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LARGE TAX REFUNDS AND THE GHOST PREPARER

Earlier this year a Charlotte man was charged with tax fraud in a 20 count criminal indictment, charging him with aiding and assisting in the preparation and filing of false returns over a five year period.

According to the allegations, between 2014 and 2021 the Defendant, Tijan Mboob (“Mboob” or the “Defendant”) prepared hundreds of fraudulent returns. The indictment further alleges that the Defendant was a “Ghost Preparer,” who failed to identify himself as a paid tax preparer on the tax returns he submitted to the IRS on behalf of his clients, despite the fact he was compensated for his services.

The IRS requires paid return preparers to provide information, including name, address and phone number for the preparer, Federal Tax Identification or Social Security Number and PTIN number as well as other information.

The indictment specifically alleges that Mboob prepared tax returns on behalf of his clients which contained fabricated and fraudulent items. Some of the items included false filing status, false American Opportunity and education credits, false itemized deductions and false reforestation credits. The hundreds of fraudulent returns prepared by the Defendant resulted in the overall reduction in tax liability on behalf of his clients and their receipt of large refunds totaling $4.7 million dollars.

Finally, the indictment indicates that the Defendant failed to report any of the preparation fees he eared as income for 2017 and 2019, and in addition, failed to file returns for 2019 and 2019.

Each Year the IRS warns the public about return preparer scams.  However, there is no shortage of victims, who fall prey to these predators each year.

While the Ghost Preparer is also a paid preparer, he differs from the fraudulent return preparer who provides identifying information on the tax returns he or she prepares. The Ghost Preparer will submit a fraudulent tax return and designate the tax return as “Self-Prepared.” In doing so, he or she will deliberately omit any paid return preparer information at the bottom of the tax return. Clients are delighted to learn that they are getting a $10,000 refund, only to later discover that it was too good to be true.  How is this possible?

Its possible thanks to the illegal business practices some return preparers engage in. Most are unlicensed and not subject to Circular 230. In addition, many conduct business using a nominee as the face of the tax preparation business. These charlatans are generally are able to grow their practices based solely on their ability to generate large taxpayer refunds for their clients and by word of mouth.

The return preparer, who engages in these illegal acts, will have a federal identification number, as well as PTIN and ERO numbers. These preparers are monitored by the IRS, who, through AI and analytics is able to identify patterns in certain types of deductions, business losses, credits and withholding.  Many of these preparers have been identified and either civilly enjoined from preparing tax returns or criminally prosecuted. The ones who escape prosecution simply set up shop down the road, making use of new nominee.

A Client who receives a large tax refund to which he or she is not entitled may be thrilled and think he or she hit the jackpot.  That joy quickly gives way to fear and anxiety when the Taxpayer receives a notice from the IRS. In certain cases, it can involve multiple years.

The morale of the story is choose your return preparer wisely and asks lots of questions.  It is always best when selecting a return preparer to select an attorney, certified accountant or enrolled agent, all of whom are subject to Circular 230, which governs the conduct of return preparers.   Further, if a friend or relative recommends a return preparer based on the fact that they systematically receive large refunds, I would be suspicious.

If you have been receiving large refunds, it would be wise to have a tax attorney, certified public account or enrolled agent review your tax return.

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FBAR PROSECUTIONS-FORMER CFO SENTENCED TO EIGHTY SIX MONTHS IN PRISON

On September 21, 2023 a  former CFO of  a Russian natural gas company was sentenced to seven years in prison, ordered to pay $4 million dollars in restitution and an additional $350,000 in fines in connection with a number of tax and financial reporting crimes that included engaging in a scheme to hide millions of dollars in income in undisclosed Swiss bank accounts, submitting false filings with the IRS,  failure to file  a Report of Foreign Bank and Financial Accounts (“FBAR”), making false statement to the IRS, and willfully failing to file tax returns.  The Russian CFO was also named a defendant in a $44 million dollar FBAR Penalty Suit commenced by the U.S. Government  in June of 2023 (See Complaint styled as: United States of America v. Mark Anthony Gyetvay).

INTRODUCTION

31 U.S.C.  § 5314 requires U.S. Citizens and Permanent Resident of the United States to file a “report.”  The FBAR implementing regulations provide that a “U.S Person who has a financial interest in or signature or other authority over a bank, securities or other financial account in another country” is required to file an FBAR “for any year in which the aggregate balance for such foreign financial account or accounts exceeds $10,000 at any time during the calendar year” See 31 C.F.R. § 1010.350(a) and 31 C.F.R. § 1010.306(c) (2011).

31 U.S.C. § 5321(a)(2) authorizes the Secretary of the Treasury  to impose penalties for failure to file an FBAR report. The relevant FBAR penalty provisions include a $10,000 Penalty under Section 5321(a)(5)(B) for non-willful violations (the “Non-Willful FBAR Penalty”), which may be excused where “reasonable cause” can be established as well as a Willful FBAR Penalty for willful violations. The Willful FBAR Penalty under Section 5321(a)(5)(C) is the greater of $100,000 or 50% percent of the amount of the “transaction” or in cases where no FBAR is filed, the balance in the account at the time of the violation.

Persons who fail or refuse to file their FBARS and/or those who fail or refuse to report the income derived from their Foreign Financial Accounts (“FFA’s”) may feel that the Government has overlooked them. Those who have hidden their foreign assets by placing them in the name of a nominee, Shell Company or some other entity may, likewise, now feel they are safe.

Prior to the termination of the Offshore Voluntary Disclosure Program (“OVDP”) in September of 2018, at risk Taxpayers sought protection from criminal prosecution by entering into the OVDP.  Some OVDP participants deliberately omitted large account balance FFA’s from their FBAR filings in order to reduce the Miscellaneous Offshore Penalty.  Other elected to “Opt Out” of the OVDP in hopes of either no penalty or paying the less onerous Non Willful FBAR Penalty.

There were also those who attempted to game the system by foregoing the use of the OVDP or it prior iterations and instead utilizing one of the two Streamlined Procedures as a means of avoiding the costly Willful FBAR Penalty, associated legal costs and possible criminal prosecution.

Taxpayers who intentionally omitted FFA’s with significant balances have been subject to the Willful FBAR Penalty, and in some cases, have also been prosecuted.  Some U.S. Taxpayers, who Opted Out of the OVDP, have been successful in reducing or totally avoiding any FBAR Penalty. However, many others have been less fortunate and consequently subject to the Willful FBAR Penalty in amounts far in excess of the Miscellaneous Offshore Penalty they would have paid had they remained in the OVDP.

The offshore tax evasion playbook, which has been around for quite some time with some slight variations, is still in use. Some of the practices include, but are not limited to, forming an offshore nominee entity in a blacklisted or designated tax haven jurisdiction and opening an FFA in the name of the nominee, Shell Company or other entity to obscure the identity of the true account owner. In many cases, the true account owner will secretly retain beneficial ownership in the FFA or asset as a means of retaining control and dominion over the account proceeds.

A savvy tax cheat will on occasion will have the mail related to the offshore account or asset held at the Foreign Financial Institution. The true account owner will then periodically travel to the foreign country to retrieve the mail in person or make arrangements for someone else to. Alternatively, the account owner will meet with a representative from the Foreign Financial Institution in the U.S. for the handoff.

For their part, Foreign Financial Institutions (“FFI’s”), Wealth Management Firms and other foreign counterparts have historically accommodated, promoted, and actively facilitated the secreting of offshore assets and income by U.S. taxpayers in exchange for receiving substantial bank, legal and advisory fees. Foreign governments have also been complicit by either turning a blind eye to these illicit practices or by relying on bank secrecy laws.  That has all changed thanks to U.S. global enforcement initiatives, international cooperation and the recent 80 billion dollars received by the IRS.

ENFORCEMENT HISTORY AND DEVELOPMENT

The catalyst for change started in 2008 when the DOJ prosecuted Swiss UBS, as well as a number of its advisors, attorneys and financial professionals for assisting U.S. taxpayers in hiding foreign assets and income from the IRS.  To avoid prosecution, UBS and the U.S. Government entered into a deferred prosecution agreement (DPA’s) wherein UBS was, among other things, required  to pay stiff penalties and admit that it’s cross border banking practices made use of Swiss privacy laws to aid and assist U.S. Taxpayers in committing offshore tax evasion.  As part of the deal, UBS also agreed to take affirmative steps to improve transparency and to provide the U.S. Government with information on its U.S. account holders.

Since the UBS case and the DOJ’s establishment of the Swiss Bank Program, many FFI’s have been subject to prosecution and have entered into either DPA’s or a non-prosecution agreements (“NPA’s”). These institutions have also been required to pay large penalties, agree to compliance reforms and have had to provide information on their U.S. account holders. Even small FFI’s that rely on correspondent banks to process financial transactions have not escaped DOJ scrutiny. They too have had to tow the line.

While the U.S. assault on international banking practices and U.S. account holders over the past fifteen years has motivated some U.S. customers to come out of the dark and disclose their foreign assets and income, many taxpayers persist in holding out and are actively engaged in unlawful practices, designed to avoid detection by the IRS.

Many U.S.  account holders have scrambled to close existing accounts at one FFI and transferring the proceeds or assets to another.  In some instances the move entails transferring an existing account in one country to an FFI in another. Still others have elected to form multiple entities as means of making detection more difficult.

United States of America v. Mark Anthony Gyetvay

The IRS resolve in making offshore tax evasion a top priority is evidenced by the sentence handed down by Judge Joan Ericksen of the United States District Court for the Middle District of Florida against Gyetvay as well as by the commencement of Willful FBAR Penalty collection suit.

The facts related to the conviction and sentencing of Gyetvay and the FBAR Penalty collection suit are worthy of mention given the level of premeditation and amount of time and effort expended by the defendant in carrying out his nefarious plan.  The dire consequences Gyetvay now faces should serve as an ominous warning to those who not know when to stop digging.

The defendant, Mark Anthony Gyetvay (“Gyetvay,” “defendant” or “taxpayer”) is a birthright citizen of the United States and also a citizen of Russia and Italy. From the court records, the defendant is well educated having earned various degrees including an accounting degree from Arizona State University and a graduate degree in Strategic Management from Pace University.  Gyetvay is also a Certified Public Accountant, licensed in the State of Colorado.

