U.S. Tax Court Rules Silent Illinois Politician Committed Tax Fraud; Statute of Limitations does not Bar Assessment of Old Deficiency

On July 30, 2012, the U.S. Tax Court concluded that Betty Loren-Maltese, a locally well-known Illinois politician, fraudulently underreported income on her 1994 income tax return by omitting two substantial conversions of campaign funds to personal use.  Betty Loren-Maltese v. Commissioner, T.C. Memo 2012-214, is available here.

Ms. Loren-Maltese was the President of Cicero and the Republican Committeeman of Cicero Township, Illinois in 1994.  (Some readers may recognize Cicero as a town known for the headquarters of Chicago mobster Al Capone.  Certainly, Ms. Loren-Malteses actions did not help Ciceros colorful reputation.  She is the widow of another well-known local politician, Frank Maltese, who was sentenced to prison for being a mob bookmaker and pleading guilty to a federal gambling charge.) In 2002, Ms. Loren-Maltese was sentenced to serve eight years prison for conspiracy to defraud the town through a pattern of racketeering via multiple acts of bribery, money laundering, mail and wire fraud, official misconduct and interstate transportation of stolen property. See her criminal conviction in U.S. v. Spano, 421 F.3d 599 (7th Cir. 2005) here.

In addition to her criminal conviction, the Commissioner issued a notice of deficiency alleging civil tax-fraud for tax year 1994.  The Commissioner contended that Ms. Loren-Maltese withdrew more than $350,000 from the Committeeman Fund to finance her purchase of a classic black 1993 Cadillac Allante convertible and to invest in a luxury golf course.  The Commissioner also contended that the car and investment created taxable income in which she fraudulently tried to evade the tax due on the income.

Thus, there were three issues of law in the case related to the car purchase and golf course investment: (1) the general rules of tax fraud; (2) the proper treatment of money taken by a politician from her campaign fund for personal use; and (3) the effect of taking the Fifth Amendment in civil tax litigation, right against self-incrimination. Below, we explore how the Tax Court addressed these issues.

(As a threshold matter, it is important to take notice that the Commissioner was required to establish the underpayment from the personal use of campaign funds was fraudulent because fraud stops the clock on the statute of limitations under Sections 6501(a) and (c) available here.  Because so much time had passed since Ms. Loren-Maltese filed her 1994 tax returns, proving fraud was the only way the Commissioner could prevail.)

The Car

In 1994, Ms. Loren-Maltese purchased a classic black limited edition 1993 Cadillac Allante convertible with a check that was drawn on the Committeeman Fund.  The documents, prepared by the dealer and reviewed by Ms. Loren-Maltese, indicated that she was the owner and not in a capacity for the Town of Cicero or the Republican Party.  Using the Committeeman Fund to purchase the car for personal use is critical because Ciceros town attorney informed Ms. Loren-Maltese that she did not have to disclose contributions or expenditures for the Committeeman Fund, but did have to file publicly disclosed financial reports that gave detailed lists of contributions and expenditures for the Organization Fund.  The attorney also informed her that if she took money from the funds, she would have to pay tax on it and consider it personal income.  Nonetheless, she purchased an individual auto-insurance policy, indicated the use was for pleasure, and gave the dealership her personal information such as her address and drivers license number.  Under Illinois law, the name of the title creates a prima facie presumption that she is the owner of the car.

The court explained that paper formalities were not enough to prove an underpayment existed from the failure to include the personal use of the Committeeman Fund as personal income.  In response, the Commissioner pointed to her silence at trial.  She invoked the Fifth Amendment on virtually every question about the car, including its purchase, use, reporting, and her use of Committeeman Funds to buy it.  This silence severely injured her case because it allowed the court to draw a negative inference against her and because the Commissioner had voluminous evidence against her, such as her use of personal funds for insurance payments and maintenance for the car.  Human nature also allowed the court to draw inferences from her silence if, under the circumstances, it wouldve been natural for her to object.  See U.S. v. Hale, 422 U.S. 171 (1975).  Furthermore, the car was garaged at her summer home in Indiana.  Thus, the court determined car was purchased for personal use with money she personally converted from the Committeeman Fund and failed to include that income on her tax return, which created an underpayment.

However, to prove fraud, the Commissioner was required to provide some evidence that she understood that she used campaign funds for personal use and willfully did so with the intent to evade taxes she knew would have been due.  The Commissioner already established that an underpayment existed, and subsequently, the Commissioner needed to establish some portion of that underpayment was due to fraud.  Furthermore, fraud requires a state of mind, which is commonly defined as an intentional wrongdoing on part of the taxpayer with the specific purpose to evade a tax believed to be owing.  See McGee v. Commissioner, 61 T.C. 249 (1973).  It is rare to have direct proof of someones state of mind, so the court typically relies on circumstantial evidence.  In this case, the court looked for “badges of fraud,” which were inadequate records, implausible or inconsistent explanations of behavior, concealing assets, engaging in illegal activities, and attempting to conceal activities.

The court explained that she was well-advised by the town attorney on the details of titling and tracing funds but used this knowledge to hide her use of campaign funds.  She also asked to garage the car at someone elses home after learning she was the subject of a federal investigation.  Therefore, the court found that the Commissioner had shown by clear and convincing evidence that Ms. Loren-Malteses understatement of income was due to fraud.

The Golf Course

The other item of the asserted underpayment of taxes came from Ms. Loren-Malteses investment in the Four Seasons resort and golf course in Miscauno Island, Wisconsin.  The resort was in desperate need of renovation, and the money for the work came from loans by Ms. Loren-Maltese and other investors.  Between July and September of 1994, Ms. Loren-Maltese gave and personally signed three checks totaling $350,000, also drawn from the Committeeman Funds account, to investors for the Four Seasons.

Despite her use of the Committeeman Funds account, all documents relating to the loan and promissory notes identified Ms. Loren-Maltese in her personal capacity only.  The purchase in her personal capacity only is further evidenced through the investment group commissioning research into the complicated Wisconsin laws.  The lawyer who conducted the research carefully noted the names of the parties involved, the amount of investments, and their legal capacities.  There was no mention of Ms. Loren-Maltese in any representative capacity while other investors were indentified as holding interests as partnerships.  As a result, the court determined that Ms. Loren-Maltese did not include in her personal income the money taken from the Committeeman Fund, which resulted in an underpayment of taxes. 

