Tax Evasion

Tax Evasion and Failure to File Texas 
An Overview of Federal Prosecutions for Title 26 (Income Tax) Violations

By John Teakell Attorney-At-Law
Dallas, Texas

I. INTRODUCTION

This memo is divided into three main parts and several subparts. The main parts are: 1) statutes and applicable caselaw; 2) the standards for classifying a particular transaction as a gift or loan and important tangentially related issues to the classification; and 3) explaining why it appears that the government can prosecute a transferee even though a donor has already prosecuted regarding tax evasion.

One idea is to argue that payments received are gifts. If the payments are characterized as gifts, then paying the gift tax is the donors' responsibility. However, there is a guarantor-type liability on the part of the donee as well, meaning that the IRS can collect the transferor/donor's gift tax deficiencies from the transferee/donee, even though it is really a donor tax. As for who must report the gift tax, the onus appears to be on the donor to file the return.

II. FEDERAL STATUES, JURY INSTRUCTIONS, AND CASE LAW

A. Elements of tax evasion and failure to file, proper jury instructions, and burden of proof as to the criminal action (as opposed to civil or deficiency action).

1. Statutes for failure to file and tax evasion: Please note that 26 U.S.C.A. § 7201 et seq. contain several different criminal provisions, but I only included Tax Evasion and Failure to File.

26 U.S.C.A. § 7201. Attempt to Evade or Defeat Tax (Tax Evasion).

Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.

26 U.S.C.A. § 7203. Willful failure to file return, supply information, or pay tax. Please note that at the bottom of this section, it is a felony to willfully fail to file for violating section 6050I, which pertains to cash receipts (which might include negotiable instruments) in one transaction (or 2 or more related transactions) of greater than $10,000 acquired by a business while in the course of that business. This might really hit your clients hard if money deposits are considered business transactions.

Any person required under this title to pay any estimated tax or tax, or required by this title or by regulations made under authority thereof to make a return, keep any records, or supply any information, who willfully fails to pay such estimated tax or tax, make such return, keep such records, or supply such information, at the time or times required by law or regulations, shall, in addition to other penalties provided by law, be guilty of a misdemeanor and, upon conviction thereof, shall be fined not more than $25,000 ($100,000 in the case of a corporation), or imprisoned not more than 1 year, or both, together with the costs of prosecution. In the case of any person with respect to whom there is a failure to pay any estimated tax, this section shall not apply to such person with respect to such failure if there is no addition to tax under section 6654 or 6655 with respect to such failure. In the case of a willful violation of any provision of section 6050I, the first sentence of this section shall be applied by substituting "felony" for "misdemeanor" and "5 years" for "1 year".

2. Proper Jury Instructions on Tax Evasion:

U.S. v. Masat, 948 F.2d 923 (5th Cir.(Tex.) Dec 03, 1991) - tax evasion instructions (not just whether the transactions were gifts or loans).

Page 931:

Masat also contests the district court instructions regarding the essential elements of tax evasion under 26 U.S.C.A. § 7201.FN13 To establish a violation of section 7201, the Government must prove beyond a reasonable doubt: (1) the existence of a tax deficiency; (2) an affirmative act constituting evasion or attempted evasion of the tax; and (3) willfulness. See United States v. Kim, 884 F.2d 189, 192 n. 1 (5th Cir.1989) (citation omitted); United States v. Chesson, 933 F.2d 298, 303-04 (5th Cir.1991), cert. denied, 502 U.S. 981, 112 S.Ct. 583, 116 L.Ed.2d 608 (1991) (citations omitted).

Pages 931-32, n.15:

FN15. The district court instructed the jury:

An act is done knowingly if it is done voluntarily. The purpose of adding the word, "knowingly," in an indictment is to insure that no one would be convicted for an act done because of mistake, accident, or other innocent reason. Willfulness is an essential element of the crime of tax evasion. A person acts "willfully" in regard to the offenses charged against the defendant, if he voluntarily and intentionally violates a known legal duty; specifically, a person acts willfully if: (1) he commits such a violation for the purpose of depriving the government of taxes and revenues imposed by and derived from the income tax laws; (2) it is the legal duty of such person to make such payments to the government; and (3) such person knows it is his legal duty to make such payments.