The court records also reveal an impressive work history on the part of the taxpayer.  The defendant worked for PriceWaterhouse Coopers, a Big Four public accounting firm, until 1995 when Gyetvay became a partner.

In 2003 the defendant left public accounting and became the CFO of Novatek, a Russian independent gas producer. In 2005 the Taxpayer was successful in navigating Novatek through an initial public offering on the London Stock Exchange. In recognition of his services Gyetvay was promised and eventually received a significant block of Novatek Shares.

In October of 2005 the taxpayer formed Opotiki Marketing (“Opotiki), a nominee entity organized under the laws of Belize. He thereafter opened an Account (“Opotiki Account”) at Coutts & Company, LTD (“Coutts”), a Swiss Private Baking and Wealth Management Firm located in Zurich, naming Opotiki as the record owner of the account, but naming himself as the beneficial owner of the account.

To prevent the IRS from discovering the existence of the Opotiki Account, the defendant also requested that Coutts hold all mail related to the Opotiki Account at the Firm’s “Hold Mail” counter. The hold mail tactic was very common prior to DOJ’s crackdown on the international banking industry. At this time, the maximum assets under management in the Opotiki Account were $12, 650, 792.

The taxpayer was so impressed with himself that in 2007 he decided to form Felicis Commercial Corp (“Felicis”), a British Virgin Island nominee entity. Thereafter, Gyetvay opened a separate account with Coutts (the “Felicis Account”), naming Felicis as the account holder and designating himself as the sole beneficiary of the Felicis Account. At this time Felicis had over $53 million dollars’ worth of assets under management.

The defendant failed to file U.S. Income Tax Returns, failed to file FBARS and took further steps to frustrate the U.S. Government, including removing himself as the beneficial owner of the FFI’s and making his wife, a Russian Citizen, the beneficial owner of the accounts. He also used his wife’s Moscow address as her residence, despite the fact that both Gyetvay and his wife resided in Naples Florida.

In response to pressure from the U.S. Government and in light of the UBS prosecutions and the Swiss Bank Program, Coutts instituted compliance procedures which included bringing in outside U.S. attorneys and accountants to review whether the U.S. account holders were in compliance with U.S. Tax and financial reporting laws. As part of its compliance procedures, Coutts also required its U.S. clients to sign a declaration permitting the disclosure of their account to the IRS.

 

Sensing that the posse was on his trail, Gyetvay closed the Opotiki and Felicis Accounts at Coutts and transferred the assets to the newly created accounts at Hyposwiss (the “Hyposwiss Accounts”), listing defendant’s wife as the beneficial owner and using a Moscow address as Ms. Gyetvay’s principal residence. In 2013 Falcon Private Bank acquired the assets of Hyposwiss.

Gyetvay did not retain an accountant to prepare his tax returns for 2006 through 2008 until July of 2010, when Ms. Gavrilova decided to pursue becoming a Permanent Lawful Resident of the United States. That decision required the defendant to explain to immigration authorities why he failed to file tax returns for the 2006 through 2008.  Consequently, the defendant retained an Atlanta-based accounting firm (the “Atlanta Firm”).

As part of the information gathering and due diligence processes, the Atlanta Firm sent Gyetvay a tax organizer for each year. The defendant completed and returned the organizer to the Atlanta Firm. Gyetvay also provided the accountants with information on his income and foreign bank accounts. The defendant falsely represented to the Atlanta Firm that he had no foreign financial accounts during the 2006-2008 tax years. He also deliberately underreported his earnings to the Atlanta Firm.

Based upon the responses and information provided by Gyetvay, the Atlanta Firm did not prepare FBARs on behalf of the defendant and also underreported defendant’s income for 2006 through 2008 for U.S. tax purposes.

In addition to filing false tax returns for the tax years 2006 through 2008, Gyetvay rejected the Atlanta Firm’s advice that Gyetvay file FBARs for the 2006 through 2008 tax years and that he completely disclose all of his FFA’s.

For the tax years 2009-2015 Gyetvay received significant amounts of income in the form of wages, dividends and interest income from his FFA’s. Once again, the defendant failed to file timely tax returns, failed to timely pay to the taxes due and owing to the IRS and failed to file FBARS.

In 2015 Falcon announced that it had entered into a Non-Prosecution Agreement with the DOJ under the Swiss Bank Program.  Sensing the need to make some form of offshore disclosure, the defendant decided to utilize the Streamlined Foreign Offshore Procedures rather than participate in the OVDP.

The Streamlined Foreign Offshore Procedures is only available to taxpayers who meet the non-residency requirement that in any one or more of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed: (1) the individual did not have a U.S. abode and (2) the individual was physically outside the United States for at least 330 full days.

Both the Foreign and Domestic Streamlined Procedures require that the taxpayer submit original or amended returns for the previous three years and FBARS for the previous six, along with a Statement of Facts, which is attached to either Form 14653 or 14654, certifying that the compliance failure was the by-product of non-willful disregard. Forms 14653 and 14654 as well as the accompanying Statement of Facts, both must be signed under penalties of perjury.

The Streamlined Domestic procedures require a miscellaneous offshore penalty of 5% of the offshore assets, while the Streamlined Foreign procedures carry no penalty. There is no mystery as to why Gyetvay utilized the Streamlined Foreign procedures.

Seeking to avoid any penalty, on July 13, 2015 Gyetvay signed  Form 14653, (Certification by U.S. Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures) covering the tax years 2011-2013. In the certification, the defendant falsely claimed that he worked and resided in Russia from 1995. He also falsely claimed that while abroad, he made annual tax payments to the IRS and tried to file his U.S. Tax Returns.

The defendant’s excuse for non-compliance was that Gyetvay, a CPA, was unable to file his returns due the complexity of the U.S. tax laws and his inability to find capable U.S. tax preparers in Russia. Based upon his explanation, the taxpayer maintained that his actions were not willful.   The foregoing statements were made despite the fact that defendant and his wife owned a residence and lived, in Naples, Florida during the time period at issue.

Gyetvay also signed under the penalties of perjury, Form I-684, Affidavit of Support under Section 213A of the Immigration and Nationality Act in connection with sponsoring his wife for Permanent Resident status in the United States. In his Affidavit the defendant stated that his mailing address and place of residence was in Naples, Florida.  In addition, the defendant also represented that he was registered as a Florida voter and that he held a Florida driver license.

In connection with his Streamlined Foreign filings, Gyetvay paid taxes, interest, and penalties in the amount of $4,649,609.77 for unfiled 2011 through 2013 tax returns, but paid no FBAR penalty since he claimed overseas residence.

Despite having an interest in foreign bank accounts since at least 2001 and despite being advised by the Atlanta Firm that he should file FBARs, Gyetvay did not file an FBAR until he made his false disclosures in his Streamlined Foreign submission.

As part of his Streamlined Foreign filings, the defendant filed FBARs for calendar years 2008 through 2013, where Gyetvay disclosed his accounts at Coutts (Switzerland), Citibank (Russia), First United Bank (Russia), Hyposwiss (Switzerland), and Falcon (Switzerland). However, the disclosures were incomplete. The defendant also failed to properly report the account number and account value of certain FFA’s.

Defendant timely filed his FBAR for 2014, but once again, his FBAR filing contained deliberate misrepresentations.  Gyetvay falsely reported that he had signatory authority, but no financial interest, in a Falcon Account ending in 3116. In this regard, the defendant also failed to report the highest balance of the Falcon 3116 Account, despite having reported the highest balance in his 2013 FBAR filing.

In addition Gyetvay failed to report his interest in a Falcon Account with account number ending in 4056, despite having included the account in his 2013 FBAR filing. The glaring omissions resulted in defendant having to file an amended FBAR for 2014.

As a consequence of the defendant’s systematic and deliberate attempts to defraud the U.S. Government, the jury trial found Gyetvay guilty of the following:

  1. willfully failing to timely file a 2013 and 2014 federal income tax returns, in violation of  26 U.S.C. § 7203;
  2. willfully making a false statement in Gyetvay’s Streamline Submission that his failure to report all income, pay all tax, and submit all required information returns, including FBARs, was “not due to any willfulness” in violation of 18 U.S.C. § 1001 and 18 U.S.C. 1002; and
  3. willfully failing to file an accurate FBAR for 2014, in violation of 31 U.S.C. § 5314; 31 U.S.C. 5322(a); 31 C.F.R. § 1010.350, 31 C.F.R. § 1010.306(c)-(d), and 31 C.F.R. § 1010.840(b).

In addition, the United States filed a FBAR collection suit against Gyetvay. The U.S. Government alleges that defendant owes close to 44 million dollars in Willful FBAR Penalties for 2014, together with accrued interest and failure to pay penalties under 31 U.S.C. § 3717, and fees.

The Gyetvay conviction as well as the FBAR Willful Penalty suit underscores the seriousness associated with taking steps to hide your foreign assets and income from the IRS.  Waiting to see if the U.S. Government is coming after you is no plan at all. For those who think they can continue to avoid detection, I urge you to listen to the Ojay’s “For the Love of Money.”

 

 

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PROSECUTIONS FOR UNPAID EMPLOYMENT TAXES ON THE RISE

The assessment of the § 6672 penalty can be devastating, and in some cases, life changing. Individuals who are subject to the penalty usually state that they were unaware that failure to collect and pay employment taxes to the IRS could result in personal liability for unpaid payroll taxes, and in certain cases, criminal prosecution. The recent increase in the number of employment tax examinations and criminal prosecutions is alarming and certainly underscores the Government’s commitment to making employment tax fraud a priority.

The § 6672  penalty, commonly known as the “Trust Fund Recovery Penalty” (“TFRP”) imposes personal liability on individuals who are required to collect,  account for, and pay over employment taxes and who willfully fail to collect such tax, or truthfully account for and pay over such tax. The requirements for imposition of the penalty are: (1) the penalized person is deemed to be a “responsible person” or someone responsible for having collected and paid the tax in the first place; and (2) the penalized person must have willfully failed to collect and pay that tax. Godfrey v. United States, 748 F.2d 1568, 1574 (Fed. Cir. 1984).  The TFRP provides the IRS with an alternate means of collecting unpaid employment taxes, when the employer is unable to do so, by permitting the IRS to pierce the corporate veil and hold those responsible for the employer’s failure to pay the outstanding taxes. White v. United States, 372 F.2d 513, 516, 178 Ct.Cl. 765 (1967).

