Second Circuit Holds Onerous § 6707 Penalty -- $61 Million -- Based on BullShit Tax Shelter Subject to Flora Full Payment Rule (4/26/18; 5/8/18)

In Larson v. United States, ___ F.3d ___, 2018 U.S. App. LEXIS 10418 (2d Cir. 2018), here, the Second Circuit held that, in order to pursue the refund suit for the § 6707 penalty, Larson, a convicted tax shelter promoter, had to prepay the $67,661,349 penalty assessed.  Needless to say, the tax shelter was of the BullShit genre.  I had written on this litigation at the trial level.  SD NY District Court Rejects Partial Payment § 6707 Penalty Refund Suit (Federal Tax Crimes Blog 1/2/17; 1/9/17), here.

The Court of Appeals applied the Flora rule which generally requires full payment for refund suit. Flora v. United States (Flora I), 357 U.S. 63 (1958); and Flora v. United States (Flora II), 362 U.S. 145 (1960).  The opinion is straight-forward in stating the rule and rejecting Larson's claims under the Fifth Amendment, the APA and the Eighth Amendment.

The opinion does state, though, that something may be amiss quotation marks omitted):

We close with a final thought. The notion that a taxpayer can be assessed a penalty of $61 million or more without any judicial review unless he first pays the penalty in full seems troubling, particularly where, as Larson alleges here, the taxpayer is unable to do so. But, while the Flora rule may result in economic hardship in some cases, it is Congress' responsibility to amend the law. 

Larson and those similarly subject to this and other potentially onerous penalties may ultimately litigate in the following possible venues:

• In a collection suit brought by the Government to reduce the penalty to judgment, usually brought just short of the 10 year collection period. 
• A CDP proceeding, with Tax Court prepayment remedy, See IRM 8.22.8.10.5 (10-01-2012), IRC 6707 or 6707A Disclosure Penalties ("2. A taxpayer may dispute a IRC 6707 and IRC 6707A penalty in CDP if the taxpayer did not have a prior opportunity to do so")
• Perhaps in a bankruptcy proceeding, but I have not researched that issue. [See the Addendum immediately below which answers this question.]

ADDENDUM 5/8/18 4:10PM:

Michael Little, British/US Lawyer, Convicted for Offshore Account Enabler and Personal Income Tax Charges (4/22/18)

I have previously posted on the prosecution of Michael Little, a UK barrister, U.S. lawyer and U.S. citizen.  Little was an enabler for U.S. persons evading U.S. tax liabilities and FBAR reporting requirements.  I list the significant prior blogs at the end of this blog.  In the second superseding indictment, here, Little was indicted for one count of tax obstruction (§ 7212(a), six counts of failure to file his own income tax return (§ 7203), one count of failure to file FBAR (31 USC § 5314 & 5322(a); CFR §§ 103.24, 103.27(c,d) and 103.59(b); and 2 USC § 2), one count of defraud / Klein conspiracy (18 USC § 371), and ten counts of aiding and assisting (§ 7206(2)).

On April 10, 2018, Little was convicted on all counts.  See the jury verdict here; see also the USAO Press Release on the convictions here.  Key excerpts from the press release are:

Geoffrey S. Berman, the United States Attorney for the Southern District of New York, announced that a federal jury today found MICHAEL LITTLE guilty of charges that he participated in an 11-year tax fraud scheme in which he advised and helped an American family to defraud the Internal Revenue Service by hiding approximately $14 million in overseas Swiss bank accounts and by other means, failed to file his own personal tax returns, and assisted in the filing of false tax returns.  The three-week-long trial took place before U.S. District Judge P. Kevin Castel, who is scheduled to sentence LITTLE on September 6, 2018. 

