IRS Reorganization and Tax Prosecutions · 6/30/2006 · Some of the most significant changes to...

IRS Reorganizationand Tax

Prosecutions

What Has Changed for IRS Criminal Investigation and Our

Relationship with the Departme nt of Justice . . . . . . . . . . . . . 1By Mark E. Matthews

IRS Creates Counsel/Special Agent Team . . . . . . . . . . . . . . . 11By Nancy Jardini and Mark E. Matthews

New IRS Publicity Strategy . . . . . . . . . . . . . . . . . . . . . . . . . 15By Mark E. Matthews

Prosecution of Abusive Trust Cases . . . . . . . . . . . . . . . . . . . 19By Martin E. Needle, Dora S. Welsh, and Beth Elfrey

Recycled “Redemption”: The Latest Illegal Tax Protester

Scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25By Jennifer E. Ihlo and Melissa E. Schraibman

The Internal Revenue Service’s Voluntary Disclosure Policy 30By Stan ley J. Okula, Jr.

Missing in Action: The Absent Witness Instruction in Tax

Prosecutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37By Thom as E. Zehnle

Obtaining Foreign Evidence and Other Types of Assistance for

Criminal Tax Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43By James P. Springer

Character Evidence in Tax (and Other) Cases . . . . . . . . . . . . 51By Robert Miskell

Holding the Defendant Responsible for the Loss in a Criminal

Tax Pro secution : Is Restitution the Answer? . . . . . . . . . . . . 57By Mitchell J. Ballweg and Karen Quesnel

July 2001

Volume 49

Num ber 4

United StatesDepartment of Justice

Executive Office forUnited States AttorneysOffice of Legal Education

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Louis De FalaiseActing Director

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In This Issue

MARCH 2001 UNITED STATES ATTORNEYS' BULLE TIN 1

What Has Changed for IRS CriminalInvestigation and Our Relationshipwith the Department of Justice?By: Mark E. Matthews Chief, IRS Criminal Investigation

In July 2000, the Internal Revenue ServiceCrimin al Investiga tion ("C I") finalized an historicreorganization. We achieved numerous long-sought goals, including line authority over all CIspecial ag ents and employe es, referral au thority tothe Department of Justice for our investigationsand a direct reporting relationship to theCom mission er. Until la st July, CI S pecial A gentsreported mo st directly to multifunction al (i.e.,civil and crimin al) IRS district directors, arelationship mirrored at IRS headquarters with anAssistant Commissioner for CI reporting to amultifunctional executive subordinate to theCom mission er. Com mission er Cha rles O. R ossottihas now placed all criminal enforcement resourcesunde r the Ch ief, Crim inal Inves tigation, w ho, inturn, reports directly to him. Two significantreasons fo r the reorga nization were:

1. The Restructuring and Reform Act of 1998(RRA 98) set th e groun dwork for the IRS toredesign to serve taxpayers and taxpractit ioners more e ffective ly and e fficien tly.RRA 98 included redesign for the CriminalInvestigation Division.

2. The 1999 W ebster Report, written by JudgeWilliam Webster, made dozens of detailedrecommendations, including the majorstructural changes described above.

Some of the most significant changes to IRSCrimin al Investiga tion were virtually invis ible tothe field special agents and our key constituents:the Department of Justice Tax Division and theOffices of the U nited States A ttorneys. Howe ver,num erous in ternal ch anges h ave occu rred that w illensure a m ore focused tax complianc e strategy, astreamlin ed app roach to c ase man agement withinCI, and a much more coordinated and effective

media s trategy. (See article “IRS Public ityStrategy” by Mark Matthews in this issue of theUSA Bulletin) The revised CI mission statementreflects that focus:

I. Mission of IRS Criminal Investigation

Criminal Investigation (CI) serves theAmerican public by investigating potentialcriminal violations of the Internal Revenue Codeand related financial crimes in a manner thatfosters confidence in the tax system andcompliance with the tax law.

A. Line Autho rity

The IRS CI has line authority through theChief CI who reports directly to theCommissioner. The local CI Special Agent-In-Charge (SAC) reports directly to the NationalOffice th rough his or her D irector of F ieldOperations (DFO), who is located in the IRSareas. This ensures that case management is nowthe responsibility of professional lawenforcemen t officials within the IRS .

B. IRS Lead D evelopment Cen ters

A new concept for the IRS CI was theestablishmen t of Lead De velopmen t Centers(LDC). These centers, which are beingimplem ented as this article is p ublishe d, willassist CI special agents in developing andassigning inve stigative leads. LD Cs will be a p artof the D irector, Field Opera tion's staff. Th ey willperform database analysis, develop leads to thelevel required for P rimary In vestiga tion (P I)assignment, and review leads for consistencywith the IRS C omplia nce Stra tegy. The LDC willproce ss all frau d refer rals from the fou r newly-created IRS Operating Divisions and send themto the field offices. Fu rther, the L DCs willinterface with CI Field Offices, OperatingDivisions, task forces, and FinCEN (FinancialCrimes Enforcement Network) to select, develop,

JULY 2001 UNITED STATES ATTORNEYS’ BULLET IN 2

and assign lea ds. As of M ay 2001, the BaltimoreLDC is staffed and operating. During the nextyear, LD Cs will b e open ed in A tlanta, St.Petersb urg, G arden C ity, Philade lphia, C incinn ati,Indianapolis, Kansas City, Austin, Denver, Fresnoand Portland. (See appendix A – CaseManagem ent Process)

C. Fr aud R eferra ls

Both structural and process changes are beingestablished in the Operating Divisions to revivethe referral program so that CI can focus on taxinvestigations. Both CI and Operating Divisionresources will be dedicated to fraud detection andinvestigation at key organizational levels. Formaleduca tional, referr al, and fe edbac k proces ses willbe established. The Operating Divisions havehired Fraud Area Managers for their four areaoffices. T hese m anagers will supe rvise over s ixtyfraud referral program specialists who will bespread across the country. T hese sp ecialists willwork directly with R evenue A gents and O fficersto develop q uality fra ud ref errals to CI.