The TFRP usually comes into play when a business is experiencing a financial crisis and the owner elects to use the available funds to pay other creditors, such as a bank or a supplier. In more egregious cases the responsible person may use the trust funds for personal expenses or to support an extravagant lifestyle.

Employers are required to withhold income and FICA taxes from employee salaries and must also contribute the employer’s share of FICA taxes. The withheld funds are to be placed in trust with the government designated as the beneficiary.

The IRS commitment to pursue those who have failed to account and deposit payroll taxes on behalf of their employees is underscored by the remarks made by the Assistant Attorney General at a Federal Bar Association Conference:

“Since January 2015, the Tax Division has sharpened its focus on civil and criminal employment tax enforcement.  As most of you know, these cases involve employers who fail to collect, account for, and deposit tax withheld from employee wages.  These withholdings represent 70 percent of all revenue collected by the IRS, and as of September 2015, more than $59 billion of tax reported on Forms 941 remained unpaid.  These employers are literally stealing money, knowing that their employees will receive full credit for those amounts when they file their returns.  The employers gain an unfair advantage over their competitors and the U.S. Treasury is left holding the bag.” Acting Assistant Attorney General Remarks at Federal Bar Association Tax Law Conference (March 4, 2016).

26 U.S.C § 6672 (a) provides in part:

“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.”

The assessment of the TRFP requires that the IRS establish that the person against whom enforcement is sought had a duty to collect, account and pay over employment taxes.

The term “person” is defined in 26 U.S.C. § 6671(b) and includes:

“an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.”

The courts use the term “person” and “responsible person” interchangeably. While the term “person” is statutorily defined, the latter is not. Rather, the term “responsible person” is a creation of the courts. Slodov v United States, 436 U.S. 238 – Supreme Court 1978.  In order to be considered a responsible person, the taxpayer must be “under a duty” to collect, truthfully account for, and pay over” any taxes. The inquiry will always focus on whether the person has “significant control over the enterprise’s finances.” Fiataruolo v. United States, 8 F.3d 930, 939 (2d Cir. 1993) (quoting Hochstein v. United States, 900 F.2d 543, 547 (2d Cir. 1990)).

While many of the cases involve officers, directors and shareholders, the courts have expanded who qualifies as a responsible person to include creditors, employees, accountants and attorneys.  If the responsible person could have impeded the cash flow of the business to prevent the trust funds from being squandered, then he or she will be held liable Thomas v. United States, 41 F.3d 1109, 1113 (7th Cir. 1994). Furthermore, the TFRP can be assessed against more than one person. Thibodeau v. United States 828 F.2d 1499, 1503 (11th Cir. 1987). Consequently, each person found liable can be held responsible for the full amount of unpaid trust fund taxes.

The IRS considers the following factors when making a determination of whether a person is a responsible person:

  1. Does the person(s) have a duty to perform?
  2. Does the person(s) have the power to direct the act of collecting trust fund taxes?
  3. Does the person(s) have the accountability for and authority to pay trust fund taxes?
  4. Does the person(s) have the authority to determine which creditors will or will not be paid?
  5. Does the person(s) have the status, duty and authority to ensure that the trust fund taxes are paid?
  6. Is the person(s) an officer, director, or shareholder of the corporation?
  7. If the person(s) is an officer, what do the corporate by-laws state regarding the person(s) responsibilities as it relates to financial matters?
  8. Does the person(s) have the ability to sign checks?
  9. Does the person have the authority to hire and fire employees?
  10. Does the person have the authority to sign and file the excise tax or employment tax returns, such as Form 941, Employer’s Quarterly Federal Tax Return?
  11. Does the person control payroll/disbursements?
  12. Does the person control the corporation’s voting stock? and
  13. Does the person(s) make federal tax deposits?

While no one factor is dispositive, check-signing authority is considered strong indicia of responsibility, even in cases where the check signer is instructed by a superior not to pay the taxes.  Howard v. United States, 711 F.2d 729, 734 (5th Cir. 1983). The facts in each case are evaluated by the IRS when making a determination as to responsibility. As the Court of Appeals pointed out in Godfrey:

“. . . the case law makes abundantly clear, a person’s “duty” under § 6672 must be viewed in light of his power to compel or prohibit the allocation of corporate funds. It is a test of substance, not form.” Godfrey 748 F.2d at 1576.

In addition to establishing that the individual is a “responsible person”, it is necessary that the Government prove that the person acted willfully.  The Internal Revenue Manual defines “willfulness” in the context of the TRFP as:

“intentional, deliberate, voluntary, and knowing, as distinguished from accidental. Willfulness is the attitude of a responsible person who with free will or choice either intentionally disregards the law or is plainly indifferent to its requirements.” I.R.M. § 8.25.1.3.2

Some of the factors the I.R.S will consider in making a determination of whether a responsible person was willful include:

  • Whether the responsible person had knowledge of a pattern of noncompliance at the time the delinquencies were accruing;
  • Whether the responsible person had received prior IRS notices indicating that employment tax returns have not been filed, or are inaccurate, or that employment taxes have not been paid;
  • The actions the responsible party has taken to ensure its Federal employment tax obligations have been met after becoming aware of the tax delinquencies; and
  • Whether fraud or deception was used to conceal the nonpayment of tax from detection by the responsible person. Id.

The courts have construed “willfulness” under § 6672 to mean the “voluntary, conscious and intentional act” of paying creditors other than the IRS when the company is financially troubled. Phillips v. IRS, 73 F.3d 939, 942 (9th Cir. 1996) (quoting Davis v. United States, 961 F.2d  867, 871 (9th Cir. 1992); Klotz v. United States, 602 F.2d 920, 923 (9th Cir. 1979)).

While evidence of willfulness requires proof of a voluntary, intentional, and conscious decision not to collect and remit taxes thought to be owing, it does not require proof of a special intent to defraud or deprive the Government of monies withheld on its account. Godfrey 748 F.2d at 1576, citing Scott v. United States, 354 F.2d at 295. The Court of Claims has consistently rejected the view that “a finding of willfulness entails a showing of evil motive, bad purpose, or calculated malevolence.” Id. at 1576. The focus of inquiry is rather “on the deliberate nature of the individual’s election not to pay over the money and the circumstances of that refusal.” Id. at 1576.  Consequently, if a person deemed a responsible party discovers that there are unpaid taxes, the responsible person has an immediate duty to use all unencumbered funds to pay taxes. United States v. Kim, 111 F.3d 1351, 1357 (7th Cir. 1997). Failure to pay the back taxes will result in personal liability on the part of the responsible person.

The Court of Appeals in Godfrey echoed the White definition of willfulness as meaning “a deliberate choice voluntarily, consciously, and intentionally made to pay other creditors instead of paying the Government.” Godfrey 748 F.2d at 1577, citing Scott 372 F.2d at 521. The Court of Appeals citing Feist v. United States, 607 F.2d at 961 also noted that willful conduct may also include a reckless disregard of an “obvious and known risk” that taxes might not be remitted. Finally, the Godfrey Court citing Bauer v. United States, 543 F.2d at 150; stated: “Mere negligence in failing to ascertain facts regarding a tax delinquency,” however, “is insufficient to constitute willfulness under the code.” Godfrey 748 F.2d at 1577.

When an employer falls behind on the payment of its payroll taxes, the IRS will send out a Federal Deposit Tax Alert Notice to the business.  If unanswered a Revenue Officer (“RO”) is assigned to the business to investigate the reason the business in non-compliant. The RO will attempt to bring the business into compliance by directing the business to set up a special trust account for the deposit of employment taxes. If the business fails to come into compliance, the next step will be to conduct an investigation of potentially responsible individuals against whom the § 6672 penalty can be assessed. The RO will then attempt to secure the business’s bank records and other records of the business. The RO will also issue Letter 3586 to the potentially responsible individuals setting a meeting (“Interview”). Letter 3586 is accompanied by Notice 784 “Could You Be Personally Liable for Certain Unpaid Federal Taxes.”

Following the Interview, the RO will determine whether to proceed with the proposed assessment. If the RO decides to move forward, he or she will generate and send the responsible person a 60 day Preliminary Notice styled as “Letter 1153” together with Form 2751 (“Proposed Assessment of Trust Fund Penalty”)   Thereafter, the IRS must wait 60 days after the issuance of Letter 1153 and the Proposed Assessment before issuing a notice and demand for payment. The responsible party has 60 days to respond and 75 days if the letter is addressed out of the country.

Most individuals are ill equipped to handle an IRS Interview and may unwittingly say something that will be used to establish responsible party status. In some cases, an individual’s statements may serve as a basis for a referral to the Criminal Investigation.  The RO will use Form 4180 (“Report of Interview with Individuals Relative to Trust Fund Recovery Penalty”) when conducting TFRP Interview.

Prosecutors will typically look to see whether an IRS Form 2751 or Form 4180 was completed during the civil administrative part of the case, because these documents may contain relevant admissions or statements by the defendant. See Moore v. United States, 648 F.3d 634, 636 (8th Cir. 2011) (approved admission of Form 2751 in § 6672 case); United States v. Thayer, 201 F.3d 214 (3d Cir. 1999) (in § 7202 case, the court noted that the defendant signed a Form 2751, “accepting personal responsibility for

unpaid tax liability and civil penalties”); United States v. Korn, 2013 WL 2898056 (W.D.N.Y. 2013) (in § 7202 case, Magistrate Judge noted that the Revenue Agent’s interview of the defendant was memorialized on a Form 4180).

Internal Revenue Code Section 7202 is used to prosecute persons who willfully fail to comply with their

Statutory obligations to collect, account for, and pay over taxes imposed on another person. This includes employment tax crimes, which are regularly prosecuted under § 7202, as well as 26 U.S.C. § 7201 (tax evasion), 26 U.S.C. § 7206(1) (false returns), 26 U.S.C. § 7212(a) (obstruction), and 18 U.S.C. § 371 (conspiracy to defraud).

To establish a violation of § 7202, the prosecutor must prove the following elements beyond a reasonable doubt:

(1) Duty to collect, account for, and pay over a tax;

(2) Failure to collect, truthfully account for, or pay over the tax; and

(3) Willfulness.

