False tax returns, mail fraud, and money laundering.

• Author: Andreozzi, Randall P.

Tax return preparers take note: The Third Circuit Court of Appeals (1) may have opened the door to a new approach that could result in significantly increased criminal penalties for taxpayers who file false returns. According to the court's opinion in Yusuf, (2) taxpayers who mail or e-file their tax returns and knowingly understate their taxable income thereon may be exposing themselves to the same money laundering charges levied against drug dealers and financiers of international terrorism. To make matters worse, in Yusuf these counts were stacked upon some of the more traditional tax crimes imposed under the Internal Revenue Code. (3)

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At present, the significance of Yusuf is unclear. The Eleventh Circuit has reached a contrary result in a case (4) involving facts similar to Yusuf. Moreover, recent amendments to the federal money laundering statutes included in the Fraud Enforcement and Recovery Act of 2009 (FERA) (5) have further complicated the issues raised in the case.

A simple example demonstrates the potential consequences of the Yusuf decision. Picture a client operating a cash-generating business, such as a retail store or a restaurant. (6) Traditionally, if that client willfully underreports the business's income on a federal tax return, the client faces the risk of various civil and criminal tax penalties under the Internal Revenue Code. On the criminal side, the government could charge the client with criminal tax evasion under Sec. 7201, which carries a maximum prison sentence of five years and a fine of up to $100,000 (or $500,000 in the case of a corporation). Alternatively, the government could charge the client with willfully making a false statement on his or her tax return under Sec. 7206(1), which carries a maximum prison sentence of three years and a fine of up to $100,000 (or $500,000 in the case of a corporation). These criminal sanctions may be imposed in addition to any civil tax, penalties, and interest that may be assessed. A major purpose of the penalty regime in the Code is to deter tax crimes. (7)

The addition of mail or wire fraud and money laundering charges raises the stakes. Under Yusuf, a client could now face the very real possibility of 20 years or more in prison and the forfeiture of any assets involved in or traceable to the money laundering. Tax advisers everywhere need to take notice of this holding and consider its potential application. The concerns raised by the decision are an issue not only for taxpayers facing criminal investigation but also for clients who aggressively seek to minimize their tax liability. This article examines Yusuf and the money laundering statutes, including the applicable provisions of FERA. It also provides recommendations to minimize the risks posed for both taxpayers and their advisers under the money laundering rules.

Money Laundering

Money laundering involves concealing or disguising the proceeds of certain types of unlawful activity. The money laundering rules of particular concern in tax cases are found in Section 1956 of title 18 of the U.S. Code. (8) This section prohibits a variety of offenses that can be broadly classified as transaction money laundering, transportation money laundering, and sting operations, where the crime involves property that a law enforcement officer represents to be the proceeds of unlawful activity. (9)

In Yusuf, the taxpayers were charged with a transportation offense under Section 1956(a)(2) of the statute. This provision targets the transporting, transmission, transfer, or attempt to transfer a monetary instrument or funds across international borders. In order to obtain a conviction under this subsection, the government must show that the defendant intended to promote a "specified unlawful activity" or knew that the funds involved in the transportation, transmission, or transfer represent the proceeds of some form of unlawful activity and intended to conceal the nature, location, source, ownership, or control of the funds or to avoid a transaction reporting requirement. (10)

For taxpayers not involved in international transactions, the provision most likely to be applicable is Section 1956(a) (1), which prohibits transaction money laundering. To convict under this rule, the government must show that the defendant conducted or attempted to conduct a financial transaction knowing that the property involved resulted from unlawful activity. The assets must also be the proceeds of a specified unlawful activity, as that term is defined in the statute. Finally, there must be proof that a defendant participated in the transaction with the intent to promote the carrying on of specified unlawful activity" or with the intent to engage in conduct constituting tax evasion or a violation of Sec. 7206. (12) Alternatively, the government can show that the defendant knew the transaction was designed to conceal the nature, location, source, ownership, or control of the proceeds of specified unlawful activity or was designed to avoid a transaction reporting requirement under state or federal law. (13)

In almost all cases, as part of its prosecution the government must prove that a specified unlawful activity occurred. The money laundering rules define this term by reference to a long list of crimes, including mail and wire fraud. (14) Significantly, even though the law refers to tax evasion and Sec. 7206 when discussing the intent requirements for money laundering, "[t]ax crimes, ... in and of themselves, are not among the crimes listed in the statute as 'specified unlawful activity.'" (15) The Third Circuit did not address this point in Yusuf.

In addition, the government can prosecute a defendant for money laundering even if it cannot obtain a conviction for the specified unlawful activity itself. This is noteworthy because the statute of limitation restarts each time a defendant engages in a financial transaction that involves proceeds. (16) The money laundering statute defines the term "transaction" broadly to include a purchase, sale, loan, gift, transfer, delivery, or other disposition. (17)

Although the money laundering law provides for a maximum prison sentence of 20 years, the sentence of a taxpayer convicted under this provision is likely to be affected by the federal sentencing guidelines. (18) An example helps illustrate the significance of a money laundering charge:

[I]f a taxpayer is convicted under 26 U.S.C. [section]7201 of committing tax evasion by underreporting $1,000,000 of "clean money" and causing a tax loss of $280,000, then the taxpayer's base offense level would be 16 under the November 1997 version of the Sentencing Guidelines. Assuming the taxpayer has no criminal history, accepts responsibility for his actions, and pleads guilty to the charge, then his sentencing range would be 12-18 months imprisonment. If that same taxpayer is convicted under 18 U.S.C. [section]1956(a)(1)(A)(ii) with laundering money with the intent to engage in the $1,000,000 tax evasion, then the taxpayer's base offense level would be 23. If that taxpayer pleads guilty and accepts responsibility for his actions, hen his sentencing range for this offense would be 51-63 months, almost five times as much as the underlying offense. (19) The sentencing guidelines have been revised since this example was drafted. However, the essential point remains: There is a significant increase in penalties where money laundering applies.

The Yusuf Opinion

The Yusuf case arose from a 78-count indictment (20) in which the United States alleged that United Corporation, the operator of the largest retail grocery chain in the U.S. Virgin Islands, along with several of its principals, skimmed revenues from United's legitimate supermarket operations and filed Virgin Islands gross receipts tax returns that did not report the skimmed income. (21) In Yusuf, the government alleged mail fraud as the underlying unlawful activity for purposes of the money laundering charges against United and the other defendants because United had mailed its allegedly false tax returns. In a pretrial motion to strike, the defendants moved to have the money laundering charges dismissed, (22) arguing that unpaid taxes illegally disguised and retained through filing false tax returns were not "proceeds" of mail fraud for purposes of proving an international money laundering charge.

The district court agreed, holding that "the mailing of the allegedly false gross tax returns did not result in proceeds, as that term is commonly interpreted," and struck the money laundering charges from the indictment. However, on appeal, the Third Circuit overturned the district court, holding that unpaid taxes constitute proceeds of mail fraud for these purposes. Like money laundering, mail or wire fraud also carries potential 20-year sentences, in addition to fines. (23)

The Court's Reasoning

In Yusuf, the Third Circuit reasoned that every time United Corporation mailed its...