Tax evasion.

• Author: Graham, Lori
• Position: Twelfth Survey of White Collar Crime

1. INTRODUCTION II. IRC SECTION 7201

   1. Elements

      1. Existence of a Tax Deficiency

      2. Affirmative Act Constituting Evasion

      3. Willfulness

   2. Defenses

      1. Lack of Deficiency

      2. Lack of Willfulness

      3. Third Party Liability/Reliance.

      4. Selective Prosecution

   3. IRS Investigations under Section 7201

      1. MS Policy

      1. Notice of Criminal Proceedings

      2. Fifth Amendment Issues and Disclosure of Documents

      3. The Role of Counsel

3. IRC SECTION 7202

   1. Willful Failure to Collect Tax

   2. Willful Failure to Account for and Pay Over Tax

   3. Elements

      1. Duty to Collect and/v account For and Pay Over Tax

         1. The Responsible Person

         2. The Statutory Duty

      2. Failure to Collect Tax or to Truthfully Account For and Pay Over Tax

      3. Willfulness

   4. Defenses

4. IRC SECTION 7203

   1. Elements

      1. Requirement to File a Return

      2. Failure to File a Return

      3. Willfulness

      4. Knowledge of Requirement

   2. Defenses

5. IRC SECTION 7206

   1. Section 7206(1): Tax Perjury

      1. Elements of the Offense

         1. Signing a False Return or Document

         2. Penalty of Perjury

         3. Falsity as to a Material Matter

         4. Willfulness

      2. Defenses

   2. Section 7206(2): Aiding and Assisting

      1. Elements

         1. Aiding and Assisting

         2. Material Falsity

         3. Willfulness

      2. Defenses

6. STATUTE OF LIMITATIONS VII. FEDERAL SENTENCING GUIDELINES

   1. Violations of IRC Section 7201

   2. Violations of IRC Section 7202

   3. Violations of IRC Section 7203

   4. Violations of IRC Section 7206

1. INTRODUCTION

   This article outlines the elements of tax evasion under the United States Internal Revenue Code ("IRC") sections 7201, 7202, 7203, and 7206. Section II of this article presents the general elements of the crime, the Government's investigative process, and available defenses. Section III addresses the failure to collect and withhold tax in violation of [sections] 7202. Section IV describes prosecution under [sections] 7203 of a willful failure to file taxes. Section V discusses [sections] 7206 and prosecution for "tax perjury" and "aiding and assisting" tax fraud. Sections VI and VII discuss the IRC statute of limitations and application of the Federal Sentencing Guidelines respectively.

2. IRC SECTION 7201

   Violations of the IRC are prosecuted under an array of criminal tax statutes.(1) The "capstone of [this] system of sanctions"(2) is the felony provision 26 U.S.C. [sections] 7201, which imposes a maximum penalty of $100,000 and/or a prison term of five years for a willful attempt to defeat any tax obligation.(3)

   To prove a [sections] 7201 violation, the government must prove three elements: (1) the existence of a tax deficiency; (2) an affirmative act constituting an evasion or attempted evasion of the tax; and (3) willfulness.(4) The government bears the burden of proving each element beyond a reasonable doubt.(5)

   1. Existence of a Tax Deficiency

      While all circuits require proof of a tax deficiency, some interpret [sections] 7201 to require proof of a "substantial tax deficiency."(6) The term "substantial" refers to the "amount of the tax evaded," and not to the amount of income unreported.(7) The existence of a deficiency may be demonstrated by the use of either direct or circumstantial evidence.(8)

      The most accurate means of proving a deficiency with direct evidence is the "specific item method." Under this method, the taxpayer's books and records provide direct evidence that taxable transactions occurred that were not reported.(9) Direct evidence can also include third-party testimony.(10) However, "proof of unreported taxable income by direct means is extremely difficult and often impossible" for the government to obtain.(11)

      In the absence of direct evidence, the government usually relies on three methods of obtaining circumstantial evidence of unreported taxable income (1) net worth; (2) cash expenditures; and (3) bank deposits.(12) These methods do not require the government to prove either the exact amount of the deficiency(13) or its source.(14) "The government may choose to proceed under any single theory of proof or a combination method, including a combination of circumstantial and direct proofs."(15)

      The "net worth" method of proof is the most common method used to establish tax evasion.

