False Returns 3 Page4

---

[ Back ] [ Next ]

 

A. Time Frame

[3] The government alleged that the Count 1 conspiracy spanned from August 14, 1981 to June 13, 1997 , the Count 25 conspiracy from August 14, 1981 to February 1, 1998 , and the Count 64 conspiracy from January 1, 1987 to June 13, 1997 . Thus, there is substantial overlap in timing. It is worth noting here that the government argued that "from the very beginning" of the Count 1 agreement, there was a plan to steal the clients' money, which would involve mail and wire fraud (Count 25) and money laundering (Count 64). ("From the very beginning of the agreement between the parties, the agreement was to engage in tax crimes together with mail and wire fraud crimes together with money laundering crimes.")

B. Geographic Locations

[4] Bates contends that the vast majority of activities relevant to all three counts occurred in Sacramento , California , and the Cayman Islands . The government does not dispute this contention. The indictment and the evidence at trial support Bates's contention that the overt acts for all three counts occurred in the same geographic locations.

C. Participants

All four defendants were charged in Count 1, and all defendants except Charlotte Wadsworth were charged in Counts 25 and 64. However, the third factor depends not only on overlap in membership, but also the roles of the overlapping members. Stoddard [ 97-2 USTC ¶50,574], 111 F.3d at 1455. Bates contends that the roles were the same in all three counts.

[5] The government argued at trial that the defendants each played different roles in the various schemes. However, that many overt acts are incorporated by reference between the conspiracy counts supports the defendants' argument that the (different) role of each defendant was similar across the three alleged conspiracies.

D. Overt Acts

[6] Although the overt acts for three counts are not identical, they substantially overlap. For Count 1, the government alleged 166 overt acts; for Count 25, 151 of the 166 overt acts are incorporated by reference, and 23 new overt acts are added; for Count 64, overt acts are incorporated by reference from Counts 1 and 25.

The overt acts in Count 1 generally relate to defendants: (1) forming various UBOs, (2) accepting fees (in the form of checks or wire transfers) for the UBOs, (3) depositing fees, (4) serving as agents or trustees for the UBOs, (5) advising clients they need not file taxes, (6) writing letters to clients and the IRS, (7) forming corporations and bank accounts in the Cayman Islands, (8) opening bank accounts in California, and (9) authorizing wire transfers between various accounts. Count 25 adds overt acts pertaining to specific fraudulent investments defendants persuaded the UBO clients to pursue.

E. Statutes Violated

[7] The three conspiracy counts allege a violation of the same statute --18 U.S.C. §371 --although Count 64 also alleges a violation of 18 U.S.C. §1956(h). However, the fifth factor considers not only the violation of the same statute, but also whether the goals of the conspiracies were similar. Stoddard [ 97-2 USTC ¶50,574], 111 F.3d at 1456.

The government specifically addressed in closing argument how 18 U.S.C. §371 can relate to three separate crimes. In arguing that "the conspiracy counts are very different," the government first pointed to the two distinct types of crimes covered by §371: (1) conspiracy to defraud the United States in the exercise of its lawful governmental functions, and (2) conspiracy to violate a specific section of the United States Code. The government further explained that Count 1, the first type of conspiracy, related to defrauding the IRS in the assessment of taxes, whereas Counts 25 and 64 related to violations of different code sections (mail or wire fraud sections, and money laundering sections, respectively).

However, the government argued to the jury that the goals of defrauding the government, and engaging in mail and wire fraud and money laundering, were all inter-related:

This case is a situation where the defendants had a single unified plan from the very beginning. This is not a situation where the defendants that engaged in one type of activity and then did that for a while and then decided to get into some other type of activity which might be fraudulent and then to launder money at the end of day.

 

The defendants had a single, unified plan from, as I say, the very get-go in this case. From the very beginning of the agreement between the parties, the agreement was to engage in tax crimes together with mail and wire fraud crimes together with money laundering crimes. That's the only way the defendants' actions and their activities make any sense at all is to look at all the actions as pieces of a bigger essentially three-dimension, circular-type of a scheme.

The tax scheme was set up in a certain way specifically for the purpose to create the ability to engage in mail and wire fraud. ... And the defendants could not engage in mail and wire fraud if they did not launder money. ... So from the very beginning, the defendants had it in their mind the aspect of stealing --effectively stealing, to use a generic term, money from the investors and use the promotion of the tax vehicle as a way to accomplish that fraud.

The government concluded closing arguments with the point that all the counts were fraud crimes to enrich the defendants --with respect to the tax crimes, to collect fees on the UBOs; with respect to money laundering, "to move the money around and get what [defendants] need without being caught"; and with respect to mail and wire fraud, more monetary motives.

[8] Given the government's contention that the goal for all three conspiracies was one and the same --to steal money --it appears under Stoddard that they should be treated as one conspiracy, at least for the purpose of sentencing. Considering all five Arnold factors, it was arguably error for Bates and Smith to be sentenced to consecutive terms on the three conspiracy counts.

[9] However, an error is not plain unless it is "clear" or "obvious." United States v. Olano, 507 U.S. 725, 734 (1993). Plain error "is so clear-cut, so obvious, a competent district judge should be able to avoid it without benefit of objection." United States v. Turman, 122 F.3d 1167, 1170 (9th Cir. 1997) (citing United States v. Frady, 456 U.S. 152, 163 (1982)). In this complex case, with hundreds of overt acts, multiple defendants, and weeks of trial, it was not plain or obvious that only one conspiracy transpired. Indeed, the government convinced the jury that the defendants engaged in three separate conspiracies.

[10] To muddle the multiplicity issue further, defendants did not merely fail to argue that there was one overarching conspiracy for double jeopardy purposes; they argued the opposite position: that each of the three conspiracy counts were themselves duplicitous, encompassing multiple agreements and conspiracies in each one. That is, they asserted that there were even more conspiracies. As to Count 1, Smith disputed one overarching conspiracy to defraud the United States because the overt acts covered six alleged UBOs, with differing (1) time periods, (2) identity of defendants involved, (3) identity of taxpayers involved, and (4) specific transactional facts. Smith posed the "same argument and analysis" from Count 1 to Counts 25 and 64. Thus, it was not clear or obvious that the three conspiracies were multiplicitous, even at the sentencing stage. The defendants have failed to show plain error.

III. Dismissal of Indictment Based on Potentially Biased Grand Jury

Smith argues that the district court erred in denying his motion to dismiss the indictment because the grand jurors were not questioned about their contacts with the IRS to ensure that they could serve as impartial jurors.

We review de novo the district court's denial of a motion to dismiss an indictment. United States v. Rivera-Sillas, 376 F.3d 887, 889 (9th Cir. 2004). A district court may not dismiss an indictment for error in a grand jury proceeding unless the error prejudiced the defendant. Bank of N.S. v. United States [ 88-2 USTC ¶9547], 487 U.S. 250, 254 (1988). "Substantial proof of grand jury bias is required to overturn an indictment." United States v. Miller, 105 F.3d 552, 555 (9th Cir. 1997).

[11] Smith bases his grand juror (potential) bias claim on 28 U.S.C. §1866(c)(2), which states in part that "no person or class of persons shall be disqualified, excluded, excused, or exempt from service as jurors: Provided, That any person summoned for jury service may be ... (2) excluded by the court on the ground that such person may be unable to render impartial jury service." Not surprisingly, neither §1866(c)(2) nor any Ninth Circuit case ⁶ requires probing the grand jurors with questions about their feelings toward the IRS.

[12] Given that Smith makes no factual allegation of actual bias on the part of any grand juror in his case, he has not shown "[s]ubstantial proof of grand jury bias," see Miller, 105 F.3d at 555, let alone prejudice, see Bank of N.S. [ 88-2 USTC ¶9547], 487 U.S. at 254. Thus, the district court did not err in denying dismissal of the indictment on this ground.

IV. Search and Arrest Warrants

Smith argues that the district court erred by denying his motion to suppress evidence based on defects in the search and arrest warrants, alleging that: (1) the search warrant lacked particularity and was facially overbroad, (2) the government agents flagrantly seized items outside the scope of the warrant, (3) the agents failed to provide a complete copy of the warrant at the outset of the search, and (4) the search and arrest warrants were invalid because they lacked a court seal and the magistrate judge did not sign the arrest warrant.

We review de novo the district court's denial of a motion to suppress, and the factual findings supporting the denial for clear error. United States v. Mann, 389 F.3d 869, 874 (9th Cir. 2004), cert. denied, 125 S.Ct. 1719 (2005).

A. Particularity and Overbreadth

[13] "The Fourth Amendment requires that a warrant particularly describe both the place to be searched and the person or things to be seized." United States v. Spilotro, 800 F.2d 959, 963 (9th Cir. 1986). As Spilotro explained, "[t]he description must be specific enough to enable the person conducting the search reasonably to identify the things authorized to be seized." Id. The purpose of the breadth requirement is to limit the scope of the warrant "by the probable cause on which the warrant is based." In re Grand Jury Subpoenas, 926 F.2d 847, 856-57 (9th Cir. 1991). Both the particularity and breadth requirements prevent "general, exploratory rummaging in a person's belongings." Id. at 857 (quotation marks and citations omitted).

Smith argues the warrant in this case "failed to restrict government agents in any meaningful way, converting the warrant into the type of general, overbroad warrant prohibited by the Fourth Amendment." Specifically, Smith argues that paragraphs 1 through 11 of the search warrant's Attachment B "authorized the seizure of virtually all of Smith's personal and business records, electronic documents, photographs, films, and videotapes ... 'for the period of January 1990 through the current date.'"

Attachment B describes the items to be seized as follows:

For the period January 1990 through the current date:

1) The following documents relating to the promotion of UBOs: seminar tapes, presentation documents, video tapes, literature, flyers, advertising, and business cards.

2) UBO client files to include UBO names, individuals names, addresses, telephone numbers, and other identifying information; contracts of "UBO Organization"; copies of minutes; domestic and foreign bank account statements; wire transfer documents; canceled checks; deposit slips; copies of money orders; copies of cashier's checks; correspondence to, from, and on behalf of UBO clients including correspondence with the IRS; copies of Forms SS-4, Request for Employer Identification Number; records of payments from and to UBO clients reflecting dates and purpose of such payments; invoices; receipts; memoranda; copies of tax returns, and any documents used in the preparation of tax returns.

3) All documents relating to any alleged defense contractor loan investment program including literature, contracts, agreements, notes, financial statements and records, correspondence, memoranda, receipts, advertising, and other records; copies of letters and invoices or monthly statements to investors.

4) All documents pertaining to the purchase, and/or sale, and/or transfer of real property including escrow statements, deeds, deeds of trust, mortgages, notes, correspondence, closing statements, mortgage payments and down payments including documents reflecting the form, amount, and date of such payments. Documents pertaining to the purchase/sale of personal property including vehicles, furniture, and other items to include receipts, contracts, agreements, financial statements, purchase agreements, and correspondence.

5) All books and records of UBO businesses, including general journals, general ledgers, financial statements, balance sheets, income statements, cash receipts and disbursements journals[.]

6) All documents relating to the receipt and disbursement of income, by or from any UBO, including credit card receipts and statements, receipts, invoices, statements of accounts at domestic and foreign banks, check registers, cancelled check, money orders, cashier's checks, wire transfer documents, bank drafts, safety deposit box records, stocks, bonds, and other securities, investment records, loan applications, and other financial statements, promissory notes, telephone toll records and bills, personal calendars, address and telephone books, rolodex indices, records relating to domestic and international travel including tickets, reservations, hotel receipts, travel logs, itineraries, and receipts, Forms 1099 and other tax documents; any other records used to reconstruct income and expenses; records relating to safe deposit box rental.

7) All documents reflecting current ownership, occupancy, and use of premises including utility bills, receipts, correspondence, monthly statements, photographs, film, and video tapes.

8) All information and/or data stored in the form of magnetic or electronic coding on computer media or on media capable of being read by a computer or with the aid of computer-related equipment. This media includes, but is not limited to, floppy diskettes, fixed hard disks, removable hard disk cartridges, laser disks, video cassettes, and any other media which is capable of storing magnetic coding.

9) All electronic devices which are capable of analyzing, creating, displaying, converting, or transmitting electronic or magnetic computer impulses or data. These devices include, but are not limited to, computers, computer components, computer peripherals, word processing equipment, modems, monitors, printers, plotters, encryption circuit boards, optical scanners, external hard drives, and other computer related electronic devices.

10) All instructions or programs stored in the form of electronic or magnetic media which are capable of being interpreted by a computer or related components. The items to be seized include, but are not limited to, operating systems, application software, utility programs, compilers, interpreters, and any other programs or software used to communicate with computer hardware or peripherals either directly or indirectly via telephone lines, radio, or other means of transmission.

 

11) All written or printed material which provides instructions or examples concerning the operation of a computer system, computer software, and/or any related device which is present at the scene.

[14] The warrant's Attachment B describes with sufficient specificity the types of documents and property sought. Potentially problematic is its breadth: though limited in time period and subject matter (UBO businesses and loan investment program since 1990), the warrant is quite broad as it relates to those enterprises. However, even an "extraordinarily broad" warrant authorizing the seizure of essentially all business records may be justified when there is "probable cause to believe that fraud permeated the entire business operation." United States v. Offices Known as 50 State Distrib. Co. , 708 F.2d 1371, 1374 (9th Cir. 1983). This is just such a case. The magistrate judge reviewed Agent O'Keeffe's affidavit in support of the application for the search warrant, which detailed her comprehensive investigation of the UBO scheme. The affidavit concluded that "the entirety of the businesses operated by Bates, Smith and their associates are criminal in nature." Agent O'Keeffe's affidavit provided ample probable cause to meet the "permeated-with-fraud" exception to the particularity and breadth requirements.

B. Seizure Outside the Scope of Warrant

Smith claims that federal agents flagrantly seized innocuous personal items outside the scope of the warrant, such as Christmas gifts, computer monitors, and computer games. However, computer monitors and computer games (to the extent they were on computer diskettes) were within the scope of the warrant. The alleged Christmas gifts remain unidentified in the record. Thus, there is no evidence that there was any evidence seized outside the scope of the warrant.

C. Defects in Providing Warrant to the Smiths

The district court held that the warrant "was provided to the Smiths on a prompt basis." The district court further held that, although Agent O'Keeffe's affidavit was not attached to the warrant, the warrant was valid and served the purpose of providing notice to the Smiths that the officers were executing a search under the color of law. Smith argues that the search of his home violated Federal Rule of Criminal Procedure 41(d) (1997) ⁷ because (1) agents failed to provide a copy of the search warrant at the outset of the search, and (2) the warrant was incomplete without the affidavit that was incorporated by reference into the warrant.

1. Failure to Provide Search Warrant at Outset of Search

At the evidentiary hearing, there was some discrepancy as to the length of time after the search began before Smith and his wife received a copy of the warrant. It is clear that the search did not start as soon as the agents entered the home, as they initially conducted a safety sweep for approximately fifteen minutes. The district court established that a delay of thirty to forty-five minutes occurred before the Smiths received the warrant.

[15] Under United States v. Gantt, 194 F.3d 987, 1001 (9th Cir. 1999), "[a]bsent exigent circumstances, Rule 41(d) requires service of the warrant at the outset of the search on persons present at the search of their premises." While the court recognized that "'technical' violations of Rule 41(d) require suppression only if there was a 'deliberate disregard of the rule' or if the defendant was prejudiced," it held that suppression was justified due to the deliberate violation in Gantt's case. Id. at 1005. Gantt was not served with the search warrant until after she was arrested, hours after the search and hours after she requested to see the warrant. Id. at 1000.

[16] In Smith's case, there is neither deliberate disregard of Rule 41(d) nor any prejudice. Gantt's interpretation of Rule 41(d) to require service of the warrant at the outset of the search was issued in 1999, whereas the search of Smith's home took place in 1997. Agent Adams's testimony reveals he did not know of an obligation to show the warrant at the outset of the search -- Adams "never" before had presented a warrant at the time of entry. Instead, his team typically did a safety sweep first, as was done in the Smith home.

Furthermore, unlike in Gantt, after Mrs. Smith asked for the warrant, she got one. The timing may be disputed --ten minutes after the request or half an hour later --but regardless, she and her husband received the warrant near the outset of the search. As the district court found, the delay was not unreasonable.

[17] Nor was the delay prejudicial. Upon receiving the warrant, Mrs. Smith "just kind of glanced at it" and believes that her husband "might have looked at it" more than she did. She admits that she chose not to review the warrant. Neither of the Smiths disputed the warrant after having access to it, and the search went on for another several hours. Thus, under Gantt, there was only a technical violation of Rule 41(d), which does not require suppression.

