Panel Presentation: “Spies” Evasion – When Does Failure to File Constitute Tax
Evasion? What are the basics tax attorneys should know when representing
clients with criminal tax exposure?
Panel Presentation: “Spies” Evasion When Does Failure to File Constitute Tax Evasion?
What are the basics tax attorneys should know when representingclients with criminal tax exposure?
Course Materials by David W. Klasing Esq. M.S.-Tax CPA and the Tax Law Office of David W. Klasing, P.C. All Copyrights reserved. Note: A great deal of the information in this presentation package came from our website that is accessible at: www.taxe sqcpa.net 2603 Main St., Suite 1180, Irvine, CA 92614, Phone (949) 681-3502 Fax: (949) 681-3504
JUDGE DICKRAN M. TEVRIZIAN, JR. (RETIRED)
Dickran M. Tevrizian, Jr. was a judge the United States District Court for the Central District of California, a position he has held since 1986. He is the first Armenian-American to have served as a Federal Judge in the history of the United States. Judge Tevrizian began his judicial career at age 31 when former California Governor Ronald Reagan appointed him to the Los Angeles Municipal Court in 1972. He was one of the youngest judges ever to be appointed to the judiciary by Governor Reagan. Six years later, California Governor Edmund Brown, Jr. elevated Judge Tevrizian to the Superior Court of the State of California for the County of Los Angeles. In 1982, lie returned to the practice of law and stayed until his appointment as a Federal Judge by President Ronald Reagan. On August 5, 2005, Judge Tevrizian took senior status and retired from the Federal Judiciary on April 19, 2007.
Judge Tevrizian graduated Cum Laude from the University of Southern California with a B.S. in Finance in 1962. Three years later, he received his J.D. from the U.S.C. School of Law. From 1966 until His appointment to the Los Angeles Municipal Court, Judge Tevrizian was first an associate and later became a partner in the law firm of Kirtland and Packard. From 1982 until his appointment to the United States District Court, Tevrizian practiced law in the Southern California area as a partner in the law firm of Manatt Phelps Rothenberg &Tunney and as Of Counsel to the law firm of Lewis, D’Amato, Brisbois & Bisgaard. In 1987, he was named Trial Judge of the Year by the California Trial Lawyers Association. Judge Tevrizian was also named the 1994-1995 Trial Jurist of the Year by the Los Angeles County Bar Association, in 1998, Judge Tevrizian was named Federal Court Trial Judge of the Year by the Malibu Bar Association. In 1999, Judge Tevrizian was award the Ellis Island Medal of Honor, in 2002,
Judge Tevrizian was awarded the Maynard Toll Award from the Los Angeles County Bar Association for his service to the under privileged. In 2003, he was awarded the Distinguished Public Service Award from the Orange County Federal Bar Association. In 2005, Judge Tevrizian received the Emil Gunipert Award for his efforts in promoting alternative dispute resolution. He received the 2005 Justice Armand Arabian Leaders in Public Service Award. From 1999 to 2007, Judge Tevrizian served as an Advisory Director to the University of California, Los Angeles (U.C.L.A.) School of Public Policy. Judge Tevrizian and his wife Geraldine are residents of Pasadena, California.
Judge Tevrizian has been a lecturer for numerous Bar Associations, California Continuing Education Programs and State Bard Mandatory Continuing Legal Education Seminars. He also has served on Boards of Directors for number charitable organizations such as: Armenian General Benevolent Union (A.G.B.U.); Glendale Memorial Hospital Foundation; Armenian Eye Care Project; Exception Children’s Foundation; and Southwestern University School of Law.
Upon Judge Tevrizian’s retired from the federal judiciary, the University of Southern California named him the first holder of a Judge Robert M. Widney Chair in the faculty of the University of Southern California. In addition, Judge Tevrizian assumed the role of a private mediator/arbitration with Judicial Arbitration and Mediation Services (JAMS) in their Los Angeles office.
Recently, Judge Tevrizian was named to the Advisor)’ Board of Legal Zoom and as a member of the Board of Directors for Children’s Hospital of Los Angeles and Tutor Perini Corporation.
Evan Davis is an Assistant United States Attorney in the Major Frauds Section of the Criminal Division in the Central District of California. He has spent most of the past 16 years working on tax cases, first as a civil litigator for the Tax Division of the Department of Justice, then as a criminal and civil litigator in the US Attorney’s Tax Division, through his current job as a whitecollar criminal prosecutor. While at DOJ, he focused on bringing injunction cases against tax scam promoters, including the infamous Irwin Schiff and Eddie Kahn, who sold a tax scheme to and was convicted alongside the actor Wesley Snipes. Among other federal jury trials, he has tried five criminal tax cases and one civil tax case. Evan graduated Order of the Coif from Cornell Law School and cum laude from Colgate University.
Richard Speier, Jr. retired from IRS Criminal Investigation in 2006 after 29 years as a special agent, manager and executive. He was the Acting Chief, Criminal Investigation at the time of his retirement. In this position and his prior position as the Deputy Chief Criminal Investigation (CI), he supervised CI’s 4,600 employees and was responsible for directing CI’s entire investigative program. Since his retirement from government service, Rick has served as a consultant to attorneys and corporate clients who seek his guidance in matters dealing with a variety of financial crimes and tax controversy matters. Rick has extensive experience as an expert trial witness.
David S. De Jong, LLM, CPA, practices law with the Rockville, Maryland, firm of Stein Sperling Bennett De Jong Driscoll PC, concentrating his practice in tax planning and controversy, estate planning, business transactions and valuations. An adjunct professor for over 25 years at five universities, he currently teaches part-time at the Washington and Lee University School of Law. For 16 years he coauthored J. K. Lasser’s annual tax planning book. Mr. De Jong has litigated cases in each federal tax forum and has testified as an expert witness over 50 times in court, arbitrations and before disciplinary panels. Active in many professional groups, Mr. De Jong is a Past President of the American Association of Attorney-Certified Public Accountants. In 2006, he was listed as one of the Top 100 Attorneys in the United States by Worth magazine; he has received additional accolades from Washingtonian Magazine, Washington Smart CEO, Super Lawyers and CPA Magazine. Mr. De Jong received his BA from the University of Maryland in 1972, his JD from Washington and Lee University in 1975. and his LLM in Taxation from Georgetown University in 1979.
David W. Klasing Esq. CPA M.S.-Tax has earned dual California licenses that enable him to simultaneously practice as an Attorney and as a Certified Public Accountant in the practice areas of Taxation, Estate Planning and Business Law. He provides businesses and individuals with comprehensive Tax Representation, Planning & Compliance Services and Criminal Tax Representation. He has more than 20 years of professional tax, accounting and business consulting experience, coupled with extensive knowledge about federal and state tax codes, regulations and case law. As a former auditor, Mr. Klasing uses his past experience in public accounting to help his clients avoid tax problems before they develop where possible. As a Combo Attorney CPA he aggressively protects his clients’ interests during audits, criminal investigations or in Tax Litigation. Mr. Klasing has assisted thousands of businesses and individuals through the audit / litigation and appeal process, and Mr. Klasing has a proven and sustained record of achieving favorable results for the clients he serves.
Mr. Klasing is admitted to practice before all California State Courts, the United States District Court for the Central District of California and the United States Tax Court.
Mr. Klasing’s education includes a bachelor’s degree in business administration, with an emphasis in accounting, from California State University Los Angeles, a master’s degree in taxation from Golden Gate University and a Juris Doctor from Western State University College of Law.
Having earned a master’s degree in taxation with an emphasis in the gift and estate tax arena, along with having taken classes in Law School on Estate’s, Trusts and California Community Property, Mr. Klasing practices in the estate, trust and accounting areas.
Mr. Klasing’s professional involvement includes serving as the current chair of the American Association of Attorney – Certified Public Accountant Education Committee, the (2012/2013) chair of the California State Bar Association, Tax Procedure and Litigation Committee, the 2013 chair of the Orange County Bar Association Taxation Section. He is also a member of the American Bar Association Tax Section; the Orange County Bar Association, Tax, Business and Corporate Law, Trust & Estate Sections, the California Society of Certified Public Accountants State Committee on Taxation and the American Association of Attorney Certified Public Accountants. He is an “A” rated current member of the Better Business Bureau. He has a 10.0 AVVO rating (Superb)
The “Spies evasion” doctrine:
The “Spies evasion” doctrine is, essentially, one of the common ways the government convicts a non-filer target of tax evasion. It is essentially a road map for the government to follow that will find a non-filer target criminally liable for felony income tax evasion when the following elements indicative of a non-filer’s willfulness can be proven. The target willfully (1) fails to file a tax return, and (2) his or her action is coupled with an “affirmative act of evasion,” that is likely to mislead the government.
Sources of federal law that defines “tax evasion” in general:
The specific source of federal law that defines tax evasion is Section 7201 of the Internal Revenue Code. However, that definition has been expanded, amplified, and interpreted by case law, the underlying treasury regulations, and revenue rulings. At a basic level, Section 7201 provides that a person commits tax evasion when he or she “willfully attempts in any manner to evade or defeat any tax or its payment.”
Significance of the Spies evasion doctrine:
Section 7201 “Spies evasion” is a tremendously more serious offense than the seldom charged section 7203 misdemeanor surrounding the non-filing of a tax return. This is because the mere non-filing of a tax return is typically a Section 7203 misdemeanor, while a “Spies Evasion” type fact pattern may cause the Section 7203 offense to rise to the level of a Section 7201 felony. The willful failure to file a return and pay federal income tax where a taxpayer knows federal tax is due is only a misdemeanor United States v. Masat, 896 F.2d 88, 97-99 (5th Cir. 1990).
Tax evasion, however, must be proved by some sort an affirmative act rather than a failure to act. Tax evasion is most commonly proven by showing the willful filing of a false return. A “Spies Evasion” type fact pattern will enable the government to establish an affirmative act even where returns are not filed!
In Spies the Supreme Court identified at least seven examples of conduct that constituted affirmative acts of evasion. The Court stated: “We think the affirmative willful attempt may be inferred from conduct such as  keeping a double set of books,  making false entries of alterations,  or false invoices or documents,  destruction of books or records,  concealment of assets or covering up sources of income,  handling of one’s affairs to avoid making the records usual in transactions of the kind, and  any conduct, the likely effect of which would be to mislead or to conceal.” Spies United States , 317 U.S. 492, 499 (1943).
Unfortunately for many taxpayers, case law has greatly expanded what it means to engage in an “affirmative act of evasion.” By way of example of a recent application of this doctrine, In N. Stierhoff, CA-1, 2009-1 ustc, a target was convicted and sentenced
for committing Spies Evasion. The affirmative acts that elevated his non-filing from a misdemeanor into a felony were that the target operated his business under a false name, concealed his identity and income, and of course was a non-filer.
“Egg shell” audit:
An eggshell audit is a civil audit in which the return(s) under examination contain a material understatement of income, material overstatement of deductions or credits were claimed that the taxpayer was not entitled to, the end result of which was that the taxpayer showed less tax liability than they would have owed had a true, complete and accurate return been filed. These errors can be caused by mere negligence, which may result in a 20% negligence penalty on any additional income tax found to be owed under audit, or via willful intent which would indicate underlying criminal issues with the tax filings under audit, which may result in 3 to 5 years in jail and or a 75% fraud penalty.
Reverse “egg shell” Audits:
Reverse egg shell audits are parallel and simultaneous civil and criminal investigations where essentially a criminal tax investigation is disguised as a civil audit. Reverse eggshell audits usually stem from a referral from a civil examiner (revenue agent) to a Fraud Referral Specialist whose sole job it is to work up the case for a handoff to a special agent in the criminal investigation (CI) division or upon a request by CI that a civil auditor be assigned to an ongoing criminal investigation. Ordinarily in a standard civil audit, the auditor is not on notice at the outset of an audit regarding a taxpayer’s potentially criminal tax conduct, however, in a reverse egg audit; it is the taxpayer and potentially their representative who is not on notice about the auditor’s true intentions.
Warning signs to look for in determining if there has been a criminal referral and therefor an egg shell audit has reversed into a reverse egg shell audit:
A criminal referral is likely to follow a civil audit if firm indications of fraud exist in the mind of the civil auditor. Note: An omission of income greater than $10,000 in a single year will result in an automatic referral to a technical fraud advisor for possible development of the case for a hand off to the criminal investigation division.
Commonly recognized warning signs that precede a criminal referral include:
A civil audit may be suspended before completion and referred to CI for criminal investigation without the knowledge of the taxpayer.
The Revenue Agent becomes unexplainably unreachable.
The Revenue Agent focuses heavily on the “intent” of the client in taking positions on a return or worse yet mentions a pattern of noncompliance on several tax returns.
The Revenue Agent focuses prepares a net worth analysis or subpoena’s bank records.
The Revenue Agent gathers an excessive amount of documentation or makes excessive copy requests.
The Revenue Agent makes undisclosed contact with third parties.
The target receives a summons for records or for an appearance.
More than one revenue agent, the agent and their manager or worse yet two revenue agents, an attorney from chief counsel’s office and a court reporter attend a client interview.
An officer of the IRS wearing a gun and a badge approaches the target and reads them something similar to a Miranda warning (this is an IRS special agent from the criminal investigation division of the IRS). If you have reason to suspect this may happen counsel your client to demand that counsel be present for their questioning and remain silent!
The typical eggshell audit is said to reverse where a temporary suspension of a civil audit occurs which is often indicated where a civil auditor cancels a subsequent appointment and then fails to contact or return the taxpayer’s calls for several weeks while the referral process to CI progresses.
Understanding why a reverse egg shell audit is so dangerous for a taxpayer:
Because of recent changes in IRS internal policy, parallel investigations are on the rise and are rapidly becoming a favorite tool of the IRS. The advantages to the government in utilizing reverse egg shell audits is that the ample investigatory tools available to the average civil auditor such as third party subpoenas to banks and witnesses can be utilized without the taxpayer having the opportunity to utilize the constitutional protections of the due process clause, the fourth amendment privilege against unreasonable searches and seizures, and the fifth amendment right not to self-incriminate which are the most powerful tools available to criminal defense counsel.
Ordinarily an IRS civil revenue agent’s primary concern is supposed to be determining the correct civil tax liability for the tax years at issue, while an IRS Special Agent from the Criminal Investigation Division is primarily concerned with gathering evidence to prove criminal violations have occurred and to prove it at trial if need be. CI Special
Agents are required to advise taxpayer’s of their constitutional rights against self-incrimination and of the taxpayer’s right to have an attorney present during an interview via a non-custodial reading of their rights which states that anything they say may be used in a subsequent criminal prosecution for tax crimes. Because of this requirement, the initial interview with the special agent will often be delayed while the investigated taxpayer obtains legal counsel. To avoid granting the investigated taxpayer this tactical advantage in a reverse egg shell audit, initial contact is often made via a civil revenue agent to avoid putting the investigated taxpayer on notice that they are under criminal investigation while the civil examiner continues to collect information and conduct interviews with the taxpayer (and more importantly their often unseasoned representative) is none the wiser.
Reverse egg shell audits therefore present grave danger to less informed taxpayers who often tragically employ less sophisticated & often less expensive tax representatives, (i.e.CPAs & E.A.’s) that lack attorney client privilege and usually have a conflict of interest with the client because they prepared the original returns at issue and thus need to protect their own reputation with the taxing authorities. These less sophisticated representatives will often blindly cooperate with the auditor under the misconception that the taxpayer is merely complying with a standard civil audit and thus unwittingly waive the taxpayer’s constitutional rights that experienced criminal tax defense counsel would have exercised if they suspected their client was facing a criminal investigation.
Moreover, Reverse egg shell audits / parallel investigations often involve cooperating federal agencies (such as the SEC, FBI, DEA, ABC and the DOJ) and the civil and criminal investigation functions of the IRS. This flavor of egg shell audits additionally carries the added risk that the examination conducted by the IRS will advance the criminal investigation of the cooperating federal agency.
Lastly, revenue agents commonly continue to collect information after the discovery of firm indications of fraud, and thus procedurally go off the reservation by effectively conducting their own personal reverse eggshell audit. The continued investigation by the revenue agent without proper notice to the taxpayer and their representative that subsequent statements made and information provided will likely be used in a subsequent criminal investigation and prosecution violates the taxpayer’s constitutional rights that would exist if they were approached by the criminal investigation division directly and received a Miranda like reading of their rights.
Effective criminal tax defense counsel’s goals in an egg shell audit:
In the typical eggshell audit criminal tax defense counsel seeks to avert the emergence of a criminal investigation, by attempting to prevent a client from making any criminal admissions. In a reverse eggshell audit, they endeavor to discover any ongoing clandestine criminal tax proceeding and possibly limit the taxpayer’s cooperation in order to protect the taxpayer from criminal prosecution by protecting their constitutional rights against self-incrimination and unreasonable search and seizures.
Methods to obtain the above goals:
Taxpayers facing an egg shell audit should only be represented by experienced criminal tax defense counsel and the CPAs who perform via a Kovel agreement (United States V. Kovel, 296 F.2d 918 (2nd Cir. 1961)) effectively subordinating them to the attorneys supervision and rendering communication between the CPA and the client subject to the attorney client privilege. The original return preparer should never provide representation in an egg shell audit as they do not have attorney client privilege and are often subpoenaed to help make the government’s case in chief against the taxpayer. Also they cannot be trusted to be more concerned with protecting their own reputation than in helping the client avoid criminal prosecution.
Taxpayers faced with an eggshell audit are in dire need of an experienced criminal tax defense attorney who is able to advise the taxpayer on how exactly to comply with the auditor’s data requests, questioning, summonsing of records and all other investigatory techniques while simultaneously preventing the client from making criminal admissions or providing false information that can effectively waive the client’s 5th Amendment privilege against self-incrimination and 4th amendment privilege against unreasonable searches.
The Criminal Tax Defense Attorney’s largest concern in an eggshell audit is to dissuade the examining agent from referring the case to the criminal investigation unit of the IRS because CID’s primary mission is to deter the general public from committing tax crimes by criminally prosecuting a sample of taxpayers caught cheating to make an example out of them.
