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Article Excerpt
I. INTRODUCTION
II. CRIMINAL INVESTIGATIONS UNDER I.R.C. [section][section] 7201, 7202, 7203, 7206, AND 7212(A) A. Policies and Procedures of IRS Investigations 1. Purposes of IRS Investigations 2. Policies 3. Constitutional Considerations a. Notice and Due Process Requirements b. Substantive Rights and IRS Internal Regulations c. Fifth Amendment Issues and Disclosure of Documents 4. Statute of Limitations B. I.R.C. [section] 7201 1. Elements a. Existence of a Tax Deficiency b. Affirmative Act Constituting Evasion c. Willfulness 2. Defenses a. Lack of Deficiency b. Lack of Willfulness c. Third Party Liability/Reliance d. Selective Prosecution C. I.R.C. [section] 7202 1. Willful Failure to Collect Tax 2. Willful Failure to Account For and Pay Over Tax 3. Elements a. Duty to Collect and/or Account For and Pay Over Tax i. The Statutory Duty ii. The Responsible Person b. Willfulness 4. Defenses D. I.R.C. [section] 7203 1. Elements a. Requirement to File a Return b. Failure to File a Return c. Willfulness 2. Defenses E. I.R.C. [section] 7206 1. I.R.C. [section] 7206(1) a. Elements i. Signing a False Return or Document ii. Penalty of Perjury iii. Material Falsity iv. Willfulness b. Defenses 2. I.R.C. [section] 7206(2) a. Elements i. Aiding and Assisting ii. Material Falsity iii. Willfulness b. Defenses F. I.R.C. [section] 7212(a) 1. Elements a. Corruption, Force, or Threat of Force b. Endeavor to Obstruct the Administration of the IRS 2. Defenses G. Sanctions Under the United States Sentencing Guidelines 1. Violations of I.R.C. [section] 7201 2. Violations of I.R.C. [section] 7202 3. Violations of I.R.C. [section] 7203 4. Violations of I.R.C. [section] 7206 5. Violations of I.R.C. [section] 7212(a) III. CRIMINAL CONSPIRACY INVESTIGATIONS UNDER 18 U.S.C. [section] 371 A. Elements B. Defenses C. Statute of Limitations
I. INTRODUCTION
This Article outlines the elements, defenses, and sentencing consequences of various criminal tax violations under the United States Internal Revenue Code ("I.R.C."), [section][section] 7201, 7202, 7203, 7206, and 7212(a).
Section II of this Article examines the policies and procedures of Internal Revenue Service ("IRS") investigations, as well as the applicable punishments set forth in the United States Sentencing Guidelines ("Guidelines"). Section II also addresses the basic elements of and defenses to the following crimes: tax evasion under [section] 7201, failure to collect tax under [section] 7202, willful failure to file taxes under [section] 7203, "tax perjury" and "aiding and assisting" tax fraud under [section] 7206, and interference with the administration of internal revenue laws under [section] 7212(a). Finally, Section III details criminal investigations of conspiracy to violate the tax laws under the defraud clause of 18 U.S.C. [section] 371.
II. CRIMINAL INVESTIGATIONS UNDER I.R.C. [section][section] 7201, 7202, 7203, 7206, AND 7212(A)
Part A of this Section examines the policies and procedures of IRS investigations, constitutional considerations, and the statute of limitations for I.R.C. violations. Parts B through F of this Section address the basic elements and defenses of the following offenses: tax evasion, failure to collect tax, failure to file taxes, "tax perjury" and "aiding and assisting" tax fraud, and interference with the administration of internal revenue laws. Part G explains the applicable punishments in the Guidelines and various possible sentencing enhancements.