Defendant's conduct is not "willful" if he acted through negligence, even gross negligence, inadvertence, justifiable excuse or mistake, or due to his good faith misunderstanding of the requirements of the law. In this connection the defendant contends that he had a good-faith misunderstanding of his obligations under the law. Whether such a good-faith misunderstanding exists or not is a question of fact for your determination. You are instructed that if you find defendant, in good faith, did not understand his legal obligations, he is entitled to an acquittal. However, you are also instructed that mere disagreement with the law does not constitute good faith misunderstanding of the requirements of the law. It is the duty of all persons to obey the law whether or not they agree with it.

Willfulness necessarily depends upon the defendant's state of mind at the time of the acts or omissions with which he is charged. Intent may be established through inferences drawn from the facts and circumstances established by the evidence.

The government contends that the defendant filed income tax returns in the years prior to the years charged in the indictment. If you find that the defendant did file returns in previous years, you may infer that the defendant knew the law required him to make and file returns. Such knowledge may be considered by you as a circumstance bearing upon the question of whether the defendant's conduct was willful.

[8] The term willful means a voluntary, intentional violation of a known legal duty. *932 See Chesson, 933 F.2d at 304 (citation omitted). The district court explained this term.FN16 Masat's main argument is that the district court should have instructed the jury that the Government must prove that he acted in bad faith or with evil intent. In Cheek v. United States, 498 U.S. 192, 111 S.Ct. 604, 609-10, 112 L.Ed.2d 617 (1991), on remand, 931 F.2d 1206 (7th Cir.1991), the Court similarly noted that willfulness simply means a voluntary, intentional violation of a known legal duty. The Court did not expressly adopt the bad purpose or evil motive language which Masat requested. Thus, the district court's instruction was adequate and embodied the applicable law.FN17

3. How does the IRS prove a deficiency (the first element of a criminal tax evasion case)?

One of two methods: 1) specific items theory or 2) net worth theory.

U.S. v. Smith, 890 F.2d 711 (5th Cir.(Miss.) Dec 04, 1989)

Page 713

Before discussing the error asserted by appellant, it is best for us to describe generally the mechanics of a net worth case. An income tax return reflects the taxpayer's statement to the government that the taxpayer received money (or items of value) and that the receipts, after appropriate deduction, were subject to the applicable tax. The government may question a taxpayer's voluntary disclosure and certification of correctness by employing one or both of two generally accepted analytical methods. The government can present evidence that a specific item of income was not disclosed on the return, i.e., taxpayer did not include wages from his employment with XYZ Corporation or his interest income from a savings account with ABC Homestead. The government may also demonstrate that specific deductions were not experienced by the taxpayer, or were inflated. This procedure is known as the specific items theory.

Another method which may be employed is the net worth analysis. Simply stated, an increase in a taxpayer's patrimony must be traced to acquisitions with after tax income, donations or non-taxable transactions. If these sources fail to explain the increase and the increase can reasonably be attributed to sources which should have been reported, but were not, the taxpayer may well be convicted of tax fraud.

[1] The government utilized both the specific items method and the net worth method in prosecuting its case against the taxpayer. For the return year of the taxpayer's defeat, 1983, only the net worth method was invoked. The net worth method has long been approved as a tool to prove a willful violation as required by 26 U.S.C. § 7201. See Holland, 348 U.S. 121, 75 S.Ct. 127, 99 L.Ed. 150 (1954); Tax Management Criminal Tax Procedure, 162-Second A10-13. Essential to this methodology is the taxpayer's opening net worth. The government must prove the taxpayer's opening net worth for calendar year 1983 with reasonable certainty.

Holland, 348 U.S. at 132, 75 S.Ct. at 133-34; United States v. Terrell, 754 F.2d 1139, 1146 (5th Cir.), cert. denied, 472 U.S. 1029, 105 S.Ct. 3505, 87 L.Ed.2d 635 (1985); United States v. Sorrentino, 726 F.2d 876 (1st Cir.1984). We join the Seventh Circuit in observing that sloppy or mediocre financial and accounting evaluation upon which a conviction is obtained can be the genesis for reversal. United States v. Achilli, 234 F.2d 797 (7th Cir.1956), aff'd on other grounds, 353 U.S. 373, 77 S.Ct. 995, 1 L.Ed.2d 918 (1957).