Once a revenue agent discovers significant and affirmative indications of fraud during a civil audit, he will first privately consult with his manager and upon receiving his managers approval he then secretly consults with a “fraud referral specialist” that works directly with the auditor to develop a “fraud development plan,” for the sole purpose of documenting the affirmative acts and firm indicators of fraud in order to refer the case to the criminal investigation function of the IRS. Criminal tax defense counsel must know when to weigh the benefit of continuing to cooperate with the civil revenue agent in an effort to quell the agent’s suspicion before a referral is made or choosing to advise his client to remain silent to protect the taxpayer from self-incriminating themselves by admitting to tax fraud or in making statements that the auditor later proves to be lies Page | 9 which amounts to a felony in and of itself as it is a felony to lie to a federal agent after a referral has been made.
Questioning the auditor regarding whether there is an open criminal investigation, grand jury investigation, associated technical fraud advisor or associated special agent of the criminal investigation division achieves different objectives in an eggshell versus a reverse eggshell audit. In an egg shell audit, this line of questioning may become necessary to protect the taxpayer but must be asked in such a manner as not to raise the auditor’s suspicion that tax fraud exists in the client’s fact pattern. If a reverse eggshell audit is underway, this line of questioning can help protect the taxpayer, because it will alert counsel to the existence of a clandestine criminal investigation or, if the revenue agent provides more than a tacit denial of the existence of a parallel criminal investigation, subsequent information and statements may be suppressible under Tweel.
One of the strongest protections available to criminal tax defense counsel is found under Tweel, which held that any auditor deception in a reverse egg shell audit has to be tacit rather than affirmative otherwise subsequently procured information will be suppressible. Thus when a revenue agent lies when he or she states that there is no parallel criminal investigation underway, a technical fraud advisor has not been associated with the audit, or if they continue their civil investigation after badges of fraud have been detected which are sufficient to trigger a halt to the civil examination and a criminal referral, any subsequently procured documents and statements are suppressible in a subsequent criminal prosecution.
An argument can also be made that all subsequent information and the taxpayer’s statements collected subsequent to the revenue agents original discovery of badges of fraud is inadmissible under Tousaint and thus can be suppressed. However contrary hair splitting case law holds that if the auditor’s conduct is merely a deception that violates IRS procedure but falls short of violating the U.S. Constitution or applicable federal statutes, the evidence collected by the auditor will not be held to be inadmissible in a subsequent criminal prosecution under Caceres and thus will not be suppressed. This split in federal case law creates a continuum of auditor behavior that requires measuring actions taken by an auditor that are often clandestine and thus hard to analyze and therefore makes the reverse egg shell audit extremely risky to the effected taxpayer.
It is often assumed that a taxpayer’s IRS master file is flagged if the taxpayer is involved in a criminal investigation, and thus a civil auditor could theoretically respond to an inquiry by a taxpayer’s representative whether there is an open criminal investigation, grand jury investigation, associated technical fraud advisor or associated special agent of the criminal investigation division. While the civil revenue agent will almost certainly Page | 10 be aware of the coding in the file, when queried, they will have to either answer honestly or more likely refuse to respond at all, in either event the criminal tax defense attorney will have learned something. In my opinion a refusal to deny a parallel tax criminal investigation is underway is as good as an admission that one is.
Accordingly, a taxpayer representative’s failure to ask the right questions at the sensitive juncture between an egg shell audit and it’s progression into a reverse egg shell, or failure to recognize the approaching juncture altogether, may result in a permanent loss of a taxpayer’s constitutional rights and privileges.
DEFENSE TACTICS DURING CIVIL EXAMINATION
A civil examiner is required to refer a case to the Criminal Investigation Division (CID) as soon as a firm indication of fraud is discovered in order to protect the taxpayer’s fifth amendment rights against self-incrimination and fourth amendment right against unreasonable searches and seizures. Thus, a civil examination should be immediately suspended while the IRS pursues a criminal tax investigation. However this is occasionally not the case.
Consequently, tax defense counsel should endeavor to prevent their client’s from offering testimony or evidence during a civil examination where it is indicative or probative of criminal intent, including making false statements and creating any record or displaying conduct that is likely to mislead or conceal especially in cases where there is an arguable Fifth Amendment claim. On the other hand, once a civil examination has begun, a taxpayer’s failure to make books and records unconditionally available to the examining agent may result in referral of the matter for criminal investigation. To this end, I routinely counsel my client’s that when speaking to a civil examiner they only have two choices: 1. Tell the truth! 2. Remain silent!
A substantial majority of reported convictions in criminal tax cases involve taxpayers who cooperated fully early in the investigation, without counsel, and either lied or made damaging admissions to CID agents. CID agents have the advantage during the first interview: they have prepared, they have reviewed tax returns, and they know the direction and scope of the investigation, consequently unrepresented taxpayers are at a distinct disadvantage.
A couple of cases are illustrative of the case law in this area that defense counsel can use to his client’s advantage:
In one notable case, taxpayer’s counsel argued that the evidence gathered by the examining agent was inadmissible in a subsequent criminal trial because there had been firm indications of fraud from the beginning of the audit and thus the audit should have been suspended pending a referral of the case to CID which would have put the taxpayer on notice of his criminal tax exposure. The Seventh Circuit held that the consensual search at the exam level was unreasonable under the Fourth Amendment and violated the due process clause of the Fifth Amendment because the taxpayer’s consent was induced by fraud, deceit, trickery or misrepresentation by the examining agent. To prevail under this line of case law, Tax Defense Counsel must establish that the agent affirmatively misled the taxpayer about the investigation and that this deceit was a material factor in the taxpayer’s decision to give information to the agent.
In another illustrative criminal tax case, to find out whether his client’s ongoing investigation was criminal or civil, the taxpayer’s attorney asked the examining agent whether a CID agent was involved in the investigation. The agent correctly responded that no special agent was involved. The Fifth Circuit held that records turned over by the taxpayer’s attorney to the agent could not later be used in a criminal tax case against the taxpayer because the agent deliberately deceived the taxpayer’s attorney by not informing him of the criminal nature of the investigation even though his previous statement was correct. The court held that his deception invalidated the taxpayer’s consent to the examination of his records and made the examination an unreasonable search and seizure in violation of the Fourth Amendment.
By contrast, in another illustrative civil case (non-criminal) before the Tax Court, the Tax Court refused to bar the use of evidence collected in a criminal investigation that was disguised as a civil audit because the taxpayer was aware that the information could be used in a civil case.
In some instances, moreover, the taxpayer’s tax defense counsel may object to the agent’s summonses based on protections of confidentiality that may apply to tax advice given by a federally authorized tax practitioner. The privilege may be asserted only in any noncriminal tax matter before the IRS or in any noncriminal tax proceeding in federal court brought by or against the United States.
LACK OF INTENT
Proving that a taxpayer acted intentionally in violation of a known legal duty is a critical element of most of the government’s criminal tax cases and is often the most difficult one for the prosecution to prove. In the absence of a confession or the testimony of an accomplice, intent usually must be established by circumstantial evidence concerning the taxpayer’s actions. The admissibility of circumstantial evidence is frequently a close question that criminal tax counsel can endeavor to suppress. Questions concerning the admissibility of evidence of intent are best raised with the tax defense counsel at both the Tax Division of the Justice Department and the U.S. Attorney’s office, since both organizations are bound by guidelines and experience that encourage them to consider declination if the only admissible evidence of intent is that of carelessness.
DEFECTS IN METHOD OF PROOF
When the IRS relies on indirect or circumstantial methods of proof, guidelines established by the courts establish safeguards that must be complied with in the use of that circumstantial evidence. Effective Tax Counsel can ensure that these safeguards are complied with.
IMPROBABILITY OF CONVICTION
Both the IRS and the Department of Justice regard the probability of conviction to be an important standard of review. A number of factors that are not sufficient by themselves to cause eclination, when viewed together, might be sufficient reason to decline a case. A combination of a health condition, personal tragedy, and prepayment of liabilities could form the basis for declination. If a physical or mental health defense is raised, it should be supported by a medical opinion letter, medical records, and the curriculum vitae of the medical professional who treated the taxpayer.
Potential Tax Practitioner criminal liability:
It is important to emphasize the obvious that tax evasion is a very different concept than tax avoidance is. Tax avoidance involves the careful, legal structuring of one’s affairs so his or her tax liability is legally reduced or minimized. Tax avoidance is legal. As one famous judge put it, “one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934). Tax evasion, by contrast, is not legal and it involves the willful attempt to avoid paying one’s tax liability after it has been incurred.
A tax practitioner can be found guilty to the same extent as the taxpayer who actually owes the taxes. This is because the scope of tax evasion is defined broadly in Section Specifically, Section 7201 provides that tax evasion includes a person’s attempt “in any manner”—including helping another—“to evade or defeat any tax” or its payment (emphasis added). Thus, the statute allows the IRS to prosecute a person for the evasion of another’s tax liability. The defendant need not be the taxpayer in question.
To successfully prosecute a violation of the aiding or assisting provisions for aiding or assisting another to file a false form, the government must prove beyond a reasonable doubt that;
The defendant aided, assisted, procured, counseled, or advised the preparation or presentation of a document
The document was false as to a material matter
The defendant acted willfully.
Charges under this provision are most often brought against, accountants, bookkeepers and others (including an entity’s employee’s) who prepare or assist in the preparation of tax returns. However, the statute is not limited solely to the direct preparation of a return but is much broader in that the statute reaches any intentional conduct that contributes to the presentation of a false document to the IRS. Case law in the area provides the following examples:
An individual who sold discounted winning horse or dog race tickets to others for cash, thereby causing the filing of a false Form 1099s, as well as the individuals who signed government forms provided to the racetracks that falsely stated that he or she was the winner of the horse or dog race;
A person who knowingly prepared overstated appraisals to substantiate overstated deductions for charitable contributions;
Persons who fabricate and then sell fictitious invoices to others to support nonexistent deductions;
A breeder who, in furtherance of a fraudulent tax shelter, signed back-dated contracts for the purchase of livestock;
An employee who prepared false books and records that were eventually used to prepare the entity’s returns;
The be charged under these provisions one need only assist in the preparation of, and need not sign or file the actual false document. The statute has thus been applied to individuals who communicate false information to their return preparers, thereby causing the tax preparer to file a false return. On the other hand, the statute specifically provides that the taxpayer who signs and files the return or document need not know of, or consent to, the false statement for the aiding and abetting statue to be brought against the preparer. For example, a tax preparer who inflates deductions understates income or claims false credits on a client’s return may be charged with aiding and abetting even if the taxpayer for whom the return is prepared is unaware of the falsity of the return he signed and filed. Moreover, a tax preparer who utilizes information provided by a client that the preparer knows to be false in the preparation of a return can be criminally charged with assisting in the preparation of a false return.
FALSE AS TO MATERIAL MATTER
The courts that have ruled on what constitutes a material matter have held materiality to be a matter of law to be decided by the court and not a factual issue to be decided by the jury.
To establish willfulness in the delivery or disclosure of a false document, the government need only show that the accused knew that the law required a truthful document to be submitted and that he or she intentionally violated the duty to be truthful. The crime of aiding or assisting in the preparation or presentation of a false return or document requires that the defendant’s actions be willful in that the defendant knew or believed that his or her actions were likely to lead to the filing of a false return. The Ninth Circuit (the appeals court for Southern California and thus controlling precedent) has held that the government must prove not only that the accused knew that the conduct would result in a false return, but must additionally establish that tax fraud was in fact the objective of the allegedly criminal conduct.
STATUTE OF LIMITATIONS
The statute of limitations for the crime of aiding or assisting the preparation or presentation of a false return or other document is six years. The statute of limitations for charges involving delivery or disclosure of a false document starts to run from the date the document is disclosed or submitted to the IRS.
Examples of evasion of assessment type convictions of practitioners:
In United States v. Wilson, 118 F.3d 228 (4th Cir. 1997), the court considered the evidence that the government introduced against the defendant that he (the defendant) attempted to mislead the IRS or conceal the taxpayer’s assets. The court considered the following evidence, among others: (1) that the defendant “prepared and executed false, backdated notes;” (2) that he “participated in a meeting where he discussed removing money from [another’s] bank accounts in order to prevent the IRS from attaching the money;” (3) that he provided the IRS revenue officer misinformation; (4) that he “prepared numerous corporate documents for [various parties], knowingly named “strawmen” as officers and directors;” and (5) that he instructed someone “how to funnel money” from one person to another to make it look like one of the parties had made an investment when he had not in fact done so.
In R.J. Ruble, DC N.Y., 2009-2 ustc, a well-known attorney was convicted of income tax evasion for designing and marketing a tax shelter. The government proved that attorney either knew or alternatively consciously disregarded the fact that the tax shelter he designed and marketed lacked economic substance. There was no business purpose to employ the shelter other than to obtain a tax benefit, and that there was no reasonable probability that the shelter would result in any profit apart from the anticipated tax benefits.
Examples of evasion of payment type convictions of practitioners:
In R. Huebner, CA-9, 95-1 ustc a practitioner who routinely serviced tax protesters by drafted sham promissory notes and then claiming the fake debt on the protestor’s bankruptcy petitions to remove IRS wage levies was convicted of aiding and abetting attempted income tax evasion. The practitioner created false claims indicative of financial distress, with the purpose of frustrating the government’s collections under its levies. Convictions for conspiracy to defraud the United States were also sustained because the false assertions provided the required affirmative act with the intent to deceive the government.
A line of cases, with some variations among the circuits, have held that when a return preparers accepts checks from their clients with the understanding that the funds are to be used to pay the client’s tax liability, any diversion of the earmarked funds for the return preparers’ personal use coupled with a failure to pay the tax is a criminal attempt to evade tax.
Exposure of Tax Practitioners to “tax obstruction” under (§7212):
The crime known as “tax obstruction” is found in IRC § 7212, which actually lists several crimes. However, there is one clause in this statute—known as the “Omnibus Clause”— that is the focus here. An Omnibus Clause violation exists when someone (anyone) “in any way corruptly . . . obstructs or impedes, or endeavors to obstruct or impede, the due administration” of the tax laws. § 7212.
To establish a Section 7212(a) omnibus clause violation, the IRS must prove three elements beyond a reasonable doubt: (1) that the defendant made a corrupt effort, endeavor, or attempt (2) to impede, obstruct, or interfere with (3) the due administration of the tax laws (Internal Revenue Code). U.S. v. Wood, 384 Fed. Appx. 698 (10th Cir. 2010).
Exposure of Tax Practitioners to “aiding or assisting a false return” under IRC § 7206(2):
The crime known as “aiding or assisting a false return” is codified in IRC § 7206(2), which essentially makes it a felony for someone to “willfully aid . . . assist, procure, counsel, or advise” someone in the preparation of a document (e.g. a tax document) that is “materially” false.
Broken up into its elements, the government must prove five things, each one beyond a reasonable doubt: (1) the defendant aided, assisted, procured, counseled, or advised another in the preparation of a tax return (or another document in connection with a matter arising under the tax laws); (2) that tax return (or other document) falsely stated something; (3) the defendant knew that the statement was false; (4) the false statement was regarding a “material” matter; and (5) the defendant aided, assisted etc. another willfully (that is, with the intent to violate a known legal duty).
One thinks here of a CPA, enrolled agent, or other tax preparer who is trying to help his or her client pay less tax, but that person (the taxpayer himself or herself) was not involved in the tax preparation process. But the tax crime of aiding another to prepare a false document captures more than just CPAs and enrolled agents. It includes anyone who prepares false documents—for example, an appraiser who values a business interest for tax purposes, or a tax shelter promoter. An appraiser might have to discern the value of a partial interest in a business or other asset contributed to a charity. An inflated value would achieve a higher charitable deduction to the taxpayer, but if that value is not defensible, the appraiser could be charged with “aiding in the preparation of a false return” under § 7206(2).
Tax evasion and the definition of a “person”:
Section 7201 states that “any person” will be guilty of tax evasion if he attempts to evade or defeat a tax or its payment. The question, however, is whether “person” includes partners of a partnership, or an employee of a corporation, and the like. It does. The answer is found in Section 7343 of the Internal Revenue Code, which defines “person” for purposes of tax offenses. It explains that “person” includes “officer[s] or employee[s] of a corporation, or member[s] or employee[s] of a partnership,” provided that such person is “under a duty to perform the act” that constitutes the tax offense. In addition case law has extended the term to include tax preparers, and corporations.
Section 7201 – two distinct criminal offenses, or two means of committing one and the same offense?
At first blush, Section 7201 of the Internal Revenue Code would seem to create two criminal offenses. Section 7201 provides that a person commits tax evasion when he or she “willfully attempts in any manner  to evade or defeat any tax . . . or  [its] payment.”
First, there is the offense for willfully attempting to evade or defeat a tax assessment. Stated simply, a taxpayer commits the crime of “evading of assessment” of a tax when he attempts to prevent the government—that is, the IRS—from determining his true tax liability. This would include, for example, the filing a false income tax return that “low balls” or omits income. It also includes a return that claims deductions that the taxpayer is not entitled to. These actions are a crime because they falsely lower the taxpayer’s “taxable income,” which is the figure ultimately used to compute tax liability.
Second, Section 7201 creates an offense for willfully attempting to evade or defeat the payment of a tax. Typically, this offense arises after the IRS has asserted you owe a tax, and the taxpayer actively conceals money or assets from the government in an attempt to avoid paying his or her tax liability.
Early case law (e.g. Sansone v. United States, 380 U.S. 343, 354 (1965)) said these were two, distinct crimes, but several Circuits have more recently treated them as constituting basically the same offense. These Circuits maintain that they both consist of an Internal Revenue Code Section 7201 offense of tax evasion. Thus, “Section 7201 evasion,” as it is sometimes called, may be committed by either attempting to evade a tax assessment or by attempting to evade its payment. In United States v. Mal, 942 F.2d 682, 686 (9th Cir. 1991), the Ninth Circuit held “that § 7201 charges only the single crime of tax evasion, and that an individual violates the statute either by evading the assessment or the payment of taxes.” Id at 688. Furthermore, even the IRS’s own Tax Crimes Handbook explains that “[t]hese two offenses share the same basic elements necessary to prove a violation of I.R.C. § 7201.” https://www.irs.gov/pub/irsutl/tax_crimes_handbook.pdf
Section 7201 statute of limitations:
Under I.R.C. § 6531(2) there is a six year limitation period in which the government can charge for the offense of willfully attempting to evade or defeat the payment of any tax. The crime of tax evasion is completed when the false or fraudulent return is willfully and knowingly filed. However, for purposes of the statute of limitations on criminal prosecutions, returns filed before the due date are treated as having been filed on the due date. The affirmative act need not occur before or at the time the return is filed or due. Events occurring after the return is due, such as lying to government agents, are commonly relied on to establish attempted evasion. It is the latest affirmative act of evasion and not the due date of the tax returns at issue that triggers the limitations period.