2. Warrant Missing Affidavit

[18] That the Smiths were given the search warrant without the affidavit of Agent O'Keeffe, though incorporated by reference in the warrant, does not require suppression. Smith argues that Gantt held that "when a warrant incorporates by reference the supporting affidavit, the affidavit comprises part of the warrant itself and must be provided with the rest of the warrant. 194 F.3d 987, 1001 n.7." The cited footnote 7 states: "Showing Gantt the face of the warrant without Attachment A certainly did not satisfy Rule 41(d). Without Attachment A, the warrant violated the Fourth Amendment's particularity requirement and for purposes of Rule 41(d) was not a valid warrant."

What Smith leaves out is the content of Attachment A in Gantt's case, which is substantively different from the O'Keeffe affidavit. In Gantt, "[i]nstead of describing the items to be seized, the warrant stated 'see Attachment A.' Attachment A was a two-page, typed list of items to be seized." Id. at 996. In Smith's warrant, Attachment B, which described the items to be seized, was attached. It was Agent O'Keeffe's affidavit, admittedly important in the magistrate judge's probable cause determination, that was missing. Agent O'Keeffe's affidavit was not related to the particularity requirement, which was satisfied by Attachment B.

Smith confuses the "well-settled principle that a warrant's overbreadth can be cured by an accompanying affidavit that more particularly describes the items to be seized," United States v. Luk, 859 F.2d 667, 676 (9th Cir. 1988), with the contention, unsupported by case law, that an affidavit incorporated by reference must always be attached for the search warrant to be valid --even if the warrant is not overbroad without the attachment. For example, in United States v. Hayes, 794 F.2d 1348, 1355 (9th Cir. 1986), the court held that the affidavit could not be considered because it did not accompany the warrant; nevertheless, the court went on to examine the warrant "on its face" for overbreadth, determining it met the breadth requirement and did not require suppression, id. at 1355-56.

[19] Thus, here, the warrant without the affidavit was facially valid standing alone. The failure to attach the affidavit does not require suppression.

D. No Court Seal on Search and Arrest Warrants; No Magistrate Judge's Signature on Arrest Warrant

Smith argues that the search and arrest warrants are void because (1) the arrest warrant was initialed only by the court clerk, but not signed by the magistrate, in violation of Rule 4(c)(1) of Criminal Procedure, and (2) neither warrant contained the seal of the court. The district court found that neither alleged defect invalidated the warrants.

First, Rule 9, rather than Rule 4(c)(1), governs arrest warrants on an indictment. Rule 9(b)(1), pertaining to the form of the warrant, states it must be signed "by the clerk," not the magistrate judge.

Smith's second argument that the court seal must be affixed to both the search and arrest warrants also fails. The argument relies on 28 U.S.C. §1691, which states: "All writs and process issuing from a court of the United States shall be under the seal of the court and signed by the clerk thereof." However, the Federal Rules of Criminal Procedure for arrest warrants on an indictment (Rule 9) and search warrants (Rule 41) make no mention of the requirement for a court seal. The arrest warrant and search warrant follow the stated dictates of Rules 9 and 41, respectively. The magistrate judge unquestionably issued a bench warrant without bail on Smith, and a deputy clerk signed an arrest warrant, as required by Rule 9. The search warrant was issued and signed by a magistrate judge on January 3, 1997.

[20] Thus, there appears to be only a technical violation of 28 U.S.C. §1691. None of this circuit's cases has suppressed evidence for lack of a court seal. Cf. Ystrom v. Handel, 252 Cal. Rptr. 110, 114 (Ct. App. 1988) (lack of court's seal "is a mere technicality and does not render [a summons] 'substantially defective'").

[21] We have refused to suppress evidence or reverse convictions based on technical rule violations. In a similar context, "'technical' violations of Rule 41(d) require suppression only if there was a 'deliberate disregard of the rule' or if the defendant was prejudiced." Gantt, 194 F.3d at 1005. Here, there is no evidence in the record that officers executing either warrant relied in bad faith on them because they lacked the court seal, and certainly no evidence of deliberate disregard of 28 U.S.C. §1691. Neither is there a scintilla of prejudice to the defendant: if the warrants did have the court seal, Smith's home would still have been searched, and his person still arrested. Thus, neither suppression nor reversal of Smith's conviction is warranted by this technical violation of 28 U.S.C. §1691.

V. Sufficiency of the Evidence

Smith and Bates argue that the evidence is insufficient to sustain their convictions for: (1) multiple counts of aiding and assisting in the preparation and presentation of false tax returns, under 26 U.S.C. §7206(2); and (2) conspiracy to defraud the United States in the ascertainment, computation, or assessment of taxes, under 18 U.S.C. §371.

After the jury verdict, the district judge denied a Federal Rules of Criminal Procedure 29 motion for judgment of acquittal as to all defendants. We review de novo the district court's ruling on a motion for acquittal. United States v. Johnson, 357 F.3d 980, 983 (9th Cir. 2004). The evidence is reviewed in the light most favorable to the prosecution to determine "whether any rational trier of fact could have found the essential elements of the crime beyond a reasonable doubt." Id. (internal quotations and citations omitted).

Section 7206(2) pertains to any person who:

Willfully aids or assists in, or procures, counsels, or advises the preparation or presentation under, or in connection with any matter arising under, the internal revenue laws, of a return, affidavit, claim, or other document, which is fraudulent or is false as to any material matter, whether or not such falsity or fraud is with the knowledge or consent of the person authorized or required to present such return, affidavit, claim, or document[.]

[22] Under §7206(2), the government must prove that "(1) the defendant aided, assisted, or otherwise caused the preparation and presentation of a return; (2) that the return was fraudulent or false as to a material matter; and (3) the act of the defendant was willful." United States v. Salerno [ 90-1 USTC ¶50,261], 902 F.2d 1429, 1432 (9th Cir. 1990). Defendants argue that the government presented insufficient evidence on all three elements.

A. Aid, Assist In, Procure, Counsel, or Advise

[23] Although Smith and Bates did not actually prepare their clients' tax returns, the plain language of §7206(2) is satisfied by aid, assistance, procurement, counsel, or advice in the preparation or presentation of a false or fraudulent return --there need not be actual preparation of the return at issue. Unsurprisingly, we do not require defendants engaged in tax schemes to physically "prepare" the tax returns to be found guilty of §7206(2). See, e.g., United States v. Crum [ 76-1 USTC ¶9214], 529 F.2d 1380, 1382 (9th Cir. 1976) ("[T]he reach of Section 7206(2) is clearly not limited to acts of tax return 'preparers[.]'").

[24] A review of the record reveals ample evidence of aid, assistance and advice in the preparation of the defendants' clients' false tax returns. To promote their tax shelter scheme, the defendants explicitly advised their clients to transfer all of their income and assets to the UBO, and then not to file any tax returns (for the business trust, personal income, or otherwise). Smith advised UBO clients to have their employers issue pay checks, commission checks, or other income sources in the name of the UBO instead of the clients' names. Further, defendants established mechanisms for the UBO income to go undetected by the IRS, such as keeping end-of-the-year income below a certain threshold through "distributions," false "business deductions," and non-interest-bearing accounts. These actions directly caused clients to file false and fraudulent returns. ⁸

B. Fraudulent or False Return

Smith argues that the particular 1040 personal returns or 1065 partnership tax returns were not false for omitting income or revenue that should have been reported on a separate 1041 trust return. However, IRS Agent Brown testified that although revenue in a business trust such as a UBO would typically be reported on a form 1041, as a default the income could also be reported on a 1040 personal income tax return. In any event, the income had to be reported on some IRS form. Thus, the under-reporting of income on the clients' personal returns, that could have been but was not reported elsewhere, made the personal returns "false" or "fraudulent."

[25] Agent O'Keeffe methodically went through each allegedly false or fraudulent return, and testified to the substantial understatement of income on each one. Viewing the evidence in the light most favorable to the prosecution, there is sufficient evidence from which a rational juror could find that the returns were false or fraudulent.

C. Willfulness

Smith argues that the evidence was insufficient to show that he acted willfully "with specific intent to defraud the government in the enforcement of its tax laws." Salerno [ 90-1 USTC ¶50,261], 902 F.2d at 1432. While there is nothing "inherently unlawful with an UBO," and the government told the jury during closing argument to assume UBOs are "legitimate," the government provided ample evidence that Smith gave advice to unlawfully use UBOs to file false or fraudulent tax returns (or not to file at all).

Smith further argues that there was no evidence presented that Smith was advised by the IRS that UBOs must file a tax return or that his actions were illegal. However, Smith worked in concert with Bates, who kept busy drafting "response" letters to the IRS disputing the IRS's contention that taxes needed to be paid.

Finally, Smith argues that "even under the government's own theory, Smith's purpose was to steal money or defraud the persons who purchased UBOs from him; he did not have the specific intent to defraud the government in the enforcement of its tax laws." Smith ignores that stealing from clients and defrauding the government are not mutually exclusive --and that the evidence is sufficient to establish both purposes.

Smith argues that this case is analogous to Salerno , where this court reversed the defendants' §7206(2) convictions because, although they were guilty for implementing a scheme to embezzle millions from the casino, "the government failed to prove the scheme had as a purpose the violation of the federal tax laws." [ 90-1 USTC ¶50,261], 902 F.2d at 1430. The government had to show that the defendants engaged in the scheme "not merely for their own benefit but with a specific intent to cause the casino to file false tax returns." Id. at 1432. However, there was neither evidence that the defendants had anything to do with preparation of tax returns, nor "evidence that the defendants had any motive for conducting a scheme to defraud the government, [n]or that they ever mentioned their own taxes, much less the tax returns of the casino." Id.

Unlike in Salerno , Smith and Bates had as "a purpose," although not their sole purpose, the violation of tax laws. They specifically advised clients that the UBO income need not be reported on any kind of tax return, and told them not to consult friends, family, or accountants about their UBOs. The evidence was sufficient to prove that the defendants had a "specific intent to cause" their clients to file false returns.

[26] Further unlike Salerno , Smith and Bates had a "motive" for conducting a scheme to defraud the government: to hook the clients into giving them control over the clients' money so they could steal it. Finally, unlike in Salerno , here there was ample mention of the clients' tax returns within the scheme. Thus, there was sufficient evidence, viewing the evidence in the light most favorable to the prosecution, to find that the defendants willfully intended to cause false or fraudulent returns to be filed.

D. Conspiracy Count 1

Smith argues that the reasons for the insufficiency of the §7206(2) counts apply to invalidate the Count 1 conspiracy conviction. Because his arguments with respect to the §7206(2) counts fail, they fail equally with respect to the conspiracy count.

VI. Alleged Juror Bias & Misconduct

Smith and Bates argue that they are entitled to a new trial because of two instances of alleged juror misconduct and bias. We review a district court's denial of a post-verdict evidentiary hearing for an abuse of discretion, United States v. Saya, 247 F.3d 929, 934 (9th Cir. 2001), and its denial of a new trial on the assertion of juror misconduct or bias for abuse of discretion as well, United States v. Hanley, 190 F.3d 1017, 1031 (9th Cir. 1999). "Because of the trial judge's unique opportunity to observe the jurors during trial, to hear the defenses asserted, and to hear the evidence, the judge's conclusion about the effect of the alleged misconduct deserves substantial weight." Saya, 247 F.3d at 937 (quotations and citations omitted).

A. Juror #9's Alleged Bias

[27] "The Sixth Amendment guarantees criminal defendants a verdict by impartial, indifferent jurors." Dyer v. Calderon, 151 F.3d 970, 973 (9th Cir. 1998) (en banc). "A court confronted with a colorable claim of juror bias must undertake an investigation of the relevant facts and circumstances." Id. at 974. However, "[a]n evidentiary hearing is not mandated every time there is an allegation of jury misconduct or bias. Rather, in determining whether a hearing must be held, the court must consider the content of the allegations, the seriousness of the alleged misconduct or bias, and the credibility of the source." Hanley, 190 F.3d at 1031 (quotations and citation omitted). An evidentiary hearing is not necessary where the court knows "the exact scope and nature" of the bias allegation. Saya, 247 F.3d at 935 (internal quotations and citations omitted).

About a month after the jury returned the verdicts in this case, Juror #9 wrote the following letter to Agent O'Keeffe:

Dear Bridget,

My name is Brandt Mayer and I was juror #9 in the Bates/Smith/Wadsworth trial in Sacramento recently. As a sworn in juror as you know, we were not allowed to converse with anyone on the case.

Now that it's over and forgotten by me (thank god) I would like the opportunity to be able to talk with you. Not about the case of course, or your profession or mine, but in a casual way.

I was deprived not being allowed to just walk up and start a conversation with you, which normally for me is completilly [sic] out of character, as I am a bit timid.

After listening to you on the stand [you] showed a very "kind" aura about you. You're [sic] sofistication [sic] also impressed me. You're [sic] introduction led me to believe that you are a single woman and has given me the comfort and insentive [sic] to write you.

I am hoping that you remember who I was: You were getting off the elevator one day on the 10th floor and I leaned out of the elevator accross [sic] from you as we (the jurors) were heading down. I purposly [sic] gave you a smile. It appeared that you returned a smile back to me. In fact the jurors teased me about that for days afterward, but that's ok, I told them that the smile was for me and not them.

Could it be possable [sic] to send an e-mail to me? A "get aquianted" [sic] type. I will surely respond.

But if you are finding this type of approach odd, tastless [sic], or in anyway [sic] out of line, or that you're simply not interested, I will surely understand and appollogize [sic]. I couldn't think of any other way to give it a try and I thought it couldn't hurt. Take care.

Agent O'Keeffe promptly reported the letter to prosecutors who in turn reported the letter to the court and opposing counsel. Thereafter, Smith and Bates moved for a new trial based on Juror #9's claimed bias; Bates also requested an evidentiary hearing. Both sides submitted briefs on the issue and argued the motion before the district court ruled. After considering the evidence, the district court denied the motion without conducting an evidentiary hearing.

With Juror #9's letter in hand, the district court understood the exact nature and scope of the bias allegation. Cf. Saya, 247 F.3d at 935. The district court examined the content of the allegations from the letter and never doubted the credibility of the source to which defendants pointed --Juror #9 himself. Cf. Hanley, 190 F.3d at 1031. In analyzing the seriousness of the allegations, the district court took into account that (1) Agent O'Keeffe was one of the last witnesses to take the stand after six weeks of trial (thereby limiting her influence on Juror #9), (2) Agent O'Keeffe was a summary witness who presented no new evidence, (3) other than the "kind aura" statement, there was "absolutely no tangible evidence that there was any extraneous information or extraneous influence on this juror by anyone," (4) there was "absolutely no evidence that Juror Number 9 did anything inappropriate during the trial" (noting at most a smile was exchanged), and (5) there was no evidence filed by defendants or declarations from any of the jurors that there was extraneous information or influence.

The district court logically reasoned it was unlikely that this juror was attempting to impress Agent O'Keeffe by finding defendants guilty, since he voted to acquit Charlotte Wadsworth, to acquit Bates of 88 out of 111 counts against him, and to acquit Smith on three counts. Furthermore, Juror #9 explicitly wrote Agent O'Keeffe that he had no desire to discuss the case with her, making the argument that he was trying to impress her with guilty verdicts even more attenuated.

An evidentiary hearing to listen to Juror #9's testimony regarding the trial would likely not have produced any valuable information. When inquiring into the validity of a verdict, pursuant to Federal Rule of Evidence 606(b),

a juror may not testify as to any matter or statement occurring during the course of the jury's deliberations or to the effect of anything upon that or any other juror's mind or emotions as influencing the juror to assent to or dissent from the verdict or indictment or concerning the juror's mental processes in connection therewith, except that a juror may testify on the question whether extraneous prejudicial information was improperly brought to the jury's attention or whether any outside influence was improperly brought to bear upon any juror.

(emphasis added). Thus, even if the juror's thought process was biased with his alleged "infatuation" with Agent O'Keeffe, the court was not free to hear evidence in this regard. Further, it was clear from Juror #9's letter that there was neither extraneous prejudicial information from Agent O'Keeffe (a smile can hardly be so deemed), nor "outside influence [that] was improperly brought to bear."

[28] The district court did not abuse its discretion in denying the evidentiary hearing and a new trial. Even if this juror had something of a crush on Agent O'Keeffe, his letter made clear that he diligently performed his duty as a juror, never speaking to Agent O'Keeffe during the trial, and at most exchanging a smile with her. It is unlikely that any trial goes by without one juror finding one witness nice or attractive. The only unusual thing about this case is that Juror #9 put his feelings in writing. The district court was well within its discretion in finding no evidence of juror misconduct and no extraneous influences on the juror, such that an evidentiary hearing was not required.