Once the court determined she used the Committeeman Fund for personal use, the court then determined that Ms. Loren-Maltese failed to carry her burden to establish that the understatement of income arising from the Four Seasons investment wasnt done with fraudulent intent.  She tried to argue the investment was done on behalf of the Committeeman Fund as the loan repayments were signed over to the Fund.  However, the checks were only signed over after a grand jury subpoena for information and the documents relating to investments made in the Four Seasons were served.

Additionally, her argument that the investment was done on behalf of the Committeeman Fund is inconsistent with her Form D-2s, Report of Campaign Contributions and Expenditures.  The forms indicated great discrepancies between the reported assets and the actual account balances of the Committeeman Fund and the differences do not coincide with the Four Seasons investment. Once again, her argument also failed due to her negative inference from taking her Fifth Amendment when asked at trial about whether she knowingly falsified the Form D-2s to disguise her investment in the Four Seasons.  The omissions and inconsistencies in the forms, along with her less-than-credible argument, flash another badge of fraud, which is that of implausible explanations.

Ms. Loren-Maltese also argued that she complied with state reporting requirements and treated the promissory note as an investment.  Nevertheless, there were exceptionally suspicious imprecision from the loan and repayments on note.  Other expenditures and receipts on the D-2 include exact values of modest expenses like keychains and fast-food meals.  Consequently, the court concluded that the her attempts to recharacterize the investment as an investment on behalf of the Fund, rather than a conversion of the Funds assets to her personal use failed to refute the Commissioners argument that any understatement from her failure to include the amount of her investment in the Four Seasons as income on her 1994 was due to fraud.

The court also took note of Ms. Loren-Malteses level of education and business experience as a factor in determining fraudulent intent.  She was a capable politician who managed the business affairs of the Town, understood contracts and the importance of title, understood what a nominee was, and hired attorneys to help her with the Four Seasons investment.  She also used her knowledge as an experience politician to conceal her activities.

In conclusion, the court found that both the car and golf course should have been included in her income.  Her failure to do so was due to fraud.  Thus, the statute of limitations was not barred for assessing her 1994 deficiency.

The attorneys at Fuerst Ittleman, PL have extensive civil and criminal tax litigation experience before the U.S. District Courts, the U.S. Tax Court, and the U.S. Circuit Courts of Appeal.  You can contact us by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.

Update: Workers Compensation Fraud Task Force Announces Multiple Arrests in Workers Compensation Check Cashing Scheme

On July 30, 2012, Florida Chief Financial Officer Jeff Atwater and Broward County Sheriff Al Lamberti announced multiple arrests in an investigation conducted by the Florida Workers’ Compensation Fraud Task Force known as “Operation Dirty Money.” The arrests come as part of a larger effort of the Florida Department of Financial Services’ Division of Insurance Fraud to combat workers’ compensation fraud facilitated by money services businesses (“MSB”)

As we previously reported here, MSB facilitated workers’ compensation fraud has been in the crosshairs of Florida officials since August of 2011. At that time, the Financial Services Commission of the Florida Office of Financial Regulation issued a cabinet report to Governor Rick Scott regarding MSB facilitated workers’ compensation schemes. The report revealed that MSBs have played an active, critical, and sometimes unknowing part in defrauding the workers’ compensation insurance market in Florida. A complete overview of the fraud scheme can be read here.

As a result of these findings, Florida C.F.O. Atwater announced the creation of the “MSB Facilitated Workers’ Compensation Fraud Workgroup” to develop comprehensive reforms to combat the fraud scheme. The efforts of the Workgroup culminated with its report and recommendations which were presented to the Insurance and Banking Subcommittee  of the Florida House of Representatives. A summary of the Workgroup’s report and recommendations can be read in our previous report here.

The efforts of the Workgroup ultimately paid off this past legislative session as the Florida Legislature unanimously passed CS/HB 1277, which adopted many of the the Workgroup’s recommendations. The changes implemented by CS/HB 1277 became effective July 1, 2012. A summary of the new law can be read in our previous report here.

According to officials, “Operation Dirty Money” has resulted in the arrests of eight individuals in Broward, Miami-Dade, and Palm Beach Counties for their involvement in a large-scale check cashing scheme to evade the costs of workers’ compensation coverage. The joint investigation revealed that Hugo Rodriguez was the ring leader of the group. According the authorities, Rodriguez and his company Oto Group, Inc. established 10 shell companies to funnel over $70 million in undeclared payroll through several MSBs in Broward, Miami-Dade, and Palm Beach Counties. Through the use of these shell companies, Rodriguez was able to conduct large construction projects while avoiding the costs associated with paying workers’ compensation premiums. Since the inception of the Florida Workers’ Compensation Fraud Task Force, the State of Florida has shut down 12 shell companies and identified $140 million in fraudulent transactions associated with their operation.

If you have questions pertaining to the Office of Financial Regulations, the BSA, anti-money laundering compliance, or how to ensure that your business maintains regulatory compliance at both the state and federal levels please contact us at contact@fidjlaw.com.

Update: Online Poker Sites Reach Settlement With Justice Department Over Fraud Allegations; Payment Processor Associated with Online Poker Fraud Sentenced

As we have detailed in previous reports here and here, on April 15, 2011, federal prosecutors shut down online poker sites PokerStars, Full Tilt Poker and Absolute Poker and indicted eleven people in connection with their involvement with the sites’ operation.

As we discussed, these actions were part of a larger effort by the Justice Department to target internet gambling websites for violations of federal law. After more than a year of litigation, however, the dispute between the websites and the Justice Department appears to have been resolved in the final days of July, 2012.

Although the law does not specifically address internet pay for play poker sites, The Unlawful Internet Gambling Enforcement Act of 2006 (“UIGEA” defines “unlawful internet gambling” as: 1) placing, receiving or transmitting a bet, 2) by means of the Internet, even in part, 3) but only if that bet is unlawful under any other federal or state law applicable in the place where the bet is initiated, received or otherwise made. Thus, although there is no federal law directly addressing the regulation of online poker sites, the Department of Justice has used UIGEA to prosecute internet pay for play poker operators and their payment processors.