Differentiation of IRC §7201’s “attempt to evade” and the common-law crime of “attempt”:
IRC Section 7201’s definition of “attempt to evade” is materially different from the common law crime of “attempt”. This was one of the holdings of the Supreme Court in Spies. The distinction between IRC Section 7201’s definition of attempt and the criminal attempt of common law is not a mere hair-splitting matter. The significance is huge. The punishment for attempting a common law crime is ordinarily significantly less severe than accomplishing the completed act of the crime. For example, the punishment for attempted murder (e.g. trying but failing to kill someone) is less severe than for actually committing murder (actually killing the person).
However, that is not how it works with tax evasion. IRC Section 7201 finds a person liable when he “willfully attempts in any manner to evade or defeat any tax.” In Spies the Court stated that this “attempt to evade or defeat” a tax is an “independent crime, complete in its most serious form when the attempt is complete, and nothing is added to its criminality by success or consummation.” In other words, when it comes to tax evasion, attempted “murder equals murder”: attempting to commit tax evasion (whether successful or not) is equally offensive as actually committing tax evasion. Case law has shown that even an unsigned return or a false return signed by an agent can support criminal charges for income tax evasion.
Governmental evidentiary showing that a target willfully “attempted” to commit tax fraud:
Normally, the IRS seeks to prove the requisite willfulness element by using indirect evidence rather than direct evidence—like the taxpayer’s admission to the investigating agent or a witness or confession—since direct evidence is rarely obtainable. Other direct evidence often comes from inculpatory statements made by a taxpayer’s representative that are within the scope of a valid power of attorney and are often used by the IRS against the taxpayer in a subsequent criminal prosecution.
The Third Circuit said, “[i]n the majority of criminal cases, the element of wilful intent is inferred from circumstantial evidence.” U.S. v. Voigt, 89 F.3d 1050, 1090 (3d. Cir. 1996). These are indirect facts that, when weighed together, suggest that the taxpayer attempted to commit tax fraud. The Supreme Court in Spies tremendously eased the governments’ evidentiary burden by allowing the willfulness requirement to be inferred from “any conduct, the likely effect of which would be to mislead or to conceal.”
It is instructive to point out that circumstantial evidence need not consist of “slam dunk” type facts. For example, a business engaging in only all-cash transactions is not, in itself, a fraudulent action. But, when it is combined together with other facts it could become a “negative” one, which will weigh in the government’s favor. Negative facts are called Badges of Fraud, or facts that the IRS, FTB, other taxing authorities, and the Courts tend to find equate to fraud or run with fraud.
A target’s or his or her defense counsel will often argue that the taxpayers actions were “equally consistent with innocent activity” and thus no direct link exits between their actions and an apparent “motive” or “intent” to evade taxes. For example in U.S. v. Voigt, 89 F.3d 1050, 1090 (3d. Cir. 1996), the court rejected the taxpayer’s argument that his actions were legally insignificant. In that case, the taxpayer (i) decided against purchasing some jewelry with cash when he discovered that a report to the IRS would be required; (ii) required his clients to fill out certain confidentiality agreements that forbade them from disclosing details of certain transactions; and (iii) maintained an overseas bank account. Taken individually, each of these facts is, strictly speaking, “equally consistent with innocent activity.” But the court found them to be legally significant in finding that the taxpayer had the intent to evade his taxes. The court stated that it had “no difficulty concluding” that based on his actions, when taken together, that they may “provide the jury with sufficient evidence from which it could infer that they were ‘designed’ to evade the payment of admitted tax deficiencies, even if such actions otherwise might constitute wholly innocent conduct.”
The requisite willful intent is often proven by examining the taxpayer’s entire course of conduct and convincing a jury to make reasonable inferences from the course of conduct. A targets level of education or financial sophistication is relevant in determining willfulness. For example the fact that a target was a lawyer, accountant professional or a sophisticated businessperson may be focused upon as indicative of willfulness, while the fact that a target lacked education and sophistication tends to negate the element of willfulness.
Courts have identified the following list of objective facts that when weighed together tend to indicate willfulness and thus are deemed badges of fraud and thus can be used by the government to establish willfulness for tax crimes or civil fraud penalties. The government need not prove each affirmative act alleged; it is sufficient to prove a single act.
- creating false documents;
- supplying false information to a return preparer;
- failing to keep adequate books or records;
- extensive dealing in cash;
- failure or refusal to cooperate with, or lying to, investigating agents;
- participation in illegal activities;
- withholding financial information from accountants;
- keeping a safe deposit box under an assumed name;
- consistently overstating deductions;
- claiming excess withholding exemptions;
- claiming a charitable deduction for property when the taxpayer listed the property as his own on financial statements, paid expenses and taxes for the property, and used the property to secure a mortgage;
- claiming to be exempt from income taxes;
- leaving the United States with valuable assets following an audit determining a tentative deficiency;
- maintaining a double set of books or records;
- engaging in a pattern of tax evasion in previous years;
- taking business deductions for personal expenses;
- withholding information from the person or persons responsible for preparing the taxpayer’s return;
- failing to file tax returns;
- crossing out the verification on a return;
- prior warnings by courts or others that a tax practice is unlawful.
- making false entries, alterations, invoices, or documents;
- destroying books or records;
- concealing assets or covering up sources of income;
- handling one’s affairs to avoid making the records usual in transactions of the kind;
- filing a false Form W-4, Employee’s Withholding Allowance Certificate;
- willfully filing a false return;
- ignoring books and records in computing gross profit;
- filing blank returns with different social security numbers;
- failing to report personal expenses paid by a corporation;
- concealing assets from revenue officers attempting to collect withholding tax, even though assets were revealed to an agent examining the taxpayer’s income tax return;
- instructing employees not to talk to investigating agents about illegal income and advising them to inform their employer of any such contacts.
- And if none of the above apply – remember the Spies catch all – any conduct, the likely effect of which would be to mislead or to conceal.
Case law examples of badges of fraud relied upon to establish willfulness:
In L.D. Rozin, CA-6, 2012-1 ustc a business owner’s conviction was upheld where he used suspicious loss of income insurance policies to generate tax deductions that were backdated. In S.R. King, CA-8, 80-1 ustc ¶ 616 F2d 1034 the court held that a consistent pattern of non-reported income is in itself evidence of willfulness.
In R.A. King, CA-7, 97-2 ustc, 126 F3d 987 the filing of fraudulent Forms W-4 which falsely claimed exemption from withholding established willfulness because a reasonable inference could be drawn that the false forms were filed with the primary intent of permanently eliminating income tax withholding.
In L. Beall, CA-7, 92-2 ustc, 970 F2d 343 a subcontractor directed that his paychecks be made payable to a tax avoidance organization. This action coupled with the taxpayer’s admissions made to a co-worker and pattern of non-filed personal returns were indicative of his willful evasion of taxes.
In J.C. Payne, CA-10, 92-2 ustc, 978 F2d 1177 Cert. denied, 113 SCt 2995 a taxpayer who provided false social security numbers to his bank and brokerage firms, which in turn caused these payors to issue Forms 1099 to the IRS under the false social security numbers, was properly convicted on four counts of tax evasion.
In A.K. Khanu, DC D.C., 2009-2 ustc Aff’d, per curiam, CA-D.C., 2011-2 ustc a nightclub owner was convicted for willfully attempting to evade taxes because funds were seized from him that he disclaimed ownership of that could reasonably be inferred represented unreported income.
In R.S. Carlson, CA-9, 2001-1 ustc a dentist opened bank accounts using fake personal information in an attempt to frustrate the IRS’s collection efforts. The dentist deposited large amounts of income from his dental practice to these accounts after first receiving deficiency notices for the tax years at issue. His use of a fake social security number, fake birth place and fake birth date was held to support an inference of tax evasion.
In J. Van Meter, CA-5, 2008-1 ustc a married couple was convicted for evading the IRS’s collection action where they transferred money to an offshore account, titled assets in the name of trusts and used the hidden assets to live a lavish lifestyle.
Taxpayer’s primarily attempt to commit tax evasion when they file a false return. One of the leading cases in California making this point is United States v. Boulware , 384 F.3d 794 (2004), 470 F.3d 931, 934 (9th Cir. 2006) Taxpayer’s secondarily attempt to commit tax evasion when they file a false amended return. A lead case in California on this point is Norwitt v. United States , 195 F.2d 127, 133-34 (9th Cir. 1952), cert. denied , 344 U.S. 817 (1952).
Case law holds that when a taxpayer engages in a consistent pattern of overstating deductions, it is tax evasion. For example the Eight Circuit explained that a “consistent pattern of overstating deductions” is tax evasion in Zacher v. U.S., 227 F.2d 219, 224 (8th Cir. 1955). The court states that such a “consistent pattern” exists when, for example, the taxpayer “overstate[s] casualty losses, . . . the sales tax deduction claimed exceeded the amount of sales tax paid” and he “overstate[s] [his] repair costs.”
The Government’s burden as to proving tax due and owing:
There is no certain, mathematical “threshold” that must be crossed for the government to meet is burden as to a tax being due and owing. Rather, most courts hold that the taxpayer must understate his tax liability by a “substantial amount” before they can be charged with a tax crime. Again, not all courts agree. For example, if you live in California, the government need only show that “some tax deficiency” existed. In United States v. Marashi, 913 F.2d 724, 735-736 (9th Cir. 1990), for example, the Ninth Circuit only required that a reasonable “trier of fact could have found some tax deficiency beyond a reasonable doubt”.
The government does is not required to prove a precise amount of tax due and owing. Moreover, the government is not required to show tax due with mathematical certainty. In United States v. Bender, 606 F.2d 897, 898 (9th Cir. 1979), for example, the Ninth Circuit, maintained that evidence of a Section 7201 violation does not need proof of “any specific [tax liability] amount attributable to any tax year that has been unreported. All it needs to establish is ‘some deficiency’ for each year encompassed by the charge.” See also United States v. Keller, 523 F.2d 1009, 1012 (9th Cir. 1975) expressing something similar.
The government employs various standard methods of proof however it may offer any relevant evidence in an effort to establish the existence of a tax deficiency in a tax evasion case. The government may use any one method or may use several to corroborate one another, and may use different methods for different years included in an indictment.
Direct methods include offering proof that the taxpayer omitted or failed to report all or part of a specific item of income, overstated deductions or falsely claimed credits. For example, the government could attempt to prove that the taxpayer failed to report a particular item of income, such as a sales commission, the proceeds on the sale of an asset, or service revenue from a business. The government can also endeavor to show that the taxpayer received a total amount of income greater than that the amount reported on the return as direct evidence of a deficiency. For example the government could attempt to establish through interviews with a Doctor’s clients that the amounts they had paid him during the three examined tax years exceeded the gross receipts the Doctor reported on his returns for those years.
Indirect methods are typically used when the taxpayer has no books and records or where the government cannot obtain, understand or has no faith in the books and records produced by the taxpayer. Moreover, the use of indirect methods may be resorted to when the taxpayer has purportedly complete books and records as a way of obtaining corroborating indirect evidence to support incomplete or insufficient direct evidence. For a complete discussion of indirect methods see the question entitled
Criminal Investigation Division methodology of choosing and investigating a case:
From a policy perspective, CID chooses Cases for full investigation with the goal of deterring Criminal Tax violations by covering a wide cross section of taxpayers. CID’s aim is to encourage voluntary compliance throughout the nation by covering the widest possible cross section of taxpayers. In the past, subjects of Criminal Tax investigations have included persons from every economic and vocational group and every geographic location.
Cases are selected in areas of the tax spectrum that the IRS believes have significant compliance problems. The IRS attempts to identify the specific types of individuals and businesses responsible for the greatest amount of tax fraud. CID has in the past focused on dishonest return preparers and persons engaged in the underground economy, believing these groups are involved in dishonest practices and make up a large portion of tax cheats.
Cases believed to result in high-publicity are occasionally selected to publicize the enforcement effort often involving public figures such as movie stars and musicians. By contrast, media coverage of convictions of local citizens may be limited or nonexistent. Cases involving organized crime figures, narcotics traffickers, dishonest politicians, and other types of celebrities, often generate significant publicity for CID’s enforcement efforts.
Criminal investigations are extremely expensive, because of the time required for a full investigation (often more than a year) and the expense of securing and examining books and financial records. Criminal Investigation Division personnel from experience know that some cases have a higher chance of resulting in a conviction while other cases have a small likelihood of success due to factors such as the advanced age of the defendant, the unavailability of witnesses, or the Justice Department’s dislike for a particular type of case. Annually CID has historically only had the resources to initiate less than 7,000 investigations nationally. Consequently, decisions to undertake an investigation or not often rest on the availability of resources as much as on any other factor.
Historically, the IRS has not prosecuted cases in which there is only a small deficiency at stake. The IRS’s internal CID guidelines require that a tax deficiency be at least $10,000 over three tax years to bring a tax evasion prosecution. Prosecution for signing false returns or failure to file requires a tax deficiency of at least $2,500 over three years. However, case law has shown that a taxpayer can be successfully prosecuted for filing a false return even when no deficiency is proven.
Special agents receive assignments from their managers as to information items or for full-scale investigations. Information item assignments are usually limited inquiries to determine whether sufficient potential exists to conduct a full-scale investigation of a taxpayer. If a full-scale investigation is authorized, one or more special agents are assigned and the investigation continues until the evidence is sufficient for the agent to recommend prosecution or until there is no longer reason to believe that a prosecutable case can result with available resources. An agent conducting an information assignment normally reviews the taxpayer’s returns and other related IRS documents. If the case has been referred from within the IRS, the referring employee is interviewed. Informants, if any, are also interviewed. The special agent often confers with supervisors or senior agents concerning the potential of the case, and recommends whether the case merits full-scale investigation or should be returned for civil disposition.
The District Chief of the Criminal Investigation Division (CID) or the Chief’s designee makes the final decision. Criminal Investigation Division (CID) special agents have broad powers in securing evidence, including authority to administer oaths, to take testimony of witnesses, to examine books and records, to serve administrative summonses, and to execute search and arrest warrants.
Taxpayers who are placed under arrest must be given Miranda warnings. The extent to which a taxpayer will be given Miranda warnings depends on whether he is in custody at the time of first contact by the special agent. If he is under arrest or imprisoned, the special agent must give the full Miranda warnings, even though there is no relation between the tax investigation and the reasons that the taxpayer is in custody. Interviews conducted in an IRS office or at the taxpayer’s home or business are normally noncustodial. Case law establishes that the filing of a Form 2848, Power of Attorney and Declaration of Representative, is not an invocation of the right to counsel that precludes the special agent from interviewing the signer without the representative present.
A taxpayer who was made aware that he was being investigated is generally notified when the investigation is terminated. A case in which an investigation is terminated may be referred back to the Examination or Collection Division of the IRS. If additional indications of fraud are found after the criminal investigation is discontinued, the revenue agent must refer the matter back to the Criminal Investigation Division (CID).
Methods of gathering circumstantial evidence commonly employed by the IRS Criminal Investigation Division:
The strongest evidence of a taxpayer’s willfulness is typically the size of taxpayer’s tax deficiencies that can be proven to occur over a number of years. Experience has shown the Government that a greater amount of tax deficiency can usually be established by including the use of circumstantial evidence than by the use of direct evidence of omitted income alone.
Circumstantial Methods of Proof: Net Worth Method
Under the net worth method, the taxpayer’s net worth (total assets minus total liabilities) at the end of one year is compared with his or her net worth at the end of the next year. The method calculates net income for a year by measuring the increase in net worth over a particular year which is reduced by any nontaxable sources of income received by the taxpayer such as loan proceeds or inheritances. The agent then compares the taxable income reported for the year being tested with the results of the net worth computation and thereby identifying any unexplained increase in net worth for the year tested as unreported income.
The expenditures method for uncovering omitted income is similar to the net worth method and is sometimes referred to as the cost-of-living test. This method focuses on the amount of income needed to cover the taxpayer’s identified personal expenditures for the year being tested. The agent totals all the identified personal expenditures of the taxpayer for the year tested and reduces the total by any nontaxable sources of income used to pay for the expenditures. Since one possible source of nontaxable income for the expenditures tested is wealth acquired and taxed in previous years, the agent must take into consideration all of the taxpayer’s assets and liabilities at the start of the prosecution period, in the same manner as in a net worth case. Commonly the IRS combines the net worth and personal expenditures methods to assure that its computations reflect the income used to purchase assets as well as the income used for personal expenditures.
Bank Deposits Method
Taxpayers who run Schedule C businesses and make periodic deposits to at best, a business bank account, and at worst, a commingled personal account, are typically investigated by the IRS using the bank deposits method. The agent totals deposits to all accounts (bank and brokerage) under the taxpayer’s control and then eliminates any deposits from identified nontaxable sources, such as gifts, loans, and transfers between accounts. The adjusted total of deposits is considered income. The IRS uses these methods to establish an income-producing business which allows the jury to infer how the unreported taxable income was generated. This method is also commonly used for businesses run through entities such as LLCs, S and C Corporations, and Partnerships.
Specific Item Method
Under the specific item method of proof, the government attempts to show that the taxpayer’s return at issue inaccurately reflects a specific transaction, or set of transactions, such that income is omitted, deductions are inflated or a source of income is falsified. The government is not burdened with having to prove an exact amount of unreported income to prevail but rather must prove that a substantial amount of income was unreported.
Extraordinary Criminal Investigation Division Techniques
Where appropriate, CID special agents employ surveillance, issue search warrants, implant undercover agents and utilize scientific experts to aid in a criminal investigation. For example, CID Agents have been known to go so far as to sift through a suspect’s trash to secure evidence. Note: Courts have held that you generally have no expectation of privacy in your trash and thus you were not subjected to an unreasonable search. Good defense attorneys can sometimes suppress evidence obtained by the IRS using these extraordinary techniques. In one reported case, the IRS obtained a search warrant to search a taxpayer’s real estate office and seized all the documents contained therein. At trial, none of the documents seized were allowed to be introduced because defense counsel successfully argued that the search warrant was overboard. Defense Counsel can also exploit the detailed restrictions on the use of these extraordinary techniques as contained in the Internal Revenue Manual.
Common tactics employed by the Criminal Investigation Division in conducting an investigation:
A special agent usually begins an investigation by gathering background information about the taxpayer. Other steps in the investigation may include interviewing the taxpayer his return preparer, examining the taxpayer’s books and records and returns from prior years, investigating the taxpayer’s education and employment history, and locating the taxpayer’s bank accounts.
