Friday, January 3, 2014

Civil Tax Fraud and Criminal Tax Evasion - Relevance of Intent at the Time of Filing (1/3/14)

The Procedurally Taxing Blog has this terrific entry:  Leslie Book, A Round Trip Ticket to Unwanted IRS Attention: False Documents and Fraud (Procedurally Taxing 12/31/13), here. The Blog discusses the opinion by Judge Holmes in the Tax Court in Brown v. Commissioner, T.C. Memo. 2013-275, here.  I strongly encourage readers of this blog to read it.

I will use that blog entry to extend the discussion in that blog.  So, I will give a very succinct summary.  In late 2003, The taxpayer bought an expensive plane for use in his business.  He wanted to claim 50% bonus depreciation, so he needed to place the plane in service in 2003.  On December 30, 2003, he took delivery for two short flights, returning from the second flight early on December 31, 2003.  At the destination on each of those flights, he claimed to have met with persons for business purposes.  Upon return, and into the following year, the customizers on the plane made modifications to the plane he claimed he needed for his business.  So, his significant business use did not start until well into 2014.  The question is whether he had placed the plane in service by actual business use in 2003, so that he could qualify for the 50% bonus depreciation. His proof of the business purpose consisted in part of letters from two of the persons he claimed to have met with for business purposes.  The letters had not been prepared contemporaneously, and the Judge Holmes seemed to think that they may have been prepared incident to the audit to support the claimed bonus depreciation.  The IRS was more than suspicious.  The IRS denied the depreciation and asserted penalties -- the 75% civil fraud penalty under Section 6663, here, and, in the alternative, the 20% accuracy related penalty.  The parties stipulated as to significant adjustments increasing tax and stipulated that some of those adjustments were fraudulent, thus subject to the 6663 penalty.  At the trial, the only issue was the bonus depreciation.  Under Section 6663's burden shifting rules, since the taxpayer had stipulated to fraud, the taxpayer bore the burden of showing by a preponderance of the evidence that the bonus depreciation claim was not fraudulent.  Judge Holmes denied the civil fraud penalty, but sustained the accuracy related penalty.  Judge Holmes reasoned that the the taxpayer had shown by a preponderance of the evidence that the bonus depreciation was not fraudulent.  In part, the Court reasoned (Slip Op. 45-48, footnotes omitted and emphasis supplied):
The Commissioner first contends that the "thank you" letters -- purportedly from Mastro and Pasquale but really drafted by one of Brown's employees years later -- were false documents. The Commissioner is correct that making false documents is one of the factors that indicates fraud. See, e.g., Spies, 317 U.S. at 499. Still, while these letters weren't actually written by Mastro or Pasquale, we know at least Pasquale did sign the one with his name on it. Thus, while the contents of Pasquale's letter were -- as Pasquale mildly put it -- "a little bit over the top," it's not clear that the contents of either letter were patently false
But even if they were, we don't find that they bear on the fraud analysis here. It's well established that fraudulent intent must exist at the time the taxpayer files the return. See Gleis v. Commissioner, 24 T.C. 941, 952 (1995), aff'd, 245 F.2d 237 (6th Cir. 1957); Holmes v. Commissioner, T.C. Memo. 2012-251, at *37. We found that Brown (via Fitzgerald) generated those letters during the audit process; that is, actions that took place after the filing of the return. While we have said that post-filing events can indicate fraudulent intent at the time of filing, see Holmes, at *37, we don't see any evidence that Brown formed the intent to create those letters when he filed the 2003 return. Brown testified that his practice was to have Fitzgerald write letters on behalf of business associates only "when the IRS requests them" -- that is, after a return has been filed. On the unusual facts of this case, we do find this bit of Brown's testimony credible, and it does persuade us that the letters are not good proof that Brown intended to evade tax at the time he filed his returns. See id. at *41 (finding that "[A]lthough petitioner failed to cooperate with respondent's agents by intentionally submitting a false document, his failure does not compel the conclusion that he had a fraudulent intent in filing his 2000-04 tax returns"); id. at *32 ("Although respondent has proffered some evidence of fraud, that evidence relates exclusively to petitioner's postfiling actions and does not convince us of his intention to evade tax when he filed his tax return for each year in issue"). 
* * * * 
We're not focusing here, however, on whether Brown committed fraud on the returns generally; rather we're looking at whether he has shown by a preponderance of evidence that he didn't commit fraud with respect to one specific deduction. The Commissioner concedes that the bonus-depreciation deduction at issue is a legitimate business expense (albeit for 2004, not 2003). While that concession alone certainly doesn't shield Brown from fraud, we also find persuasive that Brown actually bought the plane and took ownership of it in 2003. And we also find noteworthy that Pasquale credibly testified that Brown flew to Chicago that year to talk business with him.
Note the Court's focus that the civil fraud inquiry inquiry is into whether there was fraud at the time the return was filed.  To be sure post-filing conduct may be considered if it is relevant to the issue of the taxpayer's intent at filing.  But, in this case, Judge Holmes made the key findings of intent at the time of filing.  Those key findings were made in major part on Judge Holmes' assessment of the taxpayer's credibility.  The post-filing creation of questionable documents did not, under the facts as Judge Holmes saw them, indicate the taxpayer's fraudulent intent at filing.