B. Juror #1's Alleged Intimidation

The district court also denied defendants' motion for a new trial based on the alleged intimidation of Juror #1. During the trial, Juror #1 wrote an e-mail explaining her disagreement with the foreperson regarding her approach to analyzing the mail and wire fraud counts without first considering the basis of the conspiracy charges. She explained:

I have been criticized by the foreperson and consequently have felt intimidated into proceeding on a ruling on more than two dozen counts without having first established the underlying business relationship of the defendants. She criticized me for wanting to review my notes; she criticized me for wanting to look at the evidence, and specifically she criticized me for wanting to look at evidence relative to count one. At one point she accused me of having already made up my mind because I suggested that we consider the prosecution's foundation for the case. The foreperson then threatened to throw me off the jury.

The district court questioned Juror #1 outside the presence of the other jurors about her feelings of intimidation. After the juror reiterated her concerns from the e-mail, the judge told her:

Each of you [jurors] must decide the case for yourself, but you should do so only after you have considered all the evidence, discussed it fully with the other jurors, and listened to the views of your fellow jurors.

 

Do not be afraid to change your opinion if the discussion persuades you that you should. But do not come to a decision simply because other jurors think it is right. It is important that you attempt to reach a unanimous verdict, but, of course, only if each of you can do so after having made your own conscientious decision. Do not change an honest belief about the weight and effect of the evidence simply to reach a verdict.

Although Juror #1 told the judge that she did not believe her decisions were made based upon her own beliefs up to that point, after hearing the above instruction, she felt able to return to deliberations and make future decisions (including those on verdicts that may have been rendered previously) based on her own conscience and belief.

The attorneys for defendants and the government then had a long discussion about whether the jury should be instructed to start deliberations anew or be instructed again on their role as jurors, and whether to keep Juror #1 on the jury. The court then brought Juror #1 back in, and asked more questions regarding whether she still felt intimidated, to which she answered she did not. The court was convinced that Juror #1 made "very clear that she is not intimidated at this point, that she understands her duty as a juror, and that she is ready to continue her deliberations in this case after the entire jury is reinstructed as to 34 and 39" (which had been reread to Juror #1).

[29] Smith argues that the foreperson's bullying of Juror #1 "demonstrates that the jury was not impartial and that the jury deliberation process was not functioning properly." However, if anything, the foreperson's misconduct ran to the defendants' favor by discounting the prosecution's theories. This alleged misconduct was thoroughly investigated by the district court, and its effect cured by ensuring that Juror #1 no longer felt intimidated. The district court did not abuse its discretion in refusing a new trial on this ground.

VII. Duplicity and Multiple Conspiracies Jury Instruction

Before trial, Smith moved to dismiss Counts 1, 25, and 64, the three conspiracy charges of the indictment, arguing that each one encompassed multiple conspiracies (and thus that each one was duplicitous). Bates joined this motion. Defendants disputed that there was one overarching conspiracy within any of these counts because the overt acts covered six alleged UBOs, with differing: (1) time periods, (2) identity of defendants involved, (3) identity of taxpayers involved, and (4) specific transactional facts.

The government opposed the motion, arguing that Counts 1, 25, and 64 each contained a singular conspiracy. As to Count 1, the government asserted that defendants entered into an agreement to impair and impede the IRS through the use of UBOs "in a fashion which knowingly and intentionally understated income and overstated legitimate deductible expenses." Although the UBOs were marketed to 249 or more taxpayers, the government argued that the Count 1 conspiracy was not "taxpayer specific"; it involved "one agreement, regardless of the number of taxpayers whose income tax return[s] were involved." As to Count 25, the government argued that there was one agreement to use the mail and interstate wire communications in furtherance of a scheme to defraud. Finally, Count 64, though involving different money laundering sections (18 U.S.C. §§1956(a)(1)(A), 1956(a) (1)(B), and 1957), encompassed only one agreement to engage in money laundering. The government summarized its argument as "[o]ne agreement; one count."

After considering the pre-trial briefs and supplemental briefs of all the parties on this issue, the district court found the indictment not duplicitous as to Counts 1, 25, and 64. After the trial, during the jury instruction conference, Smith renewed the motion to dismiss these counts, claiming that the government had "not been able to show an overarching conspiracy but rather ha[d] shown individual conspiracies." The district court denied the motion, and sustained the government's objection to a multiple conspiracy instruction.

The district court's ruling that there were no duplicitous counts appears correct, and defendants do not dispute it on appeal. Instead, defendants now argue that the district court erred in denying the request for the multiple conspiracy instruction. However, this argument is not based on any of the pretrial briefing arguments or post-trial jury instruction conference arguments that each conspiracy count encompassed multiple conspiracies. Rather, defendants argue (based on their multiplicitous sentence argument) that three conspiracy counts inherently require a multiple conspiracy instruction.

This argument was never made below, and thus was waived. Even if it were not waived, the argument misconstrues the nature of a multiple conspiracy instruction, which pertains to multiple conspiracies within a conspiracy count. The district court correctly denied the multiple conspiracy instruction.

VIII. Application of Sentencing Guidelines

Smith and Bates argue that the district court erred in enhancing their sentences under the Sentencing Guidelines. "Even though the Guidelines are no longer mandatory after the Supreme Court's decision earlier this year in United States v. Booker, 125 S.Ct. 738 (2005), the district court should still consult them for advice as to the appropriate sentence, id. at 767." United States v. Kimbrew, 406 F.3d 1149, 1152 (9th Cir. 2005). We review "the district court's interpretation of the Sentencing Guidelines de novo, the district court's application of the Sentencing Guidelines to the facts of this case for abuse of discretion, and the district court's factual findings for clear error." Id. at 1151 (citation omitted).

A. U.S.S.G. §3D1.2

[30] Smith and Bates argue the district court erred by grouping the tax counts separately from the money laundering and mail and wire fraud counts, which resulted in a two-point increase in each of their offense levels. The Guidelines provide that "[a]ll counts involving substantially the same harm shall be grouped together into a single Group." U.S.S.G. §3D1.2. In part, "same harm" means the counts involve the "same victim." Id. §3D1.2(a), (b).

The government argued at sentencing that the counts in question encompassed different harms and different victims. The Presentence Investigation Reports ("PSRs") for Bates and Smith both found that the victim as to the tax fraud counts is the United States government, whereas the victims as to the mail fraud and wire fraud counts "are the clients who had their money stolen by the defendants." The district court adopted the PSRs' findings and declined to group all counts together.

[31] The district court's factual finding that multiple victims were involved is not clearly erroneous, and the district court did not abuse its discretion in applying U.S.S.G. §3D1.2.

B. U.S.S.G. §3B1.1(c)

The U.S.S.G. §3B1.1(c) aggravating role two-level enhancement applies "[i]f the defendant was an organizer, leader, manager, or supervisor in any criminal activity" involving less than five participants and that was not otherwise extensive. Smith's PSR recommended this enhancement because Smith managed the activities of Christopher Bates and Charlotte Wadsworth. The district court's adoption of this factual finding was not clearly erroneous.

IX. Increasing Smith's Sentence Based on Allocution

Near the end of Smith's sentencing hearing, the district court stated its intention "to depart somewhat from the Probation Officer's recommendations and to sentence Mr. Smith to the low end of [the] guideline range of 121 months imprisonment." Defense counsel and the prosecution presented nothing further. Then, the district court asked whether Smith wished to address the court; Smith did.

Smith made a lengthy speech, denying (1) the jurisdiction of the district court, (2) that he had any connection to any state or the United States, (3) the existence of the United States, California, Sacramento, the district court, the prosecutor, defense counsel, Judge England, a list of UBOs, and even himself, and (4) that he is a Fourteenth Amendment "person." Smith contested that the offenses he was charged with were committed by anyone, and argued that the prosecution had "failed to show any actual or threatened injury as a result of the challenged conduct." Smith demanded that the court "reconsider and withdraw the proposed sentence, reverse the conviction, enter judgment of acquittal, vacate the charges against [him], quash the indictment, dismiss the complaint and otherwise ... set [him] free."

The district court responded to Smith's speech:

The defendant's statements to the Court that were just read have made it abundantly clear to this Court that Mr. Smith has absolutely no remorse for his actions. And further, he has directly challenged this Court and its ultimate authority. Accordingly, I find that this defendant is appropriate to be sentenced not at the lower end of the guideline range but at the upper end.

Mr. Smith apparently just simply does not get it. He is a direct and continuing threat to the financial safety of the public. And this Court has the belief, well-founded belief that if he were to be released from custody at any earlier time, he would immediately resume the criminal activity for which he was on trial here in this court.

The district court then sentenced Smith to 151 months instead of 121 months. Smith's counsel made no objection to the increased sentence.

[32] Smith argues that his First Amendment free speech and Fifth Amendment due process rights were violated because he was punished with a higher sentence for expressing his views on the district court's lack of jurisdiction. But the district court made it clear that it was increasing the sentence based on Smith's lack of remorse, and his threat to the financial safety of the public when released. These are legitimate sentencing factors under 18 U.S.C. §3553(a), which include considering the "characteristics of the defendant" and the need for the sentence "to promote respect for the law," "to afford adequate deterrence to criminal conduct," and "to protect the public from further crimes of the defendant."

[33] The district court may indicate a tentative sentence and then hear from the defendant before making a final sentencing determination. See United States v. Laverne, 963 F.2d 235, 236 (9th Cir. 1992). The district court here "was able to consider the defendant's statement and was free to alter its view of the sentence if the defendant offered a sufficient reason for changing its view." Id. at 237. That the district court considered Smith's lack of remorse in sentencing him is by no means a novel concept. See United States v. Malquist [ 86-2 USTC ¶9484], 791 F.2d 1399, 1402-03 (9th Cir. 1986) ("inclusion of [defendant's] lack of repentance in the court's sentencing calculus was permissible"). The district court did not err in taking Smith's statement into consideration for sentencing. The Sentencing Guidelines, in either their mandatory or advisory status, do not insulate a defendant from his or her own foolishness.

X. Reconsideration of Bates's sentence

At sentencing, the district court stated its tentative intention to sentence Bates at the low end of the guideline range (121 months) because of Bates's medical condition. The government made "another pitch for the mid-range of 136 months" because "the defendant's criminal history is actually substantially understated." Although Bates was found not criminally liable, he was found civilly liable for fraud in the amount of $4,687,984.71.

The district court sentenced Bates to 136 months, explaining: "I have reconsidered my initial decision, and I am going to follow the recommendation of Probation for 136 months." The court further stated:

The Court wants to make it clear that the reconsideration of the sentencing is based upon not only the words that Mr. Twiss [AUSA] stated here today in open court, but also a further review of the Presentence Report and also the Court's own recollection of the magnitude of the scheme in which Mr. Bates was involved, which led to the losses of substantial sums of money, upwards of 1.8 million dollars, from varying individuals and ages, some who have lost their entire retirement system under this scheme of unincorporated business organizations.

And I want the record to reflect that as being the basis for the Court following the mid-term recommendation of 136 months.

Thus, the district court relied at least in part on proper factors, such as the magnitude of the scheme and the loss incurred by victims, in determining placement in the sentencing range. See 18 U.S.C. §3553(a)(2)(A) (sentence "to reflect the seriousness of the offense"). Furthermore, the Guidelines state that the "history" of the defendant may be considered. Id. §3553(a)(1). A civil judgment against a defendant could be a factor in the defendant's history. Thus, it does not appear that the district court relied on improper factors in sentencing Bates to the middle of the Guidelines range.

XI. Booker Issue

[34] Both Smith and Bates argue that they must be resentenced under Booker because their sentences are based on facts not found by a jury beyond a reasonable doubt. Because the defendants did not challenge their sentences on Sixth Amendment grounds in the district court, and because the record in this case does not "provide a reliable answer to the question of whether the judge would have imposed a different sentence had the Guidelines been viewed as advisory," we grant a limited remand to the district court to answer this question. United States v. Ameline, 409 F.3d 1073 (9th Cir. 2005) (en banc).

XII. Ex Post Facto Issue

Smith and Bates argue that upon resentencing, their sentences must be capped by the maximum terms of imprisonment authorized by the unenhanced base offense levels, under ex post facto principles. We have rejected that argument in United States v. Dupas, 2005 U.S. App. LEXIS 15938 (9th Cir. 2005).

CONCLUSION

For the foregoing reasons, the judgments of conviction are affirmed and the cases are remanded pursuant to Ameline.

¹ Smith and Bates were tried as co-defendants with another alleged participant in the conspiracy, Charlotte Wadsworth. Wadsworth was acquitted by the jury.

² Bates told clients that he took care of dealings with the IRS and legal advice, while Smith provided investment advice.

³ It appears from the joint reply brief that Smith joins Bates in this argument. ( "[A]ppellants' consecutive sentences on the three conspiracy counts in this case are multiplicitous and constitutionally infirm.")

⁴ Multiplicity of sentences is unlike the issue of the multiplicity of an indictment, which can be waived if not raised below. United States v. Klinger, 128 F.3d 705, 708 (9th Cir. 1997).

⁵ Title 18 U.S.C. §371 states, in part:

If two or more persons conspire either to commit any offense against the United States, or to defraud the United States, or any agency thereof in any manner or for any purpose, and one or more of such persons do any act to effect the object of the conspiracy, each shall be fined under this title or imprisoned not more than five years, or both.

⁶ Smith mischaracterizes United States v. Hashimoto [ 89-2 USTC ¶9432], 878 F.2d 1126, 1134 n.9 (9th Cir. 1989), as determining that "general questions that did not delve into a juror's attitudes and dealings with the IRS are inadequate to expose bias of petit jurors in criminal tax cases." In Hashimoto, the trial court refused defendant's request for a jury panel list to investigate whether the jurors had been audited by the IRS, as he was entitled to do under 26 U.S.C. §6103(h)(5). [ 89-2 USTC ¶9432], 878 F.2d at 1129-33. Because of the specificity of the §6103(h)(5) inquiry, general questions on juror impartiality did not overcome the presumption of prejudice from the denial of the list. Id. at 1134 n.9. However, the court found that the presumption of prejudice could be overcome by juror voire dire on past audits and attitudes toward the IRS. Id. at 1134. Hashimoto does not hold that grand jurors in tax cases must be asked such questions.

⁷ Rule 41(d) stated, in relevant part: "The officer taking property under the warrant shall give to the person from whom or from whose premises the property was taken a copy of the warrant and a receipt for the property taken or shall leave the copy and receipt at the place from which the property was taken."

⁸ Defendants mistakenly argue that this case is "indistinguishable" from United States v. Dahlstrom [ 83-2 USTC ¶9557], 713 F.2d 1423, 1429 (9th Cir. 1983), which held that "[p]rosecution for advocacy of a tax shelter program in the absence of any evidence of a specific intent to violate the law is offensive to the first and fifth amendments of the United States Constitution." Dahlstrom's holding is limited to pure advocacy or speech cases. See United States v. Schulman [ 87-1 USTC ¶9334], 817 F.2d 1355, 1359 (9th Cir. 1987) ( Dahlstrom is properly read as an advocacy case); United States v. Russell [ 86-2 USTC ¶9801], 804 F.2d 571, 576 (9th Cir. 1986) (Ferguson, J., concurring) (as a member of the Dahlstrom panel, describing the case as "primarily a First Amendment case involving pure advocacy").

 

 

 

 

[2005-2 USTC ¶50,569] United States of America , Plaintiff-Appellee v. Ralph N. Whistler, Defendant-Appellant.

U.S. Court of Appeals, 9th Circuit; 03-10667, July 5, 2005 .

Unpublished opinion affirming in part and remanding in part an unreported DC Ariz. decision.

[ Code Sec. 7206]

Procedure and administration: Crimes: Fraud and false statements. --

An individual who prepared and filed tax returns containing false information was properly convicted for aiding and assisting in the preparation of fraudulent income tax returns in violation of Code Sec. 7206(2). The term "willful" was not too vague to allege that the individual intended to violate a known legal duty. "Willfulness" is a term of art with a known meaning for tax defendants of knowing one's duty and intentionally and voluntarily violating it. Furthermore, the indictment properly alleged the statutory element of willfulness; therefore, the court's decision to not release grand jury transcripts was not an abuse of discretion. The case was, however, remanded for review of any Sixth Amendment issues.

Before: Rymer and Hawkins, Circuit Judges, and Brewster ^* , Senior District Judge.