4. Burden of proof as to whether the transactions are gifts/loans or income in a criminal case:

U.S. v. Richerson, 833 F.2d 1147 (5th Cir.(La.) Dec 02, 1987)

Page 1158

At the beginning of the charge the district court gave a general burden of proof instruction, requiring that the Government prove Richerson's guilt beyond a reasonable doubt. With regard to the tax counts the district court specifically instructed the jury that:

In order to establish that offense, the Government must prove both of the following elements beyond a reasonable doubt:

First: That substantial income tax was due and owing from the Defendant in addition to that declared in his tax return; and

Second: That the Defendant knowingly and willfully attempted to evade or defeat such tax.

The district court followed this instruction with various definitions including " A taxpayer must show that a transfer of property is out of 'detached and disinterested generosity' in order to be classified as a gift. The test for determining whether the property is a gift is the donor's intent." (Emphasis added). The four italicized words, "[a] taxpayer must show" are clearly incorrect. The defendant does not have the burden to prove anything in a criminal case.FN27 Again, however, because neither party objected to these four words at trial, the plain error doctrine governs our review.

III. IF TRANSFERRED MONIES ARE CHARACTERIZED AS "GROSS INCOME," DO ANY EXCEPTIONS OR EXCLUSIONS (e.g., gift, loan) APPLY?

A. EXEMPTION/EXCLUSION FROM GROSS INCOME (e.g., GIFTS, LOANS) CONSTRUED NARROWLY

Polone v. C.I.R., 449 F.3d 1041 (C.A.9, 2006) (headnote):

Exemptions from Internal Revenue Code's broad definition of "gross income" as "all income from whatever source derived" are construed narrowly. 26 U.S.C.A. §§ 61(a), 104.

Umbach v. C.I.R., 357 F.3d 1108 (C.A.10, 2003) (headnote):

Internal Revenue Code broadly defines gross income, such that any gain constitutes gross income, unless taxpayer demonstrates that it falls within a specific exemption. 26 U.S.C.A. § 61(a). Note: of course, as you will see later, since this is a criminal prosecution, the government must prove beyond a reasonable doubt that the payments are income (and thus negate that the payments are gifts or loans).

Fortune v. U.S., 4 Cl.Ct. 670 (Cl.Ct., 1984) (headnote):

Deductions or exclusions from gross income are matters of legislative grace and are not matters of right or equity.

B. WHAT IS A "GIFT" FOR TAX PURPOSES?

C.I.R. v. Duberstein, 363 U.S. 278 (1960) - This is the style case by the US Supreme Court laying out the "gift" test for tax purposes.

Pages 285-86

The course of decision here makes it plain that the statute does not use the term 'gift' in the common-law sense, but in a more colloquial sense. This Court has indicated that a voluntarily executed transfer of his property by one to another, without any consideration or compensation therefor, though a common-law gift, is not necessarily a 'gift' within the meaning of the statute. For the Court has shown that the mere absence of a legal or moral obligation to make such a payment does not establish that it is a gift. Old Colony Trust Co. v. Commissioner, 279 U.S. 716, 730, 49 S.Ct. 499, 504, 73 L.Ed. 918. And, importantly, if the payment proceeds primarily from 'the constraining force of any moral or legal duty,' or from 'the **1197 incentive of anticipated benefit' of an economic nature, Bogardus v. Commissioner, 302 U.S. 34, 41, 58 S.Ct. 61, 65, 82 L.Ed. 32, it is not a gift. And, conversely, '(w) here the payment is in return for services rendered, it is irrelevant that the donor derives no economic benefit from it.' Robertson v. United States, 343 U.S. 711, 714, 72 S.Ct. 994, 996, 96 L.Ed. 1237.FN7 A gift in the statutory sense, on the other hand, proceeds from a 'detached and disinterested generosity,' Commissioner of Internal Revenue v. LoBue, 351 U.S. 243, 246, 76 S.Ct. 800, 803, 100 L.Ed. 1142; 'out of affection, respect, admiration, charity or like impulses.' Robertson v. United States, supra, 343 U.S. at page 714, 72 S.Ct. at page 996. And in this regard, the most critical consideration, as the Court was agreed in the leading case here, is the transferor's 'intention.'*286 Bogardus v. Commissioner, 302 U.S. 34, 43, 58 S.Ct. 61, 65, 82 L.Ed. 32. 'What controls is the intention with which payment, however voluntary, has been made.' Id., 302 U.S. at page 45, 58 S.Ct. at page 66 (dissenting opinion). FN8