Now, consider the crime of tax evasion which may be accomplished by a fraudulent tax return.  But, Section 7201, here, is very clear that evasion may be accomplished "in any manner."  Hence, a fraudulent post-filing act to influence the IRS to give the taxpayer a benefit to which he is not entitled would be an act of evasion.  Further, in the case of documents such as proffered in this case, those documents might be prosecuted in other ways focusing on the post-filing event of proffering them to the IRS in an audit.  See Sections 7206(2), here, and 18 USC 1001(a)(3), here.  Further, of course, if a conspiracy were involved, those documents could be overt acts of the conspiracy.


  1. The world's largest and one of the world's most secret "bullshit tax shelters" is the United States of America, which, according to a latest Russian press release, is hiding 500 billion dollars for the Russian elite alone:

    пока в американских банках лежит 500 миллиардов долларов, принадлежащих российской элите

    America will never lift a finger against its own tax haven, though, because America actually honors its own "bullshit tax shelter".

  2. Nice piece Jack!

    For tax shelters though (and there are many in kind and quality), can't they always be reduced to whether "tax basis" was "created" without dollar venture/transaction risk--out of thin air to quote a phrase.

    You might say my statement is tautological for it begs the question of whether and what dollars invested in the venture/transaction were subject to that risk of loss? Not really I would respond, for cases where banks (almost universally the case) are financing the non-cash component that creates the excess basis that gets the shelter operative, bank money is NEVER subject to risk of loss in the transaction. That fact is pretty easy to establish once you clear away all the "noise" designed to obfuscate the transaction. Some of the judges are getting it: see the recent Blum case you covered in December, but others seem befuddled by detail.

    Stopping shelters would be easy too: if all dollars in excess of the actually invested dollars (always a little of those) being treated as subject to fraud penalty? If tax fraud--> massive penalty, with tax advisors/financiers jointly and severally liable for the penalty. Yet, this has not been initiated--and we wonder about societal inequality?

  3. Nice find, SwissTechie. I wonder whether the US efforts against foreign bankers aren't likely to come back to bite them. If they argue that foreign bankers broke US law and can be fined and prosecuted, wouldn't a US judge in a US court have to rule for a foreign government pursuing US banks and bankers?

  4. Depending upon context and if it were relevant to some U.S. law or treaty, U.S. courts would have to so rule. However, I wonder whether you are comparing apples and oranges, so to speak. Right now, focusing on the bank program, neither Swiss courts not U.S. courts are involved. The program is simply an offer which Swiss banks, without any Swiss court compulsion, can choose to join or not join.

    But, I don't doubt that, if U.S. persons were knowingly assisting Russian citizens violate Russian law, and that conduct were illegal under Russian law wherever it occurs (i.e., Russian law would say that such assistance is not limited to Russia), then if and when U.S. courts had the issue before them, they would have to invoke whatever jurisdiction and authority they have under law (including treaties) to assist the Russians.

    For example, the Russian authorities could make a request under Article 25 of the double tax treaty for the U.S. to gather information related to tax enforcement and the U.S. courts would enforce summonses -- compulsory process like subpoenas -- to get the information requested from banks and other U.S. sources.

    The problem is that U.S. courts would not have jurisdiction or authority with respect to any criminal prosecutions or even criminal investigations, unless they could find some treaty to be involved.

    That, of course, is why Swiss courts are not involved in the DOJ's program.

    Jack Townsend

  5. Jack I disagree with your contention that OVDI/OVDP were successes. There are about 6 million US persons living abroad. Let's say 2/3 of them have a FBAR filing obligation, the others are children or indigent. Let's say of US residents one million have foreign accounts, perhaps because of having family overseas, perhaps for nefarious reasons. That's 5 million with FBAR obligation. Annual FBARS are around 750,000 or 15% of 5 million. A couple of years ago only 300,ooo FBARs were filed, or 6% of those obliged to do so. The increase may be due to QD. ONly about 40,000 have joined OVDI/OVDP. THat's less than 1% of those with filing obligations. I would not call that a success. The shabby way in which all OVDP participants have been scared into paying the in lieu penalty because of the risks of opting out (300% of high balance) and lack of transparencey of how the optouts are handled (with suggestions by many lawyers that the process is to some extent arbitrary and unpredictable) have caused the other 99% to stay away from OVDP and if they were innocent actors to start hiding their accounts. I do not call that success. And keep in mind that the good actors who were scared or suckered into this are "American people" also.