According to the allegations contained in the Complaint, Indictment, and the evidence presented in Court during the trial: 

LITTLE, a British attorney who resides in England and is licensed to practice law in New York, was a business associate of the patriarch of the Seggerman family, an American family residing in the United States.  In August 2001, after the patriarch died, LITTLE and a lawyer from Switzerland (the “Swiss Lawyer”) met with his widow and adult children at a hotel in Manhattan, and advised them that the patriarch had left them approximately $14 million in overseas accounts that had never been declared to U.S. taxing authorities.  LITTLE and the Swiss lawyer also advised the various family members on steps they could take to continue hiding these assets from the IRS.  In particular, LITTLE discussed with the family members various methods by which they could bring the money into the United States from the Swiss accounts while evading detection by the IRS.  Among other means, he advised family members that they could bring money back to the United States in small increments, or “little chunks,” through means such as traveler’s checks, or by disguising money transfers to the United States as being related to the sales of artwork or jewelry.  Various members of the Seggerman family agreed to work together with LITTLE and the Swiss Lawyer to repatriate the offshore funds.  

In accordance with the plan he orchestrated, LITTLE assisted in opening an undeclared Swiss account for the purpose of holding and hiding the widow’s inheritance funds.  LITTLE also enlisted the assistance of a New Jersey accountant to prepare false and fraudulent tax returns and to keep falsified accounting records for a corporate entity in the United States, controlled by the widow and used to receive inheritance funds repatriated from the Swiss account.  Between 2001 and 2010, LITTLE caused over $3 million to be sent surreptitiously from the undeclared Swiss account to the United States corporate entity for the widow’s benefit.  LITTLE also worked with the New Jersey accountant to establish a sham mortgage that allowed another Seggerman family member to access approximately $600,000 of undeclared inheritance funds held in a Swiss account. 

In or about 2010, LITTLE became aware of an IRS criminal investigation into the scheme.  In an attempt to cover up his involvement, LITTLE communicated with a tax attorney and the accounting firm that had prepared the widow’s individual tax returns.  LITTLE provided false information to the tax lawyer and the accounting firm about the nature of the transfers from the Swiss account to the United States, claiming that the transfers represented “pure gifts” from a non-U.S. person who had “absolutely no relationship” to the widow.  Based on LITTLE’s misrepresentations, the accounting firm filed inaccurate tax returns for the years 2001 through 2010, which categorized the transfers of over $3 million to the widow as foreign gifts. 

LITTLE has been a lawful permanent resident of the United States, also known as a green card holder, since 1972.  As a lawful permanent resident, he had an obligation to file annual tax returns reporting his worldwide income to the IRS.  In or about 2005, LITTLE was admitted to the New York State Bar as an attorney.  Between 2005 and at least late 2008, LITTLE resided full time in New York City, where he worked and earned hundreds of thousands of dollars of income as an attorney representing clients.  During the period of 2001 to 2010, LITTLE also earned other legal fees, along with hundreds of thousands of dollars more in fees for his work on behalf of the Seggerman family.  LITTLE failed to file any tax returns with the IRS between 2005 and 2010.  He further failed to file, for years 2007 through 2010, annual Reports of Foreign Bank and Financial Accounts (“FBARs”) in connection with foreign bank accounts he controlled, which held in excess of $10,000 each year. 

Pretrial Order Excluding Government Evidence in Criminal Tax Case for Offshore Accounts (4/22/18)

In United States v. Doyle, 2018 U.S. Dist. LEXIS 66980 (S.D. N.Y. 2018), here, the defendant had been charged in a superseding indictment for tax obstruction (§ 7212(a)), tax perjury (§ 7206(1)), and conspiracy (18 USC § 371).  The superseding indictment is here; the docket entries as of yesterday are here.  "These charges allege that Defendant and others unlawfully hid Defendant's foreign bank accounts from the IRS from approximately 2003 to 2017."