The element of willfulness under § 7202 is the same as other criminal offenses under Title 26.  In this context, the Government must show that a defendant voluntarily and intentionally violated a known legal duty. Cheek v. United States, 498 U.S. 192, 200 (1991); United States v. Pomponio, 429 U.S. 10, 12 (1976); United States v. Bishop, 412 U.S. 346, 360 (1973). Evil motive or bad purpose is not necessary to establish willfulness under the criminal tax statutes. Pomponio, 429 U.S. at 12.

Thus, Courts have rejected the defense that the trust funds were used tax to pay current expenses so the   company could stay afloat and eventually pay the delinquent tax in the future. Although such facts may have emotional appeal and may have an impact in sentencing, if the government proves the defendant voluntarily and intentionally used unencumbered funds to pay creditors other than the United States, the jury may nevertheless find the defendant guilty even if the intentional non-payment of the known trust fund tax liability was motivated by a desire to keep the business afloat. Cf., Collins v. United States, 848 F.2d 740, 741–42 (6th Cir. 1988) (in a § 6672 case, the court held that “[i]t is no excuse that, as a matter of sound business judgment, the money was paid to suppliers and for wages in order to keep the corporation operating as a going concern—the government cannot be made an unwilling partner in a floundering business Criminal Tax Manual 13-14.

The following represents a sample of 2023 prosecutions evidencing that Employment Tax Fraud is a top priority for the Government:

  1. On September 1, 2023 a Kansas woman pleaded guilty to willfully failing to account for and pay over employment taxes to the IRS. According to court documents and statements made in court, Sheryl Clanton owned and operated a Construction Company (“Company # 1”), a business specializing in the construction and maintenance of underground infrastructure. The defendant was President of the Company from 2006 through 2011, responsible for filing quarterly employment tax returns and collecting and paying federal income and Social Security and Medicare taxes withheld from employees’ wages to the IRS. For the first quarter of 2010 through the last quarter of 2011, the defendant did not pay approximately $980,536 in employment taxes owed to the IRS. In 2011, the defendant abandoned the Company #1 due to its outstanding tax obligations and a bank mortgage foreclosure, and started a second Construction Company (“Company #2”). From the second quarter of 2012 through the fourth quarter of 2017, the defendant did not pay approximately $1.1 million in employment taxes or file quarterly payroll tax returns as required by law.  The defendant also operated a third underground construction business (“Company # 3”), organized in late 2011. Between 2012 and 2015, the defendants did not report or       pay nearly $100,000 of employment taxes owed to the IRS on behalf of Company # 3. In    total, the defendant caused a tax loss to the IRS exceeding $2.2 million.
  1. On or about August 10, 2023, an Oklahoma man and a Virginia man pleaded guilty, in separate cases, to willfully failing to pay over employment taxes. According to court documents and statements made in court, Stephen Christopher Parker of Oologah, Oklahoma, and Michael Baines of Portsmouth, Virginia, were co-owners of a mental health counseling services company, Family Youth Intervention Services Inc., located in Tulsa, Oklahoma. In that role, the two men were responsible for withholding, accounting for and paying over the income and Social Security and Medicare taxes withheld from the wages paid to the company’s employees. For the second quarter of 2016 they did not file the required quarterly employment tax return or pay over the entirety of those taxes. The two defendants admitted that from January 2014 through December 2017, they did not pay over a total of approximately $1,265,259 in withholdings to the IRS.
  1. On July 6, 2023 a Colorado man was sentenced to 15 months in prison for evading the payment of more than $700,000 in employment taxes he owed to the IRS. The defendant co-owned restaurants and an oil production business, which had employees from whose paychecks he withheld income and Social Security and Medicare taxes. Starting in 2002 and continuing for many years, defendant failed to pay over the withheld payroll taxes to the IRS, and further, failed to file the required quarterly employment tax returns for his businesses. After failing to collect from the businesses, the IRS assessed the tax against the defendant personally (26 U.S.C. 6672 “Trust Fund Penalty”).   To prevent the IRS from collecting through bank levies the taxes he owed, the defendant  kept   the balances of his personal and business bank accounts low, often leaving them enough funds to cover expenses and then moved any remaining money to a bank   account not subject to   IRS levy. In total, the defendant  caused a tax loss of   approximately $737,128.
  1. On June 22, 2023 a Maryland restaurant owner pleaded guilty to willful failure to account for and pay over employment taxes and to filing a false personal tax return. According to court documents and statements made in court, the defendant owned and operated Maryland restaurant since 1995. As part of managing the restaurant, defendant issued Forms W-2 to his employees and withheld federal income and Social Security and Medicare (FICA) taxes from their wages. However, from 2010 through 2021, the defendant failed to file with the IRS the required Employer’s Quarterly Federal Tax Returns (Forms 941) reporting these employment taxes and did not pay the withholdings over to the IRS. In total, the defendant did not report or pay approximately $2,813,348.94 in employment taxes due and owing to the IRS. Instead of meeting his tax obligations, the defendant used funds from his business to pay other creditors and for a variety of personal expenses, including golf club membership dues, season tickets to the Baltimore Orioles, international vacations, and salaries for himself and his wife.
  1. On June 20, 2023 a Minnesota man who owned an automobile transmission business pleaded guilty to willfully failing to account for and pay over employment taxes. According to court documents and statements made in court, the defendant, Timothy J. Lundquist, owned and an automobile transmission remanufacturing company based located in Jordan, Minnesota. The defendant was responsible for filing quarterly employment tax returns and collecting and paying over to the IRS payroll taxes withheld from employees’ wages. For at least the last quarter of 2013 through 2018, the defendant did not pay withholdings to the IRS or file required employment tax returns. In total, he caused a tax loss to the IRS of over $1.2 million.
  1. On June 13, 2023 the Chief Financial Officer (CFO) of a Mississippi company pleaded guilty to willfully failing to report and pay over employment taxes withheld from employees’ paychecks. According to court documents and statements made in court, the defendant was the CFO of Construction Company engaged in the business of pipeline-maintenance and construction.  From at least 2012 through October 2018, the defendant, Julian Russ, did not file required quarterly employment tax returns or pay over the taxes withheld from employees’ wages to the IRS, despite knowing of his obligation to do so. In total, the defendant caused a tax loss to the IRS of more than $6 million.  Russ faces a maximum penalty of five years in prison. He also faces a period of supervised release, restitution, and monetary penalties.
  1. On June 2, 2023 a Florida man was sentenced to two years and eight months in prison for conspiring to defraud the United States and conspiring to harbor aliens and induce them to remain in the United States. According to court documents and statements made in court, between November 2010 and October 2020, defendant owned and operated several Key West labor staffing companies that facilitated the employment of non-resident aliens in hotels, bars, and restaurants operating in Key West and elsewhere who were not authorized to work in the United States. The Defendant encouraged workers to enter the United States illegally and induced them to remain in the country, in violation of immigration laws. The Defendant’s labor staffing companies paid alien workers without withholding federal income and employment taxes from their wages and did not report said wages to the IRS.
  1. On May 24, 2023 a California man was sentenced to 12 months in prison for willfully failing to account for and pay over employment taxes. According to court documents and statements made in court, Larry Kudsk operated two construction businesses in California these companies served as general contractors or subcontractors, including on some government projects. The defendant was responsible for filing quarterly employment tax returns and collecting and paying over to the IRS payroll taxes withheld from employees’ wages for both companies. The defendant did not timely file employment tax returns or pay over withholdings to the IRS, resulting in a tax loss exceeding $250,000.
  1. On April 14, 2023 an Iowa man was sentenced to two years in prison for evading payment of employment taxes owed by his company. According to court documents and statements made in court, the defendant, Kevin Alexander, owned a landscaping and construction company. Defendant was responsible for filing quarterly employment tax returns and collecting and paying to the IRS taxes withheld from employees’ wages. Between 2014 and 2017, the Company paid approximately $3.8 million in wages to its employees, of which approximately $1 million in income and Social Security and Medicare taxes was withheld. The defendant did not pay those withholdings over to the IRS. When the IRS attempted to collect unpaid employment taxes, the defendant sought to conceal his income by submitting a form to the IRS concealing the full amount of K&L’s available assets.
  1. On March 15, 2023 a Michigan business owner was sentenced to 12 months and one day in prison for failing to collect and pay over to the IRS employment taxes withheld from his employees’ wages. According to court documents and statements made in court, the defendant, Yigal Ziv, owned and operated a software development firm based in Walled Lake, Michigan. The defendant was responsible for filing the Company’s quarterly employment tax returns and collecting and paying to the IRS payroll taxes withheld from employees’ wages. From the first quarter of 2014 through the first quarter of 2018, defendant collected approximately $691,000 in employment taxes from MTI’s employees, but did not file employment tax returns or pay the withheld taxes to the IRS.
  1. On March 13, 2023 a federal grand jury in Philadelphia returned an indictment charging a Pennsylvania man and woman with conspiring to defraud the IRS and other tax crimes, including failing to pay employment taxes to the IRS. According to the indictment from approximately October 2013 through December 2021, Theodore Shearba and Jennifer Cemini owned and operated a landscaping and excavation business and attempted to defraud the IRS by (1) not reporting the income they received from the business, (2) using business funds to pay for personal expenditures, (3) not paying employment taxes, including the income tax withheld from employees’ paychecks and Social Security and Medicare taxes and (4) changing business names and concealing business income to thwart IRS efforts to collect the unpaid employment taxes. If convicted, the Defendants each face a maximum penalty of five years in prison for the conspiracy count and each employment tax count.

The above illustration represent a small number of the total prosecutions in 2023, with many industries represented in the mix, including but not limited to construction, technology companies, restaurants, auto dealerships, long term care facilities, and  landscaping companies just to name a few.

If you are involved in a business that is delinquent on its payroll taxes, there is a high likelihood that you will be investigated by the IRS.  Those individuals responsible for management of the business are particularly vulnerable to the TFRP should the business ultimately fail to pay its employment taxes, and may in certain cases be subject to criminal prosecution.

 

When looking into the issue of responsibility, the IRS will most always pick the low hanging fruit.  Since the IRS considers failure to pay your employment taxes stealing, the necessity of legal representation cannot be understated. If the IRS is currently conducting an investigation into the employment taxes of your business or you are behind in your payroll taxes, it is important to be proactive particularly if there is a risk of a referral to Criminal Investigation of the IRS. As such, a potentially responsible person should never attend an Interview without the assistance and advice of counsel, since any statement you make may be considered an admission of guilt.