  6. I guess I am a little surprised that any attorney would not have discussed at some level all options -- joining OVDI/P, quiet disclosure and go-forward. (I suppose leaving the country or renouncing citizenship or might be other options, but I generally do not discuss that with my clients unless they ask.)

    I have a higher percentage of opt outs than 1%. So far, so good.

    Jack Townsend

  7. While, I would have designed a program with some different nuances (the biggest one would be to give opt outs 1/2 the penalty an audit would otherwise require), I think that the overall design of the problem is, on balance, probably pretty good, given the IRS resources.

    First, the program requires 8 years amended or delinquent returns. The taxpayer thus must do the audit work for the IRS because those returns need to be squeaky clean. So income tax audit work is minimized.

    Second, even in the program, the IRS does not assert a penalty for fraud. It asserts the relatively benign 20% accuracy related penalty which does not assume that the taxpayer is a bad actor -- just perhaps a negligent actor or one acting without substantial authority or reasonable cause.

    Third, the IRS does require 8 years and, at least as to the early years in most cases, could not get additional tax for the early years without a finding of fraud (which, if present would require the 75% civil fraud penalty), the IRS pre-empts the issue by just saying that is what the program requires. In this regard, I have settled cases before by agreeing to otherwise closed years if the IRS drops the civil fraud penalty. I do not view an agreement to settle on that basis as a finding of fraud against my client. That is just a settlement. Now, if the IRS had demanded by otherwise closed years and a civil fraud penalty for all of the years, then the IRS would be assuming a bad actor.

    Third, as to the in lieu of penalty (the 27 1/2%) penalty, this too is a settlement which a taxpayer can accept (by not opting out) or not. If the IRS program assumed the worst, it would have required 50% for at least one year, with an opt out. So, it like the income tax noted above, is a settlement without any statement that the taxpayer is a bad actor.

    Fourth, the ultimate fail safe for both the income tax and the in lieu of penalty is the opt out. Taxpayers who are not bad actors should be able to get much better results on opt out. The program was designed to permit that better result in appropriate cases.

    So, frankly, if I were the Commissioner operating with limited resources, I think I would have designed a program much like this, with some differences only in the nuances.

    Jack Townsend

  8. The problem as I see it is that with the abolishing of FAQ 35 and the Damoclean sword of 300% penalty hanging over someone, coupled with the lack of transparency as to what happens on optouts and how criteria are used, people are frightened of opting out. I believe the uncertainty is intentional, i.e. the IRS wants to discourage optouts to save itself work by threatening the chance of draconian penalties. For those with really bad conduct it's clear that they should not opt out. For the few cases at the other end of the spectrum (someone who left the Us as an infant and never even knew he was a US person) then optout seems safe. But it seems that there should be more nuance than just 27.5%, perhaps alog the lines of what TAs has suggested, or possibly either an optout cap (let's say 30 or even 35%) so that people don't optout for frivolous reasons or perhaps an optout fee of $5K to reimburse the IRS for the optout work. But I doubt that even with FAQ 35 that there would be frivolous optouts simply because of the time and legal expense involved for the taxpayer. In the 2009 program where 20% was the ceiling and it was safe to opt out there weren't too many optouts.

  9. Sorry Jack but I clearly view OVDI/P as a failure ... I am afraid a failure with LT negative consequences for the US .

  10. I agree "Guest" ...... "success for the IRS and the American people"..... I really do not know on what planet Jack is living on to call this travesty a success The IRS does not have a simple and easy method for allowing benign actors who are U.S. residents to resolve past filing delinquencies. Nor has it provided clear guidance about key terms that it has used in its programs, such as when someone will be considered “high risk,” how they may avoid a penalty (e.g., by demonstrating “reasonable cause”), and when they will be subject to the lower penalty applicable to “nonwillful” conduct. The uncertainty surrounding these terms and the consequences of opting out has prompted MANY benign actors to pay more than they should inside the OVDI/P programs.

  11. Jack we would appreciate that you cut Swisstechie some slack here, he is very passionate about what he believes and we appreciate his integrity !


Please make sure that your comment is relevant to the blog entry. For those regular commenters on the blog who otherwise do not want to identify by name, readers would find it helpful if you would choose a unique anonymous indentifier other than just Anonymous. This will help readers identify other comments from a trusted source, so to speak.