Eleventh Circuit vacates sentence in criminal tax case based on impermissible grouping under the U.S. Sentencing Guidelines

On May 4, 2012, the U.S. Court of Appeals for the Eleventh Circuit vacated a sentence handed down by the U.S. District Court for the Middle District of Florida in United States of America, v. Register, case no. 11-12773.

The facts of the case are as follows:

The Defendant was the owner and operator of Criminal Research Bureau, Inc. (“CRB”), a provider of background-check services for employers. To manage the CRB payroll, the Defendant used a payroll processing company, PrimePay, that prepared employee paychecks and submitted the necessary quarterly paperwork to the IRS. The Defendant, in turn, was responsible for paying the withheld taxes over to the IRS. From the first quarter of 2003 through the fourth quarter of 2007, federal income taxes and Federal Insurance Contributions Act (“FICA”) taxes totaling $316,220 were withheld from the wages of CRB employees, yet the Defendant never remitted the

vast majority of those funds to the IRS.

In addition, the Defendant falsified his individual federal income tax returns during this period for tax years 2003 to 2006. In 2003 and 2004, the Defendant was not on the CRB payroll; instead, he paid his personal expenses directly from the company bank account. Initially, the Defendant filed no federal returns at all for these years. However, in order to qualify for a mortgage, the Defendant ultimately filed his 2003 and 2004 returns late. In doing so, the Defendant generated Form W-2s that falsely indicated that the Defendant had been paid wages and that federal taxes had been withheld. The Defendant then used those figures to complete his Form 1040s for both years, enabling him to fraudulently collect refunds of $4,444.50 for tax year 2003 and $7,479.13 for tax year 2004. In 2005 and 2006, the Defendant added himself to the CRB payroll as an employee with an annual salary of $234,000. Again, however, the Defendant falsified his Form 1040s to indicate that federal taxes had been withheld from his salary when in fact none had been withheld. As a result, the Defendant collected refunds of $6,689.12 for tax year 2005 and $10,780 for tax year 2006 when, in reality, he owed $45,098 and $40,905 for those tax years respectively.

On December 8, 2010, Mr. Register was indicted on thirteen counts of willful failure to pay over taxes in violation of 26 U.S.C. § 7202, available here. Each count charged that federal income taxes and FICA taxes had been withheld from the wages of CRB employees during a particular quarter but were never paid over to the IRS.  The thirteen failure-to-pay-over counts in the indictment covered the period from the fourth quarter of 2004 through the fourth quarter of 2007.

The Defendant was also indicted on four counts of filing false individual federal income tax returns in violation of 26 U.S.C. § 7206(1), available here. Each count charged that the Defendant had falsely stated on his return for a particular year that federal income tax had been withheld when, in fact, he knew that it had not. The four filing-false-returns counts in the indictment covered the 2003 through 2006 tax years.

The Defendant pleaded guilty to seventeen counts of tax-related offenses. The first thirteen concerned his failure to pay over to the IRS federal taxes that had been withheld from the wages of his companys employees. The remaining four concerned the falsification of his individual federal income tax returns. After accepting his plea and holding a sentencing hearing, the district court sentenced him to twenty-seven months in prison. On appeal, the Defendant challenged the district courts calculation of the applicable guideline range under the United States Sentencing Guidelines Manual (“Guidelines” or “U.S.S.G.”).  Specifically, he argued that the district court erred by refusing to group all of his counts into a single group pursuant to U.S.S.G. § 3D1.2(b) or (d), available here,  as “counts involving substantially the same harm.”

At the sentencing hearing on May 31, 2011, the Defendant and the United States again agreed that all of the counts should be grouped for sentencing. The district court, however, disagreed with both parties and sided with the probation officer. The district court rejected the argument that the counts should all be grouped together under U.S.S.G. § 3D1.2(b), because they did not involve the same criminal objective or the same victim. And the district court rejected the alternative argument that the counts should all be grouped together under  U.S.S.G. § 3D1.2(d), because it “seem[ed] unusual” to aggregate the losses for two different offenses merely because the offense level for each is determined largely on the basis of the total amount of loss.

Therefore, the district court concluded that the total offense level was 16, which yielded a guideline range of 21 to 27 months. (If the district court had actually grouped together all seventeen counts, Registers total offense level would have been 15 instead of 16, yielding a guideline range of 18 to 24 months.) The Defendant and the United States each sought a sentence at the low end of the guideline range. The district court, however, sentenced Register to 27 months, the top of the range, on each of the seventeen counts, all to run concurrently.

The 11th Circuit observed that under the Sentencing Guidelines, counts are to be grouped together for purposes of calculating the appropriate guideline range whenever they involve “substantially the same harm.” U.S.S.G. § 3D1.2. Section 3D1.2(d) provides, in pertinent part, that counts involve substantially the same harm “[w]hen the offense level is determined largely on the basis of the total amount of harm or loss, the quantity of a substance involved, or some other measure of aggregate harm.” 

The 11th Circuit further noted that subsection (d) includes a list of guidelines covering offenses predetermined to meet its requirements and provides that they “are to be grouped.”U.S.S.G. § 3D1.2(d). Nevertheless, when the counts involve offenses to which different guidelines apply, grouping is not automatic even if all of the applicable guidelines are included in this list. United States v. Harper, 972 F.2d 321, 322 (11th Cir. 1992) (per curiam), available

here. Rather, “[c]ounts involving offenses to which different offense guidelines apply are grouped together under subsection (d) if the offenses are of the same general type and otherwise meet the criteria for grouping under this subsection.” U.S.S.G. § 3D1.2(d) cmt. n.6. “The Ëœsame general type of offense is to be construed broadly.” Id. In addition, cases have required that the offenses not only be similar in a general sense but also “closely related” on the facts of the particular case.