 

Many individuals I have counseled over the years simply waited too long. You cannot hide your head in the sand!

 

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ARE EMPLOYMENT TAX EXAMINATIONS BEING USED AS A PRETEXT FOR CRIMINAL PROSECUTION? 2022 ROUND UP

 

Prosecution for employment tax crimes in 2022, reflects an increase in investigations for employment tax violations by the Department of Justice, Tax Division and also provides some insight as to the Government’s intention to prioritize employment tax crimes. In this regard, you can expect an increase in the number of employment tax examinations and assessment of penalties under 26 U.S.C. §6672 (the “Trust Fund Recovery Penalty”) as well as an increase in criminal prosecutions under 26 U.S.C. § 7202.

In general, employment tax violations involve an employer’s obligation to (i)collect payroll taxes from its employees; (ii) file quarterly and annual payroll taxes and (iii) remit the taxes it collects from its employees together with the amounts due from the employer.

Depending upon the circumstances, the failure to comply with the Tax Laws pertaining the employment taxes can result in the assessment of the Trust Fund Recovery Penalty in cases where the employer is unable to satisfy the outstanding employment tax liability. In more egregious cases, criminal prosecution, imprisonment, orders of restitution and other monetary penalties may be imposed.

As the 2022 cases below illustrate, employment tax violations involve two scenarios: The first scenario pertains to civil liability and the assessment of the Trust Fund Recovery Penalty. Under this scenario, the employer files quarterly payroll tax returns, regularly withholds and collects payroll taxes on behalf of its employees and remits these funds to the Internal Revenue Service. In addition, the employer remits its share of employment taxes.

Using the Trust Fund concept, the employer as well as a responsible person is considered a fiduciary, and as such, is charged with the responsibility of segregating and safeguarding the employment taxes it withholds from its employees until such time that it remits those funds, together with the employer’s portion to the Internal Revenue Service.

In the civil context, problems arise when an employer experiences a downturn in business or is faced with an unforeseen and substantial expenditure. In this instance, the employer may decide to use the funds it has withheld from its employees for other business purposes including making payments to both secured and unsecured creditors, purchasing inventory or machinery as well as other legitimate business expenses, such as rent, utilities or business supplies.  The employer’s rationale for diverting the entrusted funds is that business will soon pick up or the events which caused the cash crisis have subsided. In this situation, the employer reasons that he will catch up and make the IRS whole.

However, this logic is flawed for the following reasons. An employer has an unconditional duty to (i) withhold, account for and collect employment taxes from its employees; (ii) segregate and safeguard the employment taxes it collects; and (iii) remit these taxes to the IRS in a timely fashion. Under no circumstance may the employer divert employment taxes withheld from its employees for any purpose, including the payment of legitimate business expenses.

In rare instances, the employer rebounds and is able to catch up with its employment tax obligations. However, in many cases, the employer continues the practice of using the employment taxes it collects from its employees for business purposes theorizing that the diversion of employment taxes represents a form of government loan.  In the event the employer is unable to satisfy the outstanding employment tax liability, the IRS will look to assess the Trust Fund Recovery Penalty against the responsible person equal to  100% of the employment taxes due, together with accrued interest.

To be clear. Any departure from the employer’s statutory obligations, is considered stealing by the IRS and the “responsible person” will be liable under Section 6672 for 100% of the employment taxes that should have been withheld and paid over to the Government, together with accrued interest.

The assessment of the Trust Fund Recovery Penalty is predicated upon two statutory components. First, the individual must be a “responsible person,” within the meaning of Section 6672 (a); and second, the person must have “willfully” failed to collect and remit the employment taxes due. Under IRC Section 6671(b) a responsible person includes any officer or employee of the corporation, or member or employee of a partnership, who has the duty to collect or pay employment tax.

The mere holding of a title is not controlling on the issue of a person’s liability. The determination of a person’s status is based on substantive evidence as to whether the person had the authority, duty, and status to control the Company’s financial affairs.

In order for liability to attach under Section 6672 a person must exercise significant control over the business financial operations and the ability to decide which creditors get paid. A significant factor the IRS considers is who signs the checks? The IRS also considers whether the person is an owner, officer or director of the Company, whether the person has the right to hire and fire employees, sign contracts or is otherwise active in the Company’s Day to day business. Other factors considered by the IRS is whether the person makes payroll deposits or is responsible for the disbursement of payroll.

To avoid assessment of the Trust Fund Recovery Penalty, the individual must demonstrate that he or she lacked the requisite financial control through such things as company business records, e-mails, court pleadings in litigation involving the business, and affidavits from third parties, combined with effective written and oral advocacy.

In order for liability to attach, it must also be established that the person acted “willfully” in failing to collect, account for, or pay the employment taxes. In the context of Section 6672 willfulness has been defined in Godfrey v U.S. 748 F2d 1568, 1575-76 (Fed Cir. 1984) as “voluntary, intentional and conscious decision to pay other creditors rather than remit the employment taxes to the IRS.”

The second scenario most often involves the diversion of employment taxes withheld for personal reasons including the payment of personal expenses, such as mortgage or car payments and often times include the purchase of luxury automobiles and jewelry as well as expensive dinners and exotic vacations. In cases where the IRS has assessed employment tax liability and related penalties, the individual may even form a new entity designating a nominee as the owner. This tactic is designed to frustrate IRS collection efforts. The pattern is repeated with the true owner failing to file payroll tax returns and pay over to the IRS, the employment taxes withheld from the employees of the new company.

In these instances, the responsible person charged with withholding and remitting the employment taxes may, in addition to or in lieu of the Trust Fund Recovery Penalty, be subject to criminal prosecution under 26 U.S.C. , titled” Willful Failure to Collect or Pay Over Tax.  Section 7202 provides:

“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 five years, or both, together with cost of prosecution.”

Under of Section 7202, it is the person or persons with the responsibility to collect, account for, and pay over who will be liable when there is a willful failure to perform this duty. The term “person” is construed to mean and include an individual, a trust, estate, partnership, association, company or corporations 26 U.S.C. § 7701(a)(1). Section 7343 extends the definition of “person” to include an “officer, or employee of the corporation or a member or employee of a partnership, who as such officer, employee or member is under a duty to perform the act in respect of which the violation occurs.” For purposes of the Trust Fund Recovery Penalty, 26 U.S.C. § 6671(b) provides an identical definition of “person.”

“A responsible person is someone who has the status, duty and authority to avoid the employer’s default in collection or payment of the taxes.” Ferguson v. United States, 474 F.3d 1068, 1072 (8th Cir. 2007).  In addition, a person is responsible for collecting accounting for, and paying over trust fund taxes if he or she has the authority required to exercise significant control over the employer’s financial affairs, regardless of whether the individual exercised such control in fact United States v. Jones, 33 F. 3d 1137, 1139 (9th Cir. 1994).

In addition, to prosecution under Section 7202, a person who willfully fails to file a payroll tax return can be charged under 26 U.S.C. §7203, which is a misdemeanor.

While employment tax deficiencies have historically been the subject of civil enforcement, and the by product of civil examinations, there is an alarming trend where the IRS is using the civil examination as a pretext for referring cases to Criminal Investigation (“CI”) of the IRS with the ultimate goal of prosecuting the responsible person.

While the concept of “willfulness” under Sections 6672 and 7202 seem to be substantially similar, the Department of Justice is well aware of the interplay between the civil enforcement and criminal prosecution as evidenced in The Department of Justice, Tax Division, Criminal Tax Manual, Section 9, Page 9 which provides in pertinent part:

“Prosecutors should ascertain whether an IRS Form 2751 (“Proposed Assessment of Trust Fund Recovery Penalty”) or Form 4180 (“Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Taxes) was completed during the civil administrative part of the case, and if so, whether these documents contain any relevant admissions or statement by the Defendant.”

In particular, if the individual agrees to furnish information for purposes of completing Section V entitled: “Knowledge/Willfulness of Form 4180, the responses to this Section may constitute an admission or statement by the defendants that will be used for criminal prosecution under Section 7202.

The difference between Section 6672 cases and Section 7202 criminal prosecutions relates to the burden of proof. An IRS assessment under Section 6672 is presumed to be correct, and the Taxpayer has the burden of proof of rebutting the presumption that the assessment is correct.  The standard for rebutting the presumption is a preponderance of evidence. By contrast, in a Section 7202 prosecution, the Government has the burden of proof to prove all elements of the crime beyond a reasonable doubt.

The elements that the prosecution must prove include: (i) a duty to collect, account for and pay over a tax; (ii) the failure to collect, truthfully account for, or pay over the tax; and (iii) willfulness.

According to a report issued by TIGTA in March of 2017 titled: “A More Focused Strategy is Needed to Effectively Address Egregious Employment Tax Crimes,” TIGTA concluded that: (i) employment tax non compliance is a serious crime; (ii) when employers fail to account for and deposit employment taxes, they are, in effect, stealing from the Government; and (iii) Section 7202 needs to be used more often in order to promote compliance.

The objectives outlined in the TIGTA report are realistic goals in light of the Inflation Reduction Act (“IRA”) and the additional funds the IRS anticipates receiving.  The funding under the IRA will be used to, among other things, aggressively pursue employment tax prosecutions.

The 2022 cases below have a common thread; In each case, the employer, through a responsible person, has diverted the employment taxes withheld from its employees and used the proceeds for both legitimate business expenses or to pay personal expenses or to support a responsible person’s lifestyle. While diverting employment taxes withheld for purposes of satisfying outstanding business debts or for other legitimate business purposes may seem less egregious than diverting trust funds for personal use, diverting employment taxes earmarked for the IRS is considered stealing in both cases and can serve as the basis for criminal prosecution.

The cases below represent a sampling, but not a complete inventory, of criminal prosecutions for the willful failure to pay over employment taxes for the Tax Year 2022:

  1. On December 12, 2022 a Maryland business man was sentenced by U.S. District Court Judge Richard D. Bennett to three years in prison for not paying more than $ 2 Million in payroll taxes to the IRS on behalf of its company employees. In addition, Jonas Purisch was ordered to serve three years of supervised release and ordered to pay approximately $3.4 Million in restitution to the United States.

 

According to court documents and oral testimony. Purisch operated two employee staffing companies, Titan Staffing Network, Inc. and Titan Services, LLC.  The two companies provided workers for third party manufacturing businesses in Maryland. Between March of 2018 a March of 2021, Purisch collected over $2 Million from the employer’s employees but failed to pay the withheld employment taxes over to the IRS.