On July 26, 2012, Judge Lewis Kaplan of the United States District Court for the Southern District of New York sentenced payment processor Ira Rubin to three years in prison for his role in processing payments for the online poker sites. In January, 2012, Mr. Rubin pled guilty to conspiracy charges related to illegal gambling, bank fraud, wire fraud, and money laundering. Prosecutors had alleged that after the passage of a 2006 law which prohibited banks from processing payments to offshore gambling websites, Mr. Rubin engaged in a fraudulent scheme to deceive US banks and financial institutions as to the true identity of the funds being transferred by processing these funds to appear as payments for goods and services to non-existent online merchants and fake companies. As we have previously reported, federal prosecutors have focused on payment processor prosecutions as a way of combating online pay for play poker.

Additionally, five days later, on July 31, 2012, the U.S. Department of Justice announced that it had reached a $731 million settlement with PokerStars and Full Tilt Poker regarding the forfeiture Complaint filed against the two companies in April, 2011. Under the terms of the agreement, Full Tilt agreed to forfeit virtually all of its assets to the United States, however, the Government has approved the acquisition of these assets by PokerStars in exchange for PokerStars’s agreement to reimburse $184 million owed by Full Tilt to Full Tilt’s foreign players. Additionally, PokerStars agreed to forfeit $547 million to the U.S. which will be used to compensate U.S. account holders.

Fuerst Ittleman will continue to monitor these developments. If you have questions pertaining to UIGEA, the BSA, anti-money laundering compliance, and how to ensure that your business maintains regulatory compliance at both the state and federal levels, or for information about Fuerst Ittleman’s experience litigating white collar criminal cases, please contact us at contact@fidjlaw.com.

U.S. Court of Appeals for the D.C. Circuit Affirms Son of Boss Accuracy-Related Penalty

  On June 22, 2012, the United States Court of Appeals for the District of Columbia Circuit affirmed that a partnership which utilized a Son of Boss tax shelter to overstate its basis in partnership interests had also failed to establish a reasonable cause defense to the accuracy-related penalty. A full copy of the decision, entitled 106 Ltd. v. Commr, case no. 11-1242, is available here.

According to the facts set forth in the D.C. Circuits opinion, a “Son of Boss” tax shelter employs a series of transactions to create artificial financial losses that are used to offset real financial gains, thereby reducing tax liability.  In 2001, the IRS identified the Son of Boss tax shelter as an abusive transaction if used to generate artificial losses for tax purposes and would not allow the deductions for federal tax purposes. We have previously reported on issues relating to Son of Boss tax shelters here,  here, here, and here.

David Palmlund, a Dallas businessman and the tax matters partner, appealed the decision of the U.S. Tax Court upholding the imposition of a 40% accuracy-related penalty by the Internal Revenue Service (IRS). The Tax Courts decision is available here.

Long before this matter ended up in court, Joe Garza, Palmlunds personal lawyer, approached Palmlund about a foreign currency investment opportunity that was a variation of the Son of Boss shelter.  Garza explained the mechanics of the shelter and its tax advantages and encouraged Palmlund to consult with Turner & Stone, an accounting firm that had prepared Palmlunds tax returns for more than ten years.  Turner & Stone told Palmlund that they had worked on similar shelters in the past and recommended that he proceed.  Furthermore, Garza guaranteed the transaction by promising to pay Palmlunds litigation costs if the shelter were challenged and to refund his fee if the shelter were invalidated.  Ultimately, Palmlund directed Garza to take the necessary steps to implement the shelter.

The mechanics of the transaction are explained in the opinion.  In November 2001, Palmlund executed documents forming three entities which he controlled: (1) the partnership, (2) 32 LLC and (3) 7612 LLC.  7612, LLC bought offsetting long and short foreign currency for $30,000, the difference of the $3 million and $2.97 million premiums.  7612 LLC then transferred both digital options to the partnership.  Next, 7612 LLC bought $4,000 worth of Canadian currency and transferred the currency to the partnership.  Lastly, the partnership distributed 35% of the Canadian currency to Palmlund Ltd., the family limited partnership previously formed by Palmlund.  At Palmlunds request, the partnership terminated the digital options for a profit of $10,000 excluding fees owed to Garza for implementing the shelter.  Garza also provided a comprehensive opinion letter explaining the shelter and general topics like partnership law, disguise-sale provisions, and the treatment of foreign currency options.  The letter concluded that the structure would more likely that not withstand IRS scrutiny  

The partnerships 2001 tax return prepared by Turner & Stone reported a basis in the distributed Canadian currency of $2,974,000.  On Palmlunds return, also prepared by Turner & Stone, he claimed a flow-through loss of $1,030,491 from the Canadian currency distribution.  By utilizing the Son of Boss shelter, Palmlund reduced his total income by over $1 million and thereby reduced his tax liability by nearly $400,000.  Turner & Stone charged Palmlund $6,500 more than what they had charged for preparing his previous tax returns due to the returns more complex nature.

The IRS first communicated with Palmlund in May 2004 by sending him a copy of IRS announcement 2004-46, which outlined the IRSs proposed terms of settlement for any taxpayer utilizing a Son of Boss tax shelter.  Palmlund then met with Garza and Turner & Stone and decided to amend his individual return by removing the loss attributable to the Canadian currency and paid an additional $349,329 in taxes.  He did not amend the partnerships tax return. 

Consequently, the IRS issued a final partnership administrative adjustment (FPAA) to the partnership in May 2005.  The FPAA reduced the partnership basis to $0 and pursuant to § 6662, available here, imposed a 40% accuracy-related penalty to the underpayment of taxes resulting from the partnerships overstatement of its basis in the Canadian currency.  The Tax Court granted partial summary judgment in favor of the commissioner.  Thus, the only remaining issue was whether the partnership had a reasonable cause defense under § 6664(c)(1), available here,  to defeat the penalty.

Section 6664 provides a defense to an accuracy-related penalty if the taxpayer proves it had reasonable cause for the underpayment and acted in good faith.  The taxpayer can show reasonable cause if it shows that it relied on advice from a competent and independent professional advisor.  To show reasonable cause, the advice must be based on upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances.  The advice must not be based on unreasonable factual or legal assumptions, including if the taxpayer knows or should have known it is unlikely to be true.  Lastly, the taxpayers reliance must itself be objectively reasonable.