Taxpayers can become the target of a criminal tax investigation by failing to file returns, by failing to pay taxes when due, by providing incorrect information to the IRS, or by being mentioned in an informant’s report. All the defense alternatives available to a taxpayer under investigation pose risks, including the risk of imprisonment, a substantial civil fraud penalty, and the loss in standing with business associates and neighbors when agents question them in connection with the criminal investigation. A broad investigation may produce evidence of the taxpayer’s poor reputation for truthfulness, which can be used by the government to rebut defense character witnesses.
CID’S INTERVIEWING OF THE TAXPAYER AND WITNESSES ASSOCIATED WITH THE TAXPAYER
When initially contacted by the special agent, it is a common mistake for the taxpayer to agree to answer questions without first making use of his or her Fifth Amendment privilege against self-incrimination and his or her right to have an attorney present. Taxpayers are often shown copies of their previous returns and asked whether all his or her income has been reported on them in order to elicit a false exculpatory statement. By requiring narrative (as opposed to yes or no) answers the agent encourages the unsuspecting taxpayer with substantial opportunity to mislead or to confess in order to obtain circumstantial evidence of willfulness. Therefore, Counsel as soon as retained should request that the client write up his or her recollection of the initial interview with CID. If Possible, know Witnesses related to the client’s case should be requested to obtain copies of their statements made to the IRS for use in preparing the client’s defense.
TAKING RETURN PREPARER STATEMENTS
Unfortunately, a client’s return preparer or accountant is usually placed in a position of great trust. The bad news here is that ordinarily the vast majority of what is communicated by a client to their accountant or preparer is not privileged and they can and routinely are forced to be a Witness Against the client. CID knows that the testimony of the person who prepared the returns in question often is crucial to the client’s case. If the CID special agent establishes that the taxpayer misled the preparer or withheld material information from him or her, then he or she has shown substantial evidence of criminal intent. To make matters worse, it is in the preparer’s best interest to throw the client under the bus rather than lose their own ability to practice in front of the IRS. This is why counsel should instruct client’s to distance themselves from their preparers where a possible Tax Crime or even Civil Examination with potential criminal exposure is concerned. CID knows that it is quite difficult to prove a taxpayer’s criminal intent if the preparer takes all the blame for errors on a return. However, this is not likely to occur because preparer’s know that they may become an additional target of a client’s criminal investigation if it appears that he or she conspired with or aided the client in making false representations to CID or in preparing false returns.
Special agents generally requests or subpoena’s the accountant’s workpapers used in preparing the returns and take a statement concerning the records supplied by the taxpayer for the preparation of those returns. Evidence of intent may be found if the taxpayer supplies only summary sheets to the preparer without the underlying data. Since the preparer’s testimony is so critical to CID’s case, counsel should encourage client’s to make sure that counsel is present when the preparer is interviewed if at all possible.
REVIEWING TAXPAYER’S BOOKKEEPING
In reviewing the taxpayer’s books and records, CID special agents may find evidence of intent if the books are inadequate, falsified, a duplicate set of books is discovered or the books and records are destroyed prematurely. Unorthodox books that do not follow generally accepted accounting principles, and other accounting practices that yield deceptive results that understate income or overstate expenses may also be used to indicate criminal intent. If the records are kept by anyone other than the taxpayer, the CID agent may question the accountant extensively about instructions received from the taxpayer on how records should be kept, and also about any indications that may have be communicated to the taxpayer by the bookkeeper or accountant that something was wrong with the taxpayer’s accounting system.
EXAMINING PRIOR YEARS’ RETURNS
The CID special agent will often investigate the taxpayer’s old returns even if the statute of limitations bars prosecution for those years. The IRS will use the old returns to attempt to establish a pattern of underreporting over a substantial period of time, thus evidencing willfulness. These prior returns may also be used to counter a taxpayer’s defense of reliance on a professional, by showing that a pattern of underreporting may have occurred where the taxpayer either prepared their returns personally or employed
different return preparers than the professional that prepared the returns at issue. Special attention is paid by CID to the use of and prior fictitious names used by the taxpayer and to any extravagant expenses, since these matters may indicate willful misconduct.
CANVASSING FINANCIAL INSTITUTIONS
CID agents use IRS computers to attempt to locate all bank accounts and brokerage accounts in which the taxpayer had any interest. Agents will review the deposits to the accounts discovered in an attempt to locate additional sources of previously unreported income. In some instances an analysis of deposits reveals hidden accounts, which are further evidence of willfulness. In other cases, large amounts of business deposits may indicate that income must have been under reported on returns.
DEFENSE TACTICS DURING CID EXAMINATION
Because of the case law surrounding the fourth and fifth amendments in the tax arena, cooperation with CID special agents may not be the best tactic for every taxpayer and the decision to do so is best left to competent tax defense counsel. For some situations, a more appropriate course of action is to monitor and anticipate the course of an investigation in the hopes of limiting or where possible eliminating potential criminal tax exposure. To this end, potential witnesses can be interviewed by the taxpayer’s tax defense counsel, or an investigator hired by counsel, before the CID special agent has made contact. Defense counsel should warn taxpayers under CID investigation that statements made to business associates, friends, his accountant, or an investigator may be passed on to the special agent because they are not privileged communications. An accountant who was not the preparer of the returns being investigated or investigator should be hired under the protection of a “Kovel” letter in attempt to bring the work of the accountant or investigator within the attorney client privilege by the taxpayer’s tax defense counsel to assist in following the special agent’s progress and in preparing a defense. The communication between the accountant or investigator and the taxpayer can be protected by the attorney-client privilege if specified conditions are met. The attorney must formally retain the accountant to assist the attorney in rendering legal services to the taxpayer, not merely providing accounting services. The retention letter must confirm the reason for the retention, that communications between the accountant and the attorney’s client are confidential and only made to assist the attorney in giving legal advice, and that records created by the accountant belong to the attorney.
If tax defense counsel can prove that a government agent induced a taxpayer to commit a tax crime that the taxpayer otherwise would not have committed, the defense of entrapment may be available. However, merely allowing a taxpayer to continue criminal conduct that was already started is not entrapment. The key to this defense is that the disposition to commit the crime must come from the government agent and not the taxpayer.
There are two elements to the defense of entrapment: 1. the government induced the crime, and 2. no predisposition to commit the crime is evident on the part of the defendant. To establish inducement as a matter of law, the defense counsel must be able to produce undisputed evidence making it patently clear that the government induced an otherwise innocent the defendant to commit the illegal act by trickery, persuasion, or fraud on the part of a government agent. If tax defense counsel meets this burden, then the prosecution must then prove beyond a reasonable doubt that the defendant was predisposed to commit the crime prior to first being approached by government agents. Case law shows that five factors are relevant to determining such a predisposition: (1) the defendant’s character and reputation; (2) whether in fact the government initially suggested criminal activity; (3) whether the defendant engaged in the activity for profit; (4) whether the defendant showed any reluctance; and (5) the nature of the government’s inducement.
Information commonly contained in a CID special agent’s report recommending criminal prosecution for a tax crime:
The special agent’s report (SAR) normally contains a narrative of the agent’s investigative findings. Attached to the report are commonly exhibits containing statements of witnesses that were interviewed, copies of documentary evidence, schedules and computations of income prepared by the agent, and any other materials necessary for a fair administrative review of the case. The SAR and the exhibits are normally the only material on which reviewing attorneys at the District Counsel and the Justice Department base their recommendation either to prosecute or to return the case to the IRS for processing as a civil case.
Access to the SAR and accompanying exhibits are seldom available to the Taxpayer or Tax Counsel before charges are filed. Requests for the special agent’s investigation materials under the Freedom of Information Act (commonly called a FOIA request) have been consistently denied under the investigatory record exemption and the exemption for material exempt by statute. Courts have occasionally required the government to supply an index of material contained in the SAR. The complex interaction among the Freedom of Information Act, the Privacy Act of 1974, and the disclosure provisions of the Code have left many questions unresolved. The SAR should become available to the taxpayer’s tax counsel at any trial in which the agent testifies. For this reason, the IRS usually has two agents present for every interview so that the government can present its case at trial without calling the special agent to testify that wrote the SAR. In such cases, the SAR is never disclosed.
The discovery process in a criminal tax case:
Discovery is the legal process whereby one party to a legal action goes about learning information known by the other party to the same legal action. From a criminal tax defendant’s perspective, discovery in a criminal case usually begins with a written request submitted with the applicable federal court that requests the court to order the government to provide a bill of particulars to the defendant. The bill of particulars will be ordered by the court because it allows the defendant to prepare an appropriate defense, prevents double jeopardy where the defendant may have been charged a second time for the same previously adjudicated crime, and helps to avoid surprise or prejudice at trial. However, the court will not require that information that is evidentiary in nature be included in the bill of particulars.
Historically courts have required that Taxpayers be provided with the following types of information, where applicable, in a bill of particulars:
the identity of any co-conspirators
a description of any means of deception the government was planning on proving at trial
a description of which of the taxpayer’s records the government copied
Historically Taxpayers have not been entitled to the following information in a bill of particulars because this type of information is considered “evidentiary”:
alleged dates, times, and places that the taxpayer received items of gross income;
details of a conversation that the government alleged as an overt act that it intends to offer as proof of willfulness;
In federal criminal cases, depositions ordinarily are not allowed to be taken of government personnel or other witnesses by the defendant. However, under exceptional circumstances when a deposition is held to be in the interest of justice, the taxpayer may depose prospective witnesses to preserve their testimony for trial if some doubt exists as to the witnesses’ availability for appearance at a subsequent trial. Where a court does allow a deposition it might additionally order that any book, document, record, recording, or other non-privileged material be produced at the time and place of any such deposition.
In a federal criminal case, the taxpayer is entitled to discover:
any relevant written or recorded statements the government asserts were made by the taxpayer and the substance of any oral statement made by the taxpayer;
a copy of the taxpayer’s prior criminal record if applicable;
the existence of photographs, books, papers, tangible objects, documents, and buildings and places that are relevant to preparing the taxpayer’s defense, that are intended by the government to be used as evidence at the trial, or that were obtained from or belong to the defendant by the government.
The results and associated reports of any physical or mental examinations and scientific tests and or experiments that are material to the taxpayer’s defense or that are intended by the government to be used at trial.
Except as delineated above, the memoranda, reports, or other internal documents prepared by the government in connection with the case are not subject to discovery by the defendant. Moreover, statements made by government witnesses can only be obtained in limited circumstances as provided in the Jencks Act. Under the Jencks Act, no statement or report of a government witness in a federal criminal prosecution can be discovered until after the witness has testified on direct examination in the trial of the case at issue. Only after the witness has testified on direct examination, can the taxpayer draft a motion to compel the United States produce any statements of the witness that relates to the subject matter of the testimony given at trial.
Lastly, a defendant can often obtain significant discovery of the government’s case through pre-indictment conferences held with the IRS and Justice Department. I do not recommend attending such a conference without having the protection of criminal tax counsel. Instead of benefiting from discovery you will more likely aid the government in patching up any remaining weaknesses in their case.
Role that the Grand Jury plays in the prosecution of a tax crime:
A federal grand jury must vote in favor of issuing an indictment for a taxpayer to be charged with a tax felony. A grand jury is granted substantial investigatory powers, including the power to compel testimony and require production of physical evidence to facilitate this process. Tax misdemeanors need not be approved by grand juries, but prosecuting attorneys usually elect to present misdemeanors to the grand jury for investigation and vote when accompanied by a Felony Tax Crime charge. The grand jury’s is asked to weigh if it is more likely than not that a federal crime has been committed and is to weigh whether there is probable cause to believe that the crime was committed by a particular person under the same standard. A grand jury is composed of from 16 to 23 persons chosen at the direction of the appropriate U.S. District Court. In all cases, at least 12 jurors must vote to return an indictment. In cases where a grand jury declines to charge a person, a decision called a no true bill or a no bill is recorded.
The work of the grand jury is required by law to proceed in secret and therefore only the grand jurors, the government attorneys, the court reporter, and witnesses may be present during the Grand Jury investigation. Grand jury investigation is usually chosen as an alternative to administrative investigation when the IRS is informed that an existing nontax motivated criminal investigation has uncovered evidence of tax crimes and the U.S. Attorney desires to combine all criminal charges, including tax crimes, into one indictment. Other common reasons for the use of grand jury investigation are the need to investigate quickly, and the need to grant use immunity to reluctant witnesses. Since grand jury investigations occasionally begin without a definite target, a defendant’s counsel is wise to assess if a client has potential exposure to prosecution at the earliest practicable time within the course of the Grand Jury Investigation. If defense counsel determines it is in the client’s best interest to negotiate a plea to potential criminal offenses or to secure use immunity, defense counsel’s leverage in the associated negotiations is strongest at the start of the grand jury investigation. If defense counsel’s timing in the negotiation is off, other potential defendants could strike a deal with the prosecutor first, leaving little new material to offer in a plea negotiation, and worse yet, leaving open the possibility of the other potential defendants obtaining immunity in exchange for becoming a key witness in the government Criminal Tax Case against the defense counsel’s client.
Government’s required content to include in an indictment or an information in a criminal tax case:
An indictment is required by law to contain the elements of the offense the defendant is charged with and must fairly inform the defendant of the offense so charged. The defendant is also entitled to conduct discovery as to material considered relevant to the government’s case him or her. At any subsequent trial, the Government is prohibited from presenting evidence of other crimes for the sole purpose of showing that the defendant was likely to have committed the charged offense, however other crimes may be used to show criminal intent for the charged offense if they are held to be relevant by the court. For example, if the defendant is an admitted tax protester and was previously convicted of tax evasion the previous conviction would be relevant to show the defendant most likely intended to evade taxes as to the current charges and thus the previous conviction would most likely be admitted by the current court of law.
Felonies, (defined as crimes punishable by a sentence exceeding one year), must be charged by an indictment returned by a grand jury, unless the defendant waives the right to be indicted. Misdemeanors (defined as crimes punishable by a maximum sentence of one year or less), may be charged by grand jury indictment or by information. An information is legal document listing the charges against a defendant and is filed by the appropriate federal prosecutor. An indictment or information, must be written in plain, concise, and definite terms and must include a statement of the essential facts the government is asserting constitute the charged offense.
Effective Defense strategies:
At a general level, any defense strategy will go to attacking one of the “elements” of the crime. In the case of attempted tax evasion, for example, the IRS must prove three elements beyond a reasonable doubt: that the target owed tax, acted willfully, and committed an affirmative act of evasion. Thus, a legal defense against an evasion charge will seek to deny one or more of these various elements.
One of the methods of presenting a defense is to discredit the evidence offered against the target, either because it is false or, even if it is true, try and find an argument to render it “inadmissible.” Technical rules exist regarding when evidence is admissible at trial. Often times these rules bend in favor of the taxpayer. For example, in one case, the IRS alleged that the taxpayer committed an “affirmative act” of evasion before the date of his tax deficiency. The indictment, however, only mentioned that the “crime date” was the date of the deficiency—the IRS failed to mention the pre-deficiency period. Thus, because the government made a technical error with the indictment, the IRS was precluded from using any evidence during the time prior to the deficiency. As a result, the taxpayer had a stronger defense. United States v. Voight, 89 F.3d 1050, 1089-90 (3d Cir.), cert. denied, 519 U.S. 1047 (1996).
Attacking the element of tax due and owing:
To illustrate defending the element of tax due and owing let’s consider a distribution from a C Corporation to a shareholder that was unreported and thus underlies a tax evasion charge. If possible counsel should make a showing that the taxpayer did not, in fact, have a tax liability.
It is often a contested issue as to whether a distribution received by a taxpayer from a C Corporation is taxable income or just a return on the shareholder’s (taxpayer’s) investment. That is, the taxpayer’s counsel might argue the distribution is not taxable income because it is simply a return of a portion of the taxpayer’s capital investment in the corporation. To argue the contrary, the IRS must prove that the corporation possessed accumulated earning’s and profits (“E&P”) at the time of the distribution because a shareholder receives taxable income only when the C corporation makes a distribution from earnings and profits. Therefore, as a technical defense against the IRS’s charge that a shareholder/taxpayer committed tax evasion a taxpayer’s counsel could attempt to prove that the C Corporation lacked accumulated earnings and profits at the time of the distribution.
See J. D’Agostino, CA-2, 98-1 ustc, 145 F3d 69 where a couple was accused of diverting funds from their wholly owned corporation and it was held that the funds could not be taxed to them personally as a constructive dividend because the company at the time of the distribution had no earnings or profits. Instead, the diverted funds were held to constitute a nontaxable reduction of the couple’s shareholder loan account.
Occasionally defense counsel has sought to show that the income from an alleged tax deficiency was not, in fact, “taxable income” as defined by the Internal Revenue Code. See I.R.C. Section 61. The general rule is that “gross income means all income from whatever source derived” and the Code goes on to list various, specific types of income. However, there are various items of gross income that are not expressly identified in the Code but are identified as income through case law. For example, gambling winnings. Unfortunately, in most cases, a taxpayer must pay taxes even on his net winnings. This was the holding of an important case in the Ninth Circuit from the 1970s. See Garner v. United States, 501 F.2d 228 (9th Cir. 1974), aff’d on other grounds, 424 U.S. 648 (1976). Even income from illegal activities counts as “gross income” for purposes of Section 61 of the Code and, therefore, for purposes of proving tax evasion, if the taxpayer failed to pay taxes on those proceeds. See Moore v. United States, 412 F.2d 974, 978 (5th Cir. 1969).
However, not every dollar received by a taxpayer is “income,” and thus he or she need not pay tax on it. For example, if a taxpayer borrows money from someone, the bank, or in most cases even from certain life insurance policies, it is not “income” to the taxpayer and thus they need not pay taxes on it. The effect of this is that if the government’s argument that a taxpayer committed tax evasion because they did not pay tax on this borrowed amount will fail; it will fail because the third element of the offense—that there be a tax “due and owing”—will not be satisfied. However note that bona fide loans must be distinguished from “false loans”—loans where the transferee and the transferor never “really” expect there to be repayment. Such “loan” proceeds are, in disguise, gross income, and tax must be paid on them. See United States v. Curtis, 782 F.2d 593, 596 (6th Cir. 1986) for an example like this.
