Section 7202 — Willful Failure to Collect or Pay Over Tax
Wednesday, May 29, 2013
Just ask some of these notable Hollywood Stars if its worth it. Recently Lauryn Hill — singer and occasional actress — has been sentenced to three months in federal prison for not paying taxes on the $1.8 million dollars she made from 2005 to 2007.
Other notables who were convicted of tax evasion include:
Martha Stewart: Before doing jail time for insider trading, Stewart was forced to pay $220,000 in back taxes and penalties to the State of
New York, learning the hard way that East Hampton mansions also generate taxes. Her claim that she hardly spent time there didn’t reduce her burden, or appease the state of . New York
Wesley Snipes: Snipes was found guilty on three counts of failing to file a federal income tax return, owing the government $17 million in back taxes plus penalties and interest. His attempt to pay off a portion of what he owed during his trial to avoid jail, failed and in 2008, Snipes was sentenced to three years in prison. He began serving his sentence in December 2010.
Willie Nelson: After seizing most of his assets in 1990, the federal government forced Willie to pay over $16 million in back taxes and fines for his involvement with a bogus tax shelter. Offering a note of redemption it was later discovered that Price Waterhouse had not paid Nelson’s taxes for years and invested the funds instead.
Nicolas Cage: Cage owed $6 million, according to the IRS’ 2009 charge. Accusing his ex-manager and accountant of making poor investment choices in risky real estate and failing to pay his taxes, Cage set out to make good with the IRS, but still paid considerable fines on the taxes. Be careful whom you trust with tax advice.
Marc Anthony: In 2007, the IRS served Anthony with $2.5 million in back tax bills. Then in 2010, he received two additional bills totaling over $3 million for unpaid taxes on real estate. Marc Anthony blames management, but few empathize after the IRS claimed numerous years of zero tax payments.
Annie Leibovitz: In 2009 Leibovitz owed $2.1 million in unpaid taxes for 2004-2007 and was forced to pledge the copyright to every photograph she has ever taken, or ever will, to get the loan she needed to pay her debts.
Darryl Strawberry: Mets or Yankees; Strawberry led them both to World Series titles. After years of signing autographs without paying taxes, Strawberry received a tax evasion conviction.
Boris Becker: Claiming to be living in the tax haven of
Monaco from 1991 to1993, Becker was actually at home in with his wife and kids. When the final ball dropped, Becker paid approximately $3 million in back taxes and interest on earnings from prize money, endorsements and appearance fees. Munich
“Survivor” Richard Hatch: He survived the first season of Survivor, winning $1 million. But when it came time to paying his taxes, he stayed on the island. In 2006, Hatch was found guilty of tax evasion and served part of a six-year prison sentence as a result. Then in March 2011, he returned for his third prison term for failing to file amended returns. Celebrity tax lesson: Don’t “forget” to pay taxes on your income…especially before 51 million television viewers.
Heidi Fleiss: Heidi Fleiss was sentenced in 1997 on tax evasion charges in connection with her high-profile prostitution ring. She served part of her seven-year sentence in prison and a halfway house.
While some celebrities engage in various attempts to avoid paying taxes, from filing false returns to hiding money overseas, regardless of the method or fame of the individual, the government can force those guilty of tax fraud to pay back taxes and penalties, and serve time in confinement—a costly lesson for an avoidable mistake.
TAX CRIMES AND PENALTIES
For civil and criminal tax purposes each year is separate and the government can “stack up” civil and criminal claims.
Civil Tax Penalties
The accuracy-related penalties of §§6662 and 6662A;
The fraud penalty of §6663.
Failure to Pay Tax Not Shown on the Return
A taxpayer who fails to pay a tax that is required to be (but was not) shown on a return within 21 days after the date of the IRS's notice and demand for that tax is subject to a penalty under §6651(a)(3). The notice is the IRS's notice to the taxpayer that it has assessed an additional amount in excess of the amount that has been shown on the return and its demand that the taxpayer pay this assessed amount. The grace period is only 10 business days if the amount for which the notice and demand is made is $100,000 or more.
Computation of the Penalty
The penalty is imposed at the rate of .5% for each month (or part thereof) that the assessment remains unpaid, up to a maximum of 25%. Where the tax is being paid in installments pursuant to an installment agreement with the IRS, the rate is reduced to .25% for any month in which the installment agreement is in effect if the individual taxpayer filed the tax return in a timely manner, including extensions.
The rate is increased under §6651(d) following receipt of a notice of levy or a notice of a jeopardy assessment.
Unlike interest on the same deficiency, which runs from the due date of the return, the §6651(a)(3) penalty runs from 21 calendar days (10 business days if the amount shown on the notice and demand is $100,000 or more) after the date of the notice and demand. The penalty period ends when the IRS receives payment of the penalty.