In affirming the Tax Courts decision, the D.C. Circuit found no error in the determination that the Partnership failed to establish a reasonable cause defense because Palmlund unreasonably relied on both Garzas and Turner & Stones advice.  First and foremost, Garzas and Turner & Stones role of promoting, implementing, and receiving fees from the Son of Boss strategy creates an inherent conflict of interest.   It is unreasonable of Palmlund to rely on their professional advice if they had a role in promoting the tax shelter.  According to the Court of Appeals, Palmlund knew or should have known that Garza and Turner & Stone were working together to structure and implement the tax shelter.  Therefore, Garza and Turner & Stone could not provide independent advice regarding the tax shelter.

Additionally, Palmlund unreasonably relied on Garzas opinion letter.  The letter relied on inaccurate representations as to the purposes of entering into the transaction.  The letter stated that Palmlund entered into the transaction because he believed there was reasonable opportunity to earn a reasonable pre-tax profit.  However, Palmlunds personal banker testified that Palmlund said he entered into the transaction as a tax strategy to lose money. 

There were other inaccuracies contained in the letter.  The letter stated Palmlund received the distributed Canadian currency in a partnership liquidating distribution.  However, the partnership distributed only 35% of the Canadian currency and Palmlund demonstrated his awareness of this inaccuracy as he directed Turner & Stone to amend his individual tax return to reflect the 35% distribution.  The letter also stated that the partnership did not know if it would be called upon to satisfy its obligations under the digital options.  Yet, by the time the letter was written, Palmlund had terminated the options and eliminated the partnerships obligations under them.

The DC Circuits opinion concluded by explaining that even if Palmlund did not know about the conflicts of interest, his motive for entering into the tax shelter and his business experience demonstrated his lack of good faith reliance.  The $1 million dollar loss from the transaction that earned Palmlund $10,000 should have alerted a person with Palmlunds business experience and sophistication to the shelters illegitimacy.  Thus, the D.C. Circuit affirmed the U.S. Tax Courts judgment in determining that the partnership failed to establish a reasonable cause defense to its accuracy-related penalty pursuant to § 6664(c)(1).

The attorneys at Fuerst Ittleman, PL have extensive civil and criminal tax litigation experience before the U.S. District Courts, the U.S. Tax Court, and the U.S. Circuit Courts of Appeal.  You can contact us by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.

Eleventh Circuit Rules that Tax Court Petition by Former owners Suspended the Statute of Limitations

On July 11, 2012, the Atlanta based Eleventh Circuit Court of Appeals issued its opinion in Shockley v. IRS, __ F.3d ____, (11th Cir.) available here, and overruled the U.S. Tax Court’s earlier decision in Shockley v. IRS, T.C. Memo. 2011-96.  A full copy of the Tax Court’s decision is available here.

The question addressed by the Eleventh Circuit in Shockley was whether a Tax Court petition that challenged a notice of deficiency as being invalid suspended the statute of limitations against the assessment. The facts of the case were as follows.

On May 31, 2001, pursuant to a stock purchase agreement, the Shockleys sold their shares of Shockley Communications Corporation (“SCC”), a closely held

corporation that owned and operated numerous media stations, to a third party. Pursuant to the terms of the sale, the Shockleys resigned from their positions in SCC as of that date, and at no time after the sale did they resume their roles as officers, directors, or shareholders of SCC.  Also on May 31, 2001, following the sale, the third party purchaser converted SCC to a Delaware limited liability (SCA LLC). SCA LLC immediately sold some of SCCs assets to Quincy Newspapers, Inc. The Shockleys timely filed Federal income tax returns for calendar year 2001 reporting gains from the May 31, 2001, SCC stock sale.

On or about February 24, 2002, the Internal Revenue Service (IRS) received SCCs Form 1120 for the short tax year of January 1, 2001, through May 31, 2001. That form reported a Washington, D.C., mailing address for SCC. On February 18, 2005, the IRS issued multiple notices of deficiency relating to SCCs short tax year ending May 31, 2001. The IRS also sent a notice of deficiency to “Shockley Communications Corporation” at the Washington, D.C., address reported on the 2001 Form 1120, determining a deficiency in tax of $41,566,515, a penalty under section 6662 (available here) of $8,313,303, and an addition to tax under section 6651(a)(1) (available here) of $2,078,276. The IRS calculated the determined deficiency and the penalty with respect to gain allegedly realized by SCC as a result of the sale of assets acquired and later sold by SCA LLC. However, this notice was returned to the IRS as undeliverable, and no petition was filed in the Tax Court in response.

On February 18, 2005, the IRS also sent a notice of deficiency to “Shockley Communications Corporation, Terry K & Sandra K Shockley, Officers & Shareholders” at the then- home address of the Shockleys in Madison, Wisconsin (the Madison notice). On May 25, 2005, a petition was filed in the Tax Court in response to the Madison notice (docket No. 9699-05). The petition stated that it was “filed on behalf of Petitioner subject to the invalidity of the Notice of Deficiency and the failure to properly serve the corporation as required by statute.” Without conceding the jurisdiction of the Tax Court, the Shockleys tendered a "Limited and Special Petition.”

A letter dated May 18, 2005, from the Shockleys to the Clerk of the Tax Court was also attached and was served on the Commissioner with the petition. In the letter, the Shockleys expressed concern that the notice was addressed to both SCC and the Shockleys as officers and shareholders and was mailed to their then-home address, which had never been SCCs address. The Shockleys also expressed concern that the notice might be directed to them in an individual or some representative capacity.  In an answer filed July 29, 2005, the Commissioner admitted that the Madison notice was sent to the personal residence of the Shockleys but alleged that this was a courtesy copy and that a copy of the notice of deficiency was also sent to the last known address of SCC at the Washington, D.C., address.

On April 26, 2007, the Tax Court case (docket No. 9699-05) was dismissed for lack of jurisdiction because SCC lacked legal capacity to proceed in the case through the Shockleys. The order of dismissal for lack of jurisdiction stated that the parties agreed that the case should be dismissed on this ground and thus the Court did not determine the validity of the notice of deficiency.