¬ Caution: The court has designated this opinion as NOT FOR PUBLICATION. Consult the Rules of the Court before citing this case.®

MEMORANDUM ^**

Appellant Ralph N. Whistler challenges the sufficiency of the grand jury indictment, the failure of the district court to disclose grand jury transcripts, evidentiary rulings by the district court, and the term of his sentence. We affirm Whistler's conviction. We address the sentencing issues Whistler raised on appeal before us, but we remand in accordance with United States v. Ameline, 409 F.3d 1073 (9th Cir. 2005) (en banc).

Whistler was an experienced CPA who established trusts to reduce his clients' tax liability. However, when establishing the trusts, Whistler backdated or had employees backdate documents to allow clients to claim deductions for years prior to the establishment of the trusts, deducted for expenses that never occurred, and misstated ownership of assets. Whistler then prepared and filed tax returns containing these misrepresentations. Following trial, Whistler was convicted of aiding and assisting in the preparation of fraudulent income tax returns in violation of 26 U.S.C. §7206(2) and was sentenced to 39 months imprisonment.

Whistler contends his conviction should be reversed because the grand jury indictment failed to properly allege the statutory element of willfulness. We review the sufficiency of an indictment de novo. See United States v. James, 980 F.2d 1314, 1316 (9th Cir. 1992). "[A]n indictment is sufficient if it, first, contains the elements of the offense charged and fairly informs a defendant of the charge against which he must defend, and, second, enables him to plead an acquittal or conviction in bar of future prosecutions for the same offense." United States v. Morrison, 536 F.2d 286, 288 (9th Cir. 1976) (quoting Hamling v. United States, 418 U.S. 87, 117 (1974)).

According to Whistler, the word "willful" is too vague to allege that he intended to violate a known legal duty. We disagree. In the tax context, willfulness means a voluntary, intentional violation of a known legal duty, but does not require malice, bad faith, or an evil motive. Cheek v. United States [ 91-1 USTC ¶50,012], 498 U.S. 192, 200-201 (1991). By alleging that Whistler's actions were voluntary and intentional and were conducted with his knowledge or belief that each return was fraudulent ( i.e. illegal), the indictment charges willfulness. The term "willfulness" is not vague but is a term of art with a known meaning for tax defendants of knowing one's duty and voluntarily and intentionally violating it. Because the term "willfulness" has a known meaning, the indictment sufficiently apprised Whistler of the charges raised against him. Thus, the district court properly denied Whistler's motion to dismiss the indictment.

Whistler also challenges the failure of the district court to disclose grand jury transcripts. We review the district court's decision to release or not release grand jury transcripts for abuse of discretion. United States v. Plummer, 941 F.2d 799, 806 (9th Cir. 1991). "A party seeking disclosure of grand jury transcripts must demonstrate a particularized need for the disclosure." United States v. Perez, 67 F.3d 1371, 1381 (9th Cir. 1995), withdrawn in part on other grounds, 116 F.3d 840 (9th Cir. 1997) (en banc). Whistler claims a particularized need existed because the grand jury indictment failed to allege he violated a known legal duty. Whistler's argument is based on his proposition that the grand jury indictment is insufficient. But, as explained supra, the indictment properly alleged the statutory element of willfulness. As such, there is no particularized need for the disclosure of grand jury transcripts. Therefore, the district court did not abuse its discretion in failing to disclose the grand jury transcripts.

In addition, Whistler challenges several evidentiary rulings by the district court. We review evidentiary rulings by a district court for an abuse of discretion. See United States v. Sua, 307 F.3d 1150, 1152 (9th Cir. 2002); United States v. Soulard [ 84-1 USTC ¶9386], 730 F.2d 1292, 1296 (9th Cir. 1984). According to Whistler, the district court erred when it (1) excluded evidence of litigation brought by the government against National Trust Services (a separate entity whose trusts Whistler modeled his own trusts after), (2) allowed the government's expert witness to testify, and (3) admitted summary charts offered by the government as substantive evidence. We hold the district court did not abuse its discretion or commit reversible error.

First, the National Trust Service litigation evidence had no bearing on Whistler's misrepresentations --backdated documents, phantom deductions, and misstated assets. Since this evidence was irrelevant to the conduct at issue, the district court did not abuse its discretion when excluding it. See Fed. R. Evid. 401.

Second, under the Federal Rules of Evidence, an expert can testify on an ultimate issue to be decided by the trier of fact, as long as the expert does not testify about "whether the defendant did or did not have the mental state or condition constituting an element of the crime charged or of a defense thereto." See Fed. R. Evid. 704(a)-(b); United States v. Clardy [ 80-2 USTC ¶9721], 612 F.2d 1139, 1153 (9th Cir. 1980). Here, the testimony was not improper opinion evidence because the government's expert did not express an opinion as to Whistler's state of mind. Accordingly, the district court did not abuse its discretion when it allowed this testimony.

Third, the district court did not commit reversible error in admitting summary charts into evidence or allowing their use during jury deliberations. See United States v. Abbas [ 74-2 USTC ¶9755], 504 F.2d 123, 124-126 (9th Cir. 1974). The district court provided the jury limiting instructions regarding the charts and summaries. Id. at 125. Furthermore, the defense had an opportunity to cross examine the government's expert and to challenge the factual basis of the charts. See id.; United States v. Krasn, 614 F.2d 1229, 1238 (9th Cir. 1980). Thus, any error in how the district court treated the summary charts was harmless.

Finally, the district court did not commit clear error by including tax loss attributable to false returns filed by Hunt's True Value Lumber and John and Teresa Vail in its tax loss calculation to determine Whistler's base offense level. The government submitted sufficient evidence to show that these returns were part of Whistler's illegal scheme. Nor did the district court misapply the Guidelines in taking account of the filing of false state tax returns as relevant conduct to determine Whistler's sentence. See U.S.S.G. §2T1.1, cmt. n. 2 (1995) ("In determining the total tax loss attributable to the offense, all conduct violating the tax laws should be considered as part of the conduct or common scheme or plan unless the evidence demonstrates that the conduct is clearly unrelated.") (emphasis added); United States v. Newbert, 952 F.2d 281, 284 (9th Cir. 1991) (holding that conduct in violation of state rather than federal law was relevant conduct under U.S.S.G. §1B1.3(a)(2)).

However, because Whistler did not challenge his sentence on Sixth Amendment grounds in the district court, we grant a limited remand pursuant to Ameline, 409 F.3d 1073.

AFFIRMED IN PART, REMANDED IN PART.

^* The Honorable Rudi M. Brewster, Senior United States District Judge for the Southern District of California, sitting by designation.

^** This disposition is not appropriate for publication and may not be cited to or by the courts of this circuit except as provided by Ninth Circuit Rule 36-3.

 

[90-1 USTC ¶50,319] United States of America , Plaintiff v. William A. Kilpatrick and Declan J. O'Donnell, Defendants

U.S. District Court, Dist. Colo., 82-CR-222, 11/2/89 , 726 FSupp 789

[Code Sec. 7206 ]

Criminal penalties: Aiding and advising in the preparation of false returns.--Investors were found not guilty of aiding and assisting in the filing of false and fraudulent tax returns in connection with other criminal indictments charging them with conspiring to defraud the government by impeding and impairing the lawful functions of the IRS through false and fictitious claims of deductions for advance minimum royalty payments pursuant to coal subleases and losses from partnerships based on the partnerships' research and development expenditures in violation of 18 U.S.C. §371 . The government's contention, that the claims for deductions and losses were false and fraudulent because the underlying transactions were shams, was not proven, and this resulted in the acquittal of the investors on the conspiracy charges. The determination that the government failed to prove that the transactions were shams defeated that same contention on the charge of aiding and assisting in the filing of false and fraudulent tax returns.

FINDINGS OF FACT, CONCLUSIONS OF LAW, AND ORDER

MATSCH, District Judge:

During the time relevant to these proceedings, the Internal Revenue Code (IRC) and Internal Revenue Service (IRS) regulations provided opportunities for individual taxpayers to attenuate their income tax liability by investments in programs oriented toward maximizing available deductions. Such programs were known as "tax shelters." Under the canopy of the IRC, an individual in a high tax bracket could invest in an economic activity structured to enable the taxpayer to use business expenses or losses as deductions to reduce the amount of his tax. The criminal charges tried to this court concern the taking of deductions for advance minimum royalty payments pursuant to coal subleases as business expenses under Schedule C to the investors' tax returns and losses from partnerships based on the partnership's research and development expenditures (IRC §174(A) ) reflected in Schedule E to the investor's tax returns.

Counts I and II of the indictment charge the defendants, William A. Kilpatrick (Kilpatrick) and Declan J. O'Donnell (O'Donnell), with conspiring together and with others to defraud the United States by impeding, impairing, obstructing and defeating the lawful functions of the IRS in the ascertainment, computation, assessment and collection of revenue through false and fictitious claims of deductions for such advance royalty payments and research and development payments in violation of 18 U.S.C. §371 . To obtain a conviction on these charges, the government must prove beyond a reasonable doubt that each of the defendants willfully participated in schemes designed to create false and fictitious tax deductions with the intent to defraud the government. These counts must be considered separately.

COUNT I--THE COAL LEASING PROGRAM

United Financial Operations, Inc. (UFO) was incorporated in Colorado in 1978 with Kilpatrick as president and sole shareholder. The board of directors included Kilpatrick, O'Donnell and Ms. Sheila Lerner (Lerner). UFO sponsored and administered the coal leasing program which began in 1977 and continued in 1978 and 1979. From the perspective of the investors, the program was the same in all three years. By the payment of $1,000 and an advance minimum royalty payment of $5,625 per unit, the investor became a sublessee of leases of coal properties in Pennsylvania and other states from companies which owned or leased the coal in place. That advance minimum royalty payment was deductible in the year in which it was paid as a business expense for engaging in the coal mining business as a sublessee. To make the investment more attractive, the program provided for a deduction of four times the cash invested by loans to the investors in amounts three times their cash contribution and paid to the lessor coal companies as additional advance minimum royalty payments. The loans were non-recourse loans with repayment solely from the production of coal out of the properties which were the subject of the subleases.

The government does not dispute the availability of deductions from such a program. The charge is that the objective was not to achieve coal production but to create the illusion of that economic activity through a series of sham transactions with circular check writing at its core. In 1977 Arapahoe Dakota, Inc. (ADI) was the coal company subleasing to the investors. For each 1977 investor, P&J Coal Company (P&J) issued checks in amounts of three times the cash investment to ADI in exchange for the right to mine and market the coal and a non-recourse note from the investor. ADI issued checks to P&J in the same amounts as the checks made on behalf of the investors. All of the check writing took place on December 29, 1977 , at the Colfax National Bank. The total of the checks from P&J to ADI was $1,183,125.00 from a bank account which had $23.95 as the beginning balance. ADI wrote checks to P&J totaling $1,188,125.00. The president of the Colfax National Bank, Adrian Smith, was present and participated in the exchanges of the checks, and directed that immediate credit be given to the respective accounts. The ADI checks were written on an account which had approximately $70,000 as a beginning balance. Those funds came from investors. The end result can be viewed in alternative ways. In one view, there was a check swap between P&J and ADI with no resulting effect. Each entity was in the same position as at the beginning of the day. Another view is that at the end of the day P&J had obtained the rights to produce coal by borrowing from ADI the amounts paid to it on behalf of the sublessee investors who had obtained those rights by promising to repay ADI when coal was produced. Such a transaction has economic substance.

The 1978 program was larger and more complex. Ten coal company lessors participated. A two-year program was offered. Again, the investors obtained non-recourse financing from P&J to pay the advance minimum royalty payments which exceeded their cash investment. On December 29, 1978 , checks were written at the Grand Cayman Islands branch of the Bank of Nova Scotia. The coal companies issued checks to Marlborough Investments, Ltd. (MIL) for a total of $20,836,725.00. MIL was a Cayman corporation beneficially owned by Kilpatrick. MIL issued a series of checks, totaling $20,838,725.00 to Big "C" Companies, Ltd. Big "C" Companies, Ltd. issued a series of checks to P&J for a total of $20,836,725.00 which was also the aggregate sum of the checks from P&J to the coal companies. Monte Smith, the manager of the branch participated in the exchanges of checks and the making of deposits in the bank on December 29, 1978 , which was the last business day of that year. On January 12, 1979 , the documentation of the transactions was changed with new checks being issued in different amounts and revised bank statements were prepared. Malcolm Haynes, the Assistant Manager of Operations at the bank, followed the directions of Monte Smith to meet with Kilpatrick and Lerner to make the changes. Essentially he followed a spread sheet given to him by Lerner in revising the bank records. At this time one check was issued by MIL, signed by Mr. Paris to Big "C" in the amount of $18,855,600.00 and Big "C" wrote one check in the same amount to P&J, which issued checks to the coal companies for a total of $18,850,600.00 and the coal companies wrote checks to MIL in the total of $18,845,900.

The investors in the 1978 program made non-recourse notes to P&J together with an assignment of a two-eighths ownership interest in the coal in the ground, a security interest in the remainder of the coal and the right to mine all of the investors' coal. MIL issued a series of debentures to the coal companies in the aggregate amount of $16,150,600.00.

The 1979 program was substantially similar to the 1978 program except that Big "C" Companies, Ltd. was not a participant in the documentation which took place at the Grand Cayman Islands Branch of the Bank of Nova Scotia on December 19, 1979 . Another difference was that P&J obtained an option to purchase the investors' coal in exchange for the loans made to pay advance minimum royalties to the coal companies. The flow of checks was $8,927,875.00 in one check from MIL to P&J, several checks in the same amount from P&J to the coal companies and a series of checks from the coal companies to MIL, also aggregating the same amount, $8,927,875.00.

These coal programs are the subject of Count I of the indictment. The government has marshalled substantial evidence to support the charge that the loans made by P&J on behalf of the investors were fraudulent loans for which there was no purpose other than to generate improper tax deductions and that the fraud was concealed through common ownership of the entities involved. P&J was acquired in 1977 from Jack Hill (Hill) who operated a mine through that company in Clearfield County , Pennsylvania . Although the written contract and bill of sale, dated December 23, 1977 , recited the sale of Hill's stock to John H. Pettingill for the stated consideration of $3,000, Hill testified that in addition to this cash consideration, there were notes payable to him and other owners to a total of $120,000. Hill said he has not received $50,000 which was payable to him. Hill also said that the financial condition of P&J at the time of the sale was poor and that the company was then "just existing." Kilpatrick had ownership interests in the coal companies, with the exception of a few of those involved in the 1978 program. The 1978 and 1979 "financing" took place in the Grand Cayman Islands beyond the reach of IRS auditors. Big "C" Companies, Ltd. was created as a Bahamian corporation with Oliver Hemphill (Hemphill) as its apparent owner. Hemphill made the connection with the Bank of Nova Scotia as a result of a request from O'Donnell in late December, 1978, for a recommendation of a bank which could complete transactions by the end of the year. Hemphill was known as a consultant on offshore banking. Hemphill testified that he understood that $22,000,000 in cash would be taken to the bank and deposited so that immediate credit would be available. Hemphill as signator for Big "C" signed a blank check on that company's account in the bank and left it with Kilpatrick. That was the check for $18,855,600. For the 1978 transactions, Kilpatrick took less than $400,000 in currency to the bank.

The prosecution relies principally on the circular flow of checks to prove that there was no "real loan" and no "real lender." Clearly, the amounts on deposit in the respective accounts prior to the circulation of these checks were woefully inadequate and the checks written by P&J to the coal companies would not have cleared without the credit from the deposits of the checks made to it. Stated simply, none of the entities participating in the financing had bank accounts to support loans in the amounts required for the investors.

This evidence takes on a somewhat less sinister shade when considered in the light of other facts. Circularity of the checks in the amounts of the bank deposits were well known to the bank officers participating in the financing. We do not have the benefit of the testimony of Adrian Smith or Monte Smith because they are dead. They had apparent authority to commit their banks to the extensions of credit involved in these checks and deposits and the evidence supports a finding that each of them was fully aware of the status of the bank accounts of the participating entities.

The defendants freely distributed offering memoranda outlining the coal program to the public. While there was less than full disclosure, it was made clear that the capital source driving the entire program was the coal reserves controlled by the sublessor coal companies to be mined and marketed by P&J. The subleases were for eight years. The debentures were also payable in eight years by P&J. Assuming the existence of coal in sufficient quantities and assuming appropriate market prices and costs of production it is apparent that there would be a real economic purpose served by an agreement directly between the coal companies and P&J granting P&J the right to mine and market the coal with all payments to be made from the proceeds from the sale of the coal. Examples of the result under various market scenarios are illustrated in the offering memorandum for Cheyenne Coke and Coal Company subleases. Govt. Ex. 24-1. Upon the same assumption of adequacy of the coal reserves, there would be nothing suspicious about the coal companies advancing funds to the producer, P&J, for its operating capital with the loan repayable solely from the coal proceeds. On the evidence before the court, one may conclude that the end result of the year end financing for each year was a loan from each of the coal companies to P&J repayable from coal proceeds with the purpose of the funds being the payment of advance royalties back to the coal companies. Under that scenario, P&J would be able to deduct the advance royalty payments from any current year income and such a transaction would seem to be appropriate.