The Accuracy-Related Penalty
The accuracy-related penalty for underpayments is imposed at the rate of 20% on the portion of any underpayment of tax required to be shown on a return attributable to any of the following:
• Negligence (§6662(b)(1));
• Substantial understatement of tax (§6662(b)(2));
The maximum accuracy-related penalty imposed on any portion of an underpayment is 20%.
The accuracy-related penalty also does not apply to any portion of an underpayment on which the fraud penalty is imposed.
The Fraud Penalty
Section 6663(a) provides that if any part of any underpayment of tax required to be shown on a return is due to fraud, a penalty is imposed equal to 75% of the portion of the underpayment attributable to fraud.
As discussed above, the accuracy-related penalties do not apply to any portion of an underpayment on which the fraud penalty is imposed. In addition, the fraud penalty — like the accuracy-related penalty — applies only when a return has been filed.
Evidence of Fraud:
1. Failure to Report income
The failure to report income generally is not, by itself, adequate evidence of fraudulent intent, but the consistent failure to report substantial amounts of income over a number of years may be a controlling factor in establishing fraud. A fraud penalty based on the failure to report income is generally combined with a deficiency determination. The IRS must not only establish fraud but, as an initial matter, must establish that the unreported income was in fact realized.
2. Lack of Cooperation with IRS
Failure to cooperate with the IRS can be an indication of fraud. Thus, lying or giving evasive answers to IRS investigators, delaying tactics, and other actions designed to mislead IRS agents are all indicia of fraud. These and other indicia or badges of fraud (including acts of concealment, the use of dummy business entities and bank accounts opened under assumed names or in the names of relatives or nominees) can be found in numerous criminal and civil tax fraud cases.
On the other hand, even when substantial amounts of income are not reported, the taxpayer's maintenance of full and complete records, made available to IRS investigators, serves to negate any inference of intentional wrongdoing.
3. Awareness of Tax Laws
The taxpayer's knowledge of the tax law is an important factor in determining whether fraud has been committed.
4. Criminal Prosecution
Comparisons are sometimes made between the elements necessary to convict an individual indicted for criminal tax evasion under and those required to be established by the government in a civil fraud suit.
A conviction or guilty plea in a criminal prosecution brought under collaterally estops a taxpayer from asserting a defense to the fraud penalty for the same taxable year. Yet, when a guilty plea is prompted by unusual factors, such as the poor health of the taxpayer or lack of understanding due to little education, the guilty plea may not be controlling in a subsequent civil case. These circumstances are the exceptions to the rule; a guilty plea usually is sufficient to sustain a finding of civil fraud. A plea of nolo contendere, however, is considered to be a mere statement of the taxpayer's unwillingness to contest the charges made against him and is not admissible evidence with respect to the issue of civil fraud.
A conviction or guilty plea in a criminal prosecution brought under §7206(1) — making false statements on a return — does not collaterally estop the taxpayer from asserting a defense to the fraud penalty for the same taxable year, although the conviction may be considered as evidence of the taxpayer's intent to evade payment of a tax known to be due and owing.
The civil fraud penalty can be imposed upon a taxpayer even though he is acquitted in a criminal fraud prosecution. Because the civil penalty carries a lesser burden of proof, collateral estoppel does not apply. There is also no double jeopardy, even when the civil fraud penalty is imposed on a taxpayer who is ordered to pay a criminal fine after a criminal conviction.
Section 7201 — Tax Evasion
Tax evasion, the most well known of crimes under the Internal Revenue Code, is a felony defined in §7201 as the willful attempt to evade or defeat any tax imposed by Title 26. The basic elements of a prima facie case are:
(1) the existence of a tax deficiency,
(2) an affirmative act constituting an evasion or attempted evasion of the tax, and (3) willfulness.
Conviction under §7201 requires an affirmative act evidencing an intent to conceal income from the imposition of tax. “Congress intended some willful commission in addition to the willful omissions that make up the list of misdemeanors.” For example, filing a false return could be a felonious evasion under §7201, while failing to file a return is a misdemeanor under §7203.
Willfulness has been defined as the “voluntary, intentional violation of a known legal duty.” Previously, a showing of “evil motive, bad purpose, or corrupt design” was required for a conviction of a tax crime. Courts now, however, authorize jury instructions that do not include such language. “Bad purpose” and “evil purpose” are not “magic words” that must be invoked in each criminal tax case. A good faith misunderstanding of the law is a defense to a tax crime.
Negligence, even gross negligence, is insufficient to establish willfulness. Thus, reckless disregard for the truth or negligent failure to inquire into the facts underlying criminal activity is insufficient to support a conviction.