On September 6, 2007, the IRS assessed the following amounts against SCC for the tax year ending May 31, 2001: (1) Corporate income tax of $41,566,515; (2) an addition to tax under section 6651 of $2,078,276; (3) an accuracy-related penalty under section 6662 of $8,313,303; and (4) interest of $26,953,309.60.

On appeal, the 11th Circuit turned to the Internal Revenue Code as applied to the facts. First, the 11th Circuit noted that generally under section 6501(a) (available here) the IRS has 3 years to assess a tax (or additional tax) against a taxpayer.  But under section 6503 (available here), "[t]he running of the period of limitations provided in section 6501 or 6502 (or section 6229, but only with respect to a deficiency described in paragraph (2)(A) or (3) of section 6230 (a)) on the making of assessments or the collection by levy or a proceeding in court, in respect of any deficiency as defined in section 6211 (relating to income, estate, gift and certain excise taxes), shall (after the mailing of a notice under section 6212 (a)) be suspended for the period during which the Secretary is prohibited from making the assessment or from collecting by levy or a proceeding in court (and in any event, if a proceeding in respect of the deficiency is placed on the docket of the Tax Court, until the decision of the Tax Court becomes final), and for 60 days thereafter."

The 11th Circuit then determined that the question was whether the petition filed by the Shockleys (which was dismissed because they did not have the authority to file on behalf of SCC) gave the IRS additional time to issue the statutory notice of deficiency by operation of section 6503.  In concluding that it did, and thus reversing the Tax Court, the 11th Circuit began with the well established rule that statutes of limitations are strictly construed in favor of the Government, citing to Badaracco v. Commr, 464 U.S. 386, 391, 395, (1984) (available here).  The 11th Circuit held as follows: "In short, Congress established a mechanical, bright-line test that would suspend the limitations period of § 6501 automatically upon the placing of any “proceeding in respect of the deficiency” on the Tax Court docket. To interpret § 6503(a)(1) otherwise would present the IRS with the Hobsons choice of deciding between assessing the taxpayers liability at the risk of doing so prematurely, and waiting until the resolution of the proceeding at the risk of doing so too late."

Based on that interpretation of section 6503 as applied to section 6501, the 11th Circuit quickly dispensed with the case and determined that the Tax Court’s decision that the statute of limitations was not suspended was in error, and reversed and remanded the case to the Tax Court for further consideration.

The takeaway from this decision is that Tax Court petitions filed without authority may have unintended consequences.  Accordingly, every single move in Tax Court litigation must be analyzed for possible ramifications, not only in the Tax Court, but in the Courts of Appeal.

The attorneys at Fuerst Ittleman, PL have extensive experience litigating in the Tax Court, the U.S. District Courts, the Court of Federal Claims, and the U.S. Courts of Appeal in both civil and criminal tax cases.  You can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Drugmaker Sues FDA over Orphan Drug Exclusivity

On July 5, 2012, K-V Pharmaceutical Company (“KV“) filed a complaint against the U.S. Food and Drug Administration (“FDA“) in the U.S. District Court for the District of Columbia regarding the right to exclusively market the orphan drug Makena (a hydroxyprogesterone caproate injection). KV is seeking to enforce its statutory right to market exclusivity.

On February 3, 2011, the FDA approved KVs drug Makena “to reduce the risk of preterm birth in women with a singleton pregnancy who have a history of singleton spontaneous preterm birth.” The FDA also granted KV orphan drug exclusivity that expires on February 3, 2018. Pursuant to section 527 of the Federal Food, Drug, and Cosmetic Act (“FDCA”), orphan drug exclusivity prevents the FDA from approving another companys version of the “same drug” for the same disease or condition for seven years, unless the subsequent drug is different from the approved orphan drug, or because the sponsor of the first approved product either cannot assure the availability of sufficient quantities of the drug or consents to the approval of other applications. For more information regarding Makenas FDA approval, please see our previous report.

However, compounded generic versions of Makena, commonly known as 17P, are available at a substantially lower price through compounding pharmacies. Generally, compounded drugs are not reviewed or approved by the FDA because they are made through a process by which a pharmacist or doctor combines, mixes, or alters ingredients to create a customized medication for the needs of an individual patient. 17P costs about $10 to $20 per dose at compounding pharmacies, compared to commercially-available Makena which costs about $690 per dose. Thus, many patients are seeking 17P, the unapproved compounded drug, instead of FDA-approved Makena.

In the past, the FDA has generally exercised enforcement discretion against compounding pharmacies operating in conformity with Compliance Policy Guide 460.200. However, despite the statutory market exclusivity for Mekena, on March 30, 2011, the FDA announced it did not intend to take enforcement action against pharmacies that compound 17P unless the compounded products are unsafe. As a way to explain its change in position with regard to compounding pharmacies, the FDA stated that it will not take enforcement action in an effort “to support access to this important drug, at this time and under this unique situation.” Please see our previous report for more information regarding the FDAs enforcement posture for Makena.

In its complaint, KV alleges that the FDA effectively nullified Makenas statutory seven-year period of market exclusivity in violation of section 527 of the FDCA by giving de facto approval to compounded versions of 17P that are intended for use to treat the same indication for which Makena is designated as an orphan drug and is approved. KV is seeking temporary, preliminary, and permanent declaratory and injunctive relief to restore the right to exclusively market the drug Makena.

The purpose of granting orphan drug exclusivity is to incentivize pharmaceutical manufacturers to invest money and resources developing treatments for small patient populations. Without the FDAs enforcement of the seven-year market exclusivity period against compounding pharmacies, manufacturers of orphan drugs have little incentive to develop drug treatments for rare diseases due to high research and development costs. Of course, at $690 per dose, the Makena approval raises the question of whether seven-year market exclusivity will benefit anyone in the first place. The FDAs position vis-a-vis Makena, as well as the upcoming litigation between KV and the FDA will certainly highlight the divide between these two interests.

A Motions Hearing is scheduled for August 7, 2012. Fuerst Ittleman will continue to monitor the developments of the Makena drug case. For more information regarding orphan drugs, compounded products, or for any questions regarding how your company can maintain FDA regulatory compliance, please contact us at contact@fidjlaw.com.