In determining that the Defendants tax related counts should have been grouped together, the 11th Circuit stated as follows:

As an initial matter, we have no difficulty concluding that Registers offenses otherwise meet the criteria for grouping under [subsection (d)]. The applicable guideline for the failure-to-pay-over counts is § 2T1.6, entitled “Failing to Collect or Truthfully Account for and Pay Over Tax,” and the applicable guideline for the filing-false-returns counts is § 2T1.1, entitled “Tax Evasion; Willful Failure to File Return, Supply Information, or Pay Tax; Fraudulent or False Returns, Statements, or Other Documents.” Inasmuch as both guidelines are expressly included in the “are to be grouped” together list, they clearly “otherwise meet the criteria” for grouping under subsection (d). See U.S.S.G. § 3D1.2(d).

The 11th Circuit further held that:  “Although Registers failure-to-pay-over counts under § 7202 and filing-false-returns counts under § 7206(1) are governed by different guidelines, we conclude that the underlying offenses are Ëœof the same general type.” Both are tax offenses governed by the Internal Revenue Code and Part T of the Sentencing Guidelines. The “measure of aggregate harm” is the same in both, since each involves a monetary objective. See U.S.S.G. § 3D1.2 cmt. n.6 ex. 3 (“The defendant is convicted of five counts of mail fraud and ten counts of wire fraud. Although the counts arise from various schemes, each involves a monetary objective. All fifteen counts are to be grouped together.”). And while the guidelines themselves may be different, notably, the base offense level for both is determined by looking up the amount of tax loss in the same Tax Table located at § 2T4.1. Moreover, on the facts of this case, grouping the offenses serves § 3D1.2s principal purpose of combin[ing] offenses involving closely related counts.”

Based on this analysis, the 11th Circuit determined that all 17 of the Defendants counts should have been grouped together, resulting in a lower sentencing guideline range.  As a result, the 11th Circuit vacated the Defendants sentence  and remanded the case to the district court for resentencing.

The attorneys at Fuerst Ittleman, PL have extensive criminal and civil tax litigation experience 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.

Fifth Circuit reverses District Court and holds that taxpayer did not disclose listed transaction which extended the statute of limitations on assessment

On April 26, 2012, the United States Court of Appeals for the Fifth Circuit issued its opinion in  Bemont Investments, LLC et al. v. United States of America, case # 10-41132. 

The facts are as follows:

On October 13, 2006, the IRS issued Final Partnership Administrative Adjustments (“FPAAs”) to Bemont and BPB (the “taxpayers” or “partnerships”) for tax years 2001 and 2002. An FPAA is the partnership equivalent of a statutory notice of deficiency to an individual or nonpartnership entity. The FPAAs disallowed losses from a foreign currency hedging transaction claimed on Bemonts 2001 partnership return and BPBs 2002 return. Both FPAAs also imposed four, alternative, non-cumulative penalties: (1) a 40% penalty for underpayment attributable to a gross valuation misstatement, (2) a 20% penalty for underpayment attributable to negligence, (3) a 20% penalty for underpayment attributable to a substantial understatement of income tax, and (4) a 20% penalty for underpayment attributable to a substantial valuation misstatement, all under 26 U.S.C. § 6662, available here.

The partnerships timely commenced actions for readjustment of partnership items by filing petitions in the district court.

Before trial, the court granted the partnerships motion for partial summary judgment, under Federal Rule of Civil Procedure 56, available here, holding that the government was foreclosed from imposing the valuation misstatement penalties (items (1) and (4) above). The remainder of the case proceeded to trial. After a bench trial, the court determined that the FPAA issued to Bemont for 2001 was time-barred, precluding the tax assessment and penalties related to that tax year. The court upheld the disallowance of losses reported by the partnerships and the imposition of penalties against them (items (2) and (3) above) for 2002. Both sides appealed.

The transaction underlying this dispute is described by the IRS as a “Son of BOSS” tax shelter; see our prior blog entries on this issue here. This type of shelter creates tax benefits in the form of deductible losses or reduced gains by creating an artificially high basis in partnership interests.  The IRS classified such schemes as abusive tax shelters; see Notice 2000-44, 2000-2 C.B. 255, available here. The notice designated such shelters as “listed transactions” for purposes of Treasury Regulation §§ 1.6011-4T(b)(2) and 301.6111-2T(b)(2). A listed transaction is one the IRS has determined to be a tax avoidance transaction. Treas. Reg. § 1.6011-4T.  In general, the taxpayer must file a disclosure statement with any tax return that includes gains or losses from a listed transaction. 26 U.S.C. § 6011, available here.

To address the problem of taxpayers and promoters who fail to comply with the disclosure requirements, Congress extended the usual three-year statute of limitations for the issuance of a deficiency notice or FPAA in cases involving undisclosed listed transactions until one year after the taxpayer or his tax shelter advisor has complied with the notice requirements; see 26 U.S.C. § 6501(c)(10), available here.

In this case, the partnerships filed the disclosure statements required by Notice 2000-44 and 26 U.S.C. § 6011 with their tax returns affected by participation in the transactions.  In April 2005, the IRS audited one of the partnerships indirect partners 2002 tax return and inquired about a $46 million loss allocated from one of the partnerships. The accountant who had prepared the indirect partners income tax return gave the IRS agent a copy of the agreement assigning the direct partners rights under the swaps to Bemont. The agreement listed all four swaps – two long and two short. The accountant also provided copies of the confirmation letters for the long swaps but did not provide further detail on the short swaps. No adjustments were made by the IRS to the indirect partners return for that year.