A. Policies and Procedures of IRS Investigations
1. Purposes of IRS Investigations
The IRS divides enforcement of U.S. tax laws between two investigative divisions: the Examination Division investigates civil tax cases and the Criminal Investigation Division ("CID") investigates potential criminal violations. (1) According to the Internal Revenue Manual, criminal tax investigations serve two purposes: (1) to enforce the tax laws and (2) to encourage voluntary compliance. (2)
In order to maximize deterrence of tax violations, the CID focuses on individual participation in sophisticated criminal schemes, as well as high-dollar financial transactions. (3) The IRS is also more likely to audit a prominent taxpayer than a relatively obscure person." (4) As a result, fewer agents audit returns among the general population, reducing the percentage of total returns audited. (5)
2. Policies
CID special agents are responsible for investigating alleged criminal violations under the I.R.C. and related provisions of Title 18 of the United States Code. (6) A special agent conducts an administrative investigation when the agent is notified of a matter that warrants further inquiry or may involve a potential criminal prosecution. (7) If the special agent believes the matter merits prosecution, a special agent's report ("SAR") is prepared, outlining the details of the investigation and the agent's recommendations. (8) The matter is referred to IRS counsel, who then makes a referral to the Department of Justice ("DOJ"), Tax Division or, when authorized, directly to the U.S. Attorney's Office, whichever is more appropriate. (9) Referral of a matter to the Tax Division terminates the authority of the CID to employ the administrative investigation process. (10)
The Tax Division, under the guidance of the Assistant Attorney General generally authorizes prosecution in criminal tax cases, (11) and also supports and coordinates tax litigation. (12) U.S. Attorneys assume responsibility for litigating criminal tax cases. (13)
3. Constitutional Considerations
a. Notice and Due Process Requirements
Upon initial contact with the taxpayer, investigators must identify themselves to the taxpayer as special agents of the IRS and advise the taxpayer of the pending criminal investigation. (14) The IRS guidelines mandate that special agents provide an administrative warning to the taxpayer during initial contact, (15) but the warning is not considered to be constitutionally required. (16)
b. Substantive Rights and IRS Internal Regulations
Evidence obtained in violation of the guidelines is not per se inadmissible, (17) as a rigid exclusionary rule would deter the creation of regulations that protect taxpayers. (18) Generally, courts consider whether a guideline violation may show bad faith on the part of the IRS. (19) However, regulations that are "mandated by the Constitution or federal law are often enforced by courts." (20)
The failure to follow such internal procedures may be evidence that the taxpayer's rights were violated. (21) For example, the IRS manual prohibits a criminal investigation from being conducted under the guise of a civil tax audit, (22) and the use of information gathered during such a covert criminal investigation may violate the taxpayer's Fourth and Fifth Amendment rights. (23) The burden is on the taxpayer, however, to show that: (i) the tax auditor "affirmatively misled [the taxpayer] as to the true nature of the investigation" and (ii) the misleading conduct "was a material factor in [the taxpayer's] decision to give information to the agents." (24) Courts usually defer to the judgment of an agent in determining whether the investigation should be turned over to the CID, (25) creating difficulties for taxpayers seeking to establish a constitutional violation. (26)
c. Fifth Amendment Issues and Disclosure of Documents
Although the Fifth Amendment may be invoked in any proceeding, (27) it does not shield from discovery the contents of any voluntarily prepared tax records merely because those records contain incriminating information. (28) Depending on the circumstances, however, the act of producing documents may have a "compelled testimonial aspect." (29) Accordingly, when the "act of production" itself represents an incriminating communication about the existence, possession, or authenticity of the documents, the taxpayer may invoke the Fifth Amendment privelege against self-incrimination. (30) The applicability of the privilege is determined on a document-by-document basis. (31)
In evaluating a taxpayer's Fifth Amendment claim, the district court holds an in camera hearing (32) to examine each document and determine if the taxpayer has a "reasonable fear" that criminal prosecution could result from the document's use. (33)
Should the taxpayer elect to voluntarily disclose documents to the IRS, she may revoke her consent at "any time prior to the completion of the search." (34) In cases where a taxpayer initially grants consent and later revokes it, the IRS may only use information obtained during the period of taxpayer consent. (35)
4. Statute of Limitations
Crimes arising under the I.R.C. have a three-year statute of limitations. (36) The I.R.C. delineates certain exceptions that extend the limitations period to six years. (37) The five I.R.C. sections covered in this Article--[section][section] 7201, (38) 7202, (39) 7203, (40) 7206, (41) and 7212(a), (42)--each fall under these exceptions. The statute of limitations begins to run on the date the taxpayer files the fraudulent document or on the date of the last affirmative act of evasion. (43) To satisfy the statute of limitations, the government need only file a complaint within the limitations period. (44) The statute of limitations can be tolled for tax evasion purposes if the accused is: (i) a fugitive; (45) (ii) outside the United States; (46) or (iii) involved in related enforcement proceedings. (47) These tolling provisions prevent a defendant from raising procedural issues to delay a tax violation proceeding beyond the statute of limitations period.