Attacking the element of willfulness:
The hardest element of the a government’s case to prove in charging a taxpayer with a tax crime is usually the element of willfulness because of the lack of direct evidence on this element in the absence of a confession on the taxpayer’s part. Because of the usual lack of direct evidence on willfulness, (testimony or admissions on the part of the defendant taxpayer or his counsel), the government is left to prove willfulness through the use of circumstantial evidence, such as a taxpayer’s act of keeping a double set of books or concealing assets. To attempt to prevent the government from establishing that the defendant taxpayer’s acts were willful, he or she may try to show that the defendant’s actions were merely inadvertent or that the current state of the law is uncertain as whether the taxpayer’s actions were willful. However, showing that a taxpayer disagreed with a law, was a tax protester, objects to taxes on religious grounds, or has personal problems are generally not effective defenses to willfulness.
Most criminal tax offenses require that the defendant acted willfully. Criminal tax offenses include attempted evasion, failure to file a return or pay tax, making a false return, and aiding or assisting the preparation of a false document. The Supreme Court has held that the word “willfully” has the same meaning in all the criminal tax statutes whether they be felonies or misdemeanors.
In defining willfulness, Federal Courts have consistently stated that, despite their earlier references to “bad faith and evil intent”, a current finding that a defendant acted willfully does not require any proof of motive other than an intentional violation of a known legal duty. Court’s have consistently held that willfulness may be negated by establishing good faith claim of ignorance or misunderstanding of the law or a belief that there was no violation of the law by a taxpayer, regardless of whether the taxpayer’s belief appears to be objectively reasonable. However, establishing a good faith taxpayer belief that the tax laws are unconstitutional will not negate the element of willfulness.
An intentional violation of a known legal duty can be shown by a taxpayer’s reckless disregard for the law. Courts have held that a taxpayer’s knowledge of the law is not limited to his actual knowledge but includes a reckless disregard of a legal obligation that the defendant can be shown he or she was aware of in some manner. For example, to prove that a taxpayer attempted to evade taxes the government needs only show that the taxpayer had the specific intent to evade a tax that the taxpayer knew was owing. Similarly, to prove that a taxpayer willfully failed to file a return, all that need be shown is that the taxpayer knew of the obligation to file the return and intentionally failed to do so.
Willfulness & Failure to Pay Offenses
The willfulness requirement in failure to pay taxes cases raise the issue of whether a defendant’s inability to pay the tax in and of itself negates the element of willfulness or whether the government must present evidence to show that the defendant was financially able to pay the tax on or about the time the tax was due to establish willfulness.
Proof of Willfulness
The government’s production of proof on willfulness ordinarily consists of admissions made by the defendant (often in the absence of counsel) to government investigators or witnesses that are called to establish willfulness (often employees, whistleblowers and ex-spouses). Statements tending to indicate willfulness made by a taxpayer’s representative under a power of attorney on behalf of a defendant may also be used by the IRS in a criminal prosecution. However, absent an admission by the defendant or his counsel, the government will attempt to prove willfulness through the use of circumstantial evidence. The government will attempt to meet its burden of proof as to willfulness by examining the taxpayer’s entire course of conduct and will encourage a Jury to make reasonable inferences that can be properly drawn from the examined conduct. Historically, the government has had great success in establishing willfulness based on proper inferences drawn from any conduct that appears to have been engaged in by a defendant in order to mislead or conceal.
Understatement of Income
While the understatement of income in and of itself is usually insufficient to establish willfulness, a proven pattern of substantial understatement can successfully be used by the government to establish the element of willfulness.
State of Mind
When a taxpayer’s state of mind on a particular date is critical to the government’s case on willfulness, as in willful failure to file cases, the government will present evidence of events that occurred after that particular date as evidence of the taxpayer’s earlier state of mind. Both the government and the taxpayer generally can admit evidence on subsequent events for the facts that can reasonably be inferred from them. For example, evidence of a taxpayer’s previous noncompliance with the filing rules and requirements in a year immediately subsequent to the tax year or years at issue has been deemed relevant by the court’s to show the taxpayer’s willfulness and absence of mistake in filing false returns during the tax years at issue.
Common defense tactics that make it hard for the government to prove willfulness:
Inadvertence and Negligence
Because willfulness requires an intentional violation of a known legal duty, the element of willfulness can be negated by a producing evidence to show that the defendant’s conduct was inadvertent, careless, or otherwise negligent. The government will attempt to refute this defense by showing that the defendant’s conduct is inconsistent with the claimed inadvertence or neglect. For example, in failure to file cases, the government usually relies on multiple, consecutive failures to file to negate any claimed inadvertence or neglect.
Uncertain Legal Duty
Willfulness requires that there be a legal duty with which the taxpayer fails to comply. The courts have consistently held that where the state of the law is uncertain as to whether there is a legal duty, criminal liability will not be imposed. Moreover, the weight of legal authority in this area is that the taxpayer’s actual knowledge regarding the unsettled state of the law is irrelevant. The bottom line here is that if the law is in fact uncertain, the taxpayer has not committed a crime.
Since the government’s burden in establishing willfulness requires that the taxpayer violate a known legal duty, it is a viable defense to offer evidence that the taxpayer did not know of the specific duty at issue. The Supreme Court itself has held that willfulness may be negated by a good faith claim of ignorance or misunderstanding of the law or a good faith belief that there was no violation of the law, regardless of whether the belief was objectively reasonable. One rationale for this “good faith” defense is the criminal tax provisions were not drafted with the intention of penalizing a taxpayer for innocent mistakes caused by the inherent complexities of the Tax Code.
The Supreme Court’s line of decisions in the area have held that a taxpayer is not guilty of willful failure to file if he honestly believed his income was too low to require him to file a return or if the taxpayer believed that he was not required to file a return if he was unable to pay.
The defense of mistake is not limited solely to mistakes of law. A defendant who, through a mistake of fact, unknowingly violates a statute also does not act willfully.
Reliance on Others
Evidence establishing that a taxpayer relied on the advice of counsel or an accountant may successfully be used to negate willfulness if it can be shown that the taxpayer acted in good faith and that he or she provided the preparer with full and accurate information at the time the advice was sought. This defense may not be successful if the government can establish that full disclosure to the attorney or accountant was not made at the time the advice was rendered. Reliance on a lawyer’s advice has occasionally been held a valid defense, even where such reliance was objectively unreasonable.
Mental Disease or Defect
Because the government’s burden in proving willfulness requires a showing of a specific intent to disobey the law, the courts have consistently permitted expert medical testimony to establish that the defendant has developed a delusion about the tax laws that interfered with the mental ability to form the specific intent to disobey the law.
Filing of Amended Return or Late Payment of Tax
Under the government’s voluntary disclosure policy published in the Internal Revenue Manual, a taxpayer who, in essence admits to a potential tax crime by filing an amended or delinquent return may avoid prosecution, provided the disclosure was voluntary and made before the taxpayer was first contacted by the IRS regarding a potential problem with the tax liability. However, amended or delinquent returns filed after a taxpayer has been contacted by the IRS do not qualify for the voluntary disclosure policy, even though the courts tend to hold that the filing of delinquent or amended returns or the late payment of tax is admissible by a defendant on the issue of willfulness. The filing of amended returns after notice by the IRS that a particular return is under investigation is a patently bad idea. Case law shows that in numerous instances, the very act of filing of a delinquent or amended return during the course of an IRS investigation has been presented as a key piece of evidence that eventually led directly to a taxpayer’s indictment. Case law also shows that the government routinely relies on delinquent and amended returns as the very admission that establishes the existence of an understatement in tax liability of the original return.
Unsuccessful Defenses to Willfulness
When a taxpayer’s conduct can be shown to be intentional and knowing, the taxpayer’s personal reasons for taking the criminal action are irrelevant. Accordingly, presenting evidence of, a taxpayer’s disagreement with the law, inability to pay, marital or financial difficulties, or fear of filing are generally not effective defenses. Moreover, defenses that tend to explain a taxpayer’s reasons for taking an action, or refusing to act, that do not effectively rebut the required specific intent to disobey the law are not effective defenses to willfulness. Thus, presenting evidence to show that a taxpayer was a political tax protester, had religious objections or personal problems, are generally not effective defenses to negate the element of willfulness.
Evidence on, personal problems or preoccupation with business affairs may, where extreme, tends to negate willfulness if it can be used to show that the taxpayer may have been so disturbed by the problems that they prevented the formation of a specific intent violate the law. However case law shows that such defenses are rarely successful.
While inability to pay in and of itself is not generally an effective defense, such evidence may be a defense if it can be sown that the taxpayer had the erroneous belief that returns could not be filed without the associated payment of tax. Additionally a taxpayer’s inability to pay also can be an effective defense to a failure to pay charge if it can be shown that the defendant’s inability to pay was not the result of lavish and extravagant living.
ARGUING THE STATUTE OF LIMITATIONS FOR THE SPECIFIC TAX CRIMES HAS TOLLED
Each specific tax crime has its own statute of limitations which establishes a time frame under which a criminal charge must be brought or else the charge is mute under law. However, before this defense is relied upon it must be noted that under specified circumstances, the statute of limitations may be extended. For example, when a taxpayer’s tax counsel brings or intervenes in an action to quash an IRS summons issued to a third-party record-keeper, the statute of limitations for criminal prosecution of that taxpayer is suspended for the period during which the proceeding (including appeals) concerning enforcement of the summons is pending. As an additional example, the statute is also suspended for the period that the person committing an offense is outside the United States or is a fugitive from justice.
DEFENSES COMMONLY RAISED DURING THE ADMINISTRATIVE REVIEW LEVEL OF THE CRIMINAL TAX PROCESS:
During administrative review level of potential criminal prosecution cases, effective tax defense counsel has the ability to raise several defenses that if successful may cause case to be declined. These include lack of criminal intent, no tax due, defects in method of proof, dual prosecution, health, and the improbability of a conviction. A taxpayer may avoid prosecution by showing that he was previously prosecuted for substantially the same acts. The poor health of a taxpayer will not prevent prosecution. However, if poor health and other factors creating sympathy for the taxpayer make it unlikely that the taxpayer will be convicted, prosecution may be declined.
Attempting to stop the progression of a criminal case at the District Counsel review level of the IRS or at the Department of Justice level:
Every CID recommendation to prosecute taxpayers for a Tax Crime are reviewed by District Counsel attorneys. An opportunity therefore exists for a Taxpayer’s representative to present defenses at a requested District Counsel conference. The reality is that District Counsel must be satisfied that evidence gathered by CID is sufficient to establish that a tax crime was committed and that reasonable probability of conviction exists. District Counsel is faced with two choices, decline to prosecute or return a particular case for additional investigation by CID. It is to be noted however that once a case is worked up and presented for review by District Counsel, Few cases are in fact declined.
If IRS District Counsel determines that prosecution is warranted or that grand jury investigation should take place, the case is referred to the Department of Justice. This referral takes place via a letter referred to as a Criminal Reference Letter (CRL), which sets forth the recommendation of District Counsel for prosecution, the evidence supporting the recommendation, details concerning the technical aspects of the case, and an assessment of possible prosecution problems. The CID special agent’s report and exhibits are also enclosed. A copy of the CRL is sent to the appropriate U.S. Attorney within the Department of Justice with instructions to charge specific crimes against the taxpayer and designating one or more major counts which may premise a plea agreement. Referral to the Department of Justice terminates the IRS’s authority to issue or enforce any further summonses to investigate the Criminal Tax matter. Declination, or refusal to take the case, by the Department of Justice restores the IRS’s authority to use administrative process. Cases that meet all the other requirements for prosecution may nevertheless be declined by the Justice Department simply because their trial attorneys are of the opinion that no jury would convict due to a combination of circumstances, such as the taxpayer’s age and health, the fact that the taxpayer has already suffered enough, or other circumstances likely to evoke jury sympathy. Defenses based on the lack of probability of conviction are of greatest value when conferring with the Department of Justice’s trial attorneys.
Ineffective Defense strategies:
Attempting to cure tax evasion in year 1, with carry back losses from Year 2:
It is obviously a crime to knowingly overstate one’s deductions under I.R.C. Section 7201 for example. The posed by a desperate target is whether a target’s overstatement of his or her deductions (for example) somehow may be “justified” or “cured” by his later, fortuitous, losses which are carried back to prior years.
The answer to the question is a resounding “No.” The criminal action of overstating deductions (or any act resulting in evasion) cannot be “wiped out” by subsequent and legitimate losses, however convenient that approach might appear to be. This matter was address in the Fifth Circuit in the 1960s. In Willingham v. U.S., 289 F.2d 283 (5th Cir. 1961), the taxpayer made some false deductions in 1953 in attempt to evade the tax liability. Two years later, in 1955, he sustained legitimate losses. Thus, the taxpayer desired to carry back those loses as a defense against the government.
How would this create a defense? It is a clever argument. To prove tax evasion, the government must show, among other things, that there was a tax due and owing. By carrying back net operating losses to prior years (i.e. the years when one falsely claimed a deduction), he attempted to “wipe out” his tax liability for those years (i.e. so there would be no tax “due and owing”). In this way, the taxpayer sought to “justify” his original overstatement of deductions.
Unfortunately for taxpayers, the court ruled that this argument is too clever. The courts to date frame the matter in terms of when the taxpayer’s intent to commit tax evasion is complete. The Fifth Circuit maintains that the intent is complete in the year the false deduction is claimed. Thus, later “adjustment[s] that may be permissible resulting from subsequent losses does not prevent [a prior] fraud committed . . . from being [tax evasion].” Willingham v. U.S., 289 F.2d 283, 288 (5th Cir. 1961), cert. denied, 368 U.S. 826 (1961)
Taxpayer arguments that federal taxation is unconstitutional:
Taxpayer arguments that federal tax laws are unconstitutional will not be a valid defense any more than maintaining that, say, murder is not illegal. Although certain factions have maintained that the tax laws are invalid, the Supreme Court of the United States has proclaimed the Federal Governments right to tax under the Taxing and Spending Clause of the Constitution found in Article I, Section 8. Clause 1, reads: “The Congress shall have Power to lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.”
In a recent case, a court entertained the taxpayer’s argument for the unconstitutionality of a certain tax law. The court basically held that the taxpayer had an erroneous belief and still found him liable for his tax. After the taxpayer attended various seminars and devoted himself to arguing against a legal basis for the federal taxing system, the court held against him: “We do not believe that Congress contemplated that such a taxpayer, without risking criminal prosecution, could ignore the duties imposed upon him by the Internal Revenue Code and refuse to utilize the mechanisms provided by Congress to present his claims of invalidity to the courts and to abide by their decisions.” Cheek v. United States, 498 U.S. 192, 205-06 (1991). The court went on to explain that if the taxpayer thought a tax law was invalid, his proper procedure is to first pay the tax, and then file for a refund which, if denied, he could take to the courts to ascertain the tax law’s validity and constitutionality.
SELECTIVE PROSECUTION CLAIMS
Defendants occasionally allege that they have been the victims of unlawful selective prosecution in tax cases by the government. These allegations are historically summarily dismissed. To prove unconstitutional selective prosecution the defendant must establish that others similarly situated have not been prosecuted and the decision to prosecute was based upon an impermissible consideration such as race, religion, or the desire to prevent the exercise of constitutional rights which places an almost impossible burden on the defendant.
PAYMENT OF TAX DUE OR ARGUING THAT NO TAX IS DUE
When a criminal prosecution is based on a taxpayer’s failure to report income, the government must establish that the taxpayer knew that the income was taxable. Therefore a claim that no tax is due because the taxpayer has paid the tax following commencement of the audit or now stands ready to pay all deficiencies and penalties is unlikely to prevent prosecution of the taxpayer. Payment after an audit or investigation has begun does not change the fact that the crime was complete at the time the taxpayer violated a known legal duty. However, Proving additional deductible expenses can reduce the tax deficiency and make a case less attractive for prosecution. Note however that the filing of amended returns and paying the tax due to correct previous criminal actions before an audit has begun under a Voluntary Disclosure can be quite effective at preventing criminal prosecution.
Mitigation techniques available to an actual or potential criminal charge:
Under the law, statutory authority exists for the Secretary of the Treasury and the Attorney General to compromise criminal tax cases without prosecution. However, this authority to compromise criminal cases is rarely used because allowing a defendant to buy his way out of criminal prosecutions would in effect create separate systems of justice for the rich and the poor.
Defense counsel may attempt to convince CID or Grand Jury investigators that his or her client is much more valuable to them as a witness against other potential or actual targets than as a criminal tax defendant. As a witness for the prosecution, the defense counsel’s client may receive a grant of use immunity, under which he or she cooperates fully with the IRS in exchange for an agreement that charges will not brought against him or her. Complete immunity from prosecution arising out of a transaction is called transactional or pocket immunity. Although courts have historically expressed displeasure with pocket immunity it currently continues to be routinely granted.
It is important to note that testifying under a grant of immunity is not without risks. Witnesses who receives immunity are prohibited from subsequently refusing to testify on the grounds that they might incriminate themselves. Moreover, if a case can be built against the immunized witness on evidence that is independent of the immunized testimony, the immunized witness may still face criminal prosecution. Lastly, testimony subsequently proven to be perjured, given under a grant of use immunity can also be used against the witness who made the false statements.
Historically, by far the vast majority of the criminal tax indictments brought result in pleas. Each U.S. Attorney is authorized to accept a plea of guilty to the major count of an indictment without prior approval of the IRS. Federal prosecutors are required to initially charge the most serious, readily provable offenses that are consistent with the defendant’s alleged conduct. Typically, once charges are brought, they will not be dismissed or dropped under a plea agreement unless the prosecutor has a good faith doubt about the government’s ability to prove a charge based on either a perceived legal or evidentiary weakness in the case.
By contrast, the IRS does not typically settle civil tax matters as part of a plea agreement although it has the statutory authority to do so. This rational for this is to avoid the appearance that the IRS uses the criminal process to coerce the collection of civil tax liabilities. This policy does not prevent the defendant from agreeing to civil admissions, such as receiving unreported income or claiming fraudulent deductions, as part of the criminal plea agreement. Information that the taxpayer provides in a civil case may also be used in a criminal case against the taxpayer. Thus, cooperating with a criminal investigation with or without proper legal counsel may have unexpected drawbacks for the taxpayer.
Tax Evasion or Fraud and Voluntary Disclosures:
Historically, between 1934 and 1952, the IRS had a written policy of refraining from prosecuting taxpayers who made a voluntary disclosure. Today, that written policy has changed so that a taxpayer’s voluntary disclosure is a factor that is weighed in a factsand- circumstances evaluation, but the actual of practice of the IRS is quite similar to its past written policy.