On October 13, 2006, after the ordinary three-year statute of limitations for examining the partnerships 2001 returns had expired, the IRS issued FPAAs to the partnerships. The FPAA issued by IRS to Bemont covered the 2001 tax year, disallowing the losses from the swaps and determining that Bemonts partners had no basis in the partnership. The FPAA issued by IRS to BPB dealt with the 2002 tax year, and disallowed the losses from the swaps and determined that the BPB partners had no basis.

The district court found that subpart (A) of § 6501(c)(10) did not apply because neither the partnerships nor Beal provided the required disclosure with their respective returns and because the accountant did not furnish complete information about the swaps during the audit of the indirect partners 2002 tax return. The accountant provided full disclosure regarding the long swaps, but did not disclose the offsetting short swaps.  The district court also found that an IRS summons to Deutsche Bank (a material advisor to the partnerships) revealed information to the IRS no later than July 2005 which identified Bemont and BPB as participating in a Son of Boss shelter and that the information provided substantially complied with the statute and applicable regulations issued by the IRS as set forth in 26 C.F.R. § 301.6112-1T. More specifically, the district court found that by July 2005, the IRS had information that identified BPB and Bemont, and as to these entities, the account number for the buy and sell, the foreign exchange amount, the foreign exchange rate, the amount of U.S. dollars involved, the trade and sell dates, and the percentage sold. Based on these findings, the district court held that the FPAA issued to Bemont in October 2006 was too late and the IRS was time barred from assessing additional taxes or related penalties for the 2001 tax year.

On appeal, the Fifth Circuit reversed the district court ruling that the disclosures made by Deutsche Bank were sufficient as a matter of law to meet the disclosure requirements of 26 U.S.C. section 6011, and as a result the statute of limitations was extended pursuant to 26 U.S.C. section 6501(c)(10.  The Fifth Circuit based its conclusion on the fact that the disclosure was (i) not provided by the partnerships, and (ii) was not in a form that enabled the IRS to indentify the information related to the listed transaction “without undue delay or difficulty.”  The Deutsche Bank disclosures included 226 CDs that captured 2.2 million pages of documents.  In essence, the 5th Circuit held that the disclosure was tantamount to providing the information to the IRS that forced the IRS to identify a “needle in a haystack.”

The full opinion can be viewed here.

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

Third Circuit Court of Appeals Affirms Trust Fund Tax Convictions

In United States v. DeMuro, ___ F.3d ___, available here, the taxpayers were convicted of "conspiracy to defraud the United States, in violation of 18 U.S.C. § 371, available here, commonly referred to as a “Klien” conspiracy, and 21 counts of failure to account and pay over employment taxes (employee income tax and employee FICA withheld), in violation of 26 U.S.C. § 7202, available here. The language of Section 7202 provides as follows: “Any person required under this title to collect, account for, and pay over any tax imposed by this title who willfully fails to collect or truthfully account for and pay over such tax shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $ 10,000, or imprisoned not more than 5 years, or both, together with the costs of prosecution.”

The Internal Revenue Code requires that employers withhold and pay over to the IRS income tax and social security taxes (a/k/a “FICA” taxes) collected from the employees.  These withheld  funds are referred to as "trust fund taxes" because the employer withholds the amount and keeps them “in trust” for the employee until the employer remits it to the IRS.  There is no explicit requirement that the trust fund taxes be segregated from a general operating account, all that is required is that the correct amount is remitted to the IRS on a timely basis.

There are provisions of the Internal Revenue Code that address trust fund taxes. This includes trust fund taxes penalty IRC Section 6672, available here, for responsible person to ensure that the IRS gets the trust fund taxes, and IRS Section 7512, available here, which authorizes the IRS to establish a special trust account for the employer to deposit the trust fund taxes.

As an aside, the Internal Revenue Code section 6672(a) states:

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over. No penalty shall be imposed under section 6653 [IRC Sec. 6653] or part II of subchapter A of chapter 68 [IRC Sections 6662 et seq.] for any offense to which this section is applicable.

As these statutory provisions make clear, section 6672(a) substantially tracks section 7202, and make available to the government criminal penalties for those that failure to collect and/or remit employment taxes.

But Section 7202 addresses the employer who fails to remit the trust fund taxes to the IRS.  That section is not altogether clear that an individual who did not have the direct legal obligation to remit trust fund taxes could be convicted.  In contrast, in a Klein conspiracy, all of the persons who conspired to defraud the United States “ regardless of whether the conspiracy was successful “ by failing to remit trust fund taxes would be criminally liable.  As such, a Klein conspiracy count wraps all the actors in the conspiracy without regard to individual levels of culpability and provides the government with a substantive criminal charge that has greater reach. 

In DeMuro, a IRC Section 7512 trust account was established.  The proof introduced at trial was that the taxpayers improperly disbursed funds and shut down the account without the permission of the IRS.  In the taxpayers case, the taxpayers corporation withheld the trust fund taxes, but were not remitted to the IRS.  The evidence produced at trial demonstrated that the taxpayers not only had the ability to withhold, but instead of remitting the trust fund taxes to the IRS, they spent their money on a lavish lifestyle.