The availability of immediate deductions for advance payments on coal to be produced and marketed in a subsequent year, either in the form of advance minimum royalty payments or a carved out production payment provides the purpose for the complex scheme marketed by UFO. It is not a crime to structure simple sale or lease transactions in complex ways for the purpose of minimizing the risk in a new venture by providing tax deductions to sophisticated investors with sufficient incomes to benefit from them. One investor witness testified that he invested knowing the risk of loss of the investment because he was gambling with tax dollars.

The defendant O'Donnell testified at great length at this trial. He wrote the tax opinion that formed a part of the offering memorandum for the coal programs. O'Donnell was not a tax specialist. He had met Kilpatrick through another lawyer, Al Vaughn, who asked O'Donnell if he would represent Kilpatrick on a retainer agreement for various kinds of work. Kilpatrick had been in business with Cal Am in 1977. That company formed limited partnerships to own coal leases as tax shelter investments. Joseph R. Laird, Jr. was a lawyer who was president of Cal Am Corporation. When Kilpatrick wanted to start a similar business, O'Donnell talked with Laird and with Ed Sherman, a lawyer who had a tax opinion letter in the Cal Am offering circular. O'Donnell then made his own study of those sections of the IRC and IRS regulations dealing with carved out production payments. His notes from that study are in evidence as O'Donnell's Exhibit V. O'Donnell testified that his study led him to the conclusion that production from an economically viable coal lease could be financed by a carved out production payment and that an accrual basis taxpayer could deduct advance minimum royalty payments but that the arrangement must be structured as a cash transaction to make the deduction available to cash basis taxpayers. The check circles were designed by O'Donnell as the method to accomplish that result. In O'Donnell's view of the first financing at the Colfax National Bank, upon the cash deposits by ADI of the monies received from investors, the bank made loans equivalent to the credits given to the payees on insufficient funds checks which loans were then retired by the reciprocal checks.

It is this court's understanding of O'Donnell's testimony that the carved out production payment became a cash transaction in the same way that parties might structure a trade of physical assets through an exchange of checks. Thus, Company A may wish to transfer land valued at $1,000,000 to Company B in exchange for a building worth $1,000,000. Motivated by the need to reflect the exchange in cash for purposes of valuing the property, for tax reasons or other non-fraudulent reasons, a bank could loan Company A $1,000,000 to buy the building from Company B with the understanding that Company B would pay $1,000,000 back to Company A to purchase the land on the same day. Company A then repays the loan to the bank. The funds never left the bank and neither party at the end of the day has a bank balance different from that at the start of the day. In the government's view, that would be a check swap with no economic significance. Yet, if there was also an exchange of deeds, there is no doubt that each party paid $1,000,000 in cash in connection with an economically substantive transaction.

Whether O'Donnell's tax opinion is correct is not an issue. Other proceedings in other forums will determine the actual tax consequences of these transactions. What is determinative is that O'Donnell as an experienced business lawyer with an excellent reputation reached the conclusion that this circular financing of a carved out production payment created legitimate tax deductions for the investors and the government's failure to disprove the underlying assumption that the coal reserves were adequate to support the values underlying the transaction.

When the government uses the Internal Revenue Code for purposes other than raising revenue thereby inducing particular types of conduct, it is not illegal to be innovative in putting an elaborate dress on prosaic transactions. Leveraged financing and complex investment programs have been commonplace in our economy. What divides a tax shelter from a tax fraud is the existence of some actual economic purpose and what divides civil from criminal liability is the intent of the actor. In pretrial proceedings in this case, the prosecutors articulated the view that it was not necessary for the government to prove that there were no coal reserves or that there was no economic substance to the proposed mining program. Accordingly, the court cautioned defense counsel that their offer of proof of the existence of the coal reserves and the viability of the mining plan would be rejected as irrelevant. It is, of course, the government's burden to prove beyond a reasonable doubt that each of the defendants acted with the intent to defraud the government. The government argues that it has met that burden by demonstrating that each of them participated in the exchanges of checks with knowledge of the insufficiency of the relevant bank accounts; that they concealed the true nature of the financing from the investors; and that they laid a confusing paper trail to make the transactions audit proof.

The failure to disprove the existence of the coal reserves is a fatal flaw in the prosecution's case. O'Donnell testified to his experience as a lawyer, his research into the Internal Revenue Code and regulations and his belief in the legitimacy of the deductions in the coal lease program. He testified that he believed that an economically viable coal lease was the critical element because the coal itself was the only source for repayment of the loans. He testified that the purpose of the check circle was to convert the accrued minimum royalty liability into a deduction which would be available to a cash basis taxpayer. O'Donnell further testified that he personally inspected coal properties in West Virginia which Kilpatrick acquired in 1978 and that additional properties were acquired in Tennessee . There is no evidence to dispute this testimony concerning the adequacy of the coal reserves. Other defense witnesses testified to the reputation of O'Donnell as a lawyer and as an honest man. In sum, a lawyer with a good reputation investigated the factual support for the coal mining plan, reviewed the financing scheme and gave his opinion to the co- defendant and to the investors that the deductions, while risky, were appropriate. No matter how wrong O'Donnell may have been in his analysis of the tax laws, the evidence is insufficient to find beyond a reasonable doubt that he acted with the requisite criminal intent. The evidence does not support a finding that the co-defendant, Kilpatrick, attempted to mislead O'Donnell, and, accordingly, the evidence is also insufficient to convict Kilpatrick on this count since Kilpatrick relied on O'Donnell's legal opinion.

Additional support for the finding that the defendants did not have the requisite criminal intent is found in the testimony of sophisticated investors. The government called a lawyer and several CPA's who invested in the program. While it is true that they did not have knowledge of the check circles, they were given full opportunity to investigate into the existence of coal reserves and the feasibility of producing coal in the quantities needed for support of the loans.

COUNT II--THE METHANOL PRODUCTION PROGRAM

Count II of the indictment charges the defendants and others with creation and execution of a second fraudulent tax shelter program. The tax shelter involved the sale of interests in a number of limited partnerships created for the purported purpose of developing processes for the conversion of coal and other carbon-bearing feed stocks to methanol, and to construct plants to carry out the conversion. The rights to the conversion process were owned by International Fuel Development Corporation (IFDC). In the private placement memorandum used for the marketing of the partnership units, IFDC was described as a Cayman corporation organized in 1979 with its principal asset being the methanol energy license rights to the inventions involved in the process. It was also represented that the company was not owned by any American nationals, that its owners were not related to any other organization or entity involved, and that its financial records were not available. It is clear from the evidence, however, that IFDC, like MIL, was beneficially owned by Kilpatrick. IFDC granted licenses to develop and market the technology in a particular area to the several limited partnerships.

Although there were programs in 1979, 1980 and 1981, the only detailed description of these enterprises in evidence is contained in a private placement memorandum from the 1979 program. According to it, each partnership was divided into 45 limited partnership units which sold for the unit price of $331,111. The purchaser of each unit was required to contribute $12,500 in cash with $137,500 in full recourse promissory notes. The balance of $181,111 was in non-recourse notes, payable from the partnership income, over approximately four years. Accordingly, the capital contribution to each limited partnership was $562,500 in cash, $6,187,500 in recourse notes, and $8,149,995 in non-recourse notes for a total of $14,899,995. From this total, $270,000 was payable to the general partner as commissions which were to be considered R&D expenses. The production facilities were budgeted to cost a total of $5,000,000 per territory.

The tax advantage of the program came from payment of a deductible research and development expense partially with borrowed funds. IFDC agreed to perform research and development work for the partnerships as an independent contractor at a compensation of $2,250,000 payable by the partnership on or before December 31 of the first year and a like amount on or before December 31 of the second year of the program. This sum was a deductible expense of the partnership. MIL agreed to loan the partnership $1,687,500 on or before December 31 of the first year of the program, and the same amount during the second year. These loans were secured by the limited partners' recourse notes. The purchaser of a unit would be able to deduct the proportionate share of the R&D payment, $50,000 in the first year, even though only $12,500 had been paid in cash.

Another integral part of the program was IFDC's right to buy an option to purchase each of two plants for an amount equal to cost plus 100%. The price of the option was $1,750,000 per plant, payable when construction of the plant was ordered by the partnership and to be credited to the purchase price when the option was exercised. The right to exercise the option was not to begin until 1991. The private placement memorandum included a tax opinion from Coopers & Lybrand which advised that, upon certain factual assumptions, the limited partnerships would be given partnership tax treatment and therefore losses of the partnership would be available to the individual investors. The opinion noted that IFDC should be able to make the option payment without drawing on the R&D payment. The government alleges that the program was fraudulent because the R&D payments were a sham supported only by false documentation. As in Count I, the core contention is circular financing.

The government never attempted to explain what happened to the investor cash contributions that, according to the private placement memorandum, were intended to be the cash portion of the R&D payment. The government has not argued that the defendants are guilty because the cash was misdirected. Rather, the government's claim is that the portion of each partnership's R&D payment financed by MIL was a sham. It is also worth noting that several investors testified that they were permitted by the IRS to deduct the cash portion of their investment. Accordingly, the guilt of the defendants depends upon adequate proof of fraudulent financing.

The government's evidence indicates that most of MIL's purported financing of the R&D payment occurred in the Netherlands at the offices of Insinger, Willems & Cie N.V. ("Insinger"), a credit institution. From the financial records of Insinger placed into evidence, it appears that on December 31, 1979 , MIL contributed three-fourths of the R&D payment for 32 partnerships by issuing debits from its account at Insinger and made 32 additional payments to IFDC in the amount of $62,500 each. The purpose of these $62,500 payments is unexplained. That amount is the same as the difference between the amount of the MIL loan to said partnerships and the purchase price of the option to IFDC. The Insinger records reflect that on the same day, IFDC executed 32 debit items in the amount of $1,750,000 each to MIL, totaling $56,000,000.

The second year of the 1979 program was financed at Insinger on December 31, 1980 . Instead of MIL making payments to IFDC on behalf of the partnerships, it appears that MIL actually transferred funds to the partnerships and they paid IFDC directly. The Insinger records in evidence show that MIL debited $23,184,703 to 18 partnerships. The partnerships debited $23,184,703 to IFDC. IFDC debited $23,184,703 in return for promissory notes from MIL.

Also financed on the last day of 1980 at Insinger through Insinger accounts was the first year of a methanol program independent from the 1979 program. MIL debited $16,875,000 to 10 partnerships. The partnerships debited $16,875,000 to IFDC. IFDC debited $16,875,000 to MIL.

Two partnerships, Cocahol Land (Cocahol) and Cocahol Land II (Cocahol II) were financed at the First Cayman Bank in the Cayman Islands . Cocahol was financed in September, 1979. Unlike the other financing transactions, the part of the R&D payment that is payable from the investor's cash contribution appears from the records. That is to say, the entire $2,250,000 R&D payment appears, not just the $1,687,500 payable by MIL. Funds flowed back from IFDC to MIL and to Cocahol. The records in evidence reflect that Cocahol received investor funds in the amount of $456,250. Cocahol received $106,250 from the account of Alan Vaughn, the general partner of Cocahol. Cocahol wrote a check in the amount of $562,250 to IFDC. IFDC wrote a check in the amount of $562,250 to Vaughn's account. MIL wrote a check in the amount of $1,687,500 to IFDC. IFDC wrote a check in the amount of $1,687,500 to MIL.

Cocahol was apparently financed again on September 26, 1980 , at the First Cayman Bank. International Block Construction Company (IBCC), a company beneficially owned by Kilpatrick, paid Cocahol Land $90,353. MIL paid Cocahol Land $1,309,647. Cocahol Land wrote IFDC a check for $1,400,000. IFDC wrote MIL three checks totaling $1,309,647. IFDC wrote a check to IBCC for $90,353. Cocahol was also financed at Insinger for the year 1980 in the amount of $1,073,101. Thus, a total of $2,473,101 was apparently paid for R&D to IFDC by MIL. Yet, only $1,683,647 was listed as a deduction on Cocahol's partnership tax return.

Cocahol Land II was financed on December 10, 1980 , at the First Cayman Bank. IBCC wrote Cocahol Land II a check for $458,000. MIL wrote Cocahol II a check for $1,600,000. Cocahol II wrote IFDC a check for $1,600,000. Cocahol II wrote MIL a check for $458,000. IFDC wrote MIL a check for $1,600,000. MIL wrote IBCC a check for $458,000. Cocahol II was also double funded for 1980. $1,107,523 was financed at Insinger, yet only $1,695,490 was deducted on Cocahol II's partnership tax return.

The government does not claim that deductions would not be available for research and development payments under the circumstances described in the private placement memorandum. Instead, the government's central argument is that the transactions at First Cayman and Insinger were shams. The evidence does not show beyond a reasonable doubt that the purported payments from the partnerships to IFDC were not actual transactions. It is true that neither the partnerships nor MIL had on deposit at Insinger funds sufficient to make the payments. However, the government introduced into evidence documents showing that the relationship among Kilpatrick, MIL, IFDC and Insinger was more than making merely Insinger a conduit for an exchange of debits and credits. Government Exhibit 42-7 is a line of credit agreement, dated December 28, 1979 , in which Kilpatrick represents that UFO has sold inventions and secret processes to IFDC in consideration for future payments for the exploitation of licenses for methanol production; that Insinger has a contract with IFDC for purchasing IFDC receivables and that Insinger has a standby commitment to loan $1,750,000 to MIL. Insinger agreed to

commit[] a line of credit sufficient to cover those certain outstanding loan commitments of MARLBOROUGH INVESTMENTS LIMITED, a Cayman Corporation, to I.F.D.C. Territorial Licensees as MARLBOROUGH may request from time to time. This stand-by accommodation commitment is subject to and conditioned upon maintenance of collateral security in favor of [Insinger] as provided below.

Kilpatrick agreed to give Insinger a first mortgage deed on a Clalite Cement Block manufacturing plant in Colorado , appraised for $5,000,000, together with a personal continuing guarantee to secure Insinger's advancements to MIL. Additionally, MIL is to pledge to Insinger mortgage liens on methanol plants to be constructed. By all appearances, this agreement constitutes a commitment by Insinger to fund MIL's loan obligations to the methanol partnerships. Accordingly, it cannot be said that the government has proved beyond a reasonable doubt that the financing did not occur.

Other government exhibits indicate that the relationship with Insinger was legitimate. Government Exhibit 42-1 is an agreement dated August 30, 1979 , for the sale of notes receivable by IFDC to Insinger in exchange for its note payable to IFDC and the undertaking of two contracts: a license agreement for German and Dutch speaking nations and a brokerage contract for the acquisition of an original artwork. While the document refers to certain exhibits as attachments, they were not included with the exhibit introduced into evidence. Government Exhibit 42-2 is an art acquisition brokerage contract and Government Exhibit 42-3 is a commission contract in which IFDC appoints Insinger as sales agent for marketing investments to exploit the methanol licenses. Government Exhibit 42-4 is an unsigned copy of a promissory note, dated August 30, 1979 , from Insinger to IFDC in the principal amount of $319,300,000, payable December 31, 1979 . The document describes that it is secured by a collateral transfer agreement pledging notes receivable from third party payors in the amount of $319,500. Government Exhibit 42-5 is designated a collateral transfer agreement, dated August 30, 1979 , reciting that Insinger has pledged certain third party receivables owned by it pursuant to an agreement for the sale of notes receivable from IFDC and the agreement purports to appoint UFO as escrow agent and stakeholder to hold such receivables to be delivered to IFDC upon default on Insinger's note. There is nothing in evidence to support a finding that these documents are fabrications or that Insinger was or is anything other than a European-style banking institution. Inclusion of these documents in the government's presentation of evidence casts great doubt on the sham theory of criminal liability.

The prosecutors have made much of a letter, dated June 28, 1979 , from Kilpatrick to Wilson Quintela as an admission of Kilpatrick's fraudulent intent. For that purpose, emphasis was placed on those portions of the letter asserting Kilpatrick's ownership of IFDC and Quintela's position as a figurehead for the company. Kilpatrick refers to his intention to take back the corporation and to be able to say that Quintela owns it if Kilpatrick is asked that question. Included in the letter are the following two paragraphs:

1. Due to the international nature of the alcohol patents it was necessary to change the ownership to an international corporation. Therefore, I.F.D.C. was formed as an international corporation in Cayman. U.F.O. sold all these rights and patents to I.F.D.C. but kept the administration, management and sales responsibilities in U.F.O. in the U.S.