The Court describes the primary allegations as:

In 2003, Defendant's father died and left her an inheritance of over $4 million. Id. ¶¶ 23-25, 29, 34. The Defendant, who was also executor of her father's estate, made court filings falsely stating under penalty of perjury that the total value of her father's estate was under $1 million when, in fact, it was more than four times that amount. Id. In 2006, the Defendant sought the help of Beda Singenberger, a Swiss citizen who ran a financial advisory firm, to open a Swiss bank account into which the inheritance was deposited. Id. ¶ 34. To conceal the existence of the account, the Defendant and Singenberger established a trust in Lichtenstein named Gestino Stiftung ("Gestino" or "Gestino Foundation") to hold the Swiss bank account in its name. Id. As of December 31, 2008, the account held currency and financial instruments valued at approximately $3,548,380. Id. ¶ 41. In 2010, Gestino re-domiciled from Lichtenstein to Panama. Id. ¶¶ 45, 47. As of December 31, 2016, Gestino maintained assets in various Swiss bank accounts in the amount of at least approximately $3,028,562. Id. ¶ 53. 

The Defendant is alleged to have used this arrangement to unlawfully and fraudulently avoid paying over $1.5 million dollars in United States taxes resulting from the inheritance. For each of the tax years from 2004 through 2009, the Defendant failed to report any income from foreign accounts in her tax filings, and also stated in those filings that she did not have an interest in or signatory or other authority over a financial account in a foreign country (the "Foreign Accounts Question"). Id. ¶ 63.

The motions resolved by the court related to

(i) Tax Return Issue.  The Defendant claimed the Fifth Amendment on her federal income tax returns after she became a target of investigations of her interest in foreign accounts; the issue is whether the tax returns can be admitted in evidence by the Government in support of the tax obstruction and conspiracy charges; and
(ii) Subpoena Litigation Issues.  Represented by Counsel, the Defendant continued to resist the subpoenas, raising, through her then counsel, variations of the Fifth Amendment argument and lack of possession or control of the subpoenaed documents.  The Government asserted the resistance was evidence of unlawful conduct and thus admissible in support of the charge of tax obstruction.  

The Tax Return Issue:

The Court describes the facts succinctly as follows:

from 2004 to 2009, Defendant answered "no" to the Foreign Accounts Question. However, after Defendant received a grand jury subpoena, she did not check either a "yes" or "no" in response to the Foreign Accounts Question on her 2010 through 2015 returns. Rather, she wrote "See Attached Statement" and attached a "Disclosure Statement" stating: "In the context of an on-going federal criminal grand jury investigation being undertaken in the Southern District of New York, under the auspices of the United States Attorney's Office for that District, Lacy D. Doyle hereby asserts her rights and privileges under the Fifth Amendment not to incriminate herself by responding to [the Foreign Accounts Question]." 

The defendant moved "to preclude the Government's use of her answer to the Foreign Accounts Question on her 2010-2015 tax returns in its direct case."

The Government wanted to show that "the defendant never disclosed her foreign accounts to the IRS during that time period." The Government proposed to redact any reference to her assertion of privilege on the return and simply show the foreign account question on Schedule B was blank.

The Court's resolution of the issue:

Reliance on Counsel "Defense" and Jury Instructions (4/17/18)

I just read an interesting article -- Stephen A. Saltzburg, Evidence Supporting Advice of Counsel Defense (ABA Criminal Justice Spring 2018) [no link available].  Saltzburg. here, is a prominent law professor and expert on rules of evidence in criminal trials; he makes his publications available on his publications page here, but this article does not appear yet.

The article discusses United States v. Scully, 877 F.3d 464 (2d Cir. 2017), here, a significant opinion on the reliance on counsel defense.  Scully was not a tax case, but, as readers know, this defense (sometimes in a broader category of reliance on professional) often arises in tax cases to, if successful, defeat the government's evidence of willfulness.

Saltzburg concludes his discussion with the following "Lessons:"

1. A defendant is entitled to rely on an advice of counsel defense provided there is some evidence to support the elements of that defense.
2. In proving the advice of counsel defense, the defendant may testify to what counsel advised, may call counsel to testify about the advice, and may both testify and call counsel to testify in order to establish the defense.
3. The advice provided by counsel is not offered for its truth, but to explain the defendant's state of mind, and is therefore not hearsay.
4. An advice of counsel defense waives attorney-client privilege.  So, in Scully's case, the government could call Tomao [the lawyer] as a witness even if Scully did not.
5. The government has the burden of proving beyond a reasonable doubt that the defendant acted willfully and knowingly, and the advice of counsel defense does not shift the burden of persuasion to the defense.
6. Jury instructions should make clear how the defense relates to the government's burden of persuasion.