On appeal, the taxpayers argued that the evidence of their lavish lifestyle was admitted in error.  However, the Third Circuit rejected that claim, holding instead that “personal spending can be relevant to rebut a defendant’s defense that he has not acted willfully."  The Third Circuit held as follows:  "the District Court did not abuse its discretion in finding the evidence of the DeMuros’ personal spending to be relevant to the jury’s assessment of willfulness in light of the DeMuros’ defensive arguments at trial."  

The Court also rejected the argument that the evidence of lavish lifestyle was unfairly prejudicial under Federal Rule of Evidence 403, available here. The Third Circuit addressed Rule 403 by quoting the D.C. Circuit in United States v. Gratmon, 146 F.3d1015, 1021 (D.C. Cir. 1998): “Rule 403 does not provide a shield for defendants who engage in outrageous acts, permitting only the crimes of Caspar Milquetoasts to be described fully to a jury. It does not generally require the government to sanitize its case, to deflate its witnesses’ testimony, or to tell its story in a monotone.”

The taxpayers also argued that the introduction of FRE 404(b) ("bad acts" evidence) was improper.  The specific evidence in dispute was that the taxpayers  had withheld trust fund taxes, but other monies that should have been remitted to third parties for the benefit of the employees, e.g.,  employees’ health insurance, retirement and child support payments.  The Third Circuit rejected this argument, detailing how the trial court did not abuse its discretion to admit this evidence.   The taxpayers additionally argued that details of their interaction with the IRS should have been admissible to show their lack of willfulness required for the Section 7202 counts.  The Court also rejected this argument, finding no abuse of discretion.

Ms. DeMuro also argued that the trial courts decision to exclude evidence supporting her “innocent spouse defense,” i.e. evidence showing that even if her husband was liable, she was not. The trial court excluded the evidence because "it was irrelevant to whether the wife was responsible for paying the trust fund taxes; 2) it had the potential to confuse the jury; and 3) the  statement was inadmissible hearsay."  The Court on appeal sustained the exclusion.

But the taxpayers were successful in their theory that the trial court improperly applied a 2-level enhancement for abuse of position of trust, pursuant to the U.S. Sentencing Guidelines § 3B1.3.  (The Sentencing Guidelines are available here.) That enhancement was based only on the taxpayers  failure to meet the obligation imposed under the special IRS trust account.  The Third Circuit stated:  "Our inquiry is whether the DeMuros were in positions of trust vis-a-vis the IRS based on their positions as signatories of the trust fund account set up to benefit the IRS."  The Court applied the following factors: (i) the special trust fund did not have the factor of difficulty to detect the breach of trust; (ii) the taxpayers had little authority (they had power, but not authority) over the trust fund; and (iii) the IRS did not rely upon the integrity of the taxpayers, having established the special trust fund because it did not rely upon their integrity.  Based on the analysis of these factors, the Court reversed for resentencing without the enhancement.

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.

Lawyers fired, Bank recants testimony after it is discovered that Bank altered document used at federal trial

After being held liable for $67 million in damages by a federal jury for aiding and abetting the fraud committed by attorney Scott Rothstein and his law firm, Rothstein, Rosenfeldt & Adler, TD Bank, headquartered in Canada, may be sanctioned by a federal judge and its trial counsel held in contempt for altering a document used at trial and representing to the Court that other documents did not exist.

From 2005 to 2009 TD Bank was the banker for the Rothstein law firm, the accounts of which Rothstein used to execute a $1.2 billion Ponzi scheme. Victims of the scheme have brought civil suits against TD Bank and others for banking the Rothstein firm and otherwise complying with the Rothstein scheme.  Coquina Investments wasone of those victims and filed suit against TD Bank for fraud.

Coquina Investments, in its motion for sanctions, has asked Judge Cooke for monetary penalties, referral of the bank to the Justice Department for investigation, and referral of the Greenberg Traurig law firm to the Florida Bar for an ethics investigation.

Recently, TD Bank, in response to the motion for sanctions filed by Coquina Investments, seen here,

admitted to U.S. District Judge Marcia Cooke in Miami that a document used at trial had been altered, but blamed a copying error. That response is here.

The document was a “Customer Due Diligence form” that had been altered to hide the fact that Rothstein was considered a “high risk” client by TD Banks compliance department for money laundering activity. The document was important to the issues at trial, because TD Banks money laundering expert testified that the bank had no reason to believe that Rothstein was laundering money, when the document revealed that the exact opposite was true. Also, lawyers for the bank had represented to Judge Cooke that a document entitled “Standard Investigative Protocol,” outlining the steps taken by anti-money laundering officials of the Bank, did not exist, when it in fact did.  No reason was given for why neither TD Bank nor its counsel produced the document at trial. As a result, TD Bank recanted those representations to the Court, fired its trial counsel, and obtained new counsel. Judge Cooke has set a May 17th hearing to decide whether the bank should be sanctioned and its former lawyers held in contempt of court for making incorrect representations regarding the altered document.

Donna Evans, the Greenberg Traurig partner who represented the bank at trial made the misrepresentations to the Court, is apparently no longer with the firm.

This case highlights the importance of due diligence in reviewing corporate records when producing documents for discovery in a civil lawsuit, or for use otherwise as evidence.  The sanctions availableif documents are destroyed, altered or otherwise misrepresented to not exist include dismissal of lawsuits, striking of defenses, preclusion of the use of certain evidence, and monetary sanctions. Experienced counsel, like those at Fuerst Ittleman, are always on the lookout to make sure a clients records have been adequately searched before responding to requests for production of documents in a civil case.You can contact us by email at contact@fidjlaw.comor by calling us at 305.350.5690.