 

  1. On November 29, 2022, a Michigan business owner pleaded guilty to the willful failure to collect and pay over employment taxes on behalf of his employees. Court documents reveal that Yigal Ziv (“Ziv”) or (the “Defendant”) owned and operated Multinational Technologies, Inc., a software developer located in Michigan (the “Company”). As the responsible person, Ziv was responsible for the Company’s quarterly employment tax returns and collecting and remitting the withheld taxes to the IRS. According to court records, the Defendant collected approximately $691,000 in employment taxes from the first quarter of 2014 through the first quarter of 2018, but failed to file employment tax returns and also failed to remit the employment taxes collected to the IRS.

To exacerbate matters, despite learning of the IRS criminal investigation in 2018, Ziv did not file payroll tax returns from the fourth quarter of 2019 through the fourth quarter of 2020 and further failed to pay over to the IRS approximately $199,000 in payroll taxes withheld.

Court records reveal that during the same period Ziv caused the Company to spend several hundred thousand dollars on personal expenses including mortgage payments, luxury auto lease payments and department store purchases.

Ziv is scheduled to be sentenced in February of 2023 and could face a maximum penalty of up to five years in prison, be subject to supervised release and ordered to pay restitution.

  1. On November 28, 2022 Ari Weingard (“Weingard”) or (the “Defendant”), a Miami business owner pleaded guilty to willfully failing to pay over employment taxes to the IRS. Based upon court documents, Weingard owned and operated two car rental companies, Rent Max Miami, Inc. and Rent Max North, Inc. As the sole owner and CEO for the two companies, the Defendant was responsible for filing payroll tax returns, and collecting, accounting for and paying over the payroll taxes defendant withheld from his employees to the IRS. It was further reported that between 2011 and 2016 that Weingard withheld from his employees, but did not pay over to the IRS approximately $850,000 in employment taxes owed to the IRS.  During this period the Defendant caused the two car rental companies to pay over to Weingard the sum of $50,000 in the form of a cashier’s check. In addition, the Defendant caused the rental companies to pay over to Weingard’s wife the sum of $45,000, also in the form of a cashier’s check and further directed the rental company to pay expenses relate to the Defendant’s 55-foot yacht. Weingard faces a prison sentence of up to five years, will be subject to supervised release and ordered to pay restitution and other penalties.

Sentencing has yet to be scheduled by U.S. District Judge K. Michael Moore.

  1. On November 22, 2022, Oleksandr Morgunov (“Morgunov”) or the (“Defendant”), a former resident of Key West pleaded guilty to immigration fraud as it related to the operation of several Key West labor staffing companies. According to court documents and other statements Morgunov assisted in operating Paradise Choice, LLC, Paradise Choice Cleanings, LLC, Tropical City Services, LLC and Tropical City Group, LLC, all of which operated in Southern Florida. The staffing companies facilitated the employment of individuals in hotels, bars and restaurants in Key West as well as other locations, despite the fact that the employees were not authorized to work in the United States.

In this regard, the companies withheld employment taxes from its employees, but failed to file employment tax returns and further failed to pay over employment taxes to the IRS.

The Defendant admitted that he and other co-conspirators defrauded the IRS out of more than $7.9 Million in employment taxes

Morgunov faces ten years in prison for conspiring to harbor aliens and to induce them induce them to remain in the United States. Sentencing is scheduled for January 31, 2023.

  1. On November 16, 2022, Kevin Alexander (“Alexander”) or (the “Defendant”), owner of a landscaping and construction firm pleaded guilty to tax evasion. According to court records,

Alexander owned K&L Construction. As the Company’s sole shareholder and president, the Defendant was responsible for filing quarterly employment tax returns and also responsible for collecting and paying over the employment taxes withheld from his employees.  The court records further reflect that from the second quarter of 2014 through the first quarter of 2017 the Company withheld approximately $1 Million in employment taxes, but failed to remit the withheld employment taxes to the IRS.

 

During the collection proceedings Alexander accepted responsibility for paying the Company’s outstanding tax balance. However, the Defendant submitted a false form to the IRS that concealed some of his assets. As part of his plea agreement, Alexander admitted that he submitted the false form for purposes of concealing assets and evading the payment of the Company’s outstanding payroll taxes.

 

Alexander could be sentenced to prison for up to five years. He may also face a period of supervised release and be ordered to pay restitution and monetary penalties. Sentencing is to be scheduled at a later date.

 

  1. On October 2022, a federal grand jury in New Jersey unsealed an indictment charging Zeki Donuk (“Donuk”) or (the “Defendant”) with tax evasion and employment tax crimes, filing false returns ad making statements in bankruptcy. All charges other than the employment crimes are enumerated here for purposes of context and are not part of this discussion. According to charging document, from the third quarter of 2016 through the third quarter of 2017, the Defendant did not collect or account for or pay over to the IRS employment taxes on behalf of two construction companies operated by Donuk. It is further alleged in the indictment that for those quarters the Defendant did not file quarterly payroll returns, despite his obligation to do so.

If convicted, Donuk faces up to five years in prison as well as supervised visitation, restitution, and monetary penalties.

  1. On September 21, 2022 a West Virginia Federal Grand Jury returned an indictment charging Christopher Smith (“Smith”) or (the “Defendant”) with the willful failure to pay over employment taxes. According to the indictment, Smith operated three companies, all of whom, provide ambulance services in West Virginia. The Defendant was responsible for collecting and paying over to the IRS employment taxes withheld from the three companies, but did not pay over the employment taxes withheld from the companies’ employees, nor did he pay the employer’s share of payroll taxes over to the IRS. After the IRS assessed the Section 6672 penalty against Smith, the Defendant stopped operating Stat Ambulance Service and created Stat EMS in the name of a nominee owner. The defendant continued to operate the new company and, likewise failed to pay over to the IRS, the employment taxes owed.

The indictment further alleges that after the IRS attempted to collect the unpaid employment taxes for Stat EMS as well as the resulting penalties, Smith attempted to obstruct the IRS collection efforts by making false and misleading statements. Specifically, it is alleged that Smith stated that he did not own Stat EMS and further that he did not have a personal bank account.

To further frustrate IRS collection efforts, the charging document alleges that Smith paid personal expenses from Stat EMS business bank account, transferred funds from Stat EMS to a bank account the defendant controlled, and diverted his own paychecks into a bank account in the name of another person.

If convicted, Smith faces up to five years in prison, may be subject to supervised release and ordered to pay restitution and monetary penalties. Trial has yet to be scheduled.

As the above cases illustrate there are serious consequences associated with failing to withhold, account for, collect and pay over employment taxes that are withheld from employees, ranging from the assessment of the Trust Fund Recovery Penalty against the responsible person to imprisonment for a period of up to five years, and an order to pay restitution and other monetary penalties. The outcome in each case will depend upon the facts developed in connection with Forms 2751 and 4180, and any statements made by the individual during the Form 4180 interview. The information provided by the individual for purposes of completing both Forms may constitute an admission that the individual is a responsible person and that the diversion of employment taxes withheld was willful.

Given the high stakes, it is well advised to seek the advice of an experienced Tax Attorney if you are behind on your payroll taxes, received a Notice of Examination or have been contacted by the IRS.

Since no two cases are alike, reviewing the specific facts in each case with a Tax Attorney is critical for purposes of completing Form 2751 and deciding whether to provide information for purpose of completing Form 4180 and attending the interview. Both Forms provide for the signature of the individual under penalties of perjury. Consequently, honest responses to the questions contained in either Form could constitute an admission of guilt on the part of the individual and serve as a basis for prosecution. Furthermore, if the Individual elects to attend the Form 4180 interview, any statement made during the interview can be used to establish criminal liability.

If you are contacted by the IRS or receive a Notice of an Employment Tax Examination with respect to unpaid employment taxes, do not call or communicate in any way with the agent.

There is a natural tendency on the part of Taxpayers to try and convince an agent that the individual is not a responsible party or that the failure to file payroll tax reports and the failure to collect, account for or remit the employment taxes to the IRS was not willful.

In this regard, Taxpayers who call the agent and try to plead their case often times make incriminating statements, particularly in cases where employment taxes withheld have been used to pay legitimate business expenses. For some reason, some Taxpayer believe that diverting withheld payroll taxes in order to pay business expenses or creditors is justified. Clearly, it is not.

In addition, if a Taxpayer revises or changes any prior statement in an attempt to rehabilitate his testimony he or she may suddenly find that he or she is also being charged for lying to the agent.

Instead of engaging the agent, simply tell the agent that you wish to hire an Attorney and will not make any statement or complete any form without first consulting with an Attorney. Furthermore, you should inform the agent that you have an absolute right to be represented under the Taxpayer’s Bill of Rights.

After retaining an Attorney, the legal representative will typically reach out to the agent and discuss the nature and scope of the examination. In some cases, an experienced Attorney may be able to negotiate a limitation on the scope of the exam or the number of years to be examined.

Prior to taking any action, the following decisions need to be made:

  1. Should the Taxpayer’s representative be present during the examination?
  2. Should the Representative meet alone with the agent for purposes of the examination?
  3. Where should the examination take place?
  4. Following the examination, the IRS may issue Letter 1153 and Form 2751. Should the Taxpayer provide information for purposes of completing Form 2751?
  5. Should the Taxpayer sign Form 2751? By signing Form 2751 an individual is admitting that he or she is a responsible person and that the failure to withhold, account for, collect and remit the employment taxes to the IRS was willful. This finding can subsequently be used in a criminal prosecution.
  6. Should the Taxpayer attend the Form 4180 interview? and if so, should the Taxpayer’s representative be present?
  7. Should the Taxpayer provide information for purposes of completing Form 4180?
  8. Should the Taxpayer sign Form 4180?

Based upon TIGTA’s findings and its recommendations, and in light of funding to be provided under the IRA, the IRS is poised to aggressively pursue the assessment of the Trust Fund Recover Penalty and/or criminal prosecution against those who fail collect, account for or pay their employment taxes.

Retaining a seasoned Tax Attorney can mean the difference between a civil penalty assessment and criminal prosecution.