My only quibble with these numbered bullet points is that paragraph 1 seems to suggest that defendant must prove the defense.  True, paragraph 5 says that the government must prove beyond a reasonable doubt that the defendant acted willfully and knowingly (which would be willfully in tax crimes).  As Scully makes clear, the advice of counsel defense is not really an affirmative defense that the defendant must prove in order to prevail.  Rather, the defendant must prove only to the extent of creating doubt that the government had proved its case beyond a reasonable doubt.  In this regard, the Scully court said:

While “the prosecution must prove guilt beyond a reasonable doubt,” “the long-accepted rule was that it was constitutionally permissible to provide that various affirmative defenses were to be proved by the defendant.” Patterson v. New York, 432 U.S. 197, 211 (1977). An affirmative defense is “[a] defendant’s assertion of facts and arguments that, if true, will defeat the plaintiff’s or prosecution’s claim, even if all the allegations in the complaint are true.” Black’s Law Dictionary 451 (8th ed. 2004); see also Saks v. Franklin Covey Co., 316 F.3d 337, 350 (2d Cir. 2003). In a fraud case, however, the advice-of-counsel defense is not an affirmative defense that defeats liability even if the jury accepts the government’s allegations as true. Rather, the claimed advice of counsel is evidence that, if believed, can raise a reasonable doubt in the minds of the jurors about whether the government has proved the required element of the offense that the defendant had an “unlawful intent.” United States v. Beech-Nut Nutrition Corp., 871 F.2d 1181, 1194 (2d Cir. 1989). The government must carry its burden to prove Scully’s intent to defraud, and that burden does not diminish because Scully raised an advice-of-counsel defense. Accordingly, the district court must advise the jury in unambiguous terms that the government at all times bears the burden of proving beyond a reasonable doubt that the defendant had the state of mind required for conviction on a given charge. 

That said, defendants are entitled to an advice-of-counsel instruction only if there are sufficient facts in the record to support the defense. United States v. Evangelista, 122 F.3d 112, 117 (2d Cir. 1997). There must be evidence such that a reasonable juror could find that the defendant “honestly and in good faith sought the advice of counsel,” “fully and honestly laid all the facts before his counsel,” and “in good faith and honestly followed counsel’s advice.” United States v. Colasuonno, 697 F.3d 164, 181 (2d Cir. 2012) (brackets and internal quotation marks omitted). Once the evidence meets that threshold, it is for the government to carry its burden of proving fraudulent intent beyond a reasonable doubt and for the jury to decide whether that burden was met. It is therefore potentially confusing to instruct the jury that the defendant “has the burden of producing evidence to support the defense” n5 or must “satisfy” the elements of the defense, or that it is the jury’s job to determine whether the defense was “established.” App’x 368–70.
   n5 The "burden of producing evidence," App'x 368, simply means that the issue is not for the jury's consideration at all absent some evidence of the required facts. Whether that burden is met is thus, in the first instance, for the court to decide. See, e.g., United States v. Bok, 156 F.3d 157, 164 (2d Cir. 1998). It is generally preferable, in our view, not to use the language of "burden of production" in jury instructions for fear that it would confuse the jury about the all-important burden of proof that remains on the prosecution. 

Article on Fifth Amendment Act of Production and Greenfield (4/16/18)

Caroline Rule, here, of Kostelanetz & Fink has published an excellent article on the Fifth Amendment privilege:  United States v. Greenfield: A Triumph of the Fifth Amendment's Act of Production Privilege; or Confirmation that the Privilege Can Be Entirely Abrogated by Any Act of Congress, or Even by a Treasury Regulation?, 71 Tax Lawyer 335 (2018), here (from her firm's web site, from which the article can be printed to paper or pdf with a pdf print driver; those with an ABA membership can download it from the ABA site).  Here is the Abstract:

In 1976, in Fisher v. United States, the Supreme Court first recognized the “act of production privilege” as being a necessary component of the Fifth Amendment’s privilege against self-incrimination. A grand jury subpoena or Service summons does not violate the Fifth Amendment just because documents the government seeks are incriminating; pre-existing documents are not the result of government compulsion. But, a taxpayer may refuse to produce those same documents if the compelled act of producing them is testimonial and incriminating. By producing documents, a taxpayer may “testify” that the documents exist, that she possesses and controls them, that she believes that they are described in the subpoena or summons, and that they are authentic— all admissions that may be incriminating. 