FN7. The cases including 'tips' in gross income are classic examples of this. See, e.g., Roberts v. Commissioner, 9 Cir., 176 F.2d 221.

FN8. The parts of the Bogardus opinion which we touch on here are the ones we take to be basic to its holding, and the ones that we read as stating those governing principles which it establishes. As to them we see little distinction between the views of the Court and those taken in dissent in Bogardus. The fear expressed by the dissent at 302 U.S. at page 44, 58 S.Ct. at page 66, that the prevailing opinion 'seems' to hold 'that every payment which in any aspect is a gift is * * * relieved of any tax' strikes us now as going beyond what the opinion of the Court held in fact. In any event, the Court's opinion in Bogardus does not seem to have been so interpreted afterwards. The principal difference, as we see it, between the Court's opinion and the dissent lies in the weight to be given the findings of the trier of fact.

[9] [10] [11] The Government says that this 'intention' of the transferor cannot mean what the cases on the common-law concept of gift call 'donative intent.' With that we are in agreement, for our decisions fully support this. Moreover, the Bogardus case itself makes it plain that the donor's characterization of his action is not determinative-that there must be an objective inquiry as to whether what is called a gift amounts to it in reality. 302 U.S. at page 40, 58 S.Ct. at page 64. It scarcely needs adding that the parties' expectations or hopes as to the tax treatment of their conduct in them have nothing to do with the matter.

[12] It is suggested that the Bogardus criterion would be more apt if rephrased in terms of 'motive' rather than 'intention.' We must confess to some skepticism as to whether such a verbal mutation would be of any practical consequence. We take it that the proper criterion, established by decision here, is one that inquires what the basic reason for his conduct was-in fact-the dominant reason that explains his action in making the transfer. Further than that, we do not think it profitable to go.

U.S. v. Terrell

U.S. v. Terrell, 754 F.2d 1139 (5th Cir.(Tex.) Feb 14, 1985) - this is a 5th Circuit tax evasion case where one of the issues was whether payments were gifts. The following excerpt was the jury charge on the definition of a gift. The 5th Circuit upheld it as a proper instruction. Also note, that one of the instructions is that if the transferor pays the money to transferees to keep transferees' business afloat, this instruction would not classify the payments as gifts.

Page 1149, n.3

The court thereafter properly charged the jury on the definition and elements of a gift.FN3

FN3. The instruction on gifts was as follows:

It is for you, the Jury, to decide whether certain funds are taxable or nontaxable to the Defendant. In determining whether a payment of money or property to the Defendant is a nontaxable gift, you should look to the intent of the parties at the time the payment was made, particularly the intent of the person making the payment. Such payments are gifts if they proceed from a detached and disinterested generosity, out of affection, respect, admiration, charity, or like impulses. In making this determination, however, you must look at all the facts and circumstances in this case. The characterization given to a certain payment by either the Defendant or the person making the payment is not conclusive. Rather you the members of the Jury, must make an objective inquiry as to whether a certain payment is a gift. You should look at the terms and substance of any request made by the Defendant for the funds. In addition, you may take into account the following factors:

1. A payment is not a gift if it is made to compensate the Defendant for his services. In this connection, you should consider how the defendant made his living.

2. A payment is not a gift if the person making the payment expects to receive anything in return for it. A payment would not be a gift if it was made with the expectation that it would allow the Defendant to remain in business.

3. A payment is not a gift to the Defendant if it is made with the expectation that it will be used to further the religious or ministerial activities of the Defendant.