The IRS’s behavior is indicative of its true policy. Since 1952, the IRS has only decided to prosecute a handful of cases after the taxpayer’s voluntary disclosure. Because of the IRS’s previous written policy and the IRS’s lack of prosecution of voluntary disclosure cases, tax attorneys are generally convinced that the IRS has an unwritten de facto disclosure policy of refraining from prosecution.
The IRS’s unwritten policy can be seen from its behavior, specifically, its decision to decline prosecution. One court admits, “there appears to have been few, if any, prosecutions of true voluntary disclosures [by] the IRS.” United States v. Hebel, 668 F.2d 995, 998 (8th Cir. 1982). Indeed, the IRS’s conduct seems to show that it will prosecute after a voluntary disclosure only when extraordinary facts and circumstances are present. A number of tax scholars agree: “[T]he practice of the IRS has been that it will not prosecute taxpayers who satisfy all of the requirements of the voluntary disclosure program because, if it did initiate such prosecutions, no taxpayers ever would be willing to make a voluntary disclosure in the future.” New York University Annual Institute on Federal Taxation § 27.06 (2010).
Thus, even though the IRS’s official, written position is to leave the door open to pursuing criminal prosecution after a voluntary disclosure, it is unlikely it will do so.
Voluntary disclosures typically occurs in two situations:
(a) The taxpayer’s wrongdoing is disclosed to his attorney or accountant because he wants to set matters straight; or
(b) The taxpayer discloses his wrongdoing to an attorney or accountant after he has been personally contacted by the IRS.
Generally, if a taxpayer has not been contacted by the IRS, or is not currently under audit, examination, or investigation, it is not likely he will be prosecuted after a voluntary disclosure – unless the IRS disputes the voluntary disclosure, or the IRS believes the taxpayer has engaged in an illicit income-producing activity (or is a threat to the voluntary assessment system, where the taxpayer is deemed a tax protester).
The following bolded content is the actual language of the IRS’s Voluntary Disclosure Practice:
It is currently the practice of the IRS that a voluntary disclosure will be considered along with all other factors in the investigation in determining whether criminal prosecution will be recommended. This voluntary disclosure practice creates no substantive or procedural rights for taxpayers, but rather is a matter of internal IRS practice, provided solely for guidance to IRS personnel. Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution.
A voluntary disclosure will not automatically guarantee immunity from prosecution; however, a voluntary disclosure may result in prosecution not being recommended. This practice does not apply to taxpayers with illegal source income.
A voluntary disclosure occurs when the communication is truthful, timely, complete, and when:
The taxpayer shows a willingness to cooperate (and does in fact cooperate) with the IRS in determining his or her correct tax liability; and
The taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.
A disclosure is timely if it is received before:
The IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation;
The IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance;
The IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or The IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).
Any taxpayer who contacts the IRS in person or through a representative regarding voluntary disclosure will be directed to Criminal Investigation for evaluation of the disclosure. Special agents are encouraged to consult Area Counsel, Criminal Tax on voluntary disclosure issues.
Examples of voluntary disclosures include:
A letter from an attorney which encloses amended returns from a client which are complete and accurate (reporting legal source income omitted from the original returns), which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full and which meets the timeliness standard set forth above.
A disclosure made by an individual who has not filed tax returns after the individual has received a notice stating that the IRS has no record of receiving a return for a particular year and inquiring into whether the taxpayer filed a return for that year. The individual files complete and accurate returns and makes arrangements with the IRS to pay the tax, interest, and any penalties determined by the IRS to be applicable in full. This is a voluntary disclosure because the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intent to do so and because all other elements of (3), above, are met.
While making a Voluntary Disclosure is not completely without risk and does not provide an absolute guarantee that the IRS will not refer the taxpayer to the Department of Justice for criminal prosecution, it is the IRS’s long-standing policy to refrain from referring for prosecution taxpayers who make a full Voluntary Disclosure of their transgressions by substantially complying with all of the terms of the IRS’s program. As a matter of public policy it makes little sense to prosecute those who attempt to correct their indiscretions voluntarily as this would discourage others that are similarly situated. However, on the other hand, any material indiscretion that is not corrected and subsequently discovered by the IRS is very likely to draw criminal charges as a matter of public policy to discourage others from like behavior.
Given the nature of this program, voluntary disclosures are extremely sensitive and are accompanied by strict rules and guidelines. Once taxpayers are accepted into the voluntary disclosure program, they must provide the IRS with what amounts to a signed confession upon entering the program and full cooperation while their case is being reviewed and processed. Entering the program is a one way trip that cannot be walked away from and thus, a taxpayer’s eligibility for this program must be carefully scrutinized and evaluated prior to contacting the Criminal Investigation Division of the IRS. As a prudent precaution, counsel should submit a “pre-check” of a taxpayer’s identifying information to the IRS which establishes a taxpayer’s basic eligibility for the program before submitting any potentially incriminating information to the government.
Making the Disclosure (Loud versus Quiet)
Currently in the legal profession there are two main schools of thought (and considerable controversy) regarding how to go about making a voluntary disclosure. The first school of thought is that it should be done “quietly” by sending in delinquent original or amended prior tax returns, with a check(s) in full payment through normal channels and gambling that the returns get processed without the taxpayer every hearing from the Criminal Investigation Division of the IRS because of the sheer volume of returns the taxing authority processes. Many Tax Attorneys prefer and thus direct their clients toward this method because in their opinion this method decreases the likelihood that the delinquent original or amended returns will be audited upon submission and avoidance of a perceived negative impact on a taxpayer’s ongoing reputation with the affected taxing authorities which occurs where a taxpayer makes a loud disclosure by knocking on the door of the criminal investigation division and makes the required “loud” admission of the fraudulent activity that is to be corrected.
Our office (The Tax Law Offices of David W. Klasing) generally prefers “loud” disclosure over “quiet” disclosures because if a taxing authority has begun an investigation prior to receipt of the “quiet” submission the “quiet” disclosure will not be deemed to be voluntary and thus will not comply with its Voluntary Disclosure Practice. To make matters exponentially worse, the amended return could potentially be viewed as a criminal admission of the amount by which the tax liability was understated on the original return. Thus the amended returns intended to mitigate the client’s criminal exposure can be used by the IRS to meet its burden of proof as to willfulness (which is by far the hardest element of its case to prove) if it decides to prosecute. Additionally there is some support for a growing government position stemming from the 2009 and 2011 Offshore Voluntary Disclosure Initiatives that a quiet disclosure does not comply with the terms of its Voluntary Disclosure Practice because a quite disclosure bypasses the required communication with the Criminal Investigation Division of the IRS and only the Criminal Investigation Division of the IRS can recommend that the taxpayer not be referred to the Justice Department for Criminal Investigation.
On Point Selections from The:
TAX CRIMES HANDBOOK
The entire handbook can be found at: https://www.irs.gov/pub/irs‐utl/tax_crimes_handbook.pdf
TITLE 26 TAX VIOLATIONS
TAX EVASION – I.R.C. § 7201
I.R.C. § 7201 – ATTEMPT TO EVADE OR DEFEAT TAX
Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined* not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.
* As to offenses committed after December 31, 1984, the Criminal Fine Enforcement Act of 1984 (P.L. 92-596) enacted as 18 U.S.C. § 3571, increased the maximum permissible fines for felony offenses set forth in section 7201. The maximum permissible fine is $250,000 for individuals and $500,000 for corporations.
 Two kinds of tax evasion.
Section 7201 creates two offenses: (a) the willful attemp to evade or defeat the assessment of a tax, and (b) the willful attempt to evade or defeat the payment of a tax. Sansone v. United States, 380 U.S. 343, 354 (1965). See also, United States v. Shoppert, 362 F.3d 451, 454 (8th Cir.), cert. denied, 543 U.S. 911 (2004); United States Mal, 942 F. 2d 682, 687-88 (9th Cir. 1991) (if a defendant transfers assets to prevent the I.R.S. from determining his true tax liability, he has attempted to evade assessment; if he does so after a tax liability has become due and owing, he has attempted to evade payment).
[a] Evasion of assessment.
The most common attempt to evade or defeat a tax is the affirmative act of filing a false return that omits income and/or claims deductions to which the taxpayer is not entitled. The tax reported on the return is falsely understated and creates a deficiency. Consequently, such willful under reporting constitutes an attempt to evade or defeat tax by evading the correct assessment of the tax.
[b] Evasion of payment.
This offense generally occurs after the existence of a tax due and owing has been established (either by the taxpayer reporting the amount of tax or by the I.R.S. assessing the amount of tax deemed to be due and owing) and almost always involves an affirmative act of concealment of money or assets from which the tax could be paid. As discussed in Section 1-1.04 below, it is not essential that the I.R.S. have made a formal assessment of taxes owed and a demand for payment in order for tax evasion charges to be brought. Tax deficiency can arise by operation of law when there is a failure to file and the government later determines the tax liability. United States v. Daniel, 956 F.2d 540, 542 (6th Cir. 1992).
Note: These two offenses share the same basic elements necessary to prove a violation of I.R.C.
1-1.03 Evasion of Assessment
 Elements of the Offense:
[a] An attempt to evade or defeat a tax or the payment of a tax;
[b] An additional tax due and owing; and,
Sansone v. United States, 380 U.S. 343, 351 (1965); Spies v. United States, 317 U.S. 492 (1943); United States v. Lavoie, 433 F.3d 95, 97-99 (1st Cir. 2005); United States v. Farnsworth, 456 F.3d 394, 401-03 (3d Cir. 2006); United States v. Nolen, 472 F.3d 362, 376- 77 (5th Cir. 2006); United States v. Cor-Bon Custom Bullet Co., 287 F.3d 576, 579 (6th Cir.), cert. denied, 537 U.S. 880 (2002); United States v. Daniels, 387 F.3d 636, 639 (7th Cir.), cert. denied, 544 U.S. 911 (2004); United States v. Shoppert, 362 F.3d 451, 454 (8th Cir.), cert. denied, 543 U.S. 911 (2004); United States v. Kayser, 488 F.3d 1070, 1073 (9th Cir. 2007); United States v. Anderson, 319 F.3d 1218, 1219-20 (10th Cir. 2003); United States v. Mounkes, 204 F.3d 1024, 1028 (10th Cir.), cert. denied, 530 U.S. 1230 (2000); United States v. Daniel, 956 F.2d 540, 542 (6th Cir. 1992); United States v. Masat, 896 F.2d 88, 97-99 (5th Cir. 1990).
Each element must be proved beyond a reasonable doubt. United States v. Marashi, 913 F.2d 724, 735-36 (9th Cir. 1990); United States v. Williams, 875 F.2d 846, 849 (11th Cir. 1989).
 The Attempt
[a] Attempt to evade assessment. The taxpayer must undertake some action, that is, engage in an affirmative act for the purpose of attempting to evade or defeat the assessment of a tax. This element requires more than passive neglect of a statutory duty. A mere act of willful omission does not satisfy the affirmative act requirement of I.R.C. § 7201. United States v. Masat, 896 F.2d 88, 97-99 (5th Cir. 1990).
[b] Examples of affirmative acts include:
- Filing of a false return. United States v. Habig, 390 U.S. 222, 223 (1968); Sansone v. United States, 380 U.S. 343, 351-52 (1965); United States v. Coppola, 425 F.2d 660 (2d Cir. 1969); United States v. Gricco, 277 F.3d 339, 351-52 (3d Cir. 2002); United States v. Boulware, 384 F.3d 794 (2004), 470 F.3d 931, 934 (9th Cir. 2006), reversed on other grounds, 128 S. Ct. 1168, 1182 (2008).
- Filing of a false amended return. United States v. Samara, 643 F.2d 701, 704 (10th Cir. 1981); Norwitt v. United States, 195 F.2d 127, 133-34 (9th Cir. 1952), cert. denied, 344 U.S. 817 (1952).
- Failure to file return coupled with an affirmative act of evasion is commonly referred to as a “Spies evasion.” Passive failure to file tax returns is not tax evasion. If the taxpayer failed to file a return, an evasion case can be maintained only if the taxpayer engaged in an affirmative act to conceal or mislead. Spies v. United States, 317 U.S. 492, 498-99 (1943). By way of illustration, and not by way of limitation, the Supreme Court in Spies set out examples of conduct which can constitute affirmative acts of evasion:
Keeping a double set of books.
Making false or altered entries.
Making false invoices.
Destruction of records.
Concealing sources of income.
Handling transactions to avoid usual records.
(G) Any other conduct likely to conceal or mislead.
See also, United States v. Brooks, 174 F.3d 950, 954-56 (8th Cir. 1999); United
Meek, 998 F.2d 776, 779 (10th Cir. 1993).
- Filing False W-4’s plus Failure to file a Return Equals Evasion. Filing false and fraudulent Forms W-4 claiming to be exempt from federal taxation in combination with failure to file tax returns for each year can constitute an affirmative act of evasion. See, United States v. Brooks, 174 F.3d 950, 954-56 (8th Cir. 1999); United States v. King, 126 F.3d 987, 991-94 (7th Cir. 1997) (filing false forms W-4 is an affirmative act despite the fact that those forms had expired); United States v. Willams, 928 F.2d 145, 147-49 (5th Cir.), cert. denied, 502 U.S. 811 (1991); United States v. Connor, 898 F.2d 942, 944-45 (3d Cir.), cert. denied, 497 U.S. 1029 (1990); United States v. Copeland, 786 F.2d 768, 770-71 (7th Cir. 1985); United States v. Willis, 277 F.3d 1026, 1031 (8th Cir. 2002).
- False statements to Treasury agents relating to the fraud. United States v. Beacon Brass Company, Inc., 344 U.S. 43, 45-46 (1952); United States v. Wilson, 118 F.3d 228, 236 (4th Cir. 1997); United States v. Winfield, 960 F.2d 970, 973-74 (11th Cir. 1992). But see, United States v. Romano, 938 F.2d 1569, 1573 (2d Cir. 1991)(equivocal statements to officials do not constitute an affirmative act).
- Corporate officer’s diversion of corporate funds to pay personal expenses. United States v. Boone, 951 F.2d 1526, 1540-41 (9th Cir. 1991); Katz v. United States, 321 F.2d 7, 10 (1st Cir.), cert. denied, 375 U.S. 903 (1963); United States v. American Stevedores, Inc., 310 F.2d 47, 48 (2d Cir. 1962), cert. denied, 371 U.S. 969 (1963); United States v. Brill, 270 F.2d 525, 526 (3d Cir. 1959).
- Sluicing off corporate income to principal shareholders in the guise of commissions or salaries out of proportion to the value of service rendered to the corporate taxpayer. United States v. Ragen, 314 U.S. 513, 525-26 (1942); United States v. Keenan, 267 F.2d 118, 123 (7th Cir.), cert. denied, 361 U.S. 863 (1959).
- Consistent pattern of overstating deductions. Zacher v. United States, 227 F.2d 219, 224 (8th Cir. 1955), cert. denied, 350 U.S. 993 (1956); United States v. Trevino, 394 F.3d 771, 777-78 (9th Cir. 2005), cert. denied, 547 U.S. 1022 (2006).
- Concealment of bank accounts. United States v. Wilson, 118 F.3d 228, 236 (4th Cir. 1997); Paschen v. United States, 70 F.2d 491 (7th Cir. 1934). Using a false SSN on bank accounts. United States v. Carlson, 235 F.3d 466, 469 (9th Cir. 2000), cert. denied, 121 S.Ct. 1627 (2001).
- Holding property in nominee names. United States v. Shoppert, 362 F.3d 451, 460 (8th Cir.), cert. denied, 543 U.S. 911 (2004); United States v. Wilson, 118 F.3d 228, 236 (4th Cir. 1997); United States v. Peterson, 338 F.2d 595, 597 (7th Cir. 1964), cert. denied, 380 U.S. 911 (1965).
- Representing political gratuities as gifts. Murray v. United States, 117 F.2d 40, 43-45 (8th Cir. 1941).
- Doing business in diverse names and keeping large sums of cash in safe deposit boxes in numerous banks. United States v. Zimmerman, 108 F.2d 370, 379 (7th Cir. 1939).
- Failure to file declaration of estimated tax, concealing or attempting to conceal true income, failure to pay income tax due, and filing frivolous returns —a purported income tax return (tax of $10.75) and an amended return (tax of $312.67). United States v. Afflerbach, 547 F.2d 522 (10th Cir. 1976).
- Structuring cash transactions to evade the filing of Bank Secrecy Act reports. United States v. Mounkes, 204 F.3d 1024, 1030 (10th Cir.), cert. denied, 530 U.S. 1230 (2000).
Affirmative acts pre-dating the date of deficiency.
If the indictment mentions only the date of deficiency as the date of the crime and fails to mention the predeficiency period, then the government is precluded from relying on evidence of acts occurring in the predeficiency period as evidence of affirmative acts of evasion. United States v. Voight, 89 F.3d 1050, 1089-90 (3d Cir.), cert. denied, 519 U.S. 1047 (1996).
[d] Affirmative acts serving purposes other than tax evasion.
If tax evasion motive plays any part in defendant’s conduct, the offense of tax evasion may be made out even though the conduct may also serve purposes other than tax evasion. United States v. Voight, 89 F.3d 1050, 1090 (3d Cir.), cert. denied, 519 U.S. 1047 (1996).
 Additional Tax Due and Owing
[a] Generally. The government must demonstrate the existence of a tax due and owing, i.e., a tax deficiency, to prove tax evasion. The government must prove the criminal tax adjustments include evidence of criminal intent. Defense counsel will attack this element of the case if at all possible. Therefore, it is important to verify that the income from which the tax deficiency resulted was in fact taxable income. See, I.R.C. §§ 61, 62 and 63.
[b] Examples of taxable income not expressly specified in the Code, include:
- Gambling. Garner v. United States, 501 F.2d 228 (9th Cir. 1974), aff’d on other grounds, 424 U.S. 648 (1976); McClanahan v. United States, 292 F.2d 630, 631-32 (5th Cir.), cert. denied, 368 U.S. 913 (1961).
- Campaign contributions used for personal purposes. United States v. Scott, 660 F.2d 1145, 1152 (7th Cir. 1981), cert. denied, 455 U.S. 907 (1982).
- Embezzlement. James v. United States, 366 U.S. 213, 221-22 (1961); United States v. Eaken, 17 F.3d 203 (7th Cir. 1994); United States v. Kleifgen, 557 F.2d 1293, 1298-99 9th Cir. 1977).