The act of production privilege does not apply, however, if factual admissions inherent in producing documents are a “foregone conclusion” (i.e., if the government can independently prove those facts without relying on the documents’ production). In 2016, in United States v. Greenfield, the Second Circuit narrowly drew this foregone conclusion exception. Greenfield asserted his act of production privilege in response to a 2013 Service summons seeking records of foreign bank accounts. Evidence in the government’s hands indicated that Greenfield might have controlled the accounts in 2001. But the court held that the “critical issue” was whether the government could prove that facts which would be conveyed by Greenfield’s act of producing documents were a foregone conclusion in 2013. The government could not meet this burden (although it might have done so in 2001). The court therefore applied the act of production privilege to quash the summons, because the existence and Greenfield’s control of the summonsed documents in 2013 could be incriminating. “One of Greenfield’s strongest defenses to a charge of tax evasion would be to argue that his father [who died in 2009] . . . was the sole person with knowledge of how the family’s finances were organized,” a defense which would be undermined by evidence that Greenfield took control of bank records after his father’s death. 

Greenfield seems to be a robust affirmation of the Fifth Amendment’s act of production privilege. Yet the Greenfield court was careful to distinguish its 2013 decision in In re Grand Jury Subpoena Dated Feb. 2, 2012, where it refused to apply the act of production privilege to a grand jury subpoena that sought a taxpayer’s foreign bank account records, but only from the previous five years. In the earlier case, the Second Circuit applied the so-called “required records exception” to the Fifth Amendment privilege, because a regulation under the Bank Secrecy Act (BSA), 31 C.F.R. § 1010.420, requires taxpayers sometimes even to create, and to retain for five years, records of foreign bank accounts. The Greenfield decision stated: “The Government can require an individual to produce documents related to foreign bank accounts maintained pursuant to . . . 31 C.F.R. § 1010.420, without violating an individual’s right against self-incrimination under the Fifth Amendment.”  

Consequently, the difference between Greenfield and In re Grand Jury Subpoena Dated Feb. 2, 2012 is not the result of meticulous constitutional analysis, but rests only on the length of time that an agency regulation requires foreign bank account records to be maintained. If the BSA regulation required taxpayers to maintain foreign bank account records for, say, 12 years, presumably the Greenfield court would not have engaged in its extensive discussion of the Fifth Amendment, but would simply have ordered Greenfield to respond to the summons.

The Confluence of Willful Blindness and the Sentencing Guidelines Obstruction Enhancement (4/11/18)

In United States v. Cohen, ___ F.3d ___, 2018 U.S. App. LEXIS 8769 (1st Cir. 2018), here, Cohen appealed his his convictions, and sentencing, for one count of conspiracy to convert government property, in violation of 18 U.S.C. § 371; fourteen counts of conversion of government property, in violation of 18 U.S.C. § 641; and one count of conspiracy to commit money laundering, in violation of 18 U.S.C. § 1956(h).  This is not a tax case, but readers of this blog will know of my continuing interest in the concept of willful blindness.  Cohen presents a different facet of that issue, although, as presented, it offers no particular insight.

The jury was instructed on willful blindness.  We don't have the specific instruction.  But, in sentencing, the judge applied the obstruction of justice enhancement in calculating the Guidelines range.  The judge found that Cohen had lied in his testimony at trial.  That risk, of course, is one of the risks of a defendant testifying at trial.