Direct proof of willfulness is often unavailable. Circumstantial evidence of this element of the crime may consist of, inter alia, failure to report a substantial amount of income, a consistent pattern of underreporting large amounts of income, and the expenditure of large amounts of cash that cannot be reconciled with reported income. An “affirmative willful attempt” can be inferred from, inter alia, keeping false account books and records, destruction of records, concealment of assets or income, avoidance of usual transactional records, and any other act likely to mislead or conceal. The Internal Revenue Manual sets forth a list of potential “badges of fraud” that might be deemed to constitute a willful attempt. IRM 220.127.116.11.2 (5-14-99).
Fraud, as distinguished from negligence, is always intentional. One of the elements of fraud is an intent to evade tax. Some of the indications of fraud are as follows:
A. False explanations regarding understated or omitted income;
B. Large discrepancies between actual and reported deductions of income;
C. Concealment of income sources;
D. Numerous errors, all in the taxpayer’s favor;
E. Fictitious records or other deceptions;
F. Large omissions of personal service income, specific items of income, gambling winnings, or illegal income;
G. False deductions, exemptions, or credits;
H. Failure to keep or furnish records;
I. Incomplete information given to the return preparer regarding a fraudulent scheme;
J. Large and frequent cash dealings that may or may not be common to the taxpayer’s business; and
K. Verbal misrepresentations of the facts and circumstances.
The defendant may be convicted under §7201 even if the amounts of taxes evaded are not substantial; the statute contains no substantiality requirement. IRS guidelines issued in 1989, however, state that in cases in which the “specific item” method of proof is used an indictment will be sought under §7201 only if the average yearly tax deficiency for the period under investigation is $2,500 or more. For cases in which an “indirect method of proof is utilized prosecution generally will not be sought unless the aggregate tax deficiency for the period under investigation is $10,000 or more. Such prosecutorial “floors” may be waived in flagrant cases, or where income is derived from illegal activities.
Under the Code, upon conviction of tax evasion the defendant may be fined, or imprisoned not more than five years, or both, and made to pay the costs of prosecution and any special assessments. Under 18 U.S.C. §3571, the maximum fine is $250,000 for individuals and $500,000 for corporations.
Section 7202 proscribes the willful failure to collect or pay over tax. This section provides penalties to ensure that employers comply with their obligation to withhold federal wage and FICA taxes and pay over to the government the sums withheld. In order to sustain a conviction under this section, both the failure to truthfully account for and the failure to pay over must be willful.
Under the Code, upon conviction, a defendant may be fined, or imprisoned not more than five years, or both, and made to pay the costs of prosecution. The maximum fine is $250,000 for individuals and $500,000 for corporations
Section 7206 — False Returns and Preparers of False Returns
Section 7206, a felony provision, is violated by, inter alia, any person who willfully makes any document under the Internal Revenue laws that he does not believe to be true and correct and any person who willfully aids or assists in the preparation of any document under the Internal Revenue laws that is fraudulent or false. It is the most frequently charged criminal tax violation. In a prosecution brought under §7206, venue lies in the district in which the return was signed, or in which the return was filed, or in which the acts of aiding and assisting took place.
Upon conviction the defendant may be fined, or imprisoned not more than three years, or both, and made to pay the costs of prosecution. Under the Criminal Fine Enforcement Act of 1984, the maximum fine is $250,000 for individuals and $500,000 for corporations.
The requisite elements of an offense under §7206(1) are:
(1) a belief that the return, statement or other document is not true and correct;
(3) materiality; and
(4) the making and subscribing of the document in question under penalty of perjury. The perjury is deemed to occur when the false entry is made, even if it is never relied upon.
This statute is used by the government where it is possible to prove the falsity of a return but where it would be difficult to establish the requirement of §7201 that the falsification was motivated by tax evasion. Thus, §7206 is a lesser included offense of §7201. As §7206(1) proscribes the making and subscribing of a return, only the taxpayer himself may be prosecuted under this provision.
Section 7207 — Submitting False Documents
Section 7207, a misdemeanor, is violated by any person “who willfully delivers or discloses to the Secretary [of the Treasury] any list, return, account, statement, or other document,” or other disclosures regarding private foundations 114 or information required as to certain retirement and bond-sharing plans under §6047(b), “known by him to be fraudulent or to be false as to any material matter.”
Section 7207 differs from the more serious §7206(1) in that the latter requires a subscription under penalties of perjury while the former does not; liability can attach under §7207 even when the taxpayer delivers a document prepared and signed by another person. 118 Moreover, while attempted evasion under §7201 requires an actual tax deficiency, the §7207 offense does not; the fact that a false statement does not actually influence the IRS is immaterial.