B. I.R.C. [section] 7201
Violations of the I.R.C. are prosecuted under an array of criminal tax statutes. (48) Felony tax evasion, set forth in I.R.C. [section] 7201, (49) has been called the "capstone of [this] system of sanctions." (50)
1. Elements
To prove a [section] 7201 violation, the government must show: (i) the existence of a tax deficiency; (ii) an affirmative act constituting an evasion or attempted evasion of the tax; and (iii) willfulness. (51) The government bears the burden of proving each element beyond a reasonable doubt. (52)
a. Existence of a Tax Deficiency
Courts disagree about what constitutes a tax deficiency under [section] 7201. Most circuits demand only a deficiency, (53) while the Second and Tenth Circuits require a "substantial" deficiency. (54) The term "substantial" refers to the "amount of the tax evaded," not the amount of unreported income. (55)
The existence of a deficiency may be demonstrated by the use of either direct or circumstantial evidence, (56) though proof of unreported income is difficult to uncover. (57) The most accurate means of proving a deficiency by direct evidence is the "specific item method." (58) Under the specific item method, the taxpayer's books and records provide direct evidence that the taxpayer did not report taxable transactions. (59)
In the absence of direct evidence, the government usually relies on three methods to obtain circumstantial evidence of unreported taxable income: (i) net worth; (ii) cash expenditures; and (iii) bank deposits. (60)
While the government must prove that a deficiency exists, it is not required to prove "the extent of the deficiency with mathematical certainty," (61) nor is it required to prove the exact source of the unreported income. (62) "The government may choose to proceed under any single theory of proof or a combination of circumstantial and direct proofs." (63)
The government most commonly uses the "net worth" method of proof to establish tax evasion. (64) Pursuant to this method, the government must establish the taxpayer's opening net worth with "reasonable certainty," (65) but it does not have to establish with reasonable certainty the net worth for the subsequent years under investigation. (66) Nevertheless, because the "net worth" method relies solely on circumstantial evidence, the court must ensure that the government meets its burden of proof beyond a reasonable doubt. (67)
A "simple variant of the 'net worth method'" is the "cash expenditures" method. (68) Under this method, the government seeks to demonstrate that the taxpayer's expenditures taken from taxable income exceed the income reported by the taxpayer. (69) Rather than locating the exact source of unreported income, the government merely needs to establish a "likely source" of unreported income or negate "reasonably possible nontaxable sources of income." (70) Significantly, the "cash expenditures" method does not require the government to prepare a formal net worth statement, similar to that used under the "net worth method." (71)
The "bank deposits" method requires the government to conduct a full investigation of the taxpayer's bank accounts and compare taxable deposits with reported income. (72) A jury may infer tax evasion from the difference between the two amounts. (73)
An unchallenged IRS assessment of taxes serves as prima facie evidence of a tax deficiency when a taxpayer who files no return is charged with tax evasion. (74) If a taxpayer does not file a return at all and refuses to give relevant information to the IRS, the IRS is authorized by the I.R.C. to create and execute a substitute return which may then serve as prima facie evidence of a deficiency. (75) Along these lines, the Eighth Circuit has held that, when a defendant does not "timely challenge the assessed deficiencies, they [become] administratively final," and that "a formal tax assessment that has become administratively final is prima facie evidence of the asserted tax deficiency, and if unchallenged, it may suffice to prove this element of the crime." (76) The court emphasized, however, that the IRS assessment only serves as prima facie evidence of a deficiency and "may be challenged by the defendant accused of tax evasion". (77)
b. Affirmative Act Constituting Evasion
The Supreme Court has long interpreted [section] 7201 to require a positive attempt to evade or defeat any tax. (78) Accordingly, mere "passive neglect" is insufficient to establish a violation (79); an act to evade tax must be one of commission rather than omission. (80) The "affirmative act" language has been broadly construed (81) and includes: (i) the filing of false returns; (82) (ii) keeping two sets of books; (83) (iii) making false entries or alterations; (84) (iv) making false invoices or documents; (85) (v) destroying books or records; (86) (vi) concealing assets or covering up sources of income; (vii) handling one's affairs to avoid making records usually kept for transactions; and (viii) conduct whose likely effect would be to mislead or conceal. (87)
Generally, affirmative acts associated with evasion involve concealment of the taxpayer's ability to pay taxes or the removal of assets from the reach of the IRS. (88) An affirmative act may be inferred even if the actions undertaken can be attributed to motivations other than the intent to evade taxes. (89) Moreover, the argument that the methods a taxpayer used were not likely to mislead or conceal and, thus, do not constitute an affirmative act of evasion is not a viable defense. (90)
