Accrual
Basis
7203: Willful
Failure to File Return, Supply Information, or Pay Tax: Evidence:
Accrual Basis
[80-2 USTC ¶9669]
United States of America
, Plaintiff v. Duane O. Hestnes, Defendant
U.
S. District Court, West. Dist. Wis., 77-CR-23, 492 FSupp 999, 7/9/80
[Code Secs. 446 and 7203]
Crimes: Tax evasion: Proof.--The government failed to prove that
the taxpayer had willfully and knowingly attempted to evade taxes by
pocketing cash receipts from specific customers without depositing them
in his bank account and without reporting them as income on his 1971
income tax return, where the taxpayer used the accrual method of
accounting. The court determined that because the invoices for goods
delivered and invoiced in 1971 were not available to the government, it
then did not prove that there was a distortion with respect to his
accounts receivable for 1970 and 1971. Without this evidence, no
conviction for understatement of income for 1971 with the intent to
evade taxes could be sustained, and the court granted the taxpayer's
motion for judgment of acquittal.
John
Franke, Assistant United States Attorney,
Madison
,
Wis.
53701
, for plaintiff. James Shellow
222 E. Mason St.
,
Milwaukee
,
Wis.
53202
, for defendant.
OPINION
AND ORDER
DOYLE,
District Judge:
Defendant
was found guilty by a jury on the second count of an indictment in which
he was charged with having wilfully and knowingly attempted to evade and
defeat a large part of an income tax due and owing by him and his wife
for calendar 1971, by filing a false and fraudulent return which
understated their taxable income by about $55,000. Defendant has moved
for an order setting aside the verdict and acquitting him and, if that
motion is denied, for an order granting him a new trial.
I
regret the extended delay in the entry of this decision on these motions
after verdict.
At
the core of the motion for a judgment of acquittal is a single issue. If
resolved in the defendant's favor, acquittal must be granted and many
other difficult questions need not be addressed. Nevertheless, I have
taken pains to explore the whole range of issues raised by defendant's
motions after verdict. I have done so, in part, because of the vast
amount of time and effort invested by counsel and the court in the trial
of this case--some 25 trial days. I have explored the whole range of
issues with the thought, also, that in the course of re-examining the
interplay of factors in the case, including a large number of difficult
evidentiary rulings and a number of significant jury instructions, I
might discern why it is that government counsel, on the one hand, and
defense counsel (and, in the course of several trial rulings, the
court), on the other, have perceived the single core issue so
differently.
The
essence of the government's case is that during calendar 1971, the
defendant pocketed specific receipts from specific customers in his meat
business without depositing them in his business bank account and
without reporting them as 1971 income on his tax return for 1971. 1 This method
of proof is spoken of as the specific items of income method. Therefore,
it was the government's obligation to prove beyond a reasonable doubt
that the defendant's failure to deposit and report these 1971 cash
receipts from his customers resulted in a failure to report 1971 income.
As
the government concedes in its post-trial brief, the evidence permits no
finding other than that during the period preceding, following, and
including calendar 1971, defendant followed an accrual method of
accounting. Nevertheless, again as the government now concedes, the
government intended from the start of the trial to persuade the court
that if it proved that specific payments were received from customers in
1971 and not deposited and reported, each was to be allocated to 1971
income "essentially on a cash basis." As this intention on the
government's part was revealed in the course of the presentation of its
case-in-chief, it was objected to, of course, and there ensued a
discussion among the court and counsel which persisted to the point at
which jury instructions were decided upon.
Among
the instructions as given was the following:
The
jury may not assume without evidentiary support that checks were income
in the year in which they were negotiated. If you find from the evidence
that the taxpayer was on an accrual basis in 1971, then the government
would be bound to follow an accrual method in making its calculations.
This means that defendant's income would have been required to be
reported in the year in which it is earned. Before any gross receipts
could be considered as income in 1971, the government would be required
to prove to your satisfaction that the gross receipts were in payment
for merchandise shipped and invoiced in 1971.
