Second Circuit Court of Appeals Reverses Convictions for Tax Evasion and Fraud

May 07, 2012   

On April 30, 2012, the U.S. Court of Appeals for the Second Circuit reversed  convictions for two counts of tax evasion, and vacated convictions for mail fraud on the grounds that the mail fraud and tax evasion counts were improperly joined.  The Second Circuit remanded the case to the U.S. District Court for the Eastern District of New York.  The case is United States of America, v. Litwok, and the 2nd Circuits decision is available here.

The fact are as follows.

A superseding indictment charged Litwok with mail fraud in connection with a false insurance claim relating to her house on in East Hampton, New York.  Litwok transferred nominal ownership of two of her houses to a close friend, under whose name the homes were insured by a subsidiary of Chubb Insurance Company.  Chubb received claims for damage to both homes, and claims for lodging while one of the homes was being repaired.  Chubb issued a check for the lodging “ which ultimately became the basis for the mail fraud count.

In addition to the evidence of mail fraud, the Government presented the following evidence relating to the tax evasion counts. From 1994 to 1997, Litwok operated a number of private equity companies from her East Hampton house, including Kohn Investment I LP, which she managed through Kohn Investment Management, Inc. Litwok routinely commingled her corporate and personal funds and used funds she received from her corporate investors to pay for personal expenses and gifts. Although she owed nearly $1.5 million in taxes from 1995 through 1997 based on her personal income, Litwok failed to file a single personal tax return for those years.

Three of Litwoks former accountants testified at trial. But only one accountant, Peter Testaverde, testified about work related to any of the years relevant to the tax evasion charges. Testaverde explained that Litwok had retained his accounting firm from September 1995 to September 1996 to calculate the losses and income for Kohn Investment I LP and to prepare 1995 K-1 tax forms, which provide investors with information necessary to file their own tax returns, including their portion of the partnership income. Testaverde confronted Litwok after discovering over $2.3 million in excess personal compensation based on a review of various brokerage account statements, among other documents. In response, Litwok attacked the accuracy of the account statements from her companys brokerage firm that Testaverde had relied on to calculate her compensation. She then blocked Testaverde from contacting the brokerage firm to verify the information, as would have been the normal practice. When Testaverde tried to notify Litwoks companys partners that he (Testaverde) could not prepare their K-1 forms because Litwok had prohibited him from contacting the brokerage firm, Litwok attempted to stop him. One of Litwoks two other accountants testified that his firm prepared Litwoks tax returns for 1992 and 1993, prior to the period charged in the Indictment, but she never filed them. One of these accountants, Lawrence Goldstein, also confronted Litwok, to no effect, about what appeared to be $1 million in excess personal compensation, and refused her repeated demands to adjust his accounting for her 1994 partnership tax return.

In March 2003 Litwok was charged by indictment with mail fraud relating to the lodging reimbursement claim and tax evasion for the years 1995 through 1997. The case was tried before a jury in February 2009. In May 2010, after the jury convicted Litwok on all counts, the District Court sentenced her principally to two years imprisonment and ordered her to pay $23,551 in restitution. Litwok began serving her sentence in September 2010. By order dated September 8, 2011, the Second Circuit released Litwok on bail pending the disposition of this appeal, after noting that the parties had “agreed that the appeal presents Ëœa close question or one that very well could be decided the other way.”

The Second Circuit held that evidence was sufficient to sustain the mail fraud conviction, but vacated and remanded because the wire fraud charge had been improperly joined with the tax charges.  Under Federal Rule of Criminal Procedure 8(a), available here, criminal charges may be joined if "of the same or similar character, or are based on the same act or transaction, or are connected with or constitute parts of a common scheme or plan."  

In Litwoks case, there was no relation between the tax charges and the wire fraud charges, other than perhaps both involved fraud which permitted the Government to combine the arguments.  The Second Circuit found that Litwok was prejudiced by the improper joinder, reasoning as follows:

The Government argues that the evidence of Litwok’s failure to file tax returns for her investment companies and her improper personal use of business funds had virtually no impact on the jury’s consideration of the mail fraud count. We disagree. The evidence of the 1995 tax evasion charged in Count Two included testimony about Litwok defrauding her investors of millions of dollars for personal compensation. At trial and in its closing argument, the Government was able to point to that and other evidence to describe Litwok as "a cheat, a liar, and a thief" and to otherwise contend that Litwok had a propensity to engage in fraudulent activity. Because none of the evidence of the 1995 tax evasion was related to the 1997 mail fraud offense, it would not have been admitted in a trial involving only that offense; yet it inevitably colored the jury’s view of Litwok’s role in the mail fraud scheme. The prejudice, in our view, went both ways: although the evidence of Litwok’s involvement in the fraud related to the Aborigine Way claim would have been inadmissible in a trial involving only the 1995 tax evasion count since it did not support that charge in any way, it surely affected the jury’s consideration of that count.

As to the tax evasion charges, the Second Circuit held that for tax evasion counts of conviction under 26 U.S.C. § 7201, available here, the Government was required to prove three elements at trial: “(1) the existence of a substantial tax debt, (2) willfulness of the nonpayment, and (3) an affirmative act by the defendant, performed with intent to evade or defeat the calculation or payment of the tax.” See, United States v. Josephberg, 562 F.3d 478, 488 (2d Cir. 2009), available here. The Second Circuit concluded that there was sufficient proof that Litwok engaged in an affirmative act to evade taxes in 1995.  In contrast, the Second Circuit concluded that there was insufficient evidence of any such act relating to the calendar years 1996 and 1997.

For 1995, the Second Circuit noted that the most significant testimony was that of Peter Testaverde. Testaverde testified that Litwok barred him from verifying the accuracy of the trading account statements that she claimed were inaccurate and thereby prevented him from preparing 1995 K-1 tax forms for Kohn Investment I LPs partners “ including its general partner, Kohn Investment Management, which Litwok owned. Without K-1 tax forms, the companys partners could not determine their income and file their returns. Based on Testaverdes testimony, a rational juror could find that Litwok actively prevented the filing of her returns that year. On a sufficiency challenge, her conduct constitutes an affirmative act sufficient to sustain her conviction on Count Two.

For 1996 and 1997, the Second Circuit noted that there was no evidence at trial of any affirmative act beyond a mere failure to file tax returns for calendar years 1996 and 1997.

Ultimately, the Second Circuit concluded by reversing the convictions for the 1996 and 1997 tax evasion counts, and vacated and remanded for retrial on the 1995 tax evasion count and the mail fraud count, with the counts severed from each other.

The attorneys at Fuerst Ittleman, PL have extensive experience litigating criminal and civil tax and fraud cases at both the trial and the appellate levels.  You can contact us by email at contact@fidjlaw.com or by calling us at 305.350.5690.