IRS halts fraudulent tax refund scheme involving stolen identities and fake income tax returns

On May 1, 2012, the U.S. Attorneys Office for the South District of Florida reported that a IRS and FBI undercover operation targeting identity theft tax refund fraud had resulted in the filing of criminal charges against a group of South Florida residents. Charged in the complaint are Regina Carroll, 37, of Miami, Lanny Fried, 34, of Miami Lakes, former NFL player Louis Gachelin, 31, of Miramar, former NFL player William Joseph, 32, of Miramar, Guy Maxineau, 35, of Miami, Castra Pierre-Louis, 34, of Miami, and Gunie Similien, 32, of Miami. Each defendant allegedly negotiated between 11 and 35 fraudulently obtained tax refund checks, ranging in total value from $70,000 to $120,000.

The Carroll complaint is available here.

The Fried complaint is available here.

The Gachelin complaint is available here.

The Joseph complaint is available here.

The Maxineau complaint is available here.

The Pierre-Louis and Similien complaint is available here.

According to the complaints, from February 2012 to April 2012, the FBI operated a financial services store (the store) in North Miami to accept fraudulently obtained tax refund checks from individuals looking to cash those checks. Undercover FBI agents worked at the store and charged large fees, ranging from 35% to 45 % of the face value of the checks, for their check cashing services. According to the complaints, individuals would come to the store to cash the fraudulently obtained tax refund checks using false identification documents in the name of taxpayer victim whose refund had been stolen. Often, the defendants would forge the victims signature on the back of the check while inside the store. Many of the victim taxpayers whose names appear on the refund checks have already filed identity theft affidavits with the IRS.

During the three month undercover operation, the defendants negotiated with undercover agents at the store to cash approximately $500, 0000 in fraudulently obtained tax refund checks. The conversations and transactions between the customers and undercover agents at the store were audio and video recorded by the FBI. The FBI paid the thieves from official FBI funds and none of the tax refund checks were actually cashed.

The full press release is available here.

The story has been reported in the local South Florida media such as the Miami Herald, available here.

The attorneys at Fuerst Ittleman have extensive experience litigating cases involving income tax evasion and fraud at both the trial and the appellate levels.  You can contact an attorney for a confidential meeting by calling us at 305.350.5690 or by emailing us at contact@fidjlaw.com.

Electronic Check Processing Under Increased Scrutiny By U.S. Bank Regulators Because Of Increased Risk of Money Laundering

As banking and payment processing technology continually evolve, so too does the threat that such technology may be used for illicit and illegal purposes, such as money laundering. One such technology that has recently come under increased scrutiny is electronic check processing, specifically through a procedure known as Remote Deposit Capture (“RDC”).

In 2004, U.S. banks dramatically increased their capacity to process checks. With the passage of the Check Clearing for the 21st Century Act, (“Check Clearing Act”) banks were permitted to process check images through RDC instead of the physical paper check itself. Prior to the Check Clearing Acts passage, in order for paper checks to be processed, the physical check was required to move from the location where it was deposited to the bank from which it was written. Thus, by allowing U.S. banks to process check images electronically, check-cashers from around the world could now avoid the hassle and expense of transporting large bundles of checks to banks as part of their daily operations.

However, while RDC has allowed for the faster processing of checks, the susceptibility of electronic check processing to be used unlawfully because of the difficulties and limitations which currently exist in data mining scanned checks for suspicious activity has come under scrutiny. As a result, regulators, such as the Financial Crimes Enforcement Network (“FinCEN”) and the Office of the Comptroller of the Currency (“OCC”), have increased their scrutiny of U.S. Banks electronic check processing activities.

For example, on April 5, 2012, the OCC and Citibank, N.A., entered into a Consent Order after the OCC identified numerous AML compliance program deficiencies at the bank. Among the OCCs findings were that: 1) the Bank failed to adequately monitor its [RDC]/international cash letter instrument processing in connection with foreign correspondent banking; and 2) as a result the inadequate monitoring, “the Bank failed to file timely [Suspicious Activity Reports (“SARs”)] involving RDCs. . . .” In order to comply with the Consent Order, within 90 days of the order, Citibank must develop, implement and maintain clear written policies, procedures and processes governing the use of RDCs by all clients of the bank, including policies and procedures pertaining to the issuance of SARs in relation to RDC activity. A copy of the Consent Order can be read here.

Additionally, in its October 2011 SAR Activity Review, FinCEN found that, while “SAR filings indicated no real differences in the various fraud and money laundering schemes perpetrated through the RDC check deposit channel when compared with check deposits completed through more traditional means, . . . the choice of the RDC deposit channel may have facilitated certain schemes or the expansion of services to non-traditional customers somewhat more effectively than traditional check deposit channels.” Thus, while the type of illicit activity may not vary between RDC deposits and paper deposits, the ability to be detected may.

As RDC technology evolves, FinCEN encourages banks to develop robust AML compliance programs to address these technological issues. As stated by FinCEN:

In some cases, special precautions and commensurate due diligence efforts may be appropriate when processing items from non-U.S. correspondent accounts or foreign-located customers. Banks may wish to perform periodic reviews of and generate risk management reports on the AML issues associated with RDC. Banks also may wish to ensure that their transaction monitoring systems adequately capture, monitor and report on suspicious activities occurring through RDC, especially as transactional levels increase.

See also Federal Financial Institutions Examination Council, Risk Management of Remote Deposit Capture for a more detailed analysis of risk factors that RDC providers should consider when developing an AML compliance program.