Anthony N. Verni is a Tax Attorney and a Certified Public Account. Mr. Verni has represented dozens of taxpayers in employment tax cases. For a free consultation, please contact Anthony at (561) 531-8809.

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COURT ORDERS REPATRIATION OF FOREIGN ASSETS TO AID IN FBAR PENALTY COLLECTIONS

The issue of whether the Government can repatriate a taxpayer’s foreign assets for purposes of satisfying a taxpayer’s outstanding FBAR penalty judgment has not been extensively reported on or discussed. However, the issue was recently addressed by the U.S. District Court for the Southern District of Florida in United States v. Schwarzbaum (S.D. Fla. Dkt # 18-CV-81147-BLOOM/Reinhart).  The decision signals the Biden Administration’s intent to become more aggressive in the collection of outstanding FBAR penalty judgments.

Taxpayers, who have offshore assets, but have yet to report them, should be concerned.  In particular, those who are contemplating expatriation or those who no longer reside in the United States may find themselves subject to FBAR penalties, extradition, criminal prosecution, and the imposition of additional civil fines. Likewise,  U.S. persons against whom FBAR penalties have been assessed, who continue to reside in the United States and who have parked their assets overseas as a means of preventing the Government from collecting need to rethink this strategy.

In Schwarzbaum, the Government commenced an FBAR collection suit against the taxpayer in August of 2018. At the conclusion of a five day bench trial in May of 2021, the Court entered an FBAR penalty judgment in favor of the Government in the amount of $12,555,813. The judgment was based upon Schwarzbaum’s willful failure to file FBARs in compliance with 31 U.S.C. § 5314.

The Government’s post judgment discovery revealed that the taxpayer lacked sufficient assets in the United States from which the outstanding judgment could be satisfied.  However, the discovery did make clear that the taxpayer had sufficient assets located in Switzerland from which the judgment could be satisfied.

Consequently, the Government filed a Motion with the Court for an Order directing Schwarzbaum to repatriate sufficient funds to the United States in order to satisfy the judgment, by depositing such amounts in the form of an appeal bond.

In its Motion, the Government maintained that authority for such an Order exists under, the Fair Debt Collection Procedures Act of 1990 (“FDCPA”), 28 U.S.C. § 3001 et seq.

Judge Bloom referred the Motion to a Magistrate for purposes of issuing a Report and Recommendations (“R&R”).  On June 30, 2021 the Magistrate issued his R&R, recommending that the Government’s Motion be granted. The taxpayer filed Objections to the R&R and the Government filed a Response to the Objections. On October 26, 2021, the Court, adopting the Magistrate’s R&R, entered an Order in favor of the Government.

Prior to the Courts October 26, 2021 Order, the Taxpayer filed an appeal to the U.S. District Court for the Eleventh Circuit.

The Magistrate’s R&R concluded that the Court has authority under the FDCPA by virtue of its express incorporation of the All Writs Act, 28 U.S.C. § 1651 to Order the Taxpayer to repatriate $18,227,465.89 in addition to any additional post judgment interest accrued since May 31, 2021.

The Court rejected the Schwarzbaum’s argument that the All Writs Act does not provide an independent collection remedy and that the FDCPA provides the sole remedy for collections.

The footnotes to the Order provide some context with respect to the taxpayer’s scheme. Specifically, Schwarzbaum took steps to render himself judgment proof in the U.S. including selling his home in Palm Beach County Florida, and moving from Florida to Switzerland, where he maintained three Swiss accounts totaling in excess of $49 million. The footnotes also reveal the taxpayer transferred the bulk of his liquid assets from the United States to Switzerland, prior to the Complaint being filed by the Government.

The Court adopted the R&R and held that the FDCPA incorporates the All Writs Act. Quoting from the language in 28 U.S.C. § 1651, the Court noted that that the “All Writs Act empower federal courts to ‘issue all writs necessary or appropriate in aid of their respective jurisdictions and agreeable to the usage and principles of law.’ “

The Court further noted that the FDCPA provides for issuance of various writs including writs of execution and writs of garnishment. Judge Bloom, citing United States v. Ross, 302 F.2d 831, 834 (2d Cir. 1962) and United States v. McNulty, 446 F. Supp. 90, 90 (N.D. Cal. 1978), pointed out that the cases supporting the Courts interpretation of the interplay between the FDCPA and the All Writs Act rely upon the Court having personal jurisdiction over the defendant to reach assets overseas in cases where the defendant has an outstanding judgment or tax liability to the Government.

The takeaway from this Decision is that an individual who is subject to the assessment of FBAR penalties, and who has not otherwise challenged the assessment, can certainly expect the Government to file a collection action. Any attempt to place assets outside of the reach of the Government, by maintaining or otherwise transferring assets overseas, will be dealt with by the Government in short order. One can reasonably expect that the Government will utilize post judgment Orders of Repatriation to assist in the collection of an outstanding FBAR penalty judgment. The foregoing is true whether a taxpayer expatriates moves overseas or continues to reside in the U.S.

Some may be wondering why Scwarzbaum was not indicted and extradited. Although the U.S. has an extradition treaty with Switzerland, Switzerland does not typically honor such requests. Moreover, such an indictment may have been sealed.

It is noteworthy that the number of extraditions to the U.S. in tax and FBAR related cases is on the rise. Consequently, as the saying goes:  “No matter where you go, there you are.”

 

 

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TRANSFERRING PROPERTY TO AVOID PAYING TAXES

Why it’s a Very Bad Idea?

Tax fraudA taxpayer who owes or anticipates owing a substantial amount of income tax to the IRS may be tempted to transfer his or her property to a spouse, a relative or a nominee entity with the hope of preventing the IRS from collecting the outstanding tax debt. Similarly, a taxpayer may have an incentive to transfer property to a third party, in circumstances where the taxpayer may be subject to the 26 U.S.C. § 6672(Trust Fund Penalty). The taxpayer usually justifies such a transfer as “strategic planning.” Sometimes the taxpayer acts alone. In other instances, the taxpayer may be aided by a complicit, inexperienced or incompetent attorney.

These tactical maneuvers almost always fail and invariably result in the property transfer being judicially set aside, and/or the imposition of personal liability on the part of the transferee. In addition, the illicit transfer of property can result in significant civil and criminal penalties as well as criminal prosecution.

The discussion that follows examines the judicial remedies available to IRS including the commencement of a fraudulent conveyance action in either a state or federal court pursuant to state law or the Federal Debt Collections Practices Act (“FDCPA”). The discussion will also examine the imposition of transferee personal liability under 26U.S.C. § 6901.

Fraudulent conveyance

In general, a fraudulent conveyance represents a conveyance of property to a third party without consideration or for less than adequate consideration. Procedurally, the IRS has the burden of proving that either constructiveor actual fraudexists. Constructive fraudexists where a taxpayer’s property is transferred for less than its fair value and the taxpayer is insolvent at the time of the transfer or is rendered insolvent following the transfer. Actual fraudexists where a taxpayer transfers property to a third party with actual intent to hinder, delay, or defraud the IRS in the collection of the tax debt.

Constructive fraud

In the context of constructive fraud, the IRS must establish the following elements in order to set aside a transfer of property:

    1. That the alleged transferee received property of the transferor.
    2. That the transfer was made without consideration or for less than adequate consideration.
    3. That the transfer was made during or after the period for which the tax liability accrued.
    4. That the transferor was insolvent prior to or because of the transfer of property or that the transfer of property was one of a series of distribution of property that resulted in the insolvency of the transferor.
    5. That all reasonable efforts to collect from the transferor were made and further collection efforts would be futile.

The above elements suffice to establish constructive fraud and it is unnecessary for the IRS to prove actual intent to defraud.

Actual fraud

In order to establish actual fraud, the IRS must prove the taxpayer’s actual intent to hinder or delay or defraud the IRS. The FDCPA identifies eleven non-exclusive factors to be considered including:

    1. Whether the transfer was made to an insider.
    2. Whether the transfer represents substantially all of the taxpayer’s assets.
    3. Whether the value of consideration received by the taxpayer was reasonably equivalent.
    4. Whether the taxpayer was insolvent or became insolvent shortly after the transfer was made.
    5. Whether the transfer occurred shortly before or shortly after the tax debt was incurred.

In addition to commencing an action to set aside a fraudulent conveyance, IRC § 6901provides the IRS with a procedural mechanism for holding the transferee personally liable for the debt of the taxpayer. In contrast to an action to set aside a property transfer, Section 6901 is focused on the transferee rather than to the property. It is noteworthy that commencing an action to set aside a fraudulent transfer and imposing personal transferee liability under Section 6901 are not mutually exclusive remedies. The IRS may consider reliance on the FDCPA or a state’s fraudulent conveyance statute as the basis for imposing personal transferee liability and may also pursue multiple remedies.

Transferee liability

To establish personal transferee liability, the IRS has the burden of proving the existence and extent of the transferee’s liability. In addition, where the taxpayer unsuccessfully contests the liability in a judicial proceeding, the taxpayer as well as the transferee is estopped from contesting the liability either in a fraudulent conveyance action or for purposes of imposing personal transferee liability. The IRS has the burden of establishing the taxpayer’s tax liability and the amount. However, the transferee’s liability is capped at the value of the property transferred. The transferee seeking to avoid or mitigate transferee liability must prove the taxpayer’s liability is less than the amount asserted by the IRS.

A taxpayer, who is considering making a transfer of property to avoid his or her income tax obligations is creating a substantial risk that the transfer will be set aside and/or the transferee will be personally liable. Moreover, a taxpayer may soon find himself/ herself the subject of a criminal investigation. When considering such a decision, a taxpayer should always first consult with a knowledgeable and experienced tax attorney for a comprehensive review of all the relevant facts. Depending on the circumstances, payment arrangements can be made with the IRS.

 

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Former Harvard Chemistry Chair indicted for failing to file FBAR and filing false tax returns

IRS Hard at Work Despite the Pandemic

Financial crimesIndividuals, who have failed to report their foreign financial accounts, may feel a sense of relief, in light of the corona virus and its effects on IRS investigations. Better think again!

The DOJ recently announced the superseding indictment of Dr. Charles Lieber, a former Chemistry chair at Harvard University for:

  • Failureto file Foreign Bank and Financial Accounts (FBAR) and;
  • Filing false federal income tax returns.

The initial indictment charges the former Harvard Chair withmaking false statements to federal authorities.