Fourth Circuit Affirms Federal Tax Conviction

In United States v. Jinwright, available here, the Richmond, Virginia based 4th Circuit Court of Appeals affirmed two tax convictions. The facts of the case are as follows:

Mr. and Mrs. Jinwright were former co-pastors of the Greater Salem Church in North Carolina. When Mr. Jinwright first became pastor he earned about $10,000 per year. Mr. Jinwright’s salary had increased to  about $148,000 in 2001, and about $300,000 in 2007. Between 2001 and 2007, Mr. Jinwright’s employer provided him with substantial taxable benefits that he failed to report and/or underreported on his personal income tax returns. When taking into account Mr. Jinwright’s reported and unreported compensation between 2001 and 2007, he earned almost $3.9 million. During that same time period Mrs. Jinwright received similar compensation from the church amounting to nearly $1 million.

Mr. and Mrs. Jinwright also earned income separate and apart from the church, such as compensation for speaking engagements, which,  of course, they failed to report on their tax returns. The church, like many others, applied for tax exempt status under Section 501(c)(3) of the Internal Revenue Code, available here.

In 2002, the church understated Mr. Jinwright’s total compensation. The IRS denied the tax exempt status because Mr. Jinwright’s compensation was too high.  A second application by the church was filed in 2003, listing Mr. Jinwright’s compensation as $600,000. However, in contrast to the 501(c)(3) application, Mr. Jinwright reported on his personal income tax return compensation of $280,000.

Not surprisingly, the IRS began an audit and concluded that Mr. and Mrs. Jinwright had failed to properly report taxable income of approximately $2 million between 2002-2007, and federal criminal indictments soon followed.  

Mr. and Mrs. Jinwright were charged withparticipating in a Kleinconspiracy, 18 U.S.C. § 371, available here, of three counts of tax evasion for the years 2005-2007, 26 U.S.C. § 7201, available here, and aiding and abetting tax evasion under the federal aiding and abetting statute, 18 U.S.C. § 2, available here.

Mr. Jinwright was convicted, but not Mrs. Jinwright, of three counts of tax evasion for the years 2002-2004, as well as six counts of filing a false tax return, 26 U.S.C. § 7206(1), available here.

At sentencing, the district court concluded that certain sentencing factors were present, specifically that:  (i) a tax loss of $1.3 million for the period from 1998-2008 (based on relevant conduct), resulting in a base offense level of 22 under 2T1.1 of the U.S. Sentencing Guidelines, available here; (ii) sophisticated means enhancement, a 2 level increase; (iii) an abuse of trust enhancement, a 2 level increase, and (iv) an obstruction enhancement, a 2 level increase.  For a total base level of 28, see
here, Mr. Jinwright was sentenced to 105 months, and Mrs. Jinwright to 80 months.

On appeal, the Fourth Circuit addressed the defendants contentions of error and affirmed in all respects.  The relevant analysis is as follows:

First, the Court affirmed the trail court’s use of the willful blindness instruction and the contents of the instruction.  The Court agreed with the Jinwrights that the request for willful blindness instructions should be handled with care, but declined to provide a categorical exclusion of a willful blindness instruction as no court had previously adopted such a rule.  The Fourth Circuit relied on Global-Tech Appliances, Inc. v. SEB S.A., 131 S. Ct. 2060, 2069 (2011), available here, for the proposition that "[t]he traditional rationale for [the willful blindness] doctrine is that defendants who behave in this manner are just as culpable as those who have actual knowledge."

The Fourth Circuit also held that "the district court properly set a high bar in its instruction for the government to prove willful blindness, while simultaneously recognizing the powerful evidence of such blindness in this case." The Court found that the conditions for use of the jury instruction were present: “Willfulness with respect to tax crimes has been defined in essence as a knowledge requirement, or the "intentional violation of a known legal duty." United States v. Pomponio, 429 U.S. 10, 12 (1976) (per curiam), available here. When applied, the doctrine of willful blindness permits the government to prove knowledge by establishing that the defendant "deliberately shield[ed] [himself] from clear evidence of critical facts that are strongly suggested by the circumstances." Global-Tech, 131 S. Ct. at 2068-69. Willful blindness may satisfy knowledge in a criminal tax prosecution, where "the evidence supports an inference that a defendant was subjectively aware of a high probability of the existence of a tax liability, and purposefully avoided learning the facts pointing to such liability." United States v. Poole, 640 F.3d 114, 122 (4th Cir. 2011). 

According to the Fourth Circuit, these conditions were satisfied in the Governments prosecution of the Jinwrights. Mr. Jinwright denied knowledge of his legal obligations and testified that he and Mrs. Jinwright did not know that their tax returns contained a deficiency. But the Government presented evidence to suggest that defendants were aware of a "high probability" that they were understating their income to the IRS. The Fourth Circuit further discussed and affirmed the content of the willful blindness instruction, stating as follows:

The trial court’s instruction here was thus faithful to the willful blindness standard set forth in Global-Tech.  Global-Tech synthesized the case law on willful blindness to identify "two basic requirements": "(1) the defendant must subjectively believe that there is a high probability that a fact exists and (2) the defendant must take deliberate actions to avoid learning of that fact." Global-Tech, 131 S. Ct. at 2070. The district court included this relevant language here, instructing the jury: "If you find that the defendants were aware of a high probability" that they were violating the law "and that the defendants acted with deliberate disregard to these facts, you may find the defendants acted knowingly" (emphasis added). The Jinwrights were convicted before the Global-Tech decision, but the language of the willful blindness instruction still tracks the factors enumerated there by the Supreme Court.

The Fourth Circuit also addressed the "gift issue" as to whether a gift is taxable and the jury instruction appropriate for the issue. The defendants claimed that at least some of the income was not taxable under which Section 102(a), available here. However, payments to employees from employers cannot be treated as gifts, 26 U.S.C. § 102(c).  The Court held that the instruction was not erroneous or an abuse of discretion, insofar as the jury was left to determine the factual issue as to whether the defendant received payments from their employer (the church) instead of the parishioners, which the 4th Circuit concluded the defendants conceded.

Next, the defendants argued that some income was not taxable, and hence not reportable on a tax return, if they were reimbursements for employer-related expenses.  More specifically, the defendants argued that the Government had to prove that the payments they received were not reimbursements, but in contrast, the Government contended that it must merely prove the payments and then the burden was shifted to the defendants to prove that the payments were reimbursements.  The Court held that once the prosecution introduced credible evidence that there was income, the taxpayer was required to rebut this showing by introducing credible evidence showing that there were deductions reducing or eliminating the tax due.