- Extortion Proceeds. Rutkin v. United States, 343 U.S. 130, 136-39 (1952); United States v. Cody, 722 F.2d 1052 (2d Cir. 1983), cert. denied, 467 U.S. 1226 (1984).
- Fraud Income. United States v. Dixon, 698 F.2d 445, 446 (11th Cir. 1983) (gross income includes proceeds from investment fraud scheme); Moore v. United States, 412 F.2d 974, 978 (5th Cir. 1969)(income includes gains from illegal activities).
- Loans received with no intent to repay. United States v. Curtis, 782 F.2d 593, 596 (6th Cir. 1986); United States v. Swallow, 511 F.2d 514, 519 (10th Cir.), cert. denied, 423 U.S. 845 (1975); United States v. Rosenthal, 470 F.2d 837, 842 (2d Cir. 1972), cert. denied, 412 U.S. 909 (1973); United States v. Rochelle, 384 F.2d 748, 751-52 (5th Cir. 1967), cert. denied, 390 U.S. 946 (1968).
- Kickbacks. United States v. Sallee, 984 F.2d 643 (5th Cir. 1993); United States v. Cody, 722 F.2d 1052 (2d Cir. 1983); United States v. Fogg, 652 F.2d 551, 555 (5th Cir. 1981), cert. denied, 456 U.S. 905 (1982); United States v. Swallow, 511 F.2d 514, 519 (10th Cir.), cert. denied, 423 U.S. 845 (1975); United States v. Wyss, 239 F.2d 658, 660 (7th Cir. 1957).
Tax deficiency does not include interest and penalties if the violation is evasion of assessment. United States v. Mal, 942 F. 2d 682, 687 (9th Cir. 1991).
[d] Evading another’s tax liability. A tax deficiency may be predicated on taxable income that was taxable either to the person charged or another person or entity. United States V. Trov, 293 U.S. 58 (1934); United States v. Aracri, 968 F.2d 1512, 1523 (2d Cir.1992); United States v. Frazier, 365 F.2d 316, 318 (6th Cir. 1966), cert. denied, 386 U.S. 971 (1967); Tinkoff v. United States, 86 F.2d 868, 876 (7th Cir. 1937).
[e] Assessment and demand not required. If the prosecution theory is evasion of assessment, there need not be a prior formal tax assessment or demand for payment. Tax deficiency can arise by operation of law when there is a failure to file and the government later determines the tax liability. United States v. Daniel, 956 F.2d 540, 542 (6th Cir. 1992); United States v. Dack, 747 F.2d 1172, 1174 (7th Cir. 1984).
[f] Amount of tax to be proven. The government need not prove a precise amount of tax due and owing or prove its case to a mathematical certainty. United States v. Johnson, 319 U.S. 503, 517-18 (1943); United States v. Mounkes, 204 F.3d 1024, 1028 (10th Cir.), cert. denied, 530 U.S. 1230 (2000); United States v. Bender, 606 F.2d 897, 898 (9th Cir. 1979); United States v. Keller, 523 F.2d 1009, 1012 (9th Cir. 1975).
- Most circuits require the government to show that a substantial tax deficiency existed with respect to the years involved in the charge. United States v. Burkhart, 501 F.2d 993, 995 (6th Cir. 1974), cert. denied, 420 U.S. 946 (1975); United States v. Marcus, 401 F.2d 563, 565 (2d Cir. 1968), cert. denied, 393 U.S. 1023 (1969); SwallowV.United States, 307 F.2d 81, 83 (10th Cir. 1962), cert. denied, 371 U.S. 950 (1963); United States v. Alker, 260 F.2d 135, 140 (3d Cir. 1958), cert. denied, 59 U.S. 906 (1959).
- In the Seventh and Ninth Circuits there is no statutory requirement of substantiality, so showing some tax deficiency suffices. United States v. Daniels, 387 F.3d 636, 641 (7th Cir.), cert. denied, 544 U.S. 911 (2004); United States v. Marashi, 913 F.2d 724, 735-736 (9th Cir. 1990); United States v. Bender, 606 F.2d 897, 898 (9th Cir. 1979).
[g] Technical defenses.
- Loss carryback or “Lucky Loser Argument” is no defense. Net operating losses which occur after tax returns are required to be filed cannot be carried back to eliminate a tax liability. Such carryback losses cannot be used to reduce or eliminate misstatements of tax liability when fraudulently made. Willingham v. United States, 289 F.2d 283, 287-88 (5th Cir. 1961), cert. denied, 368 U.S. 826 (1961).
- Insufficient Earnings and Profits (E&P). Many tax schemes involve shareholders of closely held C corporations (corporations that pay tax) diverting corporate receipts to themselves or their family members, having the corporation pay their personal expenses, and other schemes where the corporate funds are distributed to the shareholders without the shareholders reporting any gross income and the corporation’s taxable income being understated. In United States v. Boulware, 128 S.Ct. 1168, 1182 (2008), the Supreme Court held that in determining the taxable amount of any such corporate distributions to the shareholder the distribution rules of I.R.C. §§ 301 and 316 apply.In general, the distribution rules of sections 301 and 316 provide that corporate distributions to shareholders are paid first out of current E&P, second out of accumulated E&P, and third out of capital (if the distribution exceeds current and accumulated E&P and the shareholder’s basis in the stock of the corporation, then such excess is taxed as a capital gain). The defense is that the corporation lacked current or accumulated E&P; therefore, any distributions by the corporation to the shareholder are a non-taxable return of capital.To overcome this defense, the government must prove the corporation had current or accumulated E&P. To compute E&P, start with the taxable income of the corporation as corrected. A number of technical adjustments are made to the taxable income, most of which would not be at issue in a criminal tax case, so the amounts of these adjustments from the corporation’s records could be used. Reduce the adjusted taxable income, by the tax due on the corrected taxable income to arrive at E&P. Any distributions paid out of E&P are taxable (constructive) dividends to the shareholder.In deciding Boulware, the Supreme Court adopted the holding of the Second Circuit Court of Appeals in United States v. D’Agostino, 145 F.3d 69 (2d Cir. 1998), and rejected the following circuit court decisions: United States v. Williams, 875 F.2d 846 (11th Cir. 1989); United States v. Thetford, 676 F.2d 170 (5th Cir. 1982), cert. denied, 459 U.S. 1148 (1983); United States v. Miller, 545 F.2d 1204 (9th Cir. 1976), cert. denied, 430 U.S. 930 (1977); and Davis v. United States, 226 F.2d 331 (6th Cir. 1955), cert. denied, 350 U.S. 965 (1956).
- Reclassify business expenses. In United States v. Kayser, 488 F.3d 1070, 1073 (9th Cir. 2007), a divided panel of the 9th Circuit overturned defendant’s conviction by allowing him to reclassify previously claimed corporate business expenses as personal business expenses which offset unreported income and resulted in no tax due and owing. The court did not overrule United States v. Miller, 545 F. 2d 1204 (9th Cir. 1976), cert. denied, 430 U. S. 930 (1977), which had held otherwise, but interpreted Miller’s holding as being consistent with the court’s decision.
- Different method of reporting or accounting. As a general rule, the Government must use the taxpayer’s method of accounting in computing the income. Fowler United States, 352 F.2d 100, 103 (8th Cir. 1965), cert. denied, 383 U.S. 907 (1966); United States v. Vardine, 305 F.2d 60, 64 (2d Cir. 1962); United States v. Hestnes, 492 F. Supp. 999, 1000-01 (W.D. Wis. 1980). If the taxpayer used a particular method of reporting income, then the taxpayer is bound by that choice at trial. The taxpayer cannot report his income on the cash method and then at trial, allege that on an accrual basis unreported income would be a less than the Government proved on a cash basis. Clark v. United States, 211 F.2d 100, 105 (8th Cir. 1954), cert. denied, 348 U.S. 911 (1955). See also, United States v. Helmsly, 941 F.2d 71, 86-87 (2d Cir. 1991)(defendant not free to re-calculate taxes resorting to one of four depreciation methods to defend the charge by showing that another depreciation method would have resulted in no tax liability); United States v. Hecht, 705 F. 2d 976, 977-78 (8th Cir. 1983).
- A legitimate claim to a foreign tax credit is a defense. United States v. Cruz, 698 F.2d 1148, 1152 (11th Cir. 1983); United States v. Campbell, 351 F.2d 336, 338- 39 (2d Cir. 1965), cert. denied, 383 U.S. 907 (1966). Liability for the foreign tax credit must be fully established as an amount owed to the foreign government.
[a] Willfulness is defined as the “voluntary, intentional violation of a known legal duty.” Cheek v. United States, 498 U.S. 192, 200-01 (1991); United States v. Pomponio, 429 U.S. 10, 12 (1976); United States v. Bishop, 412 U.S. 346, 360 (1973); United States v. Pensyl, 387 F.3d 456, 458-59 (6th Cir. 2004); United States v. George, 420 F.3d 991, 999 (9th Cir. 2005).
[b] Subjective Test. A defendant’s good faith belief that he is not violating the tax laws, no matter how objectively unreasonable that belief may be, is a defense in a tax prosecution. Cheek v. United States, 498 U.S. 192, 199-201 (1991). See also, United States v. Grunewald, 987 F.2d 531, 535-36 (8th Cir. 1993); United States v. Pensyl, 387 F.3d 456, 459 (6th Cir. 2004).
- Erroneous beliefs. A defendant’s erroneous belief that tax laws are unconstitutional is no defense to tax evasion. Cheek v. United States, 498 U.S. 192, 205-06 (1991).
- Law is vague or unsettled.
(A) Where the law is vague or unsettled as to whether a transaction has generated taxable income, courts have found the defendant lacked willfulness. For instance: (i) Payments given by wealthy widower to mistresses where civil tax cases had held such payments were gifts. United States v. Harris, 942 F.2d 1125, 1131 (7th Cir. 1991). (ii) Prior Tax Court case accepting income reporting method made it inappropriate to impose criminal liability for using that method. United States v. Heller, 830 F. 2d 150, 154-55 (11th Cir. 1987). (iii) Novel issue of tax treatment of money received from sale of rare blood. United States v. Garber, 607 F.2d 92, 100 (5th Cir. 1979). (iv) Business income on Indian reservation in light of conflict among government branches on the issue. United States v. Critzer, 498 F.2d 1160, 1162 (4th Cir. 1974).
(B) The fact that an appellate court has not decided an issue does not mean that the law is vague or unsettled if established principles of tax law clearly delineate the scheme’s illegality. See, e.g., United States v. Tranakos, 911 F.2d 1422, 1430-31 (10th Cir. 1990)(addressing use of sham transactions to avoid taxation); United States v. Krall, 835 F.2d 711, 714 (8th Cir. 1987)(regarding use of sham trusts to avoid taxation); United States v. Crooks, 804 F.2d 1441 (9th Cir. 1986) (concerning principle favoring tax treatment of substance over form); United States v. George, 420 F. 3d 991, 995-96 (9th Cir. 2005)(concerning allocation of receiver fees by a cash basis taxpayer).
(C) The fact that the law is vague or unsettled does not negate willfulness if the defendant is not also subjectively uncertain of the law or if bad faith can be inferred from the defendant’s conduct. Factual evidence of the defendant’s state of mind is required to negate willfulness. United States v. Harris, 942 F.2d 1125, 1128-29 (7th Cir. 1991); United States v. Curtis, 782 F.2d 593, 598-600 (6th Cir. 1986)(rejecting defense because it allows a finding that there was no willfulness even if defendant was unaware of the legal uncertainty and because it distorts the roles of experts, judges, and juries with respect to questions of law); United States v. MacKenzie, 777 F.2d 811, 816-17 (2d 11 Cir. 1985); United States v. Mallas, 762 F .2d 361, 363 (4th Cir. 1985); United States Ingredient Technology, 698 F.2d 88, 96-97 (2d Cir.), cert. denied, 462 U.S. 1131 (1983).
- Where the defendant concealed assets or covered up sources of income, willfulness is present and good faith may not be used as a defense. United States v. Brooks, 174 F.3d 950, 954-55 (8th Cir. 1999).
- A willful blindness or deliberate indifference jury instruction permits a jury to infer knowledge if it finds the defendant closed his eyes to what was obvious to him. United States v. Willis, 277 F.3d 1026, 1031-32 (8th Cir. 2002); United States v. Dean, 487 F.3d 840, 851 (11th Cir. 2007).
Absent an admission, confession or accomplice testimony, willfulness is rarely subject to direct proof and generally must be inferred from the circumstances of the case. United States v. Wilson, 118 F.3d 228, 236 (4th Cir. 1997); United States v. Ashfield, 735 F.2d 101, 105 (3d Cir.), cert. denied, 469 U.S. 858 (1984); United States v. Spinelli, 443 F.2d 2, 3 (9th Cir. 1971); United States v. Magnus, 365 F.2d 1007, 1011-12 (2d Cir. 1966); Paschen v. United States, 70 F.2d 491 (7th Cir. 1934).
[d] Willfulness may be inferred from “any conduct, the likely effect of which would be to mislead or to conceal.” Spies v. United States, 317 U.S. 492, 499 (1943). The following are examples of conduct from which willfulness has been inferred:
- Signing return knowing that the contents of that return understated income. United States v. Olbres, 61 F.3d 967, 970-71 (1st Cir.), cert. denied, 516 U.S. 991 (1995).
- Substantial understatement of income in successive years. United States v. Lavoie, 433 F.3d 95, 98-99 (1st Cir. 2005); United States v. Kim, 884 F.2d 189, 192-93 (5th Cir. 1989); United States v. Krzyske, 836 F.2d 1013, 1019-20 (6th Cir. 1988); United States Skalicky, 615 F.2d 1117, 1120 (5th Cir.), cert. denied, 449 U.S. 832 (1980); United States v. Larson, 612 F.2d 1301, 1305 (8th Cir.), cert. denied, 446 U.S. 936 (1980); United States v. Gardner, 611 F.2d 770, 776 (9th Cir. 1980).
- Prior and subsequent similar acts reasonably close to the prosecution years. United States v. Johnson, 386 F.2d 630, 631 (3d Cir. 1967); United States v. Magnus, 365 F.2d 1007, 1011-12 (2d Cir. 1966); United States v. Alker, 260 F.2d 135, 156-57 (3d Cir. 1958), cert. denied, 359 U.S. 906 (1959).
- Failure to supply an accountant with accurate and complete information. United States v. Lavoie, 433 F.3d 95, 99 (1st Cir. 2005); United States v. Bishop, 291 F.3d 1100, 1106- 08 (9th Cir. 2002), United States v. Olbres, 61 F.3d 967, 970-71 (1st Cir.), cert. denied, 516 U.S. 991 (1995); United States v. Brimberry, 961 F.2d 1286, 1290-91 (7th Cir. 1992); United States v. Chesson, 933 F.2d 298, 304-05 (5th Cir. 1991); United States v. Michaud, 860 F.2d 495, 500 (1st Cir. 1988); United States v. Meyer, 808 F.2d 1304, 1306 (8th Cir. 1987); United States v. Ashfield, 735 F.2d 101, 106-07 (3d Cir.), cert. denied, 469 U.S. 858 (1984); United States v. Samara, 643 F.2d 701,703-04 (10th Cir.), cert. denied, 454 U.S. 829 (1981).
- Making false exculpatory statements to agents or causing them to be made. United States v. Chesson, 933 F.2d 298, 304-05 (5th Cir. 1991); United States v. Frederickson, 846 F.2d 517, 520-21 (8th Cir. 1988); United States v. Walsh, 627 F.2d 88, 92 (7th Cir. 1980).
- Destroying, throwing away, or “losing” books and records. United States v. Chesson, 933 F. 2d 298, 304-05 (5th Cir. 1991); United States v. Walker, 896 F.2d 295 (8th Cir. 1990); United States v. Conforte, 624 F.2d 869, 875-76 (9th Cir.), cert. denied, 449 U.S. 1012 (1980); United States v. Garavaglia, 566 F.2d 1056, 1059-60 (6th Cir. 1977).
- Making or using false documents, entries in books and records, or invoices. United States v. Chesson, 933 F.2d 298, 304 (5th Cir. 1991); United States v. Walker, 896 F.2d 295, 297-300 (8th Cir. 1990). This includes backdating documents such as receipts and contracts to gain a tax advantage. United States v. O’Keefe, 825 F.2d 314, 318 (11th Cir. 1987); United States v. Drape, 668 F.2d 22, 25-26 (1st Cir. 1982).
- Keeping a double set of books. Spies v. United States, 317 U.S. 492, 499 (1943); United States v. Daniels, 617 F.2d 146, 148 (5th Cir. 1980).
- Placing property or business in the name of another. United States v. Brooks, 174 F.3d 950, 954-55 (8th Cir. 1999); United States v. Daniel, 956 F.2d 540, 543 (6th Cir. 1992); United States v. Peterson, 338 F.2d 595, 597 (7th Cir. 1964), cert. denied, 380 U.S. 911 (1965); United States v. Woodner, 317 F.2d 649, 650 (2d Cir.), cert. denied, 375 U. S. 903 (1963).
- Extensively using currency and cashier’s checks. United States v. Daniel, 956 F.2d 540, 543 (6th Cir. 1992); United States v. Holovachka, 314 F.2d 345, 357-58 (7th Cir.), cert. denied, 374 U.S. 809 (1963); Schuermann v. United States, 174 F.2d 397, 398 (8th Cir.), cert. denied, 338 U.S. 831 (1949).
- Spending large amounts of cash which could not be reconciled with reported income or engaging in surreptitious transactions using cash, money orders, or cashier’s checks. United States v. Kim, 884 F.2d 189, 192-93 (5th Cir. 1989); United States v. Skalicky, 615 F.2d 1117, 1120 (5th Cir.), cert. denied, 449 U.S. 832 (1980); United States v. Holladay, 566 F.2d 1018, 1020 (5th Cir.), cert. denied, 439 U.S. 831 (1978); United States v. Mortiner, 343 F.2d 500 (7th Cir.), cert. denied, 382 U.S. 842 (1965).
- Holding bank accounts under fictitious names. United States v. Ratner, 464 F.2d 101, 105 (9th Cir. 1972); Elwert v. United States, 231 F.2d 928, 936 (9th Cir. 1956).
- Handling one’s affairs to avoid making the usual records required for such transactions. United States v. Dowell, 446 F.2d 145, 147-48 (10th Cir.), cert. denied, 404 U. S. 984 (1971); Gariepy v. United States, 189 F.2d 459, 461-63 (6th Cir. 1951).