Because,
at defendant's urging, the theory embodied in the jury instruction just
quoted was embraced by the court early in the trial, the government was
compelled to improvise and reimprovise its proofs and its theory,
contending initially that allocation of income to 1971 "essentially
on a cash basis" was permissible; then that the evidence supported
the inference that all of the unreported cash received in 1971 was for
merchandise delivered and invoiced in 1971 (with minor year-end
inferences as to when the cash actually reached defendant); then that
the evidence supported the inference that of the unreported cash
received in 1971, the portion shown to have been received for
merchandise delivered and invoiced in 1971 was substantial enough to
support a conviction; and so on. Although the government continues to
contend that the evidence was sufficient to show that a substantial
portion of the unreported cash received in 1971 was in payment for goods
delivered and invoiced in 1971, it now relies principally on a theory
developed in its brief in opposition to defendant's post-trial motions:
namely, that even if the accrual method is fully recognized in this
case, the failure to report cash received in 1971 resulted in a failure
to report 1971 income, whether it was received in 1971 for merchandise
delivered and invoiced in 1971 or for merchandise delivered and invoiced
at some earlier time.
The
essence of the accrual method is that the taxpayer is required to report
the price of goods sold as income for the year in which the goods are
sold. For a taxpayer who commences a business on January 1, 1970, for
example, it would be necessary to report as 1970 income the price of all
goods sold in 1970. If this obligation is met for 1970, the taxpayer is
under no further obligation. That is, the taxpayer is not required to
inform the government at some later time that payment for the sale has
now been received. On the other hand, if the taxpayer fails to meet this
obligation to report as 1970 income the price of goods sold in 1970, the
violation has occurred with respect to the 1970 tax year. 2
It
is possible for an accrual taxpayer to adopt the technique of adding up
invoices for goods sold and delivered in 1970 and reporting the total as
1970 income, and then a year later adding up the invoices for goods sold
and delivered in 1971 and reporting the total as 1971 income.
There
is another technique for achieving this same result. Rather than to add
up all one's invoices for goods sold and delivered in 1970 in a business
commenced on January 1, 1970, for example, one may report the sum of
cash received in 1970 from one's customers, plus the sum of the invoices
for goods sold and delivered in 1970 but for which the customers have
not paid by December 31, 1970. This latter sum represents the accounts
receivable on December 31, 1970. This technique discharges the
obligation to report as income for 1970 the price of all goods sold in
1970.
A
taxpayer employing this technique can repeat the process for 1971 by
reporting the sum of cash received in 1971 from one's customers, plus
the sum of the invoices for goods sold and delivered in 1971 but for
which the customers have not paid by December 31, 1971. As was true for
1970, this technique discharges the obligation to report as income for
1971 the price of all goods sold in 1971.
However,
for a business with a history commencing prior to January 1, 1971 (in
the example, a business which commenced January 1, 1970), there is a
danger that this technique may result in overreporting income for 1971.
A portion of the cash received from customers in 1971 may have been in
payment for goods sold in 1970; that is, for sales already reported as
1970 income although payment had not been received in 1970 from the
purchasers. If so, to use that particular portion of 1971 cash receipts
as a reflection of sales made in 1971 is to distort. Also, the accounts
receivable as of December 31, 1971 may include some carryovers from 1970
sales, the proceeds of which were receivable as early as December 31,
1970 and which were reported as 1970 income. Therefore, from the
combination of 1971 cash receipts and the accounts receivable as of
December 31, 1971 there must be deducted all accounts receivable as of
December 31, 1970. The resulting figure includes only those cash
receipts in 1971 and only that portion of the accounts receivable as of
December 31, 1971 which reflect sales made during 1971.