The Court next turned to the claims of sentencing error, but dispensed with all of these issues quickly and we will not discuss them here.

In sum, this case shows that the Department of Justice and the IRS have been and continue to be aggressive in the areas of unreported income.  Further, inconsistent positions taken on filings with the IRS, in this case the defendants personal income tax returns and the 501(c)(3) application by the church, continue to provide the IRS with initial evidence of income tax evasion, which often, as in this case, lead to an IRS audit and/or criminal investigation.

The attorneys at Fuerst Ittleman, PL have extensive experience litigating against the IRS and the U.S. Department of Justice, in addition to addressing taxpayers’ needs during IRS audits.  You can reach an attorney by emailing us at: contact@fidjlaw.com or by calling us at 305.350.5690.

GlaxoSmithKline Agrees to $3 Billion Settlement to Resolve Fraud Allegations

On July 2, 2012, the U.S. Department of Justice (“DOJ”) announced that British drug maker GlaxoSmithKline (“GSK”) agreed to plead guilty and to pay $3 billion in criminal and civil penalties for liabilities arising from the companys unlawful activities involving the promotion and sale of several pharmaceutical products. The settlement is the largest health care fraud related settlement in U.S. history. A copy of the DOJs press release can be read here.

According to the terms of the settlement agreement, GSK has agreed to plead guilty to a three-count criminal information which includes two counts of introducing misbranded drugs into interstate commerce in violation of 21 U.S.C. § 331 (a) and one count of failing to report safety data about a drug to the FDA in violation of 21 U.S.C. § 331(e) and 21 U.S.C. § 355(k)(1). A copy of the Information can be read here.

The information alleges that for two drugs, Paxil and Wellbutrin, GSK unlawfully promoted both for unapproved “off-label” uses. Generally speaking, while doctors are free to use their medical judgment to prescribe FDA approved medicines for any use, pharmaceutical manufacturers cannot promote medicines for any use that is not approved by the FDA. The promotion of a drug for “off-label” uses by a pharmaceutical manufacturer results in the drug being considered “misbranded” under the FDCA. See generally 21U.S.C.§352(f)(1); 21 C.F.R. § 201.100. According to the Information, between 1998 and 2003, GSK promoted Paxil for treating depression in patients under age 18, despite the FDA never approving the drug for pediatric use. The Information alleges that GSK promoted this “off-label” use through publishing a medical journal article which misrepresented the drugs efficacy in treating depression in patients under age 18 as well as through a series of promotional events such as dinners and spa programs. The Information further alleges that GSK promoted Wellbutrin, an anti-depressant, for various off-label uses including weight-loss, sexual dysfunction, and attention deficit hyperactivity disorder.

GSK also pled guilty to one count of failure to report safety data to the FDA regarding its drug Avandia. The information alleges that between 2001 and 2007, GSK failed to report safety data regarding two studies conducted in response to concerns of European regulators about the cardiovascular safety of Avandia. As a result of these violations, GSK has agreed to pay a total of $1 billion in criminal fines and forfeitures.

GSK also reached a civil settlement with the DOJ regarding allegations of  violating the False Claims Act for: 1) the “off-label” promotion of Paxil, Wellbutrin, Advair, Lamictal, and Zofan (including using paid spokespersons such as Dr. Drew Pinsky from MTVs Loveline to tout the various off-label uses of such products in settings where it would appear he was not acting on behalf of GSK); 2) paying kickbacks to doctors to prescribe those drugs; 3) making false and misleading statements regarding the safety of Avandia; and 4) reporting false best prices and underpaying rebates owed under the Medicaid Drug Rebate Program. A copy of the Civil Complaint can be read here. As a result of these numerous violations, GSK agreed to pay a civil penalty of $2 billion. Additionally, GSK has entered into a 5-year Corporate Integrity Agreement with the Department of Health and Human Services which has required GSK to restructure its executive compensation program to permit the company to recoup annual bonuses and incentives from executives if they, or their subordinates, engage in misconduct.

The attorneys at Fuerst Ittleman have extensive experience litigating criminal and civil cases against the federal government at both the trial and the appellate levels. You can contact an attorney by calling us at 305.350.5690 or by emailing us at contact@fidjlaw.com.

Tax Return Preparers Indicted for Assisting in Income Tax Evasion

In a Superseding Indictment, available here,

filed June 14, 2012 in the United States District Court for the Central District of California, three of the managers (David Kalai, Nadav Kalai, and David Almog) of a tax return preparation service, United Revenue Service ("URS") were indicted.  The Department of Justice has issued a press release, available here, announcing the indictment.

As the press release details,  URS had 12 offices located throughout the United States. David Kalai worked primarily at URS’s former headquarters in Newport Beach, Calif., and later at URS’s location in Costa Mesa, Calif. Nadav Kalai worked out of URS’s headquarters in Bethesda, Md., as well as URS locations in Newport Beach and Costa Mesa, Calif. David Almog was the branch manager of the New York office of URS and supervised tax return preparers for URS’s East Coast locations.

The superseding indictment alleges that the defendants prepared false individual income tax returns which did not disclose the clients’ foreign financial accounts nor report the income earned from those accounts. In order to conceal the clients’ ownership and control of assets and conceal the clients’ income from the IRS, the defendants incorporated offshore companies in Belize and elsewhere and helped clients open secret bank accounts at the Luxembourg locations of two unnamed Israeli banks.  The first unnamed Israeli bank is a large financial institution headquartered in Tel-Aviv, Israel, with more than 300 branches across 18 countries worldwide. The second unnamed bank is a mid-size financial institution also headquartered in Tel-Aviv, with a presence on four continents.

As further alleged in the superseding indictment, the defendants incorporated offshore companies in Belize and elsewhere to act as named account holders on the secret accounts at the Israeli banks. The defendants  then facilitated the transfer of client funds to the secret accounts and prepared and filed tax returns that falsely reported the money sent offshore as a false investment loss or a false business expense. The defendants also failed to disclose the existence of, and the clients’ financial interest in, and authority over, the clients’ secret accounts and caused the clients to fail to file FBARs with the Department of the Treasury. (The FBAR form is available here. The charge is 18 USC 371, commonly referred to as a "Klien Conspiracy," available here.)