As electronic banking technology evolves, so too must financial institutions AML compliance programs. If you have questions pertaining to anti-money laundering compliance, the BSA, or how to ensure that your business maintains regulatory compliance at both the state and federal levels, contact Fuerst Ittleman PL at contact@fidjlaw.com.

IRS Commissioner Ignores Taxpayer Advocate’s Recommendations Seeking to Address Unduly Harsh Penalties Faced by Participants of the Offshore Voluntary Disclosure Program

As we previously reported here, in August of 2011 the Internal Revenue Service (IRS) Taxpayer Advocate Service released Taxpayer Advocate Directive 2011-1 (TAD) which addressed the IRSs failure to treat certain participants of the 2009 Offshore Voluntary Disclosure Program (OVDP) fairly and demanding that the IRS change the way it administered the OVDP.

The OVDP was a program under which taxpayers could voluntary disclose the existence of their offshore financial accounts in exchange for the IRSs leniency in the imposition of penalties arising from the taxpayers failure to disclose these accounts in a timely fashion.  As stated by the IRS:

Recent IRS enforcement efforts in the offshore area have led to an increased number of voluntary disclosures. Additional taxpayers are considering making voluntary disclosures but are reportedly reluctant to come forward because of uncertainty about the amount of their liability for potentially onerous civil penalties. In order to resolve these cases in an organized, coordinated manner and to make exposure to civil penalties more predictable, the IRS has decided to centralize the civil processing of offshore voluntary disclosures and to offer a uniform penalty structure for taxpayers who voluntarily come forward. These steps were taken to ensure that taxpayers are treated consistently and predictably.

Voluntary Disclosure. Questions and Answers, Question 20.  (May 6, 2009).  (emphasis added).

Taxpayers who fail to report their offshore accounts on a Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”) face onerous penalties. United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year on the FBAR.  The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account. See 31 U.S.C. § 5321(a)(5).  As discussed by the IRS, however, nonwillful violations are subject to a civil penalty of not more than $10,000. Voluntary Disclosure. Questions and Answers, Question 15.  (May 6, 2009). (emphasis added).

As discussed by the Taxpayer Advocate in the TAD, the IRS lured participants in this program with promises of leniency, consistency, and predictability. 

With significant FBAR penalties as leverage, the IRS “strongly encouraged” people who failed to file these and similar returns and report income from foreign accounts to participate in the 2009 Offshore Voluntary Disclosure Program (OVDP), rather than quietly filing amended returns and paying any taxes due. It warned that taxpayers making “quiet” corrections could be “criminally prosecuted,” while OVDP participants would generally be subject to a 20 percent “offshore” penalty in lieu of various other penalties, including the FBAR penalty. While the OVDP appeared to be a great deal for those involved in criminal tax evasion, it was a terrible deal for many whose violations were not willful or who would be eligible for reasonable cause exceptions.

Taxpayer Advocate Directive 2011-1, 4.  (August 16, 2011).  (emphasis added).   

Accordingly, taxpayers who entered the OVDP having committed nonwillfull violations of the FBAR obligations could be required to pay penalties amounting to 20 percent of the assets in their foreign account, which in most cases exceeded the $10,000 cap under the ordinary regime for nonwillfull violations of the FBAR.  Notably, Question 35 of the original OVDP Frequently Asked Questions and Answers addressed this situation by providing that under no circumstances would a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes for failing to file a FBAR.  Thus, under the original terms of the OVDP, the IRS promised to compare the 20 percent offshore penalty to the total penalties that would otherwise apply to a particular taxpayer and impose the lesser of the two.

In March 2011, however, the IRS issued a Memorandum to all OVDP Examiners which retroactively changed the terms of the 2009 OVDP two years after the implementation of the program.  The memo directed IRS examiners to stop accepting less than 20 percent penalties and assume that all violations are willful unless proven otherwise.

Due to the change in practices, the TAD explained that the IRS harmed taxpayers seeking to correct honest mistakes, and thus requested the IRS revoke its March 2011 memorandum.

On August 30, 2011, the IRS appealed the TAD, arguing that under the program, “an agent could make a comparison that determine the taxpayers liability under OVDP was higher than that under existing statutes and could give the taxpayer the benefit of a lower tax liability.” It also found that the Taxpayer Advocates assertion that certain “taxpayers [are] worse off than if he or she had not entered the OVDP” was not based in fact and “contrary to guidance issued by the Deputy Commissioner Services and Enforcement.” Appeal of Taxpayer Advocate Directive 2011-1. Memorandum for Steven T. Miller, Deputy Commissioner for Services and Enforcement.  (August 30, 2011). 

In response to the IRSs Appeal, the Taxpayer Advocate issued recommendations regarding TAD 2011-1 on October 26, 2011, indicating that the IRSs OVDP guidance documents have “created confusion and consternation” in large part because “the IRS has remained silent about the seemingly reasonable way . . . that it will apply FBAR penalties.”  Recommendations Regarding Taxpayer Advocate Directive 2011-1.  Memorandum for Douglas Shulman, Commissioner of Internal Revenue Service.  (October 26, 2011).

The Taxpayer Advocate asked the IRS Commissioner to respond to the recommendations by January 26, 2012 and specifically cited to IRC §7803(c)(3), which provides that the “Commissioner shall establish procedures requiring a formal response to all recommendations submitted to the Commissioner by the National Taxpayer Advocate within 3 months after submission to the Commissioner.”  However, the Commissioner failed to do so.

