Articles Posted in Tax Fraud

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The sentence of an individual who pled guilty to tax fraud was affirmed by the Seventh Circuit Court of Appeals. John McKinney was charged with eleven counts of tax evasion and conspiracy to defraud, impede, impair, obstruct and defeat the functions of the Internal Revenue Service (IRS) in the collection of income taxes. McKinney’s actions are a textbook example of how to turn a financial problem into a criminal tax problem.

McKinney and his brother owned a construction company. Mr. McKinney failed to pay his taxes seven years between 1999 and 2006. In 2003, the IRS placed federal tax liens against McKinney for taxes he owed. He avoided the taxes by transferring money earned from his company into separate nominee accounts, which the brothers used for personal and household expenditures. McKinney gave the IRS Revenue Officer false statements regarding his ability to pay his taxes.

When his wife and sister-in-law applied for residential mortgages, which McKinney was unable to qualify for because of the federal tax liens, McKinney falsely told loan officers that they were both full-time employees of his company. However, neither worked for the company or reported this employment on their tax returns. These financial transactions diverted business income earned by the brothers into assets owned by their wives, thereby avoiding IRS tax assessments and tax liens.

The brothers made false statements regarding their inability to pay income taxes, causing the unsuspecting IRS to close its investigation in 2007. However, the IRS discovered the brothers’ tax fraud, and charged the brothers in 2011. McKinney pleaded guilty to one count of conspiracy, one count of tax evasion and three counts of making false statements. He was sentenced to nearly five years imprisonment with three years of supervised release. The court also ordered him to pay $1.5 million in restitution.
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A North Carolina residential builder was arrested on criminal tax charges stemming from his civil tax problems. The Department of Justice and the IRS announced that William B. Clayton was charged with one count of attempting to obstruct IRS efforts to collect his unpaid tax liabilities and one count of knowingly converting and disposing of U.S. government property.

According to the indictment Clayton failed to file income tax returns from 1999 to 2004. He never filed for extensions. In 2005 and 2006, the IRS began assessment and collection proceedings against Clayton. In 2007, Clayton hired a certified public accountant to represent him before the IRS, and the CPA prepared and filed delinquent tax returns for him. Based on these returns, the IRS reduced its prior tax assessments. However, Clayton did not pay his liabilities, and collection proceedings against him continued. No doubt that included tax levies, and tax liens.

Between 2007 and 2010, Clayton allegedly obstructed the IRS’ collection efforts. Clayton allegedly hid property located in Virginia, which he partially owned, from the IRS. According to the press release he destroyed property that he had previously built and owned but that the Service had seized. The IRS had planned to auction the property in an effort to pay down Clayton’s tax liabilities. However, Clayton allegedly destroyed parts of the property and vandalized others.

If convicted, Clayton could face a maximum potential sentence of three years in prison and a fine of $250,000 on the tax law obstruction charge, and 10 years imprisonment and a fine of $250,000 on the conversion of government property charge.

As the IRS and the Department of Justice point out in their press release an indictment is merely an accusation. The defendant is presumed innocent unless proven guilty beyond a reasonable doubt.

Still if the charges are true it should be a reminder to people not to allow their tax problems to turn into something worse. Depending upon Clayton’s finances, chances are he could have resolved his tax problems through an offer in compromise, or an installment payment agreement with the IRS, but instead he allowed things to proceed to a point where instead the IRS filed criminal tax charges.
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Thumbnail image for 1125087_person_jail.jpgThe convictions of a couple that committed tax fraud were affirmed by the Fifth Circuit Court of Appeals. The husband and wife were the owners and operators of a firm that prepared personal income tax returns in Texas. Donald Womack misrepresented himself as an accountant who has previously worked for the IRS. His wife, Tonya, helped Mr. Womack with the business. Her role progressed until she began filing clients’ returns with the IRS electronically. The couple used the same electronic filing identification number (EFIN).

The IRS first noticed the Womacks based on the unusual deductions that were claimed on their clients’ returns. Several of the Womack’s clients testified against the couple, including one man who testified that Mr. Womack offered to provide false mileage logs to substantiate vehicle mileage deductions. Other former clients stated that they had never given the Womacks any information that would support the deductions that the couple claimed, such as charitable or mortgage-interest deductions. These clients are probably lucky they didn’t get charged with tax evasion themselves!

The government also used an undercover IRS special agent, who brought in his tax information to the couple. Although he had calculated that he owed $300, the Womacks gave him a choice of three tax refund amounts, ranging from $3,200 to $4,200. Mrs. Womack claimed that, although she had taken a tax preparation course, all of her errors were accidental. Mr. Womack did not offer any theory as to the cause of his inaccuracies.