In a prosecution brought under §7207, venue is proper in the judicial district in which the false document is delivered or disclosed to the IRS. Upon conviction of this misdemeanor, the defendant may be fined up to $10,000 ($50,000 in the case of a corporation), or imprisoned not more than one year, or both. Under the Criminal Fine Enforcement Act of 1984, the maximum fine is $100,000 for individuals and $200,000 for corporations.
Statute of Limitations
An indictment must be brought within six years of the commission of the offense for most tax crimes, 146 including the following offenses:
Section 6531 actually creates a general three-year limitation period for prosecution of tax crimes, but the six-year “exceptions” encompass virtually all tax crimes prosecuted with any frequency.
• Defrauding or attempting to defraud the
in any manner, whether by conspiracy or not; United States
• Tax evasion (§7201);
• Aiding or assisting in the preparation or presentation of a false return or document (§7206(2));
• Willful failure to file or to pay tax (§7203);
• Offenses described in §§7206(1) and 7207 (i.e., false statements or documents whether or not verified under the penalties of perjury).
Wednesday, May 15, 2013
In Vlach v. Comm'r, T.C. Memo. 2013-116 (April 30, 2013), the Tax Court held that a series of trusts created by a physician to hold his personal and business assets and activities were shams that must be ignored for federal tax purposes. In particular, the court noted:
A. The trust documents were purchased from an abusive trust promoter,
B. The taxpayers executed the forms without variation and without seeking independent legal or tax advice,
C. The taxpayers employed a return preparer referred by the promoter,
D. The trusts never paid a salary to the physician even though he provided medical services on behalf of the trust,
E. The trust funds were used to pay the physician's personal expenses,
F. The taxpayers' relationship to the trusts' assets did not materially change after the trusts were created,
G. No economic interest passed to anyone other than the taxpayers, and
H. No documents imposed any meaningful restriction on the taxpayers' use of the trusts' property.
The court rejected the claim that the trusts were created for asset protection, noting that the taxpayers never established that the trusts actually owned the medical equipment and real estate purportedly rented by them, or that the trust structure offered more protection against potential lawsuits than the corporate form used to operate the doctor's medical practice.
A trust recognized as valid under state law isn't necessarily also recognized for income tax purposes. For instance, tax law isn't necessarily satisfied with the informality permissible under state trust law. Clear evidence of the trust's existence, and actual consistent treatment of the funds as trust funds manifestly separate from those of the settlor is required. The use of the terms “trust”, “trustee”, and “beneficiaries” isn't conclusive. Nor is any weight given to elaborate trust documents if they are part of a canned, mass-produced package that is marketed for a fee.
A trust will be ignored for tax purposes if it's considered a sham. Thus, a trust that has no economic substance apart from tax considerations will be disregarded for tax purposes, and the income of the trust will be taxed to the person who controls the trust. The Tax Court considers the following factors in deciding whether a trust lacks economic substance:
(1) whether the taxpayer's relationship to the property differed materially before and after the trust's formation;
(2) whether the trust had an independent trustee;
(3) whether an economic interest passed to other trust beneficiaries;
(4) whether the taxpayer felt bound by any restrictions imposed by the trust itself or by the law of trusts.
The Tax Court also considers whether the taxpayer has a basic understanding of the trust's operations.
Asset protection whatever form it takes is serious business and those who are interested must seek advice from a knowledgeable practitioner and avoid those who purport to provide solutions which have no economic consequence and is nothing more that paper shuffling.
Monday, May 6, 2013
The Colorado Senate recently approved a bill (HB 1042) that would allow medical marijuana businesses to deduct their expenses from their taxable income.
The legislature legalized the possession and sale of small amounts of marijuana in November 2012, and the state has had a thriving medical marijuana industry since 2009.
Most Colorado businesses can deduct their expenses automatically since their state taxes are based on their federal taxable income. But marijuana businesses are still illegal under federal law and cannot deduct their expenses under IRC section 280E. HB 1042 would allow those businesses to deduct expenses like rent and personnel costs from their state taxable income.
Sen. Lucía Guzmán (D), who sponsored the legislation, said it is a matter of fairness for businesses that have been operating with a state license. The bill allows those businesses to deduct "the regular kinds of business expenses that any other business in Colorado would be able to deduct," she said.
"It doesn't really matter anymore what you think of marijuana. It is a legal business," said Sen. Cheri Jahn (D). "And therefore they should be treated like any other business in the state of Colorado."
HB 1042 would apply only to medical marijuana businesses. The bill now goes to Gov. John Hickenlooper (D), and he is expected to sign it.