Faithfully
followed tax-year in and tax-year out by an accrual taxpayer, the
technique just described is valid and acceptable for income tax purposes
only because of the integrity of each of its three components: (1) a
number accurately aggregating all opening accounts receivable; (2) a
number accurately aggregating all closing accounts receivable; and (3) a
number accurately aggregating all cash receipts during the intervening
year. When components (1) and (2) are accurate, an inaccuracy in
component (3) inevitably distorts the figure which emerges from the
mixture of the three components: that is, the figure which purports to
reflect the price of the goods delivered and invoiced in the given year.
When the inaccuracy in component (3) inheres in the omission of cash
received during the intervening year, there is an understatement of the
price of goods delivered and invoiced during that year and thus, on the
accrual system, an understatement of income for that very year. Because
each of the three components is itself an aggregate number, the
understatement of income for the very year occurs whether the specific
unreported cash received that year was in payment for goods delivered
and invoiced in that year or for goods delivered and invoiced at some
earlier time.
My
understanding is that the proposition which I have stated in the
preceding paragraph of this opinion is the proposition upon which the
plaintiff now takes its stand and which it has embraced in its brief in
opposition to the defendant's post-trial motion for acquittal. I accept
it.
As
I have observed above, the technique of using cash receipts during a
given year, such as 1971, as a reflection of the price of goods actually
delivered and invoiced in 1971, is a valid and acceptable technique for
an accrual taxpayer only because of the integrity of each of the three
components. As I have also observed, when the integrity of component
(3)--the aggregation of all cash receipts during 1971--is undermined by
distortion, the technique results in an inaccurate computation of the
price of goods delivered and invoiced in 1971. However, it follows that
when the integrity of either component (1) or (2)--the aggregation of
the accounts receivable as of January 1, 1971 and December 31, 1971,
respectively--is undermined by distortion, the computation is also
invalid and unacceptable.
Let
us assume, for example, that on a day in 1970 defendant had delivered
and invoiced to customer A goods priced at $4000, and that A had not
made payment by the close of business on December 31, 1970. It would
have been defendant's tax obligation to report that sale as 1970 income
by including it in his closing accounts receivable as of December 31,
1970. Had he failed to include it among the accounts receivable, he
would have understated his 1970 income and, had the elements of
knowledge and wilfulness been present, the criminal evasion for 1970
would have been complete.
It
we assume further that some time in 1971 customer A had paid defendant
the $4,000 for the 1970 delivery, then had defendant included this
payment in his cash receipts for 1971, the result of combining
components (1), (2) and (3) for 1971 would have been an overstatement of
1971 income by $4,000. With respect to cash actually received during
1971, omissions of up to $4,000 would have reduced the distortion pro
tanto, and the omission of a full $4,000 would have eliminated it.
So far as a correct report of 1971 income is concerned (that is, the
price of goods delivered and invoiced during 1971), it would have been
irrelevant whether such an omission from cash receipts had been
carefully noted and explained in the business books and records and even
on the tax return or the omission had been accomplished simply by
pocketing one or several payments received from customers in 1971. If
the latter course had been chosen, it would also have been irrelevant
whether a specific receipt of cash thus pocketed had been a payment for
goods delivered and invoiced in 1971 or for goods delivered and invoiced
at some earlier time. 3
To
put all this somewhat differently, the crime charged in this case
requires the government to prove that the defendant knowingly and
willfully understated in his tax return for 1971 the price of the goods
he delivered and invoiced in 1971. Had all of the invoices for goods
delivered and invoiced in 1971 been available to the government as
evidence, it might have been in a position to prove that defendant
reported as 1971 income a sum significantly less than the aggregate
price reflected in those invoices. The attempt, however, was to prove
the understatement of 1971 income by proving that the third component of
three components of a certain formula had been distorted by the
defendant. Proof of such a distortion of that third component, however
strong, is insufficient without proof that the distortion resulted in an
understatement of income for 1971. 4 The latter
proof must establish that there had been no compensating distortion of
the first component (the figure which represented the closing balance of
accounts receivable for 1970 and the opening balance of accounts
receivable for 1971) and no compensating distortion of the second
component (the figure which represented the closing balance of accounts
receivable for 1971.