This indictment appears to be just the beginning of the Justice Departments attempts to prosecute not only those who have undeclared foreign bank accounts and under- (or un-) reported income to the IRS, but those who have assisted the taxpayers with improperly reducing (or avoiding altogether) their income tax liability to the IRS.  This also appears to be one of the first prosecutions that has implicated Israeli banks.  It has been widely reported that the Department of Justice has been investigating banks outside of Switzerland for aiding U.S. taxpayers in evading taxes. 

In criminal tax litigation, defendants must engage a trial team that can navigate both criminal law and tax law.  As federal prosecutions become increasingly sophisticated, the defense needs to keep pace with the prosecution and bring to the defense table the full array of skill sets needed to properly defend a federal indictment. The attorneys at Fuerst Ittleman have extensive tax and criminal litigation experience.  The firm regularly handles matters involving civil tax litigation, criminal defense, and criminal tax defense (at the trial and appellate levels, including U.S. Supreme Court litigation).  You can contact an attorney via telephone by calling us at 305.350.5690 or via email at contact@fidjlaw.com

Third Circuit Affirms District Court Holding the Perlman Doctrine Inapplicable Criminal Tax Grand Jury Subpoena

In the case of In re: Grand Jury, decided on May 24, 2012, the Third Circuit Court of Appeals confronted the following set of facts:

ABC Corp., John Doe 1, and John Doe 2 were the targets of a grand jury investigation. In mid-2010, the targets learned that the Government was investigating the tax implications of ABC Corp.s acquisition and sale of certain closely held companies. In December 2010, the Government issued a grand jury subpoena to ABC Corp.s former vice president of corporate acquisitions as the companys custodian of records. The subpoena sought any and all records relating to transactions entities and individuals.

At some point the Government received access to, or copies of, certain ABC Corp. documents from a law firm that previously represented the company. The firm withheld certain documents it claimed were privileged, but it did not supply the Government with a privilege log. After the current law firm commenced its representation, the former law firm transferred the documents to the law firm representing John Doe 2. In a January 2011 letter, ABC Corp.’s law firm took the position that the Government did not effectively serve the subpoena issued to ABC Corp.s former vice president. Because ABC Corp. refused to accept service of the subpoena issued to its former employee, the Government issued grand jury subpoenas to the law firms in May 2011. The subpoenas sought all documents the two firms received from ABC Corp.s former law firm relating to ABC Corp. and another entity. In response to these subpoenas, the law firms produced approximately 24 boxes of documents. These were the same documents that ABC Corp.s former firm had previously produced. They continued to withhold, however, the documents listed on the April 2011 privilege log, and provided the Government with another privilege log in June 2011 for additional documents withheld.

The Government then filed an ex parte motion to compel ABC Corp., and the law firms to produce the withheld documents.  The Government argued that the documents should be produced based on the crime-fraud doctrine, which provides that evidentiary privileges may not be used to shield communications made for the purpose of getting advice for the commission of a fraud or crime, pursuant to United States v. Zolin, 491 U.S. 554 (1989), available here. On March 8, 2012, the District Court granted the Governments motion. Shortly thereafter, the targets proceeded to the Third Circuit Court of Appeals to challenge the order of the District Court requiring ABC Corp., and the target’s attorneys and the law firms to produce documents to grand jury. 

It is fairly well settled that when a district court orders the production of possibly privileged documents, its order is typically not immediately appealable under 28 USC section 1291, available here. Instead, to obtain immediate appellate review, an objecting privilege holder must disobey the disclosure order, be held in contempt, and then appeal the contempt order; see Church of Scientology of Cal. v. United States, 506 U.S. 9, 18 n.11 (1992), available here; (a witness who “seeks to present an objection to a discovery order immediately to a court of appeals must refuse compliance, be held in contempt, and then appeal the contempt order.”)

However, the appellants argued that Perlman v. United States, 247 U.S. 7 (1918), available here, provides an exception to the contempt rule because the documents were in the custody of a third party (the law firm representing John Doe 2) who was not willing to suffer contempt for the sake of an immediate appeal.  The reason that the Perlman doctrine allows an immediate appeal is that the person/entity asserting the privilege is powerless to compel a third part to be held in contempt, so there is nothing that the person/entity can do to assert the claim of privilege. 

In this case, the Third Circuit disagreed with the targets that Perlman applied, and held that Perlman does not allow an immediate appeal of a district courts order mandating the production of supposedly privileged documents when (1) the courts order directs the privilege holder itself to produce the documents, and (2) the privilege holder has, or may obtain, custody of the documents. In short, according to the Third Circuit, Perlman does not apply when the traditional contempt route is available to the privilege holder.  The Third Circuit held that because ABC Corp. could obtain the documents from its agent (in this case the attorneys and/or law firms), the Perlman doctrine was inapplicable.  The Third Circuit went on to note that if ABC Corp. wants pre-conviction appellate review of the District Courts crime-fraud ruling, it must take possession of the documents and defy that Courts disclosure order before appealing any resulting contempt sanctions.

However, the Court also issued a dissenting opinion which reasoned that the Perlman doctrine was applicable to the facts of this case, but nonetheless would have affirmed the decision of the District Court requiring the production of documents in response to the grand jury subpoena.  The dissent noted that the District Court order required direct production of the privileged documents to the Government, and that by giving the documents back to the targets, the law firms would be in violation of a court order.  Thus, reasoned the dissent, the Perlman doctrine was applicable.

A full copy of the opinion can be found here.

This case demonstrates, among other things, that the Government will go to great lengths to obtain documents and evidence in federal criminal investigations, including subpoenaing documents that attorneys believe are subject to the attorney-client privilege.  When this happens, targets litigating against the Government have certain alternatives to production, but whether these alternatives are available will depend upon the facts and circumstances of the particular case. 

The attorneys at Fuerst Ittleman have extensive experience litigating against the federal government in civil and criminal cases, including grand jury subpoenas demanding privileged documents.  You can contact an attorney by emailing us at:  contact@fidjlaw.com or by calling us at 305.350.5690.