      [T]he Government, having concluded that the taxpayer's records are

      inadequate as a basis for determining income tax liability, attempts to

      establish an "opening net worth" or total net value of the taxpayer's

      assets at the beginning of a given year. It then proves increases in the

      taxpayer's net worth for each succeeding year during the period under

      examination and calculates the difference between the adjusted net values

      of the taxpayer's assets at the beginning and end of each of the years

      involved. The taxpayer's nondeductible expenditures, including living

      expenses, are added to these increases, and if the resulting figure for

      any year is substantially greater than the taxable income reported by the

      taxpayer for that year, the Government claims the excess represents

      unreported taxable income.(16)

      For the prosecution to succeed, the government must establish the taxpayer's opening net worth with "reasonable certainty."(17) It is not necessary, however, to establish with certainty the opening net worth for each of the subsequent years under investigation.(18) The government must also demonstrate that it has conducted a thorough investigation and has negated reasonable alternative sources of nontaxable income.(19)

      The "cash expenditures" method is a "simple variant of the `net worth method' "(20) and requires a showing that the taxpayer's expenditures were derived from taxable income which exceeded the taxpayer's reported income.(21) The government must demonstrate either a " `likely source' of the allegedly unreported income or, in the alternative, it must negate all reasonably possible nontaxable sources of income."(22) Unlike the net worth method, the cash expenditures method does not require preparation of a formal net worth statement for the period under investigation.(23)

      With the "bank deposits" method, the government adds the amount of all cash expenditures to all deposits made to the defendant's account in the current year. This amount is then compared to his reported taxable income. If the former total substantially exceeds the latter total, less deductions and exemptions, the Government then has a basis for proving tax evasion.(24) " `[T]he jury is entitled to infer that the difference between the balance of deposited items and reported income constitutes unreported income.' "(25) However, the Government must demonstrate that it conducted a full investigation into possible sources of income.(26)

   2. Affirmative Act Constituting Evasion

      The Supreme Court has long interpreted the second element of [sections] 7201 offenses to require a positive attempt to evade or defeat any tax rather than mere "passive neglect."(27) Thus, an affirmative act to evade tax must be a commission rather than an omission.(28)

      The "affirmative act" language has been construed broadly(29) to include commissions such as filing false returns,(30) keeping a double set of books,(31) making false entries or alterations,(32) making false invoices or documents,(33) destroying books or records,(34) concealing assets or covering up sources of income,(35) and avoiding making records usually kept for transactions or conduct where the likely effect would be to mislead or to conceal.(36) Generally, affirmative acts associated with evasion involve concealment of the taxpayer's ability to pay taxes or the removal of assets from the reach of the Internal Revenue Service.(37)

   3. Willfulness

      The Supreme Court has defined "willfulness" as the voluntary, intentional violation of a known legal duty.(38) To prove willfulness under [sections] 7201, the government must show that the taxpayer had a specific intent to commit the violation.(39) The government must demonstrate more than carelessness on the part of the defendant,(40) but it does not necessarily need to show bad faith.(41) The defendant's belief regarding the applicability of a legal duty is a question of fact.(42) Consequently, even an objectively unreasonable misunderstanding of the law negates a finding of willfulness.(43)

      "[P]roof of willfulness usually must be accomplished by means of circumstantial evidence."(44) Willfulness can be inferred from both the surrounding circumstances and the defendant's affirmative acts of evasion.(45) When applied, this inference often leads to a blurring of the distinction between willfulness and affirmative acts.(46)

      2. Defenses

      The following discussion addresses four defenses to tax evasion charges under [sections] 7201: (1) lack of deficiency; (2) lack of willfulness; (3) third party liability or reliance; and (4) selective prosecution.

   1. Lack of Deficiency

      The taxpayer may rebut the government's charge by showing that the income received is not taxable.(47) Moreover, in cases involving circumstantial evidence, the taxpayer may identify errors in the government's analysis in order to negate a tax deficiency.(48) In some circumstances, the taxpayer may also claim that the government failed to investigate and negate exculpatory leads furnished by the taxpayer.(49) Furthermore, the taxpayer may negate an alleged deficiency by demonstrating that it was cancelled by a deduction or by a credit not yet allowed.(50)

   2. Lack of Willfulness

      The taxpayer may avoid conviction under [sections] 7201 if the tax evasion was not willful.(51) Under the Supreme Court decision in Cheek v. United States,(52) a good faith belief that one is not violating the law negates willfulness, regardless of the objective reasonableness of the belief.(53) In assessing a lack of willfulness defense predicated on ignorance of the law, courts look to the taxpayer's conduct(54) and past record of compliance,(55) as well as to the taxpayer's sophistication and level of knowledge.(56) Most courts have ruled that a defendant's inability to pay taxes when due is not a valid defense to a finding of...