II. Essential Elements of Tax Crimes
One small word is all that distinguishes a civil tax matter from a criminal tax matter. That pestilent word is called “willfulness.” It is the cornerstone to any criminal tax matter.
In the criminal setting, the government carries the heavy burden of proving – beyond a reasonable doubt – that the taxpayer acted willfully. Willfulness is defined as an “intentional violation of a known legal duty.”
i. Proving Willfulness For Purposes of the Crime of Failure to File a FBAR
How do courts interpret willfulness? The only thing that a person need know is that he has a reporting requirement. And if a person has that requisite knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR. The latter is referred to in legal circles as the theory of “willful blindness.”
Under the theory of willful blindness, a jury may infer willfulness whenever a taxpayer intentionally fails to inquire and learn about his or her filing obligations. Instead of proving that the defendant intentionally violated a known legal duty, the government need only show that “the defendant consciously avoided any opportunity to learn what the tax consequences were.” United States v. Bussey, 942 F.2d 1241, 1428 (8th Cir. 1992).
At the outset, it is important to recognize that this theory is not widely embraced by all of the circuit courts. There are two reasons. First, it is a “watered-down” substitute for the burden of proof on what is otherwise the most critical element of a tax crime – the mens rea element. Very simply, willful blindness is much easier for the government to prove than an intentional violation of a known legal duty.
Second, for precisely this reason, willful blindness is ripe for abuse in cases where the government does not have sufficient evidence to prove willfulness under the heightened standard. This is why many courts have found its use to be “rarely appropriate.” United States v. deFrancisco-Lopez, 939 F.2d 1405, 1409 (10th Cir. 1991) (relying on several Ninth Circuit cases). And those that do permit it have restricted its use to cases where the taxpayer has purposely buried his head in the sand like an ostrich to avoid learning about the reporting requirements. The fact that the defendant was negligent in failing to inquire is not enough.
How does the government prove willfulness in the prosecution of a taxpayer for failing to file an FBAR? Seldomly are there any witnesses and only in a rare case would a defendant admit the required state of mind. So what does the government rely on? Indirect evidence. Specifically, conduct or acts from which a person’s state of mind can be inferred. These acts are commonly referred to as “badges of fraud.”
Ultimately, the jury must “look into the mind of the defendant-taxpayer to determine whether he intentionally violated the statute.” To the extent that the government can show the jury enough “badges of fraud” to prove willfulness beyond a reasonable doubt, the government will have satisfied its burden of proving criminal intent through circumstantial evidence.
How many badges of fraud must exist in order for the government to prove willfulness? Two? Three? The premise of this question is flawed. Why? Because it is not the quantity of badges of fraud that is determinative of willfulness as much as it is the quality. Indeed, the government might have a stronger case against a taxpayer that has three badges of fraud, if those badges are particularly egregious, than it has against a taxpayer that has ten.
However, that’s not to suggest that a single badge of fraud, by itself, is enough to prove willfulness, especially if that badge is just as much a characteristic of a legitimate business transaction as it is a fraudulent one. For example, consider an offshore account that is in the name of a foreign shell corporation or foreign trust. Setting up an account in such a form has any one of a number of legal purposes aside from the fraudulent purpose of concealing ownership in order to evade the reporting of taxes.
ii. Proving Willfulness For Purposes of the Crime of Failure to File a Tax Return
Willfulness is often the battleground in failure to file cases. And it is a battleground where the odds are stacked against the taxpayer who has failed to file. When willfulness exists, it is like the “Helen of Troy,” in the sense that the government will mount an offensive as aggressive as the “launching of one thousand ships.”
While the government must establish that the taxpayer knew of his duty to file the return, how many taxpayers can legitimately argue that they did not know that they had a duty to file? To the extent that the taxpayer asserts such a defense, it can easily be overcome by a showing that the taxpayer filed returns in earlier years.
How does the government prove willfulness in a failure to file prosecution? The most common way is by a pattern of failing to file tax returns for consecutive years in which returns should have been filed. There is also an element of common sense in establishing willfulness. For example, courts will look at such “human factors” as those listed below to determine whether the taxpayer was willful in failing to file: the background of the taxpayer; the filing of returns in prior years; whether the taxpayer was a college graduate with accounting knowledge; whether the taxpayer was familiar with books and records and operated a business; and what type of income the taxpayer earned.