2. It is my intention to continue to own and control I.F.D.C. because that is where all the money to be made in the plants, as well as the plant ownership will end up. However, in the initial sales in the U.S. it is important that I show different owners in each company. (U.F.O. & I.F.D.C.) This is not illegal, it simply saves a tremendous amount of work and explanation to the U.S. investors.

Government Exhibit 52-5.

Also included in the same letter are the following three paragraphs:

I have tried on several occassions (sic) to explain the problems concerning the research and development. I failed to make it clear I guess because of the language problem. Let me first say again there is no problem. We know now we can build the plant. We knew it before we started the R.&D. We know it will make alcohol with the raw materials and the efficiency forecasted when I was there.

The reason for research and development is the TAX LAWS of the U.S. If we simply build the plant--no deductions would be available to U.S. investors in the year of the investment. The price of the plant this year is $7,200,000. We are merely calling $2,200,000 of the $7,200,000 in order to deduct that amount from U.S. taxes this year.

The first plant is being fabricated now. It will be finished and ready for installation by July 15, 1979 . The installation will be completed August 1, 1979 at 5959 Osage Street , Denver , Colorado . It will be in operation at all times beyond that date, if anyone from Brasil wishes to see it. We will be using both coal and petroleum coke as raw materials. We will not use wood, sewage, garbage or any other materials containing less than 50% carbon. Those are materials used by those who do not know how to do it our way. They make no economic sense whatever.

Kilpatrick's statements concerning the fabrication of the first plant has some support from the testimony of John T. Cook who said that he visited a plant on Pecos Street in Denver before making his investment in November, 1980. The reference by Kilpatrick to the tax laws as the reason for research and development suggests that the plant was going forward into construction with an artificial allocation to R&D expense. While that would be an inappropriate deduction, it is far different from the government's view that there was no financing. Also in the same Kilpatrick letter, reference is made to having 20 orders for plants. That suggests that the IFDC payments may well have been for the purchase of options on plants ordered. Of greatest significance in this "smoking gun" letter is the insistence of Kilpatrick on reacquiring IFDC because he expected to make money from it. The inference is that money would be made in the future from the programmed development. That is quite different from the prosecution view that this whole effort was simply motivated by taking the initial cash investment. Some of the subterfuge and use of offshore entities with secret record keeping is explained by the fact that Kilpatrick was being dogged by an SEC investigation with court enforced administrative subpoenas in January, 1979, seeking complete records of P&J and the coal companies from January 1, 1977 . O'Donnell testified that the Colfax National Bank refused further participation in financing because of the SEC subpoenas. An effort to escape strict scrutiny of the SEC is not the equivalent of an intent to defraud the IRS.

It is commonplace to describe the evidence in a complex case as pieces in a jigsaw puzzle. The analogy is apt in this case because although the government has admitted hundreds of exhibits and weeks of testimony, there are too many missing pieces to complete the picture portrayed by Counts I and II of the indictment. If this were a civil case, the defendants would be required to explain many things to meet a strong prima facie case of fraud. Here, however, the defendants need explain nothing. The government's approach to this prosecution has been simplistic: proof of check circles is proof of tax fraud. It is not that easy. The ordinary check kite case is prosecuted as a mail fraud with the involved banks as victims. The transactions here were with full knowledge and participation of the banks. There is sufficient evidence in the government's own proof to create a reasonable doubt about the defendants' intentions. The prosecution has not foreclosed permissible inferences that each of the defendants did indeed seek to create attractive investment opportunities with significant tax advantages but with the primary goals of producing coal and methanol. The prosecution has also not convincingly shown that the deductible expenditures were not made in cash. These failures of proof create a reasonable doubt concerning the economic substance of the programs which entitles the defendants to acquittal of the conspiracy charges.

COUNTS III--XXVI

Counts III through XXVI charge the defendants with mail fraud, filing false tax returns and aiding and abetting the filing of false tax returns in connection with the schemes alleged in Counts I and II. Counts XIII, XIV, XXIV, XXV and XXVI, charging mail fraud, were dismissed by the court on August 25, 1989 upon the government's oral motion. Count XXVII was severed by order of the court on August 23, 1988 and was not directly at issue in the trial.

Counts III through X of the indictment charge each of the defendants with violations of 26 U.S.C. §7206(2) by aiding and assisting in the filing of false and fraudulent tax returns. The counts vary only in the particular individual and partnership tax returns in which deductions were taken for advance minimum royalty payments and R&D expense. These charges differ from the general aiding and abetting provision in 18 U.S.C. §2 in that the government need not prove that the falsity or fraud has [sic] with the knowledge or consent of the person required to file the return. It is sufficient to show that the returns were false or fraudulent as to any material matter; that the defendant aided or assisted in the preparation or filing of the return and did so willfully. In this context, willfully is the intentional violation of a known legal duty. That duty is the taxpayer's duty to file a tax return believed to be true and correct as to every material matter.

The deductions and losses in question are undoubtedly material matters. It is also clear that each of the defendants participated in the coal lease programs and methanol programs and are responsible for the advice to the subject taxpayers to take the deductions as they did on these returns. Accordingly, the controlling question is whether the government has proved beyond a reasonable doubt that the defendants knew that the deductions were not authorized factually or legally. Essentially, the government's theory of criminality on these charges is an echo of the contentions made in Counts I and II. The contention is that the claims for deductions and losses are false and fraudulent because the underlying transactions were shams. The determination that the government failed to prove that the transactions were shams defeats that contention on these charges and the defendants are found not guilty of them.

Count XI charges that Kilpatrick filed a false tax return for the calendar year 1979 by claiming a partnership loss in the amount of $2,002,945. Count XII charges O'Donnell with the filing of a false tax return for the calendar year 1979 by claiming a partnership loss of $148,533. These partnership losses were based upon losses of Agosto Ltd., a participant in the methanol transactions. Again, the government's failure to prove the fraudulent financing scheme described in Count II is determinative of these counts and the defendants are found not guilty on them.

Counts XV through XXIII charge mail fraud. The schemes to defraud supporting each remaining count are the schemes alleged in Counts I and II which were incorporated by reference. Here the government must prove that the investors were the subject of the schemes both in the purchase and the use or benefit of the tax shelters sold to them. Again, conviction on these counts requires proof that each of the defendants participated in the conspiracies charged in Counts I and II with the requisite intent--to engage in sham transactions for the purpose of causing the purchasers to believe that they were obtaining legitimate tax deductions. A distinction must be drawn between mail fraud and securities fraud. The defendants were not charged with misleading the purchasers by misstating or omitting material statements from the offering circulars or memoranda. The adequacy of these disclosures is not an issue under these charges. What the government had to prove to convict on the mail fraud counts are the same sham transactions required for the conspiracies in Counts I and II and the failure of proof there controls the determination on these charges, which must be not guilty. What is missing from the case is a tracing of the cash payments from the investors and a sufficient showing that the coal reserves were inadequate to support the debt burden in Count I and the lack of adequate assets in IFDC for its obligations in Count II.

Upon the foregoing, it is

ORDERED that William A. Kilpatrick is found not guilty of all charges against him in the indictment with the exception of Count XXVII, which has not been tried, (Counts I, II, III, IV, V, VI, VII, VIII, IX, X, XI, XV, XVI, XVII, XVIII, XIX, XX, XXI, XXII, and XXIII); and it is

FURTHER ORDERED that Declan O'Donnell is found not guilty of all charges against him in the indictment (Counts I, II, III, IV, V, VI, VII, VIII, IX, X, XII, XV, XVI, XVII, XXII, and XXIII).

 

 

[2003-1 USTC ¶50,315] United States of America v. Peter Bouzanis, George Palivos, JACPG, Inc., Peter Palivos and Louis Marin, Defendants.

U.S. District Court, No. Dist. Ill. , East. Div.; 00 CR 1065, March 6, 2003 .

[ Code Sec. 7206]

Crimes: Fraud and false statements: Financial broker: Aiding in preparation of fraudulent return: Materiality of false statement: Statute of limitations. --

A financial broker's motion to dismiss an indictment charging him with aiding, counseling, and causing the preparation and presentation of a third party's false and fraudulent tax return for the purpose of assisting that party to obtain a loan was denied. Although the return overstated the third party's income, the false statement was "material" because it had the potential for hindering IRS efforts to monitor and verify his tax liability. Consequently, the broker's indictment alleged a violation of Code Sec. 7206(2). In light of that determination, his contention that the prosecution was barred by the statute of limitations was rejected.

MEMORANDUM OPINION AND ORDER

LEFKOW, District Judge: This case revolves around the April 1996 sale of a restaurant named Waterfalls located in Antioch , Illinois . Codefendant JACPG sold the restaurant to codefendant Peter Bouzanis ("Bouzanis"). The indictment alleges that Bouzanis obtained a loan from The Money Store Investment Corporation ("The Money Store"), which loan was partially guaranteed by the United States Small Business Administration, and that JACPG and others secretly and fraudulently financed the capital that Bouzanis was required to provide to close the transaction. Defendant Louis Marin ("Marin") is a broker who introduced Bouzanis to The Money Store.

Presently before the court is Marin's motion to dismiss Count Eight (the only count in which he is named) of the Fourth Superseding Indictment. According to the indictment, Marin assisted Bouzanis in preparing an individual tax return (Form 1040) that Bouzanis filed on February 29, 1996 for the 1994 tax year, and that the return declared a false, inflated income of $52,000.00. That tax return was submitted to The Money Store in support of the loan application to make Bouzanis appear a better credit risk than he actually was. The government charges Marin with aiding, counseling and causing the preparation and presentation of a false and fraudulent tax return to the Internal Revenue Service ("IRS") which Marin did not believe was true as to every material matter, in violation of 26 U.S.C. §7206(2) (Fraud and false statements) ¹ and of 18 U.S.C. §2 (Principals). ² Marin argues that the indictment does not allege the elements of an offense under §7062(2) and that the statute of limitations bars the prosecution. The motion is denied for reasons stated below.

DISCUSSION

A. Sufficiency of the indictment

Marin argues that the indictment fails to allege an offense under 26 U.S.C. §7206(2) in that it fails to allege a necessary element: that the tax return was "fraudulent or false as to any material matter." He rests his argument on the fact that Bouzanis's income was overstated rather than understated, which statement although false is not fraudulent because, he contends, it was not material.

Marin concedes that pecuniary loss to the government is irrelevant to §7206(2), ³ but he argues that "there must be some obstruction, delay or impairment of revenue function relating to the false statement itself rather than the actual attainment of its end as measured by collateral circumstances." (Def. Mem. at 2.) If Marin means by this opaque statement that the government must allege and prove some actual impairment of IRS function, so that if the effect was only to aid Bouzanis in obtaining a loan from The Money Store and thus there is no violation, he is without support in case law. Marin relies solely on United States v. Potstada [ 62-2 USTC ¶12,117], 206 F.Supp. 792 (N.D. Cal. 1962), which ruled in line with many other cases that an indictment stated a violation of §7206(2) where it alleged that the defendant had procured the filing of a gift tax return containing a false statement even though in fact no tax was due, i.e., "that defendant obtained for the government a tax that actually was not owing." Id. at 793. Marin lifts language from Potstada in which the court referred to cases interpreting §7206(2) and its predecessor, as well as the general false statement act, 18 U.S.C. §1001, and commented, "the courts seem to hold that it is not necessary to allege any pecuniary loss to the United States as the result of such false statements, and, that it is sufficient to allege and prove obstruction, delay or impairment of governmental functions. " Id. at 794 (emphasis added). The government's burden to allege and prove obstruction, delay or impairment of governmental functions, however, was not at issue in Potstada and thus it has no persuasive force concerning the argument Marin advances. Among the cases the Potstada court referenced is a Seventh Circuit case, United States v. Borgis [ 50-1 USTC ¶9330], 182 F.2d 274 (1950), but this court searches that case in vain also for the rule of law on which Marin would rely.

In any event, neither case would govern over United States v. Peters [ 98-2 USTC ¶50,650], 153 F.3d 445, 461-62 (7th Cir. 1998), on which the government relies. There, the defendant argued that the government had to prove a tax deficiency in order to convict under §7206(1), ⁴ which argument amounted to a contention that unless there was a tax deficiency the false statement was not material. The court rejected that argument, holding that proof of a tax deficiency was not essential to prove materiality. The court set out the elements of the offense including a definition of "material": "A false statement is `material' when it has `the potential for hindering the IRS's efforts to monitor and verify the tax liability' of the corporation and the taxpayer." Id. at 461, quoting United States v. Greenberg [ 84-1 USTC ¶9509], 735 F.2d 29, 32 (2d Cir. 1984); see United States v. DiVarco [ 73-2 USTC ¶9607], 484 F.2d 670, 673 (7th Cir. 1973) (Even though the government did not prove understatement of income, the court held that a false statement as to source of income on a tax return was material, relying in part on the policy that the IRS is entitled to accurate information). There is, of course, no question that the amount of income on a tax return is material in that it would have the potential for hindering the IRS's efforts to monitor and verify Bouzanis's tax liability; thus it follows that this indictment alleges a violation of §7206(2).

B. Statute of limitations

Marin's statute of limitations argument rests on the argument rejected above that the indictment fails to allege a violation of §7206(2). Inasmuch as that argument has been rejected, so also is the argument that the prosecution is time-barred.

ORDER

Accordingly, the court denies Marin's motion to dismiss his indictment.

¹ 26 U.S.C. §7206(2) (Aid or assistance) states:

Any person who --[w]illfully aids or assists in, or procures, counsels, or advises the preparation or presentation under, or in connection with any matter arising under, the internal revenue laws, of a return, ... which is fraudulent or is false as to any material matter, whether or not such falsity or fraud is with the knowledge or consent of the person authorized or required to present such return, ... shall by guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000, ... or imprisoned not more than 3 years, or both, together with the costs of prosecution.

² 18 U.S.C. §2 (Principals) states:

(a) Whoever commits an offense against the United States or aids, abets, counsels, commands, induces or procures its commission, is punishable as a principal.

(b) Whoever willfully causes an act to be done which if directly performed by him or another would be an offenses against the United States, is punishable as principal.

³ Although making this concession, Marin cites United States v. Whyte [ 83-1 USTC ¶9185], 699 F.2d 375, 379 (7th Cir. 1983), as authority for the rule that materiality means understatement of gross income. This statement in Whyte was made in the context of whether the question of materiality is for the court or the jury. Thus, Marin takes the reference to out of context and Whyte has no bearing on the definition of materiality. See United States v. Minneman [ 98-1 USTC ¶50,347], 143 F.3d 274, 279 (7th Cir. 1998) (the defendants argued that because the defendant-taxpayer could have, but did not, take a deduction that would offset gross income, "the defendants did not have a financial motive to defraud the government" and thus the defendants did not falsify the return under 26 U.S.C. §7206(1) and 18 U.S.C. §371 (conspiracy to impede the IRS). The court disagreed, stating that "the amount of taxes owed is irrelevant to a prosecution for tax fraud.").

⁴ 26 U.S.C. §7206(1) (Declaration under penalties of perjury):

Any person who --[w]illfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter;

Although the cases cited in the briefs deal mainly with §7206(1), the parties do not dispute, nor does the court disagree, that the Seventh Circuit's interpretation of the elements of the offense is also applicable to aiding and abetting under §7206(2).

 

 

 

Rev. Rul. 2005-17 , I.R.B. 2005-14, March 14, 2005 .

[ Code Secs. 3121, 3401, 6662, 6663, 6673, 6701, 6702, 7203, 7206 and 7408]


Avoidance of tax: Penalties, civil: Failure to file return: Failure to pay tax: Filing a false return: Frivolous return: Substantial understatement: Negligence: Fraud penalties: Injunction against tax shelter promoters: Tax protestors: Federal Insurance Contribution Act (FICA): Social Security taxes: Return requirements. --

Taxpayers may not claim a refund of Social Security taxes paid based on the position that they have waived the right to receive Social Security benefits or claim a charitable contribution deduction for Social Security taxes "donated" or "gifted" to the government. There is no provision in the Internal Revenue Code, or other applicable law, that allows taxpayers to waive their right to receive Social Security benefits. Similarly, there is no authority that provides for a deduction in the amount of Social Security taxes paid as a donation or gift to the government of a taxpayer's right to receive Social Security benefits. A narrow religious exemption is provided under Code Sec. 3127, but taxpayers must meet the requirements of that section for their income to be exempted from Social Security taxes.