Lieber served as the principal investigator of the Lieber Research Group at Harvard University and received more than $15 million in federal research grants from 2008-2019. In addition, the charging document records that from 2012 until 2015,  Lieber served as a Strategic Scientist at Wuhan University of Technology (WUT) and thereafter as a Contract Participant in the Thousand Talents Plan (a program established by the Chinese government in 2008 for purposes of attracting global scholars to assist in Chinese development).

Subsequent indictment shows that Lieber entered into a three-year agreement with Thousand Talents that required WUT to pay Lieber a salary of up to $50k a month, living expenses totaling $150k and $1.5 million for purposes of establishing a research lab at WUT. The DOJ alleges that Lieber failed to report the income he received from WUT in 2013 and 2014 on his federal income tax return. Individual U.S. tax residents are required to report their income on a worldwide basis, irrespective of where the income is earned.

In addition to his failure to report the income Lieber received from WUT, the superseding indictment alleges that Lieber failed to file FBARS for 2014 and 2015 with respect to a foreign financial account he opened while in China in 2012. The account was opened to enable WUT and Thousand Talents to directly deposit Lieber’s salary and other payments. A U.S. person is required to file an FBAR (FinCen Form 114) if that person had a financial interest in or signatory authority over foreign financial accounts with an aggregated balance in excess of $10k during any time during the year. It is clear from the indictment that Lieber received more than $10k between salary and living expenses. Failing to report this amount as required by law under FBAR is a crime.

To avoid being indicted by IRS, it is crucial that U.S. persons in foreign countries to report all income earned for tax return purposes and file FBAR for any account(s) they have financial interest in/ signatory authority over with aggregate balance in excess of $10,000. 

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Quiet Disclosure Guilty Plea

Florida man pleads guilty to tax evasion and hiding funds around the world

FBAR Quiet disclosuresIn April 2020, a Florida man pleaded guilty to tax evasion and the willful failure to file FBAR’s. What makes this case particularly interesting is that the taxpayer made use of a “quiet disclosure” rather than entering into the Offshore Voluntary Disclosure Program (OVDP). This is a classic case of greed on steroids.

Experienced tax attorneys will usually discourage their clients from making quiet disclosures. However, some practitioners may be tempted to recommend using a quiet disclosure to help close the deal with the client. An uninformed or greedy client will invariably opt for the least costly strategy. Unfortunately, these same practitioners routinely fail to provide the client with an explanation of the downside risks associated with making a quiet disclosure.

The following discussion is limited to the defendant’s foreign financial accounts, his failure to file FBAR’s and his unsuccessful attempt at making a quiet disclosure. If you interested in the tax evasion portion of the case you can click on the link hereand you will be linked to the Department of Justice, Tax Division, website.

Case background

–The taxpayer owned and operated a U.S. business that bought U.S.-made agricultural machinery and parts and sold them throughout the world.  The taxpayer failed to not only file business, personal and employment income tax returns but also failed to pay corporate, employment or individual income taxes. Although the taxpayer never received a salary, he certainly was living large. In addition to the business paying all of his personal expenses, the defendant was also able to siphon off significant amounts of cash, which he used for a variety of reasons. In total, the taxpayer failed to report more than $7.7 million in income, resulting in a total tax loss to the Government of over $2.7 million.

-From 2007 to 2011, the taxpayer transferred 5.8 million from the company’s bank accounts to foreign financial accounts. The taxpayer maintained these foreign financial accounts in Croatia, Germany, Serbia, and Switzerland from 2008 to 2015. Despite knowing that he had an obligation to report these accounts on FinCEN Form 114 (FBAR), the defendant kept these accounts secret in order to avoid IRS detection.

–In 2010, an account the taxpayer held at Credit Suisse in Zurich, Switzerland reached a year-end high value of $6,177,586. The taxpayer used the Credit Suisse account to fund the purchase of a $1,350,000 yacht and a $1,650,000 waterfront home in Florida.

–In 2015, Credit Suisse closed the taxpayer’s account in Switzerland and advised him to enter the IRS’s Offshore Voluntary Disclosure Program (OVDP). To provide some context, the OVDP was terminated in September of 2018 and replaced that same year with the Voluntary Disclosure Practice rules.

–The taxpayer failed to heed the Bank’s advice and elected not participate in the OVDP. The last iteration of the OVDP provided taxpayer’s with undeclared offshore accounts the opportunity to come clean in exchange for the prospect of avoiding criminal prosecution. Under the OVDP, participating taxpayers were required to:

  • File 8 years of delinquent or amended tax returns
  • File FBARS for 8 years.
  • Submit his or her returns and copies of the electronically filed FBAR, together with a penalty worksheet to the OVDP unit of the IRS.
  • Pay any outstanding income tax, together with a 20% accuracy penalty and interest.
  • Pay a one-time miscellaneous offshore penaltyequal to 27.5% of the highest aggregate account balance(s) in any one disclosure year.

In exchange for making these disclosures and paying all taxes, penalties and interest as well as the miscellaneous offshore penalty, the taxpayer and IRS would enter into a “Closing Agreement” (Form 906). A Closing Agreement effectively bars any additional claims by the IRS or the taxpayer for any of the years included in the disclosure period.

The taxpayer’s quiet disclosure consisted of filing several delinquent tax returns with the hope that the filings would fly under the radar, and the taxpayer would avoid paying income taxes, penalties and interest as well as the miscellaneous offshore penalty. Ironically, the taxpayer did not file any FBAR as part of his quiet disclosure.

Findings of the case

As it turns out, the tax returns filed by the defendant were materially false in several respects. First, the income tax returns disclosed only the taxpayer’s Credit Suisse account but failed to disclose his other foreign financial accounts. Second, the income tax returns submitted by the taxpayer failed to include the income the defendant earned from his company as well as the foreign source income earned from the taxpayer’s undisclosed foreign financial accounts.

Making a quiet disclosure, even in cases where the taxpayer files all FBAR’s in addition to his or her amended or delinquent income tax returns, is strong evidence of the taxpayer’s intent to prevent or hinder the IRS from detecting the existence of the taxpayer’s foreign financial accounts. It also demonstrates the taxpayer’s intent to avoid the assessment and payment of FBAR penalties.

Takeaway from the defendant’s guilty plea

If you make a quiet disclosure and are caught, there are significant financial consequences, even if you are fortunate enough to avoid criminal prosecution. The use of a quiet disclosure will invariably result in the assessment of the Willful FBAR Penalties which are substantial. Any hope of merely paying the Non-Willful FBAR penalty is out the window. In addition, if you are discovered, you will have to pay the outstanding tax, as well as the related penalties and interest on any unreported income. Among the IRS penalties, you could be subject to the 75% Civil Fraud Penalty.

Where criminal risk is minimal or non-existent, it may be possible to utilize the foreign or domestic streamlined procedures, thereby eliminating or limiting the FBAR penalty to a onetime 5% penalty.

While some taxpayers have been successful in avoiding detection by the IRS by using a quiet disclosure, you do not want to be the last person without a chair when the music stops. If you have undisclosed foreign financial accounts and foreign income, don’t let greed cloud your judgment. Nor should you make a decision based upon any potential savings in legal costs. Take the time to meet with an experienced and knowledgeable tax attorney to see what your options are. If any practitioner mentions the use of a quiet disclosure as a potential disclosure strategy, run like hell!

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Bank Fraud and Criminal Tax Charges Against Michael Avenatti

Michael Avenatti’s Indictment

Michael Avenatti Case on Criminal TaxThe temptation to use unfilled or altered tax returns as well as doctored financial statements for purposes of securing a bank loan, while not common, does occur. This practice typically occurs where an individual is faced with financial difficulties and sees no other way out. The consequences of submitting false documents including unfiled and false returns are strong evidence of the willful failure to file income tax returns as well as income tax evasion.

Recently convicted in New York for trying to shake down Nike, “Creepy Porn Lawyer” Michael Avenatti(“Avenatti”)must now travel to California to face multiple charges. Among the charges in the 36 count indictment, .

The discussion that follows is limited to the practice of using false tax and financial documents for purposes of securing bank loans and the criminal tax consequences associated therewith.

According to Counts 31 and 32 of the indictment, between 2014 and 2016, Avenatti obtained three loans from Peoples Bank on behalf of companies that Avenatti either owned or controlled. The loans  included an $850k loan to GB LLC (the “January 2014 loan”), a $2,750m loan to  Avenatti’s law firm, Eagan Avenatti, LLP (“EA”) (the “March 2014 loan”) and a loan to EA in the amount of $500k (the December 14, 2014 loan”).

The Indictment

The indictment alleges that in order to secure the March 2014 loan, Avenatti provided People’s Bank with false and fraudulent individual and partnership income tax returns as well as false and fraudulent financial statements, including a 2011 unfiled individual income tax return reflecting adjusted gross income of $4.5m and a tax due of $1.5m. Avenatti also provided the bank with a personal financial statement which failed to disclosethat Avenatti still owed the IRS $850k in unpaid personal income taxes for 2009 and 2010.

In addition to his personal return and financial statement, Avenatti provided the bank with a copy of the EA’s unfiled partnership return(Form 1065) for 2012 reflecting gross income of $11.5m and ordinary business income of $5.8. In October of 2014 Avenatti filed the 2012 partnership return for EA with the IRS. The partnership return filed with the IRS materially differed from the partnership return submitted to the bank. The filed return reflected $6.2m in gross receipts compared with the $11.5m on the return submitted to the bank. Furthermore, the partnership return filed with the IRS reflected only $2.1m compared with the $5.7m in operating income.

In support of the December 2014 loan, Avenatti submitted a balance sheet for EA reflecting a cash balance of $712k as of September 2014, even though the true balance was only $27k. Avenatti also submitted a personal financial statement as of November 1, 2014 which failed to disclose the unpaid 2009 and 2010 tax liability to the IRS. In furtherance of the  December 2014 loan application, Avenatti also provided the bank with copies of his unfiled U.S. individual income tax returns for 2012 and 2013, respectively reflecting $5.4 and $4m in income and estimated tax payments of $1.6m and $1.2m. Furthermore, the 2013 individual return reflected $103k in federal withholding.

According to the indictment, Avenatti last filed individual income tax returns for the 2010 tax year but failed to file individual income tax returns for the tax years subsequent thereto. In addition, Avenatti failed to file partnership and corporate returns.

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