A jury indicted the couple on 26 counts of conspiracy and aiding and assisting in the preparation of false tax returns. Mr. Womack was ordered to serve five years in prison, plus three years of supervised release. Mrs. Womack got off with three years of prison time, plus three years of supervised release. The court also ordered them to pay over $160,000 in restitution. This is over and above any civil tax preparer penalties that may be assessed against them under Internal Revenue Code (IRC) Section 6694.The Fifth Circuit affirmed their convictions in an unpublished opinion.
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Tax problems abound for Lauryn Hill, who won five Grammys for her 1998 debut album. Her album, “The Miseducation of Lauryn Hill,” might describe her alleged actions to stop paying taxes and subsequent consequences. Former member of the Fugees band, Ms. Hill, who’s also an actress, has been charged by the the Department of Justice with Failure to File a Tax Return, but not tax evasion, on gross income of slightly more than $1.8 million over a three-year period from 2005 through 2007.

In her response to the prosecution regarding her criminal tax problems, Ms. Hill posted a 1,270-word manifesto at mslaurynhill on Tumblr. Thumbnail image for LaurynHill.jpg

“For the past several years, I have remained what others would consider underground. I did this in order to build a community of people, like-minded in their desire for freedom and the right to pursue their goals and lives without being manipulated and controlled by a media protected military industrial complex with a completely different agenda. Having put the lives and needs of other people before my own for multiple years, and having made hundreds of millions of dollars for certain institutions, under complex and sometimes severe circumstances, I began to require growth and more equitable treatment, but was met with resistance.”

Ms. Hill goes on to further describe her tax dispute: “I did not deliberately abandon my fans, nor did I deliberately abandon any responsibilities, but I did however put my safety, health and freedom and the freedom, safety and health of my family first over all other material concerns! I also embraced my right to resist a system intentionally opposing my right to whole and integral survival.”

Finally she responds to her tax problems: “I conveyed all of this when questioned as to why I did not file taxes during this time period. Obviously, the danger I faced was not accepted as reasonable grounds for deferring my tax payments, as authorities, who despite being told all of this, still chose to pursue action against me, as opposed to finding an alternative solution.”

Ms. Hill, who is facing one year in prison and a $100,000 fine for each year she failed to file, is one of a number of celebrities whose alleged tax fraud have made headlines, including Wesley Snipes, currently serving a three-year sentence.
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A physician in Kentucky was arrested and charged last month with four counts of tax fraud pursuant to Internal Revenue Code Section 7201, and two counts of failure to file tax returns in violation of IRC section 7203. According to the indictment Dr. Werner Grentz had failed to file income tax returns since 1999. There is a common myth that it is better not to file a tax return at all than to file a false tax return. Like most myths there is some truth to this one. The willful failure to file a tax return is a misdemeanor punishable by “only” one year in jail, and a fine of not more than $100,000. IRC Section 7203. On the other hand tax evasion a/k/a/ tax fraud is a felony, and the resulting imprisonment can run up to 5 years, plus a fine of not more than $100,000. IRC Section 7201.
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One advantage of a misdemeanor over a felony conviction is that it won’t result in possible deportation for green card holders. We talked about this tax problem in a past blog post. Still, as Wesley Snipes found out, three years of failing to file a tax return can result in three years in prison.

Any “advantages” should not be used as an excuse not to file a tax return when there is some uncertainty about the correct position to take on a return. It is much better to file a return with missing or even incorrect information (provided that appropriate disclosures are made) than not to file a return.

In addition, in some instances the failure to file a tax return can be charged as tax evasion. That’s what happened to Dr. Grentz. The indictments spells out that he was being charged with failure to file for two of the years, but tax evasion for four different years. In order to be convicted of tax evasion it is necessary for the IRS to show an “affirmative act”, not merely an omission to do something like the failure to file a tax return. According to the indictment in addition to not filing his tax returns he engaged in the following affirmative acts:

  • He filed Form W-4 claiming that he was exempt from income tax; and
  • He set up bank accounts in the name of two corporations (which the IRS referred to by the pejorative term “nominees”), and deposited some of his compensation into bank accounts set up in the corporate names.