PURPOSE

The Service is aware that some taxpayers are filing claims for refund of the Social Security taxes paid on wages pursuant to the Federal Insurance Contributions Act (FICA) on the basis that they have waived their right to receive Social Security benefits. The Service also is aware that some taxpayers are attempting to reduce or eliminate their federal tax liability by taking similar frivolous return positions, including reporting as a charitable contribution deduction the amount of Social Security taxes paid, on the basis that they are donating these amounts to the government. Some promoters market a package, kit, or other materials, that claim to show taxpayers how they can obtain a refund or avoid paying income taxes based on these and other meritless arguments. This revenue ruling does not apply to individuals who have satisfied the requirements of the religious exemption from FICA provided in section 3127 of the Internal Revenue Code.

This revenue ruling emphasizes to taxpayers and to promoters and return preparers that there is no right to a refund of, or a deduction for, Social Security taxes paid based on arguments that a taxypayer has waived the right to receive Social Security benefits or has donated Social Security taxes or benefits to the government. These arguments have no merit and are frivolous.

The Service is committed to identifying taxpayers who attempt to avoid their tax obligations by taking frivolous positions, including frivolous positions based on arguments regarding waiver of Social Security benefits. The Service will take vigorous enforcement action against these taxpayers and against promoters and return preparers who assist taxpayers in taking these frivolous positions. Frivolous returns and other similar documents submitted to the Service are processed through its Frivolous Return Program. As part of this program, the Service confirms whether taxpayers who take frivolous positions have filed all of their required tax returns, computes the correct amount of tax and interest due, and determines whether civil and criminal penalties should apply. The Service also determines whether civil or criminal penalties should apply to return preparers, promoters, and others who assist taxpayers in taking frivolous positions, and recommends whether a court injunction should be sought to halt these activities. Other information about frivolous tax positions is available on the Service's website at www.irs.gov.

ISSUES

1. Whether taxpayers are entitled to a refund of Social Security taxes paid on the theory that they have waived the right to receive Social Security benefits?

2. Whether taxpayers are entitled to a charitable contribution deduction for Social Security taxes paid on the theory that those amounts have been donated by them to the government?

FACTS

This plan includes claims for refund of Social Security taxes paid on wages under FICA, on the theory that the taxpayer has waived the right to receive Social Security benefits. Additionally, some taxpayers claim a charitable contribution deduction on the theory that they have donated their Social Security taxes, or their right to receive Social Security benefits, to the government.

LAW AND ANALYSIS

Social Security taxes are imposed on wages as defined in section 3121. There is no authority under the Internal Revenue Code (other than the narrow exception to the application of FICA tax provided in the religious exemption under section 3127) or any other applicable law that supports the claim that taxpayers may waive their right to receive Social Security benefits and thereby receive a refund of Social Security taxes paid. Similarly, there is no provision of law that would allow a taxpayer to claim a charitable contribution deduction as a result of the donation or gift to the government of the taxpayer's right to receive Social Security benefits or of Social Security taxes paid.

In Crouch v. Commissioner [ CCH Dec. 46,666(M)], T.C. Memo. 1990-309, the taxpayers did not pay self-employment tax based on a claim that they had withdrawn from the Social Security system. The taxpayers also claimed a charitable contribution deduction based on a purported lump-sum gift to the government of Social Security benefits. The Tax Court rejected these positions, characterizing the taxpayers' failure to pay self-employment tax as negligent and sustaining the Service's disallowance of the charitable contribution deduction. See also Derksen v. Commissioner [ CCH Dec. 41,927], 84 T.C. 355, 360 (1985) ("There are some specific exemptions from the [social security] tax but the desire not to be a part of the social security system, standing alone, is not one of them.")

A refund claim must be based on a valid argument that the taxpayer has overpaid the tax that is lawfully due and owing. See, e.g., Lewis v. Reynolds [ 3 USTC ¶856], 284 U.S. 281, 283 (1932) ("[T]he taxpayer is not entitled to a refund unless he has overpaid his tax."). Further, it is a well settled principle of law that deductions and credits are a matter of legislative grace. See INDOPCO, Inc. v. Commissioner [ 92-1 USTC ¶50,113], 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering [ 4 USTC ¶1292], 292 U.S. 435, 440 (1934). Unless specifically provided for in the Internal Revenue Code, no deduction or credit is allowed. Neither section 3121, nor any other provision of the Internal Revenue Code, allows for a refund of Social Security taxes paid on the grounds that a taxpayer has purportedly waived all rights to receive Social Security benefits. Similarly, no provision of the Internal Revenue Code allows for a charitable contribution deduction based on the purported gift or donation of Social Security taxes or benefits to the government.

CIVIL AND CRIMINAL PENALTIES

The Service will disallow any claim for refund of Social Security taxes based on the frivolous argument that a taxpayer has waived the right to receive Social Security benefits. The Service will also disallow any deduction that is based on the theory that a taxpayer has given or donated the taxpayer's Social Security taxes or Social Security benefits to the government. In addition to liability for tax due plus statutory interest, individuals who claim tax benefits on their returns based on these and similar frivolous arguments face substantial civil and criminal penalties. Potentially applicable civil penalties include, but are not limited to the following: (1) the section 6662 accuracy-related penalty, which is equal to 20 percent of the amount of taxes the taxpayer should have paid; (2) the section 6663 penalty for civil fraud, which is equal to 75 percent of the amount of taxes the taxpayer should have paid; (3) a $500 penalty under section 6702 for filing a frivolous income tax return; and (4) a penalty of up to $25,000 under section 6673 if the taxpayer makes frivolous arguments in the United States Tax Court.

Taxpayers relying on these frivolous positions also may face criminal prosecution for: (1) attempting to evade or defeat tax under section 7201, for which the penalty is a significant fine and imprisonment for up to 5 years; or (2) making false statements on a return, statement, or other document under section 7206, for which the penalty is a significant fine and imprisonment for up to 3 years.

Persons, including return preparers, who promote these frivolous positions and those who assist taxpayers in claiming tax benefits based on these frivolous positions also may face penalties and may be enjoined by a court pursuant to sections 7407 and 7408. Potential penalties include: (1) a $250 penalty under section 6694 for each return or claim for refund prepared by an income tax return preparer who knew or should have known that the taxpayer's position was frivolous (or $1,000 for each return or claim for refund if the return preparer's actions were willful, intentional or reckless); (2) a penalty under section 6700 for promoting abusive tax shelters; (3) a $1,000 penalty under section 6701 for aiding and abetting the understatement of tax; and (4) criminal prosecution under section 7206, for which the penalty is a significant fine and imprisonment for up to 3 years for assisting or advising about the preparation of a false return, statement, or other document under the internal revenue laws.

HOLDING

Taxpayers are not entitled to a refund of the Social Security taxes paid based on the position that they have waived the right to receive Social Security benefits. Moreover, a taxpayer is not entitled to a charitable contribution deduction based on the purported gift or donation of Social Security taxes or benefits to the government. Claims or deductions based on these positions are frivolous and have no merit.

DRAFTING INFORMATION

This revenue ruling was authored by the Office of Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact that office at (202) 622-7950 (not a toll-free call).

 

 

 

Rev. Rul. 2005-19 , I.R.B. 2005-14, March 14, 2005 .

[ Code Secs. 1, 6651, 6662, 6663, 6673, 6702, 7203, 7206 and 7408]


Avoidance of tax: Penalties, civil: Failure to file return: Failure to pay tax: Filing a false return: Frivolous return: Substantial understatement: Negligence: Fraud penalties: Tax shelter promoters: Tax protestors. --

Claims that the 16th Amendment to the Constitution, which authorizes Congress to lay and collect taxes on income, was not properly ratified, that the federal income tax is a violation of the Due Process Clause of the Fifth Amendment, and that the payment of taxes is a form of slavery under the 13th Amendment are frivolous. These claims have been repeatedly rejected by the courts, starting with the United States Supreme Court's decision in F.R. Brushaber v. Union Pacific Railroad Co., 1 USTC ¶4, which upheld income tax laws enacted subsequent to the 16th Amendment. Newly issued guidance sets out many of the most common frivolous arguments used by tax-avoidance schemes and details potential civil and criminal penalties that may be imposed.

PURPOSE

The Service is aware that some taxpayers are attempting to reduce their federal tax liability by claiming that the federal income tax is unlawful because it violates one or more provisions of the United States Constitution, or that they have a constitutional right not to comply with the federal tax laws. The Service is also aware that promoters, including return preparers, are advising or recommending that taxpayers take frivolous positions based on these arguments. Some promoters market a package, kit, or other materials that claim to show taxpayers how they can avoid paying income taxes based on these and other meritless arguments.

This revenue ruling emphasizes to taxpayers and to promoters and return preparers that a taxpayer cannot avoid income tax by making frivolous constitutionally based arguments.

The Service is committed to identifying individuals who attempt to avoid or evade their federal tax obligations by taking frivolous positions, including frivolous constitutional positions. The Service will take vigorous enforcement action against these taxpayers and against promoters and return preparers who assist taxpayers in taking these frivolous positions. Frivolous returns and other similar documents submitted to the Service are processed through its Frivolous Return Program. As part of this program, the Service confirms whether taxpayers who take frivolous positions have filed all of their required tax returns, computes the correct amount of tax and interest due, and determines whether civil and criminal penalties should apply. The Service also determines whether civil or criminal penalties should apply to return preparers, promoters, and others who assist taxpayers in taking frivolous positions, and recommends whether a court injunction should be sought to halt these activities. Other information about frivolous tax positions is available on the Service website at www.irs.gov.

ISSUES

1. Whether a taxpayer may refuse to file a federal income tax return, or to pay federal income tax, based on claims that the federal income tax is unconstitutional?

2. Whether a taxpayer may refuse to file a federal income tax return based on the claim that the requirement to do so violates the prohibition against self-incrimination contained in the Fifth Amendment to the U.S. Constitution?

FACTS

1. Taxpayer A is a United States citizen who resides in state X. A attended seminars on the federal tax system sponsored by S, an attorney. S made claims at these seminars that the federal income tax is unconstitutional because: (a) the Sixteenth Amendment to the U.S. Constitution, which authorizes a federal income tax, was not properly ratified by the states; (b) the federal income tax violates the due process clause of the Fifth Amendment to the U.S. Constitution; and (c) the payment of taxes is a form of involuntary servitude or slavery prohibited by the Thirteenth Amendment to the U.S. Constitution. Based on these constitutionally-based positions promoted by S, A filed a Form W-4, Employee's Withholding Allowance Certificate, with A's employer that claimed excess exemptions so that little or no federal income tax would be withheld from A's wages in 2004. Taxpayer A earned $40,000 of taxable income in 2004. Relying on these constitutionally-based positions promoted by S, A did not file a federal income tax return for 2004.

2. Taxpayer B is a United States citizen who earned $40,000 in taxable income in 2004. On B's 2004 Form 1040, federal income tax return, B wrote "Fifth Amendment privilege" on each line and did not report any taxable income for the year.

LAW AND ANALYSIS

The Sixteenth Amendment provides that Congress shall have the power to lay and collect taxes on income, from whatever source derived, without apportionment among the several states and without regard to any census or enumeration. U.S. CONST. amend. XVI. The United States Supreme Court has upheld the constitutionality of the income tax laws enacted subsequent to ratification of the Sixteenth Amendment. See, e.g., Brushaber v. Union Pac. R.R. Co. [ 1 USTC ¶4], 240 U.S. 1 (1916) (relying on the Sixteenth Amendment in holding that the income tax provisions of the Tariff Act of 1913 were not unconstitutional).

Promoters who claim that the federal income tax is unconstitutional often make frivolous arguments that there were defects in the ratification of the Sixteenth Amendment by the states. There are a number of variations on these frivolous arguments: (i) versions of the Amendment ratified by the states contained defects in spelling, punctuation, wording, or capitalization; (ii) state legislatures did not follow proper procedures in ratifying the amendment; (iii) state governors did not sign the amendment; (iv) one or more of the states that ratified the Amendment was not legally a state; and (v) the Amendment does not contain an enabling clause. These arguments have no merit, and courts have consistently rejected all challenges to the constitutionality of the federal income tax following enactment of the Sixteenth Amendment. See Knoblauch v. Commissioner [ 85-1 USTC ¶9109], 749 F.2d 200, 201 (5th Cir. 1984) ("Every court that has considered this argument has rejected it."). Arguments to the contrary are frivolous.

The Fifth Amendment prevents the federal government from taking property without due process of law. U.S. CONST. amend. V. Due process generally includes a right to notice and an opportunity to be heard. The Supreme Court has held that the procedures contained in the Internal Revenue Code fully satisfy the due process rights of taxpayers. See Phillips v. Commissioner [ 2 USTC ¶743], 283 U.S. 589, 595-99 (1931) ("The right of the United States to collect its internal revenue by summary administrative proceedings has long been settled. Where, as here, adequate opportunity is afforded for a later judicial determination of the legal rights, summary proceedings to secure prompt performance of pecuniary obligations to the government have been consistently sustained."). The argument that due process requires a hearing before tax has to be paid or can be withheld from wages is frivolous.

The federal income tax only requires payment of taxes on a person's income. It does not force a person to labor involuntarily, or to labor at all. The Thirteenth Amendment prohibits slavery and involuntary servitude, except as punishment when convicted of a crime. U.S. CONST. amend. XIII. The Thirteenth Amendment does not proscribe taxation. See Abney v. Campbell [ 53-2 USTC ¶9540], 206 F.2d 836, 841 (5th Cir. 1953) (The specification, that the act violates the Thirteenth Amendment by imposing involuntary servitude upon an employer of domestic servants, seems to us far-fetched, indeed frivolous."). Moreover, a prison sentence for failing to file a federal income tax return is not prohibited by the Thirteenth Amendment. See United States v. Drefke [ 83-1 USTC ¶9354], 707 F.2d 978, 983 (8th Cir. 1983) ("The Thirteenth Amendment, however, is inapplicable where involuntary servitude is imposed as punishment for a crime."). Failing to file a federal income tax return or to pay federal income tax based on the argument that it would constitute involuntary servitude is frivolous.

The Fifth Amendment provides that in a criminal case a person may not be compelled to be a witness against himself. U.S. CONST. amend. V. This generally means that a person cannot be forced to answer a question if the answer will be used against that person in a criminal prosecution. Courts have routinely held, however, that the Fifth Amendment provides no basis for failing or refusing to file a tax return. United States v. Stillhammer [ 83-1 USTC ¶9379], 706 F.2d 1072, 1076-77 (10th Cir.1983) ("[T]he Fifth Amendment does not serve as a defense for failing to make any tax return, and a return containing no information but a general objection based on the Fifth Amendment does not constitute a return as required by the Code."). The remote possibility that a taxpayer's statement on a tax return might be used as evidence in a future criminal prosecution will not relieve a taxpayer from the obligation to file a tax return and properly report income and pay tax due. See California v. Byers, 402 U.S. 424, 427-29 (1971) ("[T]he remote possibility of incrimination is insufficient to defeat strong policies of disclosure called for by" government regulatory scheme). Additionally, involvement in illegal activities will not relieve a person of the duty to file a federal income tax return because income earned from illegal activities is subject to the federal income tax. United States v. Sullivan [ 1 USTC ¶236], 274 U.S. 259, 263-64 (1927) ("It would be an extreme if not an extravagant application of the Fifth Amendment to say that it authorized a man to refuse to state the amount of his income because it had been made in crime.").

CIVIL AND CRIMINAL PENALTIES

In determining the correct amount of tax due, the Service will include income that taxpayers attempt to exclude based on frivolous constitutional arguments. In addition to liability for tax due plus statutory interest, individuals who claim tax benefits on their returns based on these and other frivolous arguments face substantial civil and criminal penalties. Potentially applicable civil penalties include: (1) the section 6651 additions to tax for failure to file a return, failure to pay the tax owed, and fraudulent failure to file a return; (2) the section 6662 accuracy-related penalty, which is equal to 20 percent of the amount of taxes the taxpayer should have paid; (3) the section 6663 penalty for civil fraud, which is equal to 75 percent of the amount of taxes the taxpayer should have paid; (4) a $500 penalty under section 6702 for filing a frivolous return; and (5) a penalty of up to $25,000 under section 6673 if the taxpayer makes frivolous arguments in the United States Tax Court.

Taxpayers relying on these positions also may face criminal prosecution for: (1) attempting to evade or defeat tax under section 7201, for which the penalty is a significant fine and imprisonment for up to 5 years; (2) willful failure to make a return or pay tax under section 7203, for which the penalty is a significant fine and imprisonment of up to 1 year; or (3) making false statements on a return under section 7206, for which the penalty is a significant fine and imprisonment for up to 3 years.

