Thursday, December 27, 2018

Tax Court Case Shows That the IRS Burden to Prove Fraud by Clear and Convincing Evidence Is Formidable Indeed (12/17/18)

In Matthews v. Commissioner, T.C. Memo. 2018-212, here, the taxpayer represented himself "pro se" to contest a deficiency with a year that was open based on the IRS determination of civil fraud.  The taxpayer prevailed because, the Court (Judge Vasquez) concluded, the IRS had not proved civil fraud by clear and convincing evidence, despite some acknowledged bad acts, including  lying to the agents, along the way.  The story is interesting because it shows just formidable the clear and convincing standard is.

The civil tax years in the Tax Court case were 2007 & 2008.  Previously, Matthews was originally indicted for tax evasion under section 7201 and subscribing to a false return under § 7206(1) for tax years 2004 through 2008.  A new prosecutor abandoned the tax evasion charges in a superseding indictment that charged (i) § 7206(1), tax perjury, for 2004 through 2008 and (ii) impeding the lawful function of the IRS, 7212(a) (tax obstruction).  Matthews was convicted of all charges, sentenced to a 27-month prison term, and the conviction was affirmed on appeal.  United States v. Mathews, 761 F.3d 891 (8th Cir. 2014), here.

According to a footnote (p. 17 fn 8), "SA Williams testified that the new prosecutor believed the sec. 7206(1) charges would make for a “cleaner case” than the sec. 7201 charges. As discussed infra, sec. 7206(1) does not require the Government to prove that the defendant intended to evade tax."  Note  to students and practitioners, this easier case to prove criminally beyond a reasonable doubt is often the reason that DOJ Tax foregoes a tax evasion charge ab initio, but one would have thought that DOJ Tax would have made the decision earlier.  Still, some prosecutors, particularly a new one on the block, could see the case differently and convince DOJ Tax to permit the "lesser charge" of tax perjury under § 7206(1).  (And, to close that loop, I have even had local prosecutors (AUSAs) with some gravitas with DOJ Tax convince DOJ Tax to forego criminal charges previously authorized based on their different assessments of the case.)

In the ensuing civil examination, the IRS determined that Matthews had unreported income and, based on the assertion of fraud, opened the statute of limitations and asserted the civil fraud penalty.  Matthews petitioned for redetermination to contest the fraud determination.  If successful, Matthews would owe no tax because the assessment statute of limitations had expired.

The fraud issue required that the IRS prove fraud by clear and convincing evidence.  The Court held that the IRS had failed to do so.  The Court held:

1.  Based on assessment of Matthews' credibility, the Court determined (pp. 22-31) that the IRS had failed to established fraud by clear and convincing evidence.  The aspect of the case turned upon credibility determinations.  I enclose below extended excerpts related to this credibility determination.

2.  The Court held (30-31) that the Section 7206(1) conviction was not issue preclusive on fraud.  This is a standard holding.

3.  Matthews was not bound to stipulations of fraudulent intent because contrary to record (pp. 31-33.)

Here are key quotes of interest to tax crimes practitioners who must be concerned with civil liabilities.

Petitioner lied on numerous occasions to RA Crawford and SA Williams during respondent’s civil examination and criminal investigation. However, we do not believe he did so in this proceeding. Before trial, petitioner had served a substantial prison sentence stemming in large part from his behavior during the audit and criminal investigation. We believe this experience impressed upon petitioner the importance of telling the truth. At trial petitioner admitted to making mistakes; he was respectful towards respondent and respondent’s witnesses; and he was cooperative with the Court. His testimony was convincing and withstood cross-examination. We will therefore credit, as specified below, portions of petitioner’s testimony. 
RA Crawford and SA Williams also testified at trial. We found each of them to be honest, forthright, and credible. However, we disagree with their conclusions about petitioner’s fraudulent intent. Petitioner is not a sophisticated taxpayer or financially astute. He dropped out of high school after the 10th grade and has no training or experience in bookkeeping, taxation, or accounting. At trial he appeared confused about the nature of his tax liabilities and, at one point, credibly testified: “[I]t’s over my head.” 
Given petitioner’s lack of sophistication, we question whether he knew there was a “tax owing” from the Multi-Service programs when he prepared his 2007 and 2008 returns. Petitioner consistently maintained throughout trial that he “didn’t know” how to report income from the Multi-Service programs. This testimony is consistent with his statements to SA Williams during the July 2009 interview. Petitioner’s testimony also accords with the general confusion petitioner expressed in the typed statement he attached to his 2008 return.  
* * * * 
In these cases, the misunderstanding was petitioner’s belief that his gross receipts from the Multi-Service programs did not generate tax liabilities because 90% was owed to other members and because he had other deductible expenses.  Having observed petitioner at trial, we find petitioner’s misunderstanding credible in the light of his background and sophistication level. After a thorough review of the record, we also find that petitioner’s misunderstanding was not corrected before he filed his 2007 and 2008 returns. 
In these cases, the record establishes that petitioner was an unsophisticated taxpayer with little, if any, financial acumen. While petitioner behaved reprehensibly during respondent’s civil examination and criminal investigation (which, for the most part, pertained to tax years not in issue), we believe he was genuinely confused about the taxability of the Multi-Service program income when he filed his 2007 and 2008 returns. See Cheek, 498 U.S. at 202-204. Accordingly, his misconduct during respondent’s civil examination and criminal investigation does not establish that his 2007 and 2008 returns were fraudulent.
JAT Comments:

1.  This case should remind students and practitioners why the issue of the proper standard of proof for the willfulness determination for the FBAR willful penalty is so important.  Without digging too deep into the weeds of that issue, I think the following are clear.  First, willful FBAR failures require that the defendant have violated a known legal duty.  That is a pretty strict standard in criminal tax cases requiring willfulness.  But courts have consistently said that (i) willfulness for the civil FBAR penalty may be established by lesser conduct that specific subjective intent to violate a known legal duty and that the Government need prove that less strict element of civll willfulness merely by a preponderance  of the evidence.  I think the courts have wrongfully decided both issues, but they are the judges and I am not.

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