The Taxpayer Advocate reinforced her concerns in the Taxpayer Advocate Service 2011 Report to Congress as follows:

While the maximum penalty for a “willful” failure to report foreign accounts on Form td F 90“22.1, Report of Foreign Bank and Financial Accounts (FBAR) is severe, people who voluntarily correct inadvertent violations are generally not subject to a significant penalty. Nonetheless, the IRS “strongly encouraged” nearly everyone with a violation to participate in the 2009 offshore voluntary disclosure program (OVDP) or face potentially excessive civil and criminal penalties. More than a year after the 2009 OVDP ended, the IRS changed key terms of the program to the detriment of those with inadvertent violations, damaging the IRSs credibility. The IRSs statements also leave the public confused and concerned that excessive FBAR penalties may apply to inadvertent violations.

The Most Serious Problems Encountered by Taxpayers. Taxpayer Advocate Service 2011 Report to Congress, p. 21.  (December 31, 2011).

In light of these issues, the Taxpayer Advocate expressly recommended that “the IRS issue public guidance committing not to seek excessive penalties for the inadvertent violations, revoke the March 1 memorandum, and clarify that participants of the 2009 OVDP will not be required to pay more than they would be liable for outside the program.”  Id.  She also recommended that the IRS “amend signed agreements for those who would pay less outside the program.”  Id.  Under IRC §7803(c)(3), the recommendations contained within the Taxpayer Advocate Service 2011 Report to Congress required a response by March 31, 2012.

Subsequently, the American Citizens Abroad (ACA), an advocacy group of U.S. citizens living overseas, wrote to IRS Commissioner Doug Shulman expressing concern regarding the IRSs utilization of the OVDP to camouflage a policy of taxing assets of Americans abroad by imposing large penalties for simple FBAR filing omissions. The ACA thus requested that IRS examiners account for the individual circumstances of taxpayers abroad who were previously unaware of the FBAR filing requirements, pursuant to the U.S. system of citizenship-based taxation.  Further, the ACA requested the Commissioner to comply with the measures recommended in the TAD and the 2011 Report to Congress and revoke the memo. Pursuant to IRC §7803(c)(3), the Commissioner had 90 days to formally respond to the Taxpayer Advocates recommendations contained within the 2011 Report to Congress. This deadline expired on March 31, 2012 without any response from the Commissioner.

Rather than responding to the TAD or any of the concerns raised by the ACA, Commissioner Shulman expressed pride in the revenues resulting from penalties paid by OVDP participants during a speech at the National Press Club.

As we increased our enforcement efforts and gained significant momentum, we gave taxpayers a chance to come in voluntarily and avoid going to jail. In a typical year, we used to get 100 or so taxpayers who used our voluntary disclosure program. For this program, we thought that figure would rise to maybe 1,000.  So, we are very pleased that through the end of 2011, weve had approximately 33,000 voluntary disclosures from individuals who came in under several special programs we started in 2009. To date, these individuals have paid back taxes and stiff penalties amounting to more than $4.4 billion, and the number continues to grow. We are now mining the information we have received to date and have launched our next wave of investigations on banks, bankers, intermediaries and taxpayers.

Prepared Remarks Commissioner of Internal Revenue Douglas H. Shulman before the National Press Club. IR-2012-42 (April 5, 2012). 

The purpose of the Taxpayer Advocate Service is to mandate administrative or procedural changes which violate Taxpayers rights. In the history of the Tax Advocate Service, the office has only issued six TADs aimed to force IRS compliance on issues that the advocate deems abusive or inequitable to Taxpayers.  Thus, it is clear that such directives are only issued in response to matters of utmost significance.

The inclusion of a specific deadline in IRC §7803(c)(3) by which the Commissioner must respond to the recommendations of the Taxpayer Advocate reveals Congresss intention that the concerns expressed by the Taxpayer Advocate must be  taken seriously and addressed in a timely manner.  This deadline is not unlike other deadlines enacted by Congress throughout the Internal Revenue Code which, when missed by taxpayers, are predictably dealt with much more harshly by the Commissioner.

The Commissioners failure to adhere to his statutory duty to respond to the recommendations by the Taxpayer Advocate coupled with his remarks during his speech before the National Press Club reflect that his objectives are focused solely on generating revenue, without any regard to taxpayers rights or whether such revenue is properly collected.

Fuerst Ittleman will continue to monitor the exchange between the IRS and the Office of the Taxpayer Advocate for more developments.  You may also monitor these exchanges here on the IRS website.  If you have any questions regarding the OVDP, FBAR penalties, or offshore voluntary disclosure generally, please contact us at contact@fidjlaw.com.

Third Circuit Court of Appeals Affirms Decision Against Taxpayer Whose Check Was Incorrectly Processed

On April 19, 2012, the Third Circuit in the case of United States of America v. Zarra, case no. 11-3622, affirmed the decision of the District Court granting summary judgment in favor of the government.  A full copy of the decision can be found here.

The facts of the case are fairly straightforward:

The taxpayers owed the IRS $179,501 for 1999, and in order to pay that debt, executed a check in the amount of $179,501 payable to the IRS, but due to a bank error, only $179.50 was actually transferred to the IRS from the Taxpayers account.  In July of 2000 the IRS made an assessment for the balance, and in June of 2010, the government filed suit to collect pursuant to 26 USC 7403.

After filing suit, the government moved for summary judgment arguing that there was no genuine material facts regarding the Taxpayers underpayment.  The District Court agreed.  The Third Circuit affirmed noting that the tax was assessed in July 2000 and the IRS Form 4340 documenting the assessment date was “presumptive proof of a valid assessment.”