Those two actions were enough to cause a shift from charges of not filing a tax return to tax evasion.
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The criminal tax conviction of a New Jersey couple (the DeMuros) for failure to pay payroll taxes to the IRS was affirmed by the Third Circuit Court of Appeals, United States v. DeMuro (3d Cir. 2012). The willful failure to pay payroll taxes is a violation Internal Revenue Code (IRC) Section 7202, and is punishable by up to five years in prison. Of course the willful failure by a responsible officer to pay trust fund taxes is also a violation of IRC Section 6672, and will result in a trust fund recovery penalty (TFRP) being assessed against the responsible officers. Obviously the criminal tax conviction is much more serious than the assessment of the trust fund recovery penalty.
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The DeMuros failed to pay trust fund taxes for their business of more than $546,000 over 21 calendar quarters from 2002 to 2008, resulting in a 21 count indictment. While that is a lot of money it is easy to see how a failing business could wind up in that situation since it amounts to about $25,000 per quarter, and was spread over a seven year period. A large sum, but not shocking, at least not to tax lawyers, and other tax professionals who see this type of underpayment on a semi-regular basis.

The DeMuros tried to argue that their failure to pay wasn’t willful, but to no avail. The IRS pointed to evidence that during the same time period the DeMuros spent over $5 million dollars from their personal and corporate bank accounts. Apparently several witnesses testified at trial about the DeMuros “luxury vacations, nice homes, and [Mrs. DeMuros] substantial home shopping network expenditures,” and the DeMuros argued on appeal that the admission of this evidence was “prejudicial.” The response from the Third Circuit was: “[w]hile we are sensitive to the effect that evidence of a defendant’s liberal spending habits can have on a jury, particularly in these lean economic times, the evidence admitted in this case, i.e. evidence of vacations, jewelry, cars and parties, was not so inflammatory as to carry a great risk of prejudice.”

Mrs. DeMuro argued at trial that she was not responsible for paying the payroll taxes. The IRS response was to show that that Mrs. DeMuro had the authority to fire employees and signatory authority over corporate bank accounts.

Interestingly the IRS also called as a witness the Enrolled Agent that represented the DeMuros before the IRS with regard to the payroll tax problems. The Enrolled Agent testified that he had reviewed two appeals that the DeMuros had filed, and that in his opinion they were meritless, and therefore should have been withdrawn. Advice which apparently the DeMuros didn’t follow, and the IRS relied on this as evidence of bad faith on the part of the DeMuros.
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Our tax litigation attorneys are often asked whether failing to report income is tax fraud. We explain that there are various “badges of tax fraud,” and a simple omission of income may not be tax fraud. A recent Tax Court case illustrates that when coupled with other badges of tax fraud even a small tax due can result in a 75% civil tax fraud penalty.
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In the case of Porch v. Commissioner (March 2012) Porch underwent a tax audit by the IRS for the years 2005 and 2006. At the audit Mr. Porch produced a Form 1099 and 13 unnumbered invoices which roughly totaled the gross receipts reported on the 2005 tax return. Porch did not provide his bank statements to the auditor at that point even though they had been requested. At the second meeting he furnished some, but not all of the requested bank statements. Ultimately the IRS summonsed the statements from the bank, at which point the auditor figured out that business income had been underreported by about $36,000 and $48,000 for 2005 and 2006, respectively. In addition, it turned out that Porch failed to report the gain on the sale of a house, and capital gains from the sale of securities. The tax due, however, was relatively small; $8,392 and $4,471 for 2005 and 2006, respectively.

In determining that the IRS had proven that Porch had committed tax fraud the Tax Court found the following badges of tax fraud:

• Understated Income
• Inadequate Records
• Implausible or Inconsistent Explanations of Behavior
• Failure to Cooperate with IRS
• Dealing in Cash
• Engaging in a Pattern of Behavior That Indicates an Intent to Mislead

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A few of these badges of tax fraud were the most egregious. When Porch went to the tax audit he attempted to mislead the agent by presenting documentation which suggested the amount reported was accurate when in fact he knew that was not the case. The Tax Court was also not pleased with Porch’s testimony at trial. On their 2005 tax return Porch and his wife reported adjusted gross income of around $11,000, and they deducted a similar amount for mortgage interest and taxes Porch answered in the affirmative when asked if he was the primary breadwinner in his family. Then, however, when asked how they supported themselves on the amounts set forth on the tax return he testified: “I mean it was rough. My wife, my friends, Lomax. You know, people helped me out. I mean, when I couldn’t make ends meet, you know, I prayed about it.” The judge referred to this under the heading of Implausible or Inconsistent Explanations of Behavior.

In the view of our tax litigation attorneys had Porch not been caught in several apparently dishonest statements perhaps he could have avoided the tax fraud penalty.
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