4. A payment is not a gift if the person making the payment felt he had a duty or obligation to make the payment.

5. A payment is not a gift if the person making the payment did so out of fear or intimidation.

This is not a complete listing of all the factors you should consider. You should take into account all the facts and circumstances of this case in determining whether any payment was a gift.

We find that the court's instructions were complete and accurate in all respects and reject all of appellant's objections to them as lacking in merit.

In re King, 272 B.R. 281 (Bankr.N.D.Okla., 2002) (headnote):

In determining whether a voluntary transfer of property from one person to another without compensation or consideration is a gift under the Tax Code, if the payment proceeds primarily from the constraining force of any moral or legal duty, or from the incentive of anticipated benefit of an economic nature, it is not a gift. 26 U.S.C.A. § 102.

U.S. v. Harris, 942 F.2d 1125 (C.A.7.Wis., 1991) (headnote):

"Gross income" for tax purposes does not include gifts, which are taxable to donor, rather than to recipient. 26 U.S.C.A. §§ 61, 102(a), 2501(a).

Jensen v. U. S., 511 F.2d 265 (C.A.5.Fla., 1975) (headnote):

Voluntariness of even an isolated transfer does not require conclusion that the transfer constitutes a gift for purpose of Internal Revenue Code provision excluding gifts from taxable income.

C. IF THE TRANSFER IS CONSIDERED A GIFT, THEN DOES GIFT TAX OWE?

It would appear that only the donor of the gift needs to file a gift tax return, based solely on my reading of § 6019, below. Accordingly, if a defendant prevails in arguing that the transfer is a gift, then perhaps the donors will face criminal liability for making a gift without filing a gift tax return. Based on § 6019 (below) it would appear that a donor must file a gift tax return for each year that the donor gifts more than 11k/per year, or possibly face criminal liability. Additionally, we discovered caselaw that would make the donee responsible for paying gift taxes that the donor failed to pay. That said, the donee is not responsible for filing the gift tax return.

26 U.S.C.A. § 6019 -- Gift tax returns

Any individual who in any calendar year makes any transfer by gift other than--

(1) a transfer which under subsection (b) or (e) of section 2503 is not to be included in the total amount of gifts for such year,

(2) a transfer of an interest with respect to which a deduction is allowed under section 2523, or

(3) a transfer with respect to which a deduction is allowed under section 2522 but only if--

(A)(i) such transfer is of the donor's entire interest in the property transferred, and

(ii) no other interest in such property is or has been transferred (for less than adequate and full consideration in money or money's worth) from the donor to a person, or for a use, not described in subsection (a) or (b) of section 2522, or

(B) such transfer is described in section 2522(d), shall make a return for such year with respect to the gift tax imposed by subtitle B.

D. WHO CAN THE IRS COLLECT THE GIFT TAX FROM?

Streber v. Hunter, 221 F.3d 701 (5th Cir.(Tex.) Aug 04, 2000) - Note that the transferor is the party that owes the gift tax. However, the transferees have secondary liability, i.e. they basically act as guarantors for the liability of the transferor.

Page 716, n.18

FN18. "Transferee liability" allows the government to collect gift tax from either the donor or the donee. See 26 U.S.C. § 6901 (allowing the IRS to seek gift tax liability from either the donor, Parker, or the donees, Terry and Tracy); see also Tilton v. Commissioner, 88 T.C. 590, 594, 1987 WL 39956 (1987) ("[S]ection 6901(a)(1)(A) authorizes the assessment of transferee liability, at law or in equity, in the same manner as the liability for gift taxes. This provision, however, does not create any separate liability; it merely provides a secondary method for enforcing the existing liability of a transferor.").

E. HOW DO YOU TELL A GIFT FROM A LOAN:

39 Am. Jur. Proof of Facts 2d 733 - Article called "whether a transfer of money or other personal property was a gift rather than a loan." I attached this article to the e-mail containing this memo.