c. Willfulness
The Supreme Court has defined "willfulness" as the voluntary, intentional violation of a known legal duty. (91) The willfulness requirement is closely related to the affirmative act requirement because evidence of affirmative acts is often used to show willfulness. (92)
To prove willfulness, the government must show the taxpayer had a specific intent to commit the violation. (93) To make this showing, the government must demonstrate more than mere carelessness on the part of the defendant, (94) though it need not prove bad faith. (95) Accordingly, even an unreasonable misunderstanding of the law may negate a finding of willfulness. (96) The defendant's subjective belief regarding the applicability of a legal duty is a question of fact. (97)
Some courts have held that "proof of willfulness usually must be accomplished by means of circumstantial evidence." (98) Willfulness can be inferred from both the surrounding circumstances and the defendant's affirmative acts of evasion. (99) When applied, this inference often blurs the distinction between willfulness and affirmative acts. (100)
2. Defenses
The four defenses to tax evasion charges under [section] 7201 are: (i) lack of deficiency; (ii) lack of willfulness; (iii) third party liability or reliance; and (iv) selective prosecution.
a. Lack of Deficiency
First, the taxpayer may rebut the government's charge of tax evasion by showing the nontaxable nature of the income received. (101) Moreover, in cases involving circumstantial evidence, the taxpayer may identify errors in the government's analysis to negate a tax deficiency. (102) The taxpayer may also claim the government failed to investigate and negate exculpatory leads furnished by the taxpayer. (103) Furthermore, the taxpayer may negate an alleged deficiency by proving a deduction or a credit not yet calculated. (104)
b. Lack of Willfulness
The taxpayer may also avoid conviction under [section] 7201 by establishing that tax evasion was not willful. (105) Under the Supreme Court's decision in Cheek v. United States, (106) a good faith belief that one is not violating the law negates willfulness, regardless of the objective reasonableness of the belief. (107) In assessing a lack of willfulness defense predicated on ignorance of the law, fact-finders look to the taxpayer's conduct, (108) past record of compliance, (109) sophistication and level of knowledge. (110) If a defendant can show the statutory provision at issue is ambiguous or unsettled, he may point to this ambiguity to support his lack of willful intent. (111)
A defendant may also negate willfulness by establishing negligence (112) or mistake, (113) but bears a heavy burden in making this showing. Neither a good faith disagreement with the goals and policies of the law nor a belief the statute is unconstitutional negates willfulness, (114) nor does an intent to report income and pay taxes in the future. (115) Courts have rejected a defendant's inability to pay taxes when due as a valid defense to a finding of willfulness. (116)
c. Third Party Liability/Reliance
The taxpayer may shift responsibility for an assessed deficiency to a third party, such as a tax professional or lawyer. (117) Reliance on the advice of such third parties does not establish a complete defense, but does tend to negate the willfulness element. (118) A successful claim of reliance is established when a taxpayer demonstrates good faith reliance on advice obtained after full disclosure of all the facts to which the advice pertained. (119)
d. Selective Prosecution
A taxpayer who argues the defense of selective prosecution asserts that the government based its decision to prosecute on reasons proscribed by the Constitution. (120) To successfully assert this defense, the defendant must show that the federal prosecutorial policy had both a discriminatory effect and a discriminatory purpose or intent. (121)
C. I.R.C. [section] 7202
Section 7202, which applies primarily to employers, criminalizes (i) willful failure to collect any tax required under the I.R.C. and (ii) willful failure to truthfully account for and pay over taxes. (122) Each is a separate crime under [section] 7202. (123)
1. Willful Failure to Collect Tax
The crime of willful failure to collect a tax requires proof of three elements: (i) a legal duty to collect a tax; (ii) failure to collect that tax; and (iii) willfulness. (124)
Prosecutions for a willful failure to collect taxes are relatively infrequent because most employers investigated by the IRS withhold the required amounts from employees' wages, but then fail to pay over those collected amounts to the government. (125)
2. Willful Failure to Account For and Pay Over Tax
The crime of willful failure to truthfully account for and pay over a tax has three elements: (i) a legal duty to account for and pay over a tax; (ii) a failure to truthfully account for and pay over that tax; and (iii) willfulness. (126)
3. Elements
Although the willful failure to collect taxes and the willful failure to truthfully account for and pay over such taxes constitute two separate crimes, the elements of, and defenses to, the respective [section] 7202 violations are similar and will be considered together.