On appeal, Cohen made some type of argument that the giving of the willful blindness instruction precluded a finding that he had lied for purposes of the obstruction enhancement.  Here is what the Court held:

That leaves only Cohen's argument that the imposition of the obstruction-of-justice enhancement, which requires "willful" obstruction, was erroneous given that the District Court provided the jury with a willful blindness instruction. In challenging the application of the obstruction enhancement below, Cohen argued that, in light of the willful blindness instruction, "his testimony in the eyes of the jury may have made him a damned fool, but that's not the same thing as finding that he's a damned lying fool . . . ." The District Court concluded, however, that a willful blindness instruction is not preclusive of a finding that the defendant perjured himself in testifying at trial. 

On appeal, Cohen does not develop a challenge to this conclusion but instead merely asserts that the District Court "wrongly imposed the enhancement upon one seen by the jury as willfully blind but not necessarily consciously obstructive." We, thus, deem this underdeveloped argument waived. Zannino, 895 F.2d at 17. Moreover, we note that, in any event, there is Circuit precedent that affirms sentences including such an enhancement in cases in which a willful blindness instruction was given. See, e.g., Fermin, 771 F.3d at 79-82; United States v. Camuti, 78 F.3d 738, 744-45 (1st Cir. 1996).

I attach Cohen's opening brief, here, where he makes argument and the Government's answering brief, here, essentially ignoring the argument.  Cohen's willful blindness argument starts on p. 51 of the brief.

District Court Holds Government FBAR Willful Penalty Burden of Proof is Preponderance and Recklessness is Willfulness for FBAR Willful Penalty (4/5/18)

In United States v. Garrity, 2018 U.S. Dist. LEXIS 56888 (D. Conn. 2018), here, a Government suit to reduce the willful FBAR penalty to judgment, the Court held:

1.  The Government's burden of proof on the willful penalty is preponderance of the evidence.

2.  "T]he Government may prove the element of willfulness in this case with evidence that Mr. Garrity, Sr. acted recklessly."

The opinion is relatively short and straight-forward, so I refer readers to the opinion.

This case has a lot of commotion in it, so readers with particular interest might want to review the docket entries which as of today are here.  I make some comments about it below.

JAT Comments:

1.  As I have often noted, I do not believe that the preponderance of the evidence standard should apply because I think the case is sufficiently like the civil fraud penalty that the same burden should apply.  The court dismisses the civil fraud penalty analog in footnote 3 as follows:

   n3 In light of the presumption in favor of applying the preponderance standard in all civil actions, the few structural similarities that Defendants point out between the civil FBAR statute and the civil tax fraud statute are not sufficient to warrant applying a higher standard of proof. (See ECF No. 106 at 2-3.) It is also worth noting that the Second and Eighth Circuits have applied the preponderance of the evidence standard to the tax statute imposing civil penalties for aiding and abetting tax underpayments, i.e., 26 U.S.C. § 6701. See Barr v. United States, 67 F.3d 469 (2d Cir. 1995); Mattingly v. United States, 924 F.2d 785 (8th Cir. 1991). In doing so, the Mattingly decision, on which the Barr decision relied, suggested that the clear and convincing evidence standard is limited to civil tax fraud cases brought under 26 U.S.C. § 7454(a), which requires proof of "fraud with intent to evade tax." 26 U.S.C § 7454(a); Mattingly, 924 F.2d at 787 ("[A]bsent fraud with the intent to evade tax pursuant to § 7454(a), a preponderance standard is applicable in civil tax cases.").

I should note that the reliance on § 7454(a) is misplaced.  Section 7454 relates to Tax Court proceedings - i.e., it is under subchapter C titled "Tax Court."  That statute does not govern income tax proceedings in other courts where the Government must prove fraud by clear and convincing evidence.  Moreover, the Court's curt analysis does not address the issue that the the civil fraud penalty, like the FBAR civil willful penalty, bears the same structural relationship to the criminal fraud penalty, which is like the FBAR criminal penalty.  Both are civil counterparts to criminal fraud penalties.  To simply say that they are different penalties does not really address the issue.  Still, there is a lot of contrary authority at this stage so getting courts to hold otherwise may be almost impossible.