F. IS THE TRANSFER A LOAN?

G. LOCAL LAW MAY GOVERN THE LOAN DETERMINATION-AT LEAST IN PART-WHETHER A LEGALLY ENFORCEABLE OBLICATION EXISTS ON THE PART OF THE TRANSFEREE TO PAY BACK THE TRANSFEROR

Milenbach v. C.I.R., 318 F.3d 924 (C.A.9, 2003):

[5] [6] Whether a transaction is a loan for federal income tax purposes is ultimately a question of federal law. See Helvering v. Stuart, 317 U.S. 154, 162, 63 S.Ct. 140, 87 L.Ed. 154 (1942) ("Once rights are obtained by local law, whatever they may be called, these rights are subject to the federal definition of taxability."). Initially, however, state law determines the rights and obligations of the parties to a transaction. See id. at 161-62, 63 S.Ct. 140. But once an obligation is created by local law, it is subject to the federal definition of taxability. Id. Here, the dispositive question is whether the LAMCC Agreement was sufficient, under California law, to subject the Raiders to a non-illusory and enforceable obligation to repay the LAMCC advances. If the Raiders were subject to an "existing, unconditional, and legally enforceable obligation" to repay the LAMCC advances, the advances are properly treated as loans for federal income tax purposes. Noguchi, 992 F.2d at 227.

Texas State Law re what creates an enforceable loan agreement:

Aside from a provision requiring loans over $50K to be in writing when the lender is a financial institution, the statute of frauds seems to be silent as to whether an agreement of this type must be in writing. It would seem, therefore, that a loan agreement between a transferor/donor and the transferee, if any, need not be in writing, or at least that's our preliminary conclusion.

H. REPAYMENT OF A DEBT

Another possible defense is to argue that the transferor/donor paid the money to transferee for the purpose of repaying a debt that the transferor owed to transferee.

Boyles v. U.S., 170 F.Supp.2d 573 (M.D.N.C., 2001) (headnote):

Generally speaking, returns on equity are treated as taxable income, while repayments of debt are not, unless they are for interest on a debt.

I. MISCELLANEOUS POINT: Statute of Limitations on collecting taxes (note: there might be different SOL on tax evasion and deficiency actions)

I wanted to bring this up as an issue, given that the alleged period of deficiency/lack of filing often starts a few years earlier.

IV. - MAY THE GOVERNMENT PROSECUTE THE TRANSFEREE FOR TAX EVASION, WHEN THE TRANSFEROR HAS ALREADY BEEN CONVICTED OF SAME?

After examining numerous tax evasion and underreporting cases, we reached the conclusion that the prosecution of the transferor does not provide a defense to any charges brought against the transferee. This is because, in assessing whether or not a transfer of wealth is considered "gross income," the courts focus on the facts arising from how and why the transferee received the money, not how/why the transferor received the money.

Furthermore, 5th circuit cases make clear that any person is liable who attempts to evade or defeat a tax, and it is immaterial that the tax evaded by the accused was that of another. United States v. Townsend, 31 F.3d 262, 267 (5th Cir.1994).

A. Definition of "Gross Income" is BROAD

Further underscoring the above conclusion is the definition of "gross income." The government must prove that the money received by your clients constitutes "gross income;" and if no applicable exclusions exits (e.g., it was a gift, a loan, etc.), then your client may be subject to liability. As the following cases make clear, the definition of "gross income" is extremely broad, and virtually any sort of value received qualifies as "gross income" (presumably, to include money on which the government has based a conviction of the transferor).

Carione v. U.S., 368 F.Supp.2d 186 (E.D.N.Y., 2005) (headnote):

"Gross income" generally refers to assets over which the taxpayer can exercise dominion and control.

U.S. v. Toushin, 899 F.2d 617 (C.A.7.Ill., 1990) (headnote):

Income is taxable when holder has such control over it that he has freedom to dispose of it at will.

Carione v. U.S., 368 F.Supp.2d 186 (E.D.N.Y., 2005) (headnote):

Courts should construe "income" liberally, in recognition of the intention of Congress to tax all gains except those specifically exempted.

Francisco v. U.S., 54 F.Supp.2d 427 (E.D.Pa., 1999) (headnote):

Unless taxpayer can demonstrate that specific exclusion applies, any clearly realized accession to wealth is considered "income." 26 U.S.C.A. § 61(a).

Rennie v. I.R.S., 90 A.F.T.R.2d 2002-5329 (E.D.Cal., 2002) (headnote):