a. Duty to Collect and/or Account For and Pay Over Tax
Establishing a taxpayer's duty to collect and/or account for and pay over tax requires a finding that, as an employer: (i) the taxpayer had a statutory duty to withhold tax funds from the employees' paychecks and (ii) the taxpayer was a "person" within that business entity with the responsibility for ensuring that the entity collected, accounted for, and paid over the funds. (127)
i. The Statutory Duty
Under federal income tax provisions, an employer's payroll tax liability includes: (i) Federal Insurance Contribution Act ("FICA") payments, which include the employee's contribution to Social Security and Medicaid; (128) (ii) Federal Unemployment Tax Act ("FUTA") payments; (129) and (iii) required withholdings in connection with employee income taxes. (130) Rather than actually "collecting" a tax, employers simply retain part of their employees' wages already in the employer's possession. (131)
The employer is the trustee for these funds and bears the responsibility of transmitting to the IRS the taxes owed by its employees. (132) Once an employer withholds taxes from an employee's wages, the IRS credits the withholdings to the employee regardless of whether the employer pays them over to the government. (133)
Once the employer retains the taxes, it generally need not segregate the withheld sums from other business funds until paying the taxes over to the Treasury. (134) To prevent an employer's illegal use of withheld funds, however the IRS may order the employer to open a special bank account, into which all retained tax funds must be deposited within two days after collection. (135)
ii. The Responsible Person
Once a statutory duty to collect and/or account for and pay over a tax is established, the government must then identify the person responsible for compliance with [section] 7202. (136) Neither the I.R.C. nor the Treasury Regulations provide clear guidance for the definition of a "responsible person" for purposes of [section] 7202. (137)
Courts have adopted a broad interpretation of the statute, holding that a "responsible person" is identified by her "status, duty, and authority" within the business. (138) In making this determination, courts look to the "totality of the circumstances" (139) and regularly consider the power or authority held by the person within the organization. (140) Generally, courts are more concerned with the significance of the individual's control over corporate affairs than with the individual's title or job description. (141)
A company may contain more than one responsible person, and the existence of other responsible persons within the business does not relieve any party of her individual duty. (142) A person can be found "responsible" under [section] 7202 even if the company no longer employs the person at the end of the quarter when the taxes become due. (143) Similarly, a person can be found "responsible" under [section] 7202 even if the company did not employ her at the time the taxes were collected. (144) Furthermore, even if the company instructs the person not to collect or pay over the taxes, the person is not relieved of her responsibilities under [section] 7202. (145)
b. Willfulness
Violations of [section] 7202 also require willfulness. Willfulness is a "voluntary, intentional violation of a known legal duty." (146) Willfulness means that the responsible person: (i) knew of the company's obligation to pay withholding taxes and (ii) knew that company funds were being used for other purposes instead. (147) Willfulness requires that the responsible person have knowledge that the taxes due were not being paid, (148) but does not require that the responsible person "act out of an evil motive or an intent to defraud." (149)
4. Defenses
Defenses to alleged violations of [section] 7202 include lack of knowledge of the illegal nature of the activity and inability to pay.
Knowledge of the illegal nature of one's acts is a key element of tax crimes. (150) By defining willfulness as the "voluntary, intentional violation of a known legal duty," (151) the Supreme Court in Cheek ensured that ignorance of the law would be a valid defense to criminal prosecution for tax violations. (152) However, a defendant's good faith belief that the tax laws are unconstitutional or otherwise invalid does not negate the willfulness requirement. (153)
The other defense to prosecutions under [section] 7202 is the financial inability of the taxpayer to pay the tax due. (154) Courts have rejected this defense, reasoning that "a recalcitrant taxpayer could spend his money as fast as he earns it and evade criminal liability while not paying taxes as long as his bank balance is zero when the taxpayer's taxes are due." (155)
D. I.R.C. [section] 7203
Under [section] 7203, taxpayers may be prosecuted for a misdemeanor if they willfully fail to fulfill one or more of the following obligations: (i) paying an estimated tax;...
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