Inadequate
would be a kind adjective to describe the government's proof concerning
the first and second components--the balance of accounts receivable as
of December 31, 1970 and January 1, 1971 and the balance of accounts
receivable as of December 31, 1971. The validation of the source of the
$15,701.40 figure for the 1971 closing balance of accounts receivable
was virtually nonexistent, and the validation of the source of the
$8,200 figure for the 1971 opening balance was hardly more impressive.
But even if it were accepted that those two figures appeared somewhere
in defendant's books and records, there was a total absence of evidence
that either figure was a true and accurate aggregation of the price of
goods actually delivered and invoiced prior to the pertinent date but as
yet unpaid. If the $8,200 figure was significantly less than the true
aggregate of 1971 opening accounts receivable or if the $15,701.40
figure was significantly greater than the true aggregate of 1971 closing
accounts receivable, an understatement of the cash received during 1971
may have been merely compensating. That is, an understatement of the
cash received during 1971 may or may not have resulted in an
understatement of the price of goods delivered and invoiced during 1971.
The
instruction given the jury and quoted early in this opinion strongly
implied that with respect to each specific 1971 cash receipt which was
allegedly unreported by defendant as cash received in 1971, it was
necessary for the government to prove that the payment was for goods
delivered and invoiced some time in 1971. This was the manner in which,
during the trial, defendant's counsel had stated his contention and also
the manner in which the court had expressed its view on the issue. As
explained in this opinion, I now believe that at best the instruction
given was poorly expressed and that under certain conditions an
understatement of cash received by defendant in 1971 could have resulted
in an understatement of the price of goods delivered and invoiced during
1971, whether a particular omitted cash receipt was in payment for goods
delivered and invoiced during 1971 or delivered and invoiced at some
earlier time.
That
the instruction given was poorly expressed does not give rise to a
problem in the
admin
istration of this particular case, however. This is because, viewing the
evidence most favorably to the plaintiff, a judgment of acquittal is
necessary whether the rule properly governing the case is as expressed
in the instructions given or as I would now express it.
No
jury could reasonably have found, either beyond a reasonable doubt or
even by a preponderance of the evidence, that any specific cash receipt
in 1971, which the jury believed to have gone unreported, was in payment
for goods delivered and invoiced in 1971.
On
the other hand, a more accurately phrased instruction would have
informed the jury that only under certain conditions, relating to the
true opening and closing balances of accounts receivable, would the
failure to report this or that specific receipt of cash in 1971 have
resulted in an understatement of the price of goods delivered and
invoiced during 1971.
No
jury could reasonably have found either beyond a reasonable doubt or
even by a preponderance of the evidence, that those certain conditions
were present: that the stated figures for the 1971 opening and closing
balances of accounts receivable, whatever the evidence may have shown
those stated figures to be, were accurate aggregations of the accounts
truly receivable at the pertinent dates. Therefore, no reasonable jury
could have found that an understatement of the cash received in 1971, if
there had been such understatement, had resulted in an understatement of
the price of goods delivered and invoiced in 1971 and, therefore, an
understatement of defendant's 1971 income.
Order
It
is ordered that defendant's motion for judgment of acquittal on Count II
of the indictment is granted. The defendant is released from any and all
restrictions imposed upon him as a result of the return of the
indictment in this case.
1
In this opinion I will use the term "cash" to include checks,
currency, or coins.
2
This defendant has not been charged with, or found guilty of, conduct
with respect to his tax return for 1971 which amounted to concealment of
a failure to report 1970 income in his return for 1970.
3
A similar example could be stated to demonstrate the effect of an
overstatement of the December 31, 1971 accounts receivable.
4
I appreciate that defendant challenges strongly the adequacy of the
proof that defendant pocketed and diverted to nonbusiness uses any of
the cash he received from customers in 1971. I express no opinion on
that question.