Persons, including return preparers, who promote these frivolous positions and those who assist taxpayers in claiming tax benefits based on these frivolous arguments may face penalties and may be enjoined by a court pursuant to sections 7407 and 7408. Potential penalties include: (1) a $250 penalty under section 6694 for each return prepared by an income tax preparer who knew or should have known that the taxpayer's argument was frivolous (or $1,000 for each return if the return preparer's actions were willful, intentional or reckless); (2) a penalty under section 6700 for promoting abusive tax shelters; (3) a $1,000 penalty under section 6701 for aiding and abetting the understatement of tax; and (4) criminal prosecution under section 7206, for which the penalty is a significant fine and imprisonment for up to 3 years for assisting or advising about the preparation of a false return or other document under the internal revenue laws.

HOLDINGS

1. The Sixteenth Amendment to the U.S. Constitution was properly ratified and authorizes the federal income tax. Filing a federal income tax return and paying federal income tax does not constitute the taking of property without due process of law under the Fifth Amendment to the U.S. Constitution. Filing a federal income tax return, paying federal income tax, and incarceration for failure to comply with federal income tax obligations is not involuntary servitude or slavery prohibited by the Thirteenth Amendment to the U.S. Constitution. Arguments to the contrary are frivolous.

2. A taxpayer may not properly refuse to file a federal income tax return based on the claim that the requirement to do so violates the prohibition against self-incrimination of the Fifth Amendment to the U.S. Constitution. Arguments to the contrary are frivolous.

DRAFTING INFORMATION

This revenue ruling was drafted by the Office of Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact that office at (202) 622-7950 (not a toll-free call).

 

 

 

 

Rev. Rul. 2005-20 , I.R.B. 2005-14, March 14, 2005 .

[ Code Secs. 1, 6662, 6663, 6673, 6702, 7203, 7206 and 7408]


Avoidance of tax: Tax shelters: Penalties, civil: Failure to file return: Failure to pay tax: Filing a false return: Frivolous return: Substantial understatement: Negligence: Fraud penalties: Tax shelter promoters: Tax protestors: Constitutional challenges against tax. --

Taxpayers may not refuse to file returns, or reduce or eliminate their tax liability based on their opposition to government programs or policies. Pursuant to this argument, taxpayers claim that they are not required to pay taxes if those taxes are used to support government programs or policies with which they disagree based on moral, ethical or religious beliefs. There is no authority under the Internal Revenue Code or other applicable law, however, that allows taxpayers to avoid tax liability because they do not agree with the government's programs or policies.

PURPOSE

The Service is aware that some taxpayers are attempting to reduce or eliminate their federal tax liability by taking the position that they are not required to pay taxes if those taxes might be used to support government programs or policies with which they disagree. Common examples include moral, ethical, or religious opposition to government spending for weapons programs, military operations, or medical research. The Service is also aware that promoters, including return preparers, are advising or recommending that taxpayers take frivolous positions based on these arguments. Some promoters market a package, kit, or other materials that claim to show taxpayers how they can avoid paying taxes based on these and other meritless arguments.

This revenue ruling emphasizes to taxpayers and to promoters and return preparers that liability for federal taxes does not depend on whether the taxpayer agrees with the government programs or policies that are funded with tax receipts. Any argument that taxpayers may refuse to report income or claim deductions because they oppose particular government programs or policies is frivolous and has no merit.

The Service is committed to identifying taxpayers who attempt to avoid their tax obligations by taking frivolous positions, including frivolous positions based on opposition to government programs or policies. The Service will take vigorous enforcement action against these taxpayers and against promoters and return preparers who assist taxpayers in taking these frivolous positions. Frivolous returns and other similar documents submitted to the Service are processed through its Frivolous Return Program. As part of this program, the Service confirms whether taxpayers who take frivolous positions have filed all of their required tax returns, computes the correct amount of tax and interest due, and determines whether civil and criminal penalties should apply. The Service also determines whether civil or criminal penalties should apply to return preparers, promoters, and others who assist taxpayers in taking frivolous positions, and recommends whether a court injunction should be sought to halt these activities. Other information about frivolous tax positions is available on the Service website at www.irs.gov.

ISSUE

Whether a taxpayer's disagreement with government programs or policies on moral, ethical, religious or other grounds allows the taxpayer to refuse to file federal tax returns or to refuse to pay part or all of the taxpayer's federal tax liability?

LAW AND ANALYSIS

Section 1 of the Internal Revenue Code imposes a tax on all taxable income. There is no authority under the Internal Revenue Code or any other applicable law that allows taxpayers to refuse to file tax returns because they do not agree with government programs or policies. Further, it is well settled that deductions and credits are a matter of legislative grace and are not allowed unless specifically provided for in the Internal Revenue Code. INDOPCO, Inc. v. Commissioner [ 92-1 USTC ¶50,113], 503 U.S. 79, 84 (1992). There is no provision in the Internal Revenue Code that permits taxpayers to file returns claiming deductions or credits that reduce their taxable income by the percentage they estimate the government spends on programs or policies with which they disagree.

These frivolous positions are variations of arguments taxpayers have made about religion and taxation that have been repeatedly rejected by the courts. In United States v. Lee [ 82-1 USTC ¶9205], 455 U.S. 252 (1982), a member of a religious denomination claimed that the payment of social security taxes violated his First Amendment right to free exercise of religion. The United States Supreme Court rejected this argument, stating that "the tax system could not function if denominations were allowed to challenge the tax system because tax payments were spent in a manner that violates their religious belief." Id. at 260. The Court held that religious or moral beliefs that conflict with the payment of tax provide no basis for resisting the tax. Id.

Courts repeatedly have rejected these and similar arguments that a taxpayer's religious or moral beliefs permit the avoidance of federal taxes, and have imposed penalties against taxpayers who make these arguments. See Schehl v. Commissioner [ 88-2 USTC ¶9493], 855 F.2d 364, 367 (6 ^th Cir. 1988) ("Alleged vocal opposition to taxes for a particular reason, and refusal to pay taxes, even if all assertions were taken as true...are simply not a basis to challenge an assessment of taxes."); Nelson v. United States [ 86-2 USTC ¶9545], 796 F.2d 164 (6 ^th Cir. 1986) (upholding the applicability and constitutionality of a frivolous return penalty imposed against a taxpayer who claimed a deduction based on religious objection to war expenditures); Randall v. Commissioner [ 84-2 USTC ¶9562], 733 F.2d 1565, 1567 (11 ^th Cir. 1984) ("[A]rguments involving objections to the Government's military expenditures as a basis for non-payment of taxes have been raised by taxpayers many times, and in each instance the courts have rejected them.").

CIVIL AND CRIMINAL PENALTIES

The Service will disallow deductions or other claimed tax benefits, including the exclusion of income, based on frivolous arguments regarding opposition to government programs or expenditures. In addition to liability for tax due plus statutory interest, individuals who claim tax benefits on their returns based on these and other frivolous arguments may face substantial civil and criminal penalties. Potentially applicable civil penalties include: (1) the section 6662 accuracy-related penalty, which is equal to 20 percent of the amount of taxes the taxpayer should have paid; (2) the section 6663 penalty for civil fraud, which is equal to 75 percent of the amount of taxes the taxpayer should have paid; (3) a $500 penalty under section 6702 for filing a frivolous return; and (4) a penalty of up to $25,000 under section 6673 if the taxpayer makes frivolous arguments in the United States Tax Court.

Taxpayers relying on these frivolous positions also may face criminal prosecution for: (1) attempting to evade or defeat tax under section 7201, for which the penalty is a significant fine and imprisonment for up to 5 years; or (2) making false statements on a return under section 7206, for which the penalty is a significant fine and imprisonment for up to 3 years.

Persons who promote these frivolous positions and those who assist taxpayers in claiming tax benefits based on these positions may be enjoined by a court pursuant to sections 7407 and 7408 and also may face potential civil and criminal penalties. Potential penalties include: (1) a $250 penalty under section 6694 for each return prepared by an income tax return preparer who knew or should have known that the taxpayer's argument was frivolous (or $1,000 for each return if the return preparer's actions were willful, intentional, or reckless); (2) a penalty under section 6700 for promoting abusive tax shelters; (3) a $1,000 penalty under section 6701 for aiding and abetting the understatement of tax; and (4) criminal prosecution under section 7206, for which the penalty is a significant fine and imprisonment for up to 3 years, for assisting or advising about the preparation of a false return or other document under the internal revenue laws.

HOLDING

Taxpayers may not refuse to file tax returns and may not claim deductions or credits on their tax returns based on their opposition to government programs or policies. Any claim that individuals may reduce their federal tax liability based on objections to the use of the taxes to support government programs or policies is frivolous and has no merit.
DRAFTING INFORMATION

The principal author of this revenue ruling is the Office of the Associate Chief Counsel (Procedure & Administration) Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact that office at (202) 622-7950 (not a toll-free call).

 

 

 

Rev. Rul. 2005-21 , I.R.B. 2005-14, March 14, 2005 .

[ Code Secs. 1, 6651, 6662, 6663, 6673, 6701, 6702, 7203, 7206 and 7408]


Avoidance of tax: Penalties, civil: Failure to file return: Failure to pay tax: Filing a false return: Frivolous return: Substantial understatement: Negligence: Fraud penalties: Tax shelter promoters: Tax protestors. --

The use of different forms of a taxpayer's name does not create a "straw man" that allows the taxpayer to avoid his or her tax liability. Using this theory, taxpayers claim that only documents using an individual's name with the standard capitalization (the first letter of each word capitalized and all other letters lower case) are legitimate. Documents identifying the individual in any other format, such as in all capitals, refer to a straw man. Further, taxpayers are not liable for the debts of their straw man because (1) a straw man is a debt instrument based on the labor of a real person, which is a form of slavery, or (2) the debt can be satisfied by money held in a "Treasury Direct Account" in the name of the straw man. IRS guidance provides that there is no authority for the straw man claim.

PURPOSE

The Service is aware that some taxpayers are attempting to reduce their federal tax liability by taking the incorrect position that their incomes are not subject to tax based on a theory that the government has created a separate and distinct entity, or "straw man," in place of the taxpayer and that the taxpayer is not responsible for the tax obligations of the "straw man." Some promoters market a package, kit, or other materials that claim to show taxpayers how they can avoid paying income taxes based on these and other meritless arguments.

This revenue ruling emphasizes to taxpayers and to promoters and return preparers that a taxpayer cannot avoid income tax on the erroneous theory that the government has created a "straw man." This argument has no merit and is frivolous.

The Service is committed to identifying taxpayers who attempt to avoid their tax obligations by taking frivolous positions, including frivolous positions based on meritless "straw man" or similar arguments. The Service will take vigorous enforcement action against these taxpayers and against promoters and return preparers who assist taxpayers in taking these frivolous positions. Frivolous returns and other similar documents submitted to the Service are processed through its Frivolous Return Program. As part of this program, the Service confirms whether taxpayers who take frivolous positions have filed all of their required tax returns, computes the correct amount of tax and interest due, and determines whether civil and criminal penalties should apply. The Service also determines whether civil or criminal penalties should apply to return preparers, promoters, and others who assist taxpayers in taking frivolous positions, and recommends whether a court injunction should be sought to halt these activities. Other information about frivolous tax positions is available on the Service website at www.irs.gov.

ISSUE

Whether the government's use of different forms of a taxpayer's name ( e.g., different capitalization formats, spellings) creates a "straw man," which is a separate and distinct legal entity from the taxpayer to allow the taxpayer to avoid federal tax obligations?

DISCUSSION OF THE "STRAW MAN" CLAIM

The "straw man" claim is premised on the erroneous theory that most government documents do not actually refer to individuals. Users of the "straw man" theory falsely claim that only documents using an individual's name with "standard" capitalization, i.e., lower-case with only the beginning letters of each name capitalized, are legitimate. These individuals erroneously argue that the use of the individual's name in all upper-case letters, which is common in some government documents, refers to a separate legal entity, called a "straw man." These individuals also erroneously argue that, as a result of the creation of a "straw man," they are not liable for the debts, including the tax debts, of their "straw man," that taxing the "straw man" is illegal because the "straw man" is a debt instrument based upon the labor of a real person and is, therefore, a form of slavery, or that no tax is owed by the real individual because it can be satisfied, or offset, by money in a "Treasury Direct Account" held in the name of the "straw man."

All individuals are subject to the provisions of the Internal Revenue Code. Section 1 imposes a tax on all taxable income. Section 61 provides that gross income includes all income from whatever source derived, including compensation for services. Adjustments to income, deductions, and credits must be claimed in accordance with the provisions of the Internal Revenue Code, the accompanying Treasury regulations, and other applicable federal law. Section 6011 provides that any person liable for any tax imposed by the Internal Revenue Code shall make a return when required by Treasury regulations, and that returns must be filed in accordance with Treasury regulations and IRS forms. Section 6012 identifies the persons who are required to file income tax returns. Section 6151 requires that taxpayers pay their tax when the return is due. Section 6311 requires payment of taxes by commercially acceptable means as prescribed by Treasury regulations.

There is no authority under the Internal Revenue Code or any other applicable law that supports the claim that taxpayers may avoid their federal tax obligations based on "straw man" arguments, as described in this revenue ruling, or on similar arguments. The formatting of a taxpayer's name in all upper-case letters on government documents or elsewhere has no significance whatsoever for federal tax purposes. Courts have rejected as frivolous "straw man" arguments. United States v. Furman, 168 F.Supp.2d 609 (E.D. La. 2001) (rejecting criminal defendant's contention that he was not properly identified in federal government documents that misspelled his name or used his properly spelled name in all capital letters). In addition, courts repeatedly have rejected similar arguments based on frivolous claims that purport to provide a basis for avoiding taxes, and have penalized taxpayers who have made these arguments. See, e.g., Lovell v. United States [ 85-1 USTC ¶9208], 755 F.2d 517, 519 (7th Cir. 1984) ("[A]ll individuals, natural or unnatural, must pay federal income tax on their wages...."); United States v. Romero [ 81-1 USTC ¶9276], 640 F.2d 1014, 1017 (9th Cir. 1981) ("[I]n our system of government, one is free to speak out in open opposition to the provisions of the tax laws, but such opposition does not relieve a citizen of his obligation to pay taxes.").

CIVIL AND CRIMINAL PENALTIES

The Service will challenge the claims of individuals who attempt to avoid or evade their federal tax liability by refusing to file returns and pay tax, and will disallow deductions or other claimed tax benefits, including the exclusion of income, based on frivolous "straw man" arguments. In addition to liability for the tax due plus statutory interest, individuals who claim tax benefits on their returns, or fail to file returns, based on these and other frivolous arguments face substantial civil and criminal penalties. Potentially applicable civil penalties include: (1) the section 6651 additions to tax for failure to file a return, failure to pay the tax owed, and fraudulent failure to file a return; (2) the section 6662 accuracy-related penalty, which is equal to 20 percent of the amount of taxes the taxpayer should have paid; (3) the section 6663 penalty for civil fraud, which is equal to 75 percent of the amount of taxes the taxpayer should have paid; (4) a $500 penalty under section 6702 for filing a frivolous return; and (5) a penalty of up to $25,000 under section 6673 if the taxpayer makes frivolous arguments in the United States Tax Court.

Taxpayers relying on these theories also may face criminal prosecution for: (1) attempting to evade or defeat tax under section 7201, for which there is a significant fine and imprisonment for up to 5 years; (2) willful failure to file a return under section 7203, for which there is a significant fine and imprisonment for up to one year; or (3) making false statements on a return, statement, or other document under section 7206, for which there is a significant fine and imprisonment for up to 3 years.

Persons, including return preparers, who promote these theories and those who assist taxpayers in claiming tax benefits based on these frivolous arguments may face penalties and also may be enjoined by courts pursuant to sections 7407 and 7408. Potential penalties include: (1) a $250 penalty under section 6694 for each return or claim for refund prepared by an income tax return preparer who knew or should have known that the taxpayer's argument was frivolous (or $1,000 for each return or claim for refund if the return preparer's actions were willful, intentional or reckless); (2) a penalty under section 6700 for promoting abusive tax shelters; (3) a $1,000 penalty under section 6701 for aiding and abetting the understatement of tax; and (4) criminal prosecution under section 7206, for which there is a significant fine and imprisonment for up to 3 years for assisting or advising about the preparation of a false return, statement or other document under the internal revenue laws.

HOLDING

The use of different forms of a taxpayer's name (different spellings, capitalization, etc.) does not create a "straw man" that allows taxpayers to avoid their federal tax obligations. Claims based on "straw man" arguments or on similar arguments, to avoid federal tax obligations, are frivolous and have no merit.

DRAFTING INFORMATION

The author of this ruling is the Office of Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this ruling, contact that office at (202) 622-7950 (not a toll-free call).