The teaching of Zarrra is that failure to pay the full amount due, even if it is a bank error, does not absolve a taxpayer from liability to the IRS. 

The attorneys at Fuerst Ittleman regularly represent taxpayers involved in complex disputes with the IRS.  You can contact us by calling us at 305.350.5690 or by email at contact@fidjlaw.com.

Fourth Circuit Creates Circuit Split in Virgin Islands Tax Case

On April 16, 2012, the Fourth Circuit Court of Appeals based in Richmond, Virginia affirmed the decision of the Tax Court denying the motion to intervene filed by the Government of the U.S. Virgin Islands (“GVI”) in McHenry v. Commissioner of Internal Revenue, case nos. 11-1239, 11-1366.  As we previously blogged, the Tax Court held that the GVI could not intervene in a Tax Court case of a taxpayer who was a resident (or former resident) of the USVI and claimed tax credits under the USVI’s economic development program.  In the McHenry case, the Tax Court held that its prior opinion in Appleton v. Comm’r, 135 T.C. 461 (2010) available here, was controlling and that the GVI could not intervene to challenge the IRS’s position that the statute of limitations contained in IRC Section 6501 applied to those taxpayers residing in the USVI. 

Previously, the Third Circuit Court of Appeals and the Eight Circuit Court of Appeals had reversed the Tax Court’s ruling on the issue of whether the GVI could intervene. According to the Third and Eighth Circuits, the GVI should have been permitted to intervene. The Third Circuit’s opinion is available here, and the Eight Circuit opinion is available here.

In its ruling in McHenry, the Fourth Circuit gives the Third and Eighth Circuit decisions little more than lip service, relegating both to a single footnote.  According to the Fourth Circuit, because the GVI does not administer IRC sections 932 (which provides for a tax filing with the USVI) or 934 (which authorizes the USVI to provide tax credits under the economic development program), intervention would be inappropriate.  The Fourth Circuit distinguished the Third Circuit’s opinion in Appleton by noting that the Third Circuit “stated conclusorily” that Rule 24(b)(2)’s requirement that the Virgin Islands administer the statute at issue "appears to be satisfied, as Appleton’s tax assessments are based on an income calculation which takes into account credits created pursuant to 26 U.S.C. § 934, under the [Virgin Islands’ Economic Development Program]."  Slip op. at 13. 

The Fourth Circuit further held: “Moreover, we conclude that the Third Circuit was incorrect in assuming that the tax credits claimed by Appleton were ‘credits created pursuant to I.R.C. § 934.’ Instead, they were credits created by the Virgin Islands for taxes payable to the Virgin Islands pursuant to the Economic Development Program and the Virgin Islands’ tax laws. Those Virgin Islands credits were in no way implicated in Appleton’s statute of limitations defense under U.S. tax laws, nor are they in McHenry’s defense.”  Slip op. at 14.

A full copy of the Fourth Circuit opinion is available here.

The most obvious takeaway from the McHenry opinion is that now in USVI residency cases, the GVI will be allowed to intervene in the Third and the Eight Circuits, but not in the Fourth.  There are currently 3 cases pending in the 11th Circuit on this same issue, so it is yet to be determined how this issue will be resolved in the Court. We will monitor this issue closely and update our blog with more information as soon as it is available 

The attorneys at Fuerst Ittleman have extensive experience litigating against the IRS and the Tax Division of the U.S. Department of Justice, including USVI residency cases.  You can contact an attorney by calling us at 305.350.5690 or by emailing us at: contact@fidjlaw.com.

IRS Bolsters Transfer Pricing Operations Unit

The IRS has recently gone on a hiring spree, bringing on board personnel with expertise in law, accounting, and economics, needed to identify, audit, and litigate “transfer pricing” cases. 

Transfer pricing, in short, allows taxpayers with international operation to allocate deductions to high tax jurisdictions, and allocate income to low tax jurisdiction, thereby increasing the value of the deduction and parking profits in low tax jurisdictions.  (Transfer pricing is governed by section 482 of the Internal Revenue Code, available here, which addresses the “allocation of income and deduction among taxpayers.”  Although Section 482 is fairly short, the Treasury Regulations under section 482, available here, are long and exceedingly complex.) The overall effect of transfer pricing is to decrease the amount of worldwide tax paid by the global company. The drug manufacturing and high-tech sectors extensively use transfer pricing to creatively minimize world-wide tax and reduce the amount of tax owed to the IRS, and over time, the practice of transfer pricing has come under increased scrutiny by the United States government.

In response to the increased profile that the issue has received, there has been a realignment within the IRS. The Advance Pricing Agreement (APA) program has shifted from IRSs Office of Chief Counsel to the new Transfer Pricing Operations.  (The IRSs press release on the realignment is available here.) The IRS recently hired Samuel Maruca to be the new director of its Transfer Pricing Operations unit.  Mr. Maruca, an attorney, has hired personnel from the Big 4 accounting firms, as well as law firms.  He has already hired 40 people and is looking to fill another 60 positions. As a result of the realignment, companies should expect that their transfer pricing agreements will come under scrutiny by the IRS. Likewise, increased audits and litigation regarding transfer pricing appear to be certain. 

The attorneys at Fuerst Ittleman frequently handle highly complex matters against the IRS, and are well versed on the laws governing transfer pricing.  You can contact us by phone at 305.350.5690 or by email at contact@fidjlaw.com.