Criminal Tax Litigation Update: Seventh Circuit Affirms District Court’s Sentence of Probation for Beanie Babies Creator

Jul 27, 2015   

Monday, July 27th, 2015

On July 10, 2015, the United States Court of Appeals for the Seventh Circuit affirmed the sentence of Ty Warner, the billionaire creator of Beanie Babies who pleaded guilty to evading $5.6 million in taxes by hiding assets in a Swiss bank account. The decision can be found here.

In 1996, Warner traveled to Switzerland and opened an account at UBS, which ultimately held as much as $93 million. In 2002, Warner moved his account from UBS to Zuercher Kantonalbank (ZKB), and placed his assets in the name of a Liechtenstein shell company. By that time, the account had grown to $107 million. Warner, a U.S. taxpayer, failed to report and pay taxes to the IRS on the interest income generated by his Swiss account, which amounted to $24.4 million through 2007. Consequently, Warner underpaid his taxes by $5.5 million.

The U.S. Department of Justice began to investigate UBS in 2008, and in March 2009, the IRS started its Offshore Voluntary Disclosure Program (OVDP)(Please see our prior blogs on the OVDP: available here, here, here, here, here, here, here, and here).

Warner never accessed the funds in his Swiss bank account, and in 2009 Warner applied to the OVDP. However, Warner was rejected from the OVDP because he was already under investigation. In 2011, Warner received a grand jury subpoena requiring him to turn over his Swiss bank records. Warner fought the subpoena, see In re Special Feb. 2011-1 Grand Jury Subpoena Dated Sept. 12, 2011, 691 F.3d 903, 909 (7th Cir. 2012), but ultimately was forced to comply with the subpoena.

Ty Warner was charged in 2013 in the U.S. District Court for the Northern District of Illinois for tax evasion in violation of 26 U.S.C. section 7201, available here.

The information alleged that Warner evaded $885,300 in taxes in 2002 by failing to report income from his Swiss account.  According to the information, Warner fraudulently reported he did not have a foreign bank account on his income tax return, see Schedule B (line 7b), available here, and failed to file a Report of Foreign Bank and Financial Account (FBAR), available (the former version)here, in violation of the Bank Secrecy Act, available here.

Warner pleaded guilty, agreeing to pay full restitution and a civil FBAR penalty in the amount of $53.5 million (equal to 50% of the highest balance in 2008). The plea agreement had the following U.S. Sentencing Guideline (USSG) calculation:

  • Base offense level 24 (based on $5.6 million tax loss (see USSG 2T1.1, available here)
  • a two-level enhancement for sophisticated means (see USSG 2T1.1(b)(2), available here)
  • a two-level reduction for acceptance of responsibility (see USSG 3E1.1(b), available here)
  • and a one-level reduction because the plea relieved the Government of having to prepare for trial (see USSG 3E1.1(b))
  • for a total offense level of 23.

A level 23 offense level, with no prior criminal history, results in a guideline sentence of 46-57 months, see USSG Sentencing table, available here.

Warner’s sentencing occurred in January 2014, and the District Court judge, evidently moved by Warner’s unique characteristics, sentenced Warner to probation (the Government wanted at least one year of incarceration). The Government appealed.

On appeal, the U.S. Court of Appeals for the Seventh Circuit engaged in the standard two-step process.  First, it reviewed the Guidelines calculation to ensure it was properly calculated (procedural reasonableness).  Second, it reviewed the trial judge’s analysis of the 18 U.S.C. section 3553(a) factors, available here (substantive reasonableness). See generally Gall v. United States, 552 U.S. 38 (2007), available here, and Rita v. United States, 551 U.S. 387 (2007), available here.

The 7th Circuit focused on the substantive reasonableness of the sentence and noted that the trial judge properly focused on Warner’s characteristics as an individual, which demonstrated a benevolence that was unique.  For instance, the Court cited to various instances of charitable giving that were extraordinary. As to the seriousness of the offense, the Court noted that the Government sought a sentence well below the guidelines, which was mitigated because

His crime was isolated and uncharacteristic: he had kept only one offshore account containing “a small fraction” (about 6%) of his total wealth. He was 69 years old, had no prior criminal history, and posed no danger to society. In particular, the court found, there was “no question of him violating the tax laws in the future.” Moreover, he cooperated by pleading guilty and promptly paying both full restitution and the FBAR penalty, although, it is true, his cooperation was incomplete (e.g., he resisted the government’s subpoena and did not dis-close the source of his offshore assets). The district court also appropriately took into account Warner’s attempt to enter the OVDP in September 2009.

Slip op. at 21. The Court further noted that Warner paid full restitution and a $53.6 million FBAR penalty.

The Court also recognized that a $53.6 million penalty provided an acceptable level of deterrence for Warner and anyone else considering a similar attempt to evade the payment of a tax. In particular, the Court noted that “Warner’s FBAR penalty was nearly ten times the size of the tax loss he caused (not accounting for interest).”  Slip op. at 25.

And, interestingly, in addressing sentencing disparities, the Court noted that:

probation is a common sentence in offshore tax evasion cases. The evidence introduced below shows that roughly half of the defendants convicted since 2008 have received terms of probation rather than imprisonment. And, of course, thousands more have avoided criminal prosecution altogether by entering the OVDP.

Slip op at 27 (emphasis added). Ultimately the Court affirmed the sentence of probation.

What is the impact of the Warner case? While it remains to be seen how district courts around the country will apply the Warner case, one thing is clear – “roughly half of the defendants convicted since 2008 have received terms of probation rather than imprisonment.”  In other words, district courts appear to be departing downward from the sentencing guidelines (where a sentence of incarceration is presumptively reasonable) and imposing sentences of probation.

What does this mean for taxpayers who have been, or may be, prosecuted for tax evasion and failing to disclosure foreign accounts?  It would appear that if a taxpayer can demonstrate the he is similarly situated with other defendants who have received sentences of probation, he would likewise receive a term of probation instead of incarceration.  Accordingly, it is incumbent upon the taxpayer and his attorneys to develop the facts which will demonstrate a basis to mitigate the sentence and depart from the sentencing guidelines, similar to what occurred in the Warner case. Of course, in order to demonstrate the facts necessary to receive a downward departure, the taxpayer would be wise to engage counsel and avail himself of the IRS’s Offshore Voluntary Disclosure Program.

The attorneys at Fuerst Ittleman David & Joseph have extensive criminal and civil tax litigation experience before the district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the U.S. Courts of Appeal, including representing those with unreported offshore accounts.  You can contact us by email at contact@fidjlaw.com or by telephone at 305.350.5690.