- General educational background and experience may be considered as bearing on a taxpayer’s ability to form a willful intent. United States v. Smith, 890 F.2d 711, 715 (5th Cir. 1989)(entrepreneurial experience); United States v. Segal, 867 F.2d 13 1173, 1179 (8th Cir. 1989)(successful and sophisticated businessman). See also, United States v. Tarwater, 308 F.3d 494, 506-07 (6th Cir. 2002); United States v. Coblentz, 453 F.2d 503, 505 (2d Cir. 1972); United States v. Ostendorff, 371 F.2d 729, 731 (4th Cir.) cert. denied, 386 U.S. 982 (1967).
- The defendant’s attitude toward the reporting and payment of taxes generally. United States v. Hogan, 861 F.2d 312, 316 (1st Cir. 1988); United States v. Stein, 437 F.2d 775 (7th Cir.), cert. denied, 403 U.S. 905 (1971); United States v. O’Connor, 433 F.2d 752, 754-755 (1st Cir. 1970), cert. denied, 401 U.S. 911 (1971).
- Ignorance of law and claims that tax laws are not constitutional. Cheek v. United States, 498 U.S. 192, 199-201 (1991); United States v. Pensyl, 387 F. 3d 456, 458-60 (6th Cir. 2004), and United States v. Hancock, 231 F. 3d 557, 561-62 (9th Cir. 2000).
[a] Under the Constitution, venue lies in the judicial district where the crime has been committed. U.S. Const. art. II, § 2, cl. 3; U.S. Const. amend. VI.
[b] Unless otherwise permitted by statute or rule, criminal prosecution must take place “in a district in which the offense was committed.” Fed. R. Crim. P. 18.
Venue is appropriate in any judicial district where the return was:
- subscribed; or
See, e.g., United States v. Marchant, 774 F.2d 888, 891-92 (8th Cir. 1985), cert. denied, 475 U.S. 1012 (1986)(venue appropriate where accountant prepared return); United States v. King, 563 F.2d 559, 562 (2d Cir. 1977), cert. denied, 435 U.S. 918 (1978)(prepared and signed); United States v. Gross, 276 F.2d 816, 819 (2d Cir.), cert. denied, 363 U.S. 831 (1960) (prepared); United States v. Albanese, 224 F.2d 879, 882 (2d Cir.), cert. denied, 350 U.S. 845 (1955)(prepared and mailed).
[d] Venue is also appropriate in any district where any act of the offense was begun, continued, or completed. United States v. Rooney, 866 F.2d 28, 31-32 (2d Cir. 1989).
[e] For offenses begun in one district and completed in another, or committed in more than one district, venue lies in each district in which such offense was begun, continued, or completed. 18 U.S.C. § 3237(a).
[f] General considerations in recommending venue:
- The underlying basis for venue is the taxpayer’s Sixth Amendment right to trial in the judicial district where the crime was committed.
- Bringing prosecution in taxpayer’s home judicial district obviates motion by defendant to change venue. Publicity more likely in defendant’s home district.
- Proof of venue is by a preponderance of the evidence. United States v. Maldonado-Rivera, 922 F.2d 934, 968 (2d Cir. 1990), cert. denied, 501 U.S. 1210 (1991); United States v. Griley, 814 F.2d 967, 973 (4th Cir. 1987). It is enough if the testimony justifies the reasonable inference that the violation occurred at the place alleged in the indictment. United States v. Mendell, 447 F.2d 639, 641 (7th Cir.), cert. denied, 404 U.S. 991 (1971).
- Improper venue may be waived by a defendant. United States v. Netz, 758 F.2d 1308, 1311 (8th Cir. 1985); United States v. Powell, 498 F.2d 890, 891 (9th Cir. 1974). See also, Fed R. Crim. P. 58(c)(2).
 Statute of Limitations
[a] There is a six (6) year limitation period for the offense of willfully attempting to evade or defeat any tax. I.R.C. § 6531(2).
[b] The general rule is that the limitation period begins to run 6 years from the date of the last affirmative act that took place or the statutory due date of the return, whichever is later. Specific applications of the rule are:
- Statutory due date where no return is filed or where the return is filed early. United States v. Butler, 297 F.3d 505, 511 (6th Cir. 2002), cert. denied, 123 S.Ct. 2074 (2003); United States v. Williams, 928 F.2d 145, 149 (5th Cir.), cert. denied, 502 U.S. 811 (1991); United States v. Myerson, 368 F.2d 393, 395 (2d Cir. 1966), cert. denied, 386 U.S. 991 (1967).
- Actual filing date where the tax return is filed late. United States v. Habig, 390 U.S. 222, 225-27 (1968); United States v. Daniels, 387 F.3d 636, 641-42 (7th Cir.), cert. denied, 544 U.S. 911 (2004).
- Date of the last affirmative act of evasion where acts of evasion occur after the due date. United States v. Beacon Brass, 344 U.S. 43, 45-46 (1952); United States v. Anderson, 319 F.3d 1218, 1219-20 (10th Cir. 2003); United States v. Carlson, 235 F.3d 466, 470-71 (9th Cir. 2000), cert. denied, 532 U.S. 983 (2001); United States v. Winfield, 960 F.2d 970, 973 (11th Cir. 1992); United States v. DiPetto, 936 F.2d 96, 98 (2d Cir.), cert. denied, 502 U.S. 866 (1991); United States v. Ferris, 807 F.2d 269, 271-72 (1st Cir. 1986). Contra, United States v. Uscinski, 369 F.3d 1243, 1247 (11th Cir. 2004)(the filing of a false income tax return completes the offense of tax evasion). Note: This can be problematic if act does not relate to evasion but, rather may be viewed as a separate coverup.
Tolling, Suspension, and Extension of Statute
- Tolling. Under I.R.C. § 6531, the statute of limitations is tolled while a person who has committed tax code violations is outside the United States or is a fugitive from justice.
(A) “Outside the United States” has been interpreted to mean “whenever [such persons] cannot be served criminal process within the jurisdiction of the United States under Fed. R. Crim. P. 4(d)(2).” United States v. Marchant, 774 F.2d 888, 891-92 (8th Cir. 1985), cert. denied, 475 U.S. 1012 (1986).
(B) This includes ordinary business or pleasure trips outside U.S. jurisdiction. United States v. Myerson, 368 F.2d 393, 395 (2d Cir. 1966), cert. denied, 386 U.S. 991 (1967).
- Suspension. Under I.R.C. § 7609(e)(1), the statute of limitations is suspended in certain types of summons enforcement proceedings. Generally, where an intervener in a summons enforcement proceeding is the person with respect to whose liability the summons is issued, the running of any period of limitations under section 6531(relating to criminal prosecutions) with respect to such person shall be suspended for the period during which such a proceeding, and appeals therein, with respect to the enforcement of such summons is pending.
3.Time Extension. Under I.R.C. § 6531, the statute of limitations may be extended. When an adequate complaint is instituted before a commissioner of the United States within the prescribed limitation period, the period is extended 9 months from the date of the complaint. This extension of time is not meant to allow the government additional time to develop its case, but rather is designed for use when the grand jury would not be able to return an indictment within the statutory time because of its schedule. See, Jaben v. United States, 381 U.S. 214, 219-20 (1964).
1-1.04 Evasion of Payment
 Elements of the Offense:
[a] An attempt to evade or defeat the payment of a tax;
[b] An additional tax due and owing; and,
Sansone v. United States, 380 U.S. 343, 351 (1965); Spies v. United States, 317 U.S.
492, 493- 94 (1943); United States v. Daniel, 956 F.2d 540, 542 (6th Cir. 1992); United
States v. Masat, 948 F.2d 923, 931 (5th Cir. 1991).
 The Attempt
Page | 61
[a] Attempt to evade payment. Affirmative acts of evasion of payment almost always involve some form of concealment of money or assets with which the tax could be paid or the removal of assets from the reach of the I.R.S. Merely failing to pay assessed taxes, without more, does not constitute evasion of payment (though it may constitute willful failure to pay taxes under § 7203). Thus, in the absence of an affirmative act, obstinate refusal to pay taxes due and the possession of the funds needed to pay the taxes is insufficient for an evasion charge.
[b] Affirmative acts of evasion of payment generally involve schemes to deal in currency, place assets in the names of others, transfer assets abroad or omit assets on a Form 433-A, Collection Information Statement. Examples include:
- Concealing assets by using bank accounts of family members and coworkers. United States v. Shoppert, 362 F.3d 451, 460 (8th Cir.), cert. denied, 543 U.S. 911 (2004); United States v. McGill, 964 F.2d 222, 233 (3d Cir. 1992).
- Making expenditures extensively by cash and through the use of third parties’ credit cards and placing assets in the names of third parties. United States v. Shoppert, 362 F.3d 451 (8th Cir.), cert. denied, 543 U.S. 911 (2004); United States v. Daniel, 956 F.2d 540, 543 (6th Cir. 1992).
- Taxpayer’s false statement to I.R.S. agent that she owned no real estate and had no other assets with which to pay tax. United States v. Shoppert, 362 F.3d 451, 460 (8th Cir.), cert. denied, 543 U.S. 911 (2004); United States v. Brimberry, 961 F.2d 1286, 1290-91 (7th Cir. 1992).
- Maintaining a cash lifestyle by conducting all personal and professional business in cash, possessing no credit cards, bank accounts, or accounting records and never acquiring any attachable assets. United States v. Shorter, 809 F.2d 54, 56-57 (D.C. Cir.), cert. denied, 484 U.S. 817 (1987).
- Bankruptcy fraud. A legitimate goal of a bankruptcy petitioner may be immediate protection from I.R.S. collection activities (stay of collection and removal of levies). While the act of voluntarily filing a petition for bankruptcy may not constitute an affirmative act in and of itself, if it can be shown through other affirmative acts (e.g., predicating the petition on false or fraudulent obligations) that the petitioner’s purpose in filing the bankruptcy petition was to prevent or delay I.R.S. collection efforts, the act of filing may constitute an affirmative act of evasion. See, e.g., United States v. Huebner, 48 F.3d 376, 379-80 (9th Cir. 1994)(the defendant, having created false loan documents and then filed for bankruptcy, was successfully prosecuted for evasion of payment.).
- See also, United States v. Hook, 781 F.2d 1166, 1169 (6th Cir.), cert. denied, 479 U.S. 882 (1986); United States v. Lamp, 779 F.2d 1088, 1092-93 (5th Cir. 1986); United States v. Swallow, 511 F.2d 514, 521 (10th Cir.), cert. denied, 423 U.S. 845 (1975); United States v. Trownsell, 367 F.2d 815, 816 (7th Cir. 1966); Cohen v. United 17 States, 297 F.2d 760, 762 (9th Cir.), cert. denied, 369 U.S. 865 (1962); United States v. Mollet, 290 F. 2d 273, 274-75 (2d Cir. 1961), for additional examples of acts to evade payment.
Evasion of payment may involve a single affirmative act intended to evade the payment of several years of tax due. In this situation, it is permissible to charge multiple years of evasion in one count. United States v. Shorter, 809 F.2d 54, 56-57 (D.C. Cir.), cert. denied, 484 U.S. 817 (1987)(upholding use of a single count of tax evasion covering twelve years of evasion of payment where the underlying basis of the count is an allegedly consistent, long-term pattern of conduct directed at the evasion of payment of taxes for those years). See also, United States v. Hook, 781 F.2d 1166, 1169 (6th Cir.), cert. denied, 479 U. S. 882 (1986).
 Additional Tax Due and Owing
[a] Generally. The government must demonstrate the existence of a tax due and owing, i.e., a tax deficiency, to prove tax evasion. For further information see discussion of this element in the evasion of assessment section above.
[b] It is not essential that the I.R.S. have made a formal assessment of taxes owed and a demand for payment in order to bring tax evasion charges on an evasion of payment theory. Tax deficiency can arise by operation of law when there is a failure to file and the government later determines the tax liability. See, United States v. Daniel, 956 F.2d 540, 542 (6th Cir. 1992); United States v. Hogan, 861 F.2d 312, 315-16 (1st Cir. 1988). The law is not so clear in the Third Circuit. See the discussion in United States v. Farnsworth, 456 F.3d 394, 402-03 (3d Cir. 2006), where the court stated that no assessment is required but noted that United States v. McGill, 964 F.2d 222, 233 (3d Cir. 1992), suggested otherwise.
Right of defendant to dispute assessment. Although an assessment is prima facie proof of a tax deficiency, the defendant has a constitutional right to present rebuttal evidence and have the jury decide his guilt on each element of the crime. United States Silkman, 156 F.3d 833, 835 (8th Cir. 1998).
[a]Willfulness is defined as the “voluntary, intentional violation of a known legal duty.” Cheek v. United States, 498 U.S. 192, 201 (1991); United States v. Pomponio, 429 U.S. 10, 12 (1976); United States v. Bishop, 412 U.S. 346, 360 (1973). See discussion of this element in the evasion of assessment section above.
[b] Willfulness is subjectively measured. A defendant’s good faith belief that he is not violating the tax laws, no matter how objectively unreasonable that belief may be, is a defense in a tax prosecution. Cheek v. United States, 498 U.S. 192, 199-201 (1991). See also, United States v. Grunewald, 987 F.2d 531, 535-36 (8th Cir. 1993).
Indirect proof of willfulness is the typical means of establishing the element. Willfulness may be inferred from “any conduct the likely effect of which would be to mislead or to conceal.” Spies v. United States, 317 U.S. 492, 499 (1943).
[d] Conduct from which the willful evasion of payment can be inferred includes conduct designed to place assets beyond the government’s reach after a tax liability has been assessed. United States v. Mal, 942 F. 2d 682, 687 (9th Cir. 1991); United States v. Dunkel, 900 F.2d 105, 107 (7th Cir. 1990); United States v. Masat, 896 F.2d 88, 97-99 (5th Cir. 1990).
[e] Paying taxes due after the criminal investigation commenced does not negate willfulness. United States v. Pang, 362 F.3d 1187, 1194 (9th Cir.), cert. denied, 543 U.S. 943 (2004).
[a] Venue is appropriate in any judicial district where the return was:
- subscribed; or
See, e.g., United States v. Marchant, 774 F.2d 888, 891-92 (8th Cir. 1985), cert. denied, 475 U.S. 1012 (1986) (venue appropriate where accountant prepared return); United States v. King, 563 F.2d 559, 562 (2d Cir. 1977), cert. denied, 435 U.S. 918 (1978) (prepared and signed); United States v. Gross, 276 F.2d 816, 819-20 (2d Cir.), cert. denied, 363 U.S. 831 (1960) (prepared); United States v. Albanese, 224 F.2d 879, 882 (2d Cir.), cert. denied, 350 U.S. 845 (1955)(prepared and mailed).
[b] Venue is also appropriate in any district where any act of the offense was begun, continued, or completed. United States v. Rooney, 866 F.2d 28, 31-32 (2d Cir. 1989).
For offenses begun in one district and completed in another, or committed in more than one district, venue lies in each district in which such offense was begun, continued, or completed. 18 U.S.C. § 3237(a).
 Statute of Limitations
To determine whether the statute of limitations is open for evasion of payment cases, begin with the present date, and inquire whether affirmative acts in furtherance of the crime were committed in the preceding 6 years. United States v. Shorter, 809 F.2d 54 (D.C. Cir.), aff’g 608 F. Supp. 871, 873-74, and cert. denied, 484 U.S. 817 (1987);
United States v. Hook, 781 F.2d 1166, 1171-73 (6th Cir. 1986). For example, in United States v. Voorhies, 658 F. 2d 710 (9th Cir. 1981), the defendant committed five affirmative acts of evading payment within six years prior to the date he was indicted.
1-1.05 Collateral Estoppel
I.R.C. § 7201 is a broad provision and carries the most severe penalty of the criminal tax offenses. Since criminal convictions are founded on the beyond a reasonable doubt standard, a conviction for tax evasion will collaterally estop denial of the civil fraud penalty under I.R.C. § 6663 for the same taxpayer, tax year, and type of tax. See Wright Commissioner, 84 T.C. 636 (1985); Amos v. Commissioner, 43 T.C. 50 (1964).
1-1.06 Lesser Included Offenses
 Lesser included offenses are offenses whose statutory elements comprise part of the elements needed to prove another offense, i.e., they are a subset of a “greater” or “major” offense. For example, filing a false return or failing to file a return are each substantive tax offenses which under certain circumstances could be a lesser included offense of tax evasion. Filing a false return may constitute an affirmative act of tax evasion, and when coupled with a tax deficiency, could form the basis for an evasion charge. Similarly, failing to file a return, when coupled with the requisite affirmative act(s) of evasion and a tax deficiency, also may support an evasion charge. Accordingly, such offenses are considered lesser included offenses of the major offense of tax evasion.
 Congress, in fixing varying penalties for offenses of attempting to evade federal income tax and for willfully making and subscribing a tax return not believed to be correct, did not intend to pyramid penalties and authorize a separate penalty for a lesser included offense, which arose out of the same transaction and which would be established by proof of guilt of the greater offense of attempting to evade income tax. United States v. Lodwick, 410 F.2d 1202, 1206 (8th Cir.), cert. denied, 396 U.S. 841 (1969). See also, United States v. Dale, 991 F.2d 819, 858-59 (D.C. Cir. 1993); United States v. Kaiser, 893 F.2d 1300, 1307 (11th Cir. 1990); United States v. Citron, 783 F.2d 307, 312-14 (2d Cir. 1986). Thus, in cases where a § 7203 or § 7206(1) violation is a predicate offense to a § 7201 violation, the § 7203 or § 7206(1) violation would be considered a lesser included offense in the § 7201 offense.
 The Department of Justice, Tax Division, has adopted the so-called “elements” test for lesser included offenses from Schmuck v. United States, 489 U.S. 705, 709-10 (1989). The standard is whether the statutory elements of the lesser offense are a subset of the elements of the greater offense. Schmuck, 489 U.S. at 709-10.
 One result of this policy is that an instruction of failure to file is not automatic in a Spies evasion case involving failure to file, failure to pay, and an affirmative act of evasion. If there is any doubt as to the strength of evidence on any section 7201 element, charging a section 7203 violation should also be considered.
 Similarly, charging both sections 7201 and 7206(1) should be considered in evasion cases where filing a false return can be established, but the evidence supporting a tax deficiency may not be strong enough for an evasion conviction.