How about defenses? The case of United States v. McCorkle, 511 F.2d 482 (7th Cir. 1975) (en banc) furnishes a list of defenses that have previously been asserted but which have gone down in flames. They can be grouped in the catch-all category of “factors beyond the control of the taxpayer.” As such, they range from the sublime to the ridiculous: the defendant had no funds available to pay his taxes, the defendant feared that the IRS was going to attach a lien on his property, the defendant was going through a bitter divorce, the defendant did not keep accurate records, and the defendant was contemplating suicide.
iii. No Willfulness Required For Klein Conspiracy
Unlike Code Sec. 7206(1) and 31 USC §§ 5314 and 5322(a), the Klein conspiracy does not have a similar willfulness element. Rather, the Klein conspiracy merely requires that the taxpayer intentionally enter the conspiracy and utilize deceit, craft or trickery, or at least means that are dishonest. The taxpayer need not know that defrauding the IRS was a “no-no.” However, the government must prove that he acted dishonestly. In this sense, the Klein conspiracy may be easier for the government to prove than the other two crimes.
iv. Practical and Sound Advice Regarding Willfulness
The ease with which willful blindness can be proven is a stark reminder to taxpayers of the risks inherent in making a quiet disclosure. It is the flashing neon sign in the store window. And if that sign could speak, it would say: “A quiet disclosure is not an exercise for the faint of heart, the risk-averse, or for anyone without some tolerance for risk.” The only guaranteed result is to get in OVDP and stay in it.
b. Criminal Tax Deficiency
The second critical element to any criminal tax case is a tax deficiency. Tax deficiency is defined as “additional tax due and owing.” You might be wondering why there is so much fuss about tax deficiency when tax deficiency is not a required element of any one of the tax crimes discussed above. Indeed, only tax evasion requires tax deficiency as an element of the crime and to date, the government has never charged tax evasion in connection with a foreign bank prosecution.
i. Tax Deficiency In Connection With the Crime of Failure to File a FBAR
Although willful failure to file an FBAR does not require a tax deficiency, the government usually does not prosecute taxpayers unless it has evidence of a substantial tax deficiency. Why? There are two reasons. First, criminal tax prosecutions usually result in jail time, thus depriving citizens of what our founders intended to be the most fundamental right protected by the U.S. Constitution: our freedom. And second, the potential backlash from the public. As a preliminary matter, one of the government’s primary goals in bringing a criminal tax prosecution is deterrence – in other words, to make an example out of the taxpayer in order to deter others from engaging in similar conduct.
But if the government targets a taxpayer with a small tax deficiency, there is a real risk that this strategy will backfire, resulting in a backlash from the public. For example, it may reinforce the public’s perception of Uncle Sam as a greedy “big brother” who picks on the little guy. In that sense, the government risks exacerbating the public relations nightmare that has already put it on the defensive in connection with the FATCA controversy.
For this reason, the IRS is often willing to overlook the failure to file FBARs, even for consecutive years, so long as the taxpayer has reported and paid tax on all offshore income. However, just the opposite is true for a taxpayer who has failed to report and pay tax on all offshore income: such taxpayers are pursued as aggressively as an arctic fox chasing a hare.
How much of a tax deficiency must there be before the government will bring a tax prosecution? The unofficial rule is that there must be a $ 40,000 tax deficiency for all of the years in question.
ii. Tax Deficiency In Connection With the Crime of Filing a False Tax Return
In theory, a false statement could have no effect whatsoever on calculating tax liability, yet still be considered material for purposes of violating Code Sec. 7206(1). For example, consider an offshore account that generates no interest and no taxable income (or if it does generate interest, that interest is completely offset by the foreign earned income exclusion and/or the foreign tax credit). Further, assume that the taxpayer fails to report the account on Schedule B not due to any oversight, but instead because he didn’t want the government to know about it.
If you thought that was harsh, it doesn’t even come close to taking the prize. As ridiculous as this might sound, a taxpayer could be found to have violated Code Sec. 7206(1) even by over-reporting income and tax. How is that possible? Because filing a false tax return requires a material false statement and overreporting income is just as much a misrepresentation that could adversely impact the correct amount of tax due and owing as underreporting income could.
c. Remaining Elements of These Crimes
Proving the remaining elements of these crimes is as effortless for the government as lifting a feather. For example, to prove that the taxpayer made and signed a return, the prosecutor need only point to the taxpayer’s signature on the return while citing Code Sec. 6064, which states that a taxpayer’s signature is prima facie evidence – for all purposes – that the return was signed by him.
Similarly, to prove that the return contained a written declaration that it was signed subject to the penalties of perjury, the prosecutor need only highlight the jurat beneath the signature space which states that the taxpayer is signing the return under penalty of perjury.