 02 Form 1120 $70,000 $23,800
2 § 7206(1), Tax Perjury for year 03 Form 1120 $70,000 $23,800
3 § 7206(1), Tax Perjury for year 04 Form 1120 $70,000 $23,800
4 § 7206(1), Tax Perjury for year 05 Form 1120 $70,000 $23,800
5 § 7206(1), Tax Perjury for year 02 Form 1040 $70,000 $19,600
6 § 7206(1), Tax Perjury for year 03 Form 1040 $70,000 $19,600
7 § 7206(1), Tax Perjury for year 04 Form 1040 $70,000 $19,600
8 § 7206(1), Tax Perjury for year 05 Form 1040 $70,000 $19,600
TOTAL $560,000 $173,600
Unindicted year 01 Form 1120 tax loss $23,800
Unindicted year 01 Form 1040 tax loss $19,600
Unindicted State franchise and sales tax $50,000
AGGREGATE TAX LOSS FOR ENTIRE PATTERN OF CONDUCT $267,000

Question 2b (5% of total grade): Explain to the taxpayer why the grand jury did not indict for year 01 for the Forms 1120 and 1040.  Assume for purposes of answering this question that, having watched the CI investigation, you know that the IRS fully investigated year 01 and made a tax loss determination for all of the years 01 through 06.  END OF QUESTION 2b.

The Government offers a plea deal of two counts of § 7206(1), with the remaining counts being dismissed. The Government will require that (i) the full tax loss for all years be included in the tax loss for sentencing and (ii) require contractual restitution in that full amount (including year 01), along with a 20% accuracy related penalty on the Forms 1120 and 1040 taxes. Advise the taxpayer of the following matters that the taxpayer should consider in assessing the plea deal offered:

Question 2c (2.5% of total grade): What is the maximum possible number of years of incarceration if the taxpayer rejects the plea, goes to trial, and is convicted of all counts? END OF QUESTION 2c.

Question 2d (2.5% of total grade): Is the answer you give in 2c relevant to the taxpayers’ assessment of the plea deal offered?  If not, why not.  END OF QUESTION 2d.

Assume for purposes of the following questions that the only Sentencing Guideline factors are the base offense level determined under SG § 2T1.1 and SG §2T4.1 (tax loss table), reduction(s) for acceptance of responsibility under SG §3E1.1, and the Sentencing Table under Ch. 5 Part A (with a criminal history of I). Enclosed are copies of the pertinent portions of the Sentencing Guidelines (you can assume that these are the applicable Guidelines).

Question 2e (10% of total grade): Answer the following assuming that the taxpayer accepts the plea:
(1) What is the Tax Loss.
(2) What is the Base Offense Level?
(3) What is the reduction for acceptance of responsibility (assuming the prosecutor recommends the maximum reduction)?
(4) Assuming no other adjustments, what is (i) the Offense Level for purposes of the Sentencing Table and (ii) the indicated sentencing range from the Sentencing Table?  END OF QUESTION 2e.

Question 2f (5% of total grade): Does it make any differences to the calculations in 2e if the Government requires that the taxpayer plead to 2 counts rather than 1 count?  END OF QUESTION 2f.

Question 2g (10% of total grade): Explain to the taxpayer in lay terms how rigid the application of the indicated sentencing range you calculate in answering Question 2e.  END OF QUESTION 2g.

Question 2h (5% of total grade): Advise the taxpayer of the Guidelines calculations if he does not accept the plea and is tried and convicted of all counts.  END OF QUESTION 2h. Attachments to 2013 Examination


ATTACHMENTS
SG § 2T1.1 Base Tax Crimes Provision
SG §2T4.1 Tax Loss Table
SG §3E1.1 Acceptance of Responsibility
SG Ch. 5 Part A Sentencing Table (with a criminal history of I)