D. Fraud D etection Centers

The new ly named F raud De tection Centers(FDCs) replace the Criminal InvestigativeBranches (formerly known as CIBs) located in theCustomer Service Centers. The FDCs have beenincorporated into the CI organization under theOffice of Refun d Crim es. The y work clos ely withCI field off ices to dev elop crim inal cases a s wellas to stop fraudulent refunds. In addition, theFDCs work with the other Operating Divisionswithin the S ervice Center an d in the field offices.

E. Focus of Tax

Legal source tax cases are and will be the toppriority for CI, followed by money laundering andillegal source income cases. As the WebsterRepo rt conclu ded, it is C I and C I alone tha t ischarged with en forceme nt of tax cr imes. A nti-drug enforcement is, of course, a national concern,and CI special agents will still be utilized in thoseefforts. The W ebster Repo rt made clear, ho wever,that CI should be reimbursed by other agenciesthat utilize its agents and resources in narcoticscases, an d that is, in fact, happenin g now. CI isnow focu sing on those cases of significance whereCI specif ically brings its uniqu e skills to the ta ble

and on cases with an impact on taxadministration .

CI has developed an interim compliancestrategy wh ich iden tified three separate se gmen tsof CI's investigative efforts; Legal Source TaxCases (commonly referred to as Title 26 casesalthough this segment also includes Title 18violations such as 286, 287 and 371); IllegalSource Financial Crimes (which includes Title 18and Title 26 violations as well as moneylaundering violations); and Narcotics-RelatedFinancial Crimes (which includes both tax andmoney laun dering violations.)

F. IRS Com plianc e Cou ncil

CI is a key member of the IRS ComplianceCouncil that will implement an IRS NationalCom pliance Stra tegy. The cou ncil include s CI,the IRS ope ratin g div ision s, the Co mmissio ner 'sRepresentative and external compliancestakeholders - such as the Department of Justice.The council will play an essential role in the IRS'strategic, coordinated approach to complianceissues thro ughou t the pre-filin g, filing an d post-filing efforts. CI will use the NationalCompliance Strategy to manage the mix of casesto ensure the appropriate investigations are beingconducted in order to foster compliance.

G. Partnership with Operating Divisions

CI works closely with the four operatingdivisions, and this relationship is reinforcedthrough the IRS Compliance Council. Therelationsh ips with S mall Bu siness an d SelfEmployed (SB/SE ), Wage an d Investmen t (W &I), Large and Mid-Sized Business (LMSB) andTax-E xemp t and G overnm ent En tities (TE/G E) isgeared toward specific market-segm ent taxpayersfor purposes of providing anti-fraud educationand identifying appropriate fraud cases forreferral.

H. IRS Counsel's Role in the new CI (See“IRS Creates Counsel/Special Agent Team” byNancy Jardini and Mark Matthews in this issue ofthe US A Bu lletin)

Counsel is now involved in CI cases from thevery beginning to provide guidan ce to the caseagent an d man agement officials. C ounse l isavailable to discuss all types of case related issues

MARCH 2001 UNITED STATES ATTORNEYS' BULLE TIN 3

regarding both Title 26 and money laundering.They are involved in the review of SpecialInvestigative Techniques, handle summonsenforcement, review CI cases upon completion,and prepare an evaluation memorandum for thereferrin g officia l. (See a ppen dix A -- CaseManagem ent Process.)

One of the recommendations in the WebsterReport was to restructure the way legal servicewas provided to CI. Judge Webster’srecommendations, along with the design changesbrought about as a result of the more general IRSrestructuring, resulted in the reorganization ofCrimin al Tax c ounse l. In July, 20 00, immediate lyafter C I was res tructu red, th e Trea sury Se cretary,with the endors ement o f Com mission er Rosso tti,transferred referral authority of a criminal casefrom Counsel to CI Special Agents-in-Charge.The laws regulating the disclosure of taxpayer andtax return information from the IRS to outsideagencies require that there be one centralizedauthority to refer criminal tax investigations to theJustice Dep artment for prose cution.

I. Public In form ation O fficers (PIO s) (SeeIRS P ublicity Stra tegy by Mark Ma tthews in thisissue of the USA Bulletin)

Criminal Investigation has establishedcollateral d uty position s for IRS s pecial age nts toserve as Public Information Officers (PIO). Eachof the thirty-five Special Agents-in-Charge nowhas a PIO . They ser ve as the c ontact p oint for allinternal and external CI communicationinitiatives, including issuing press releases andcoordinating with the U.S. Attorneys' Offices andother law enforcement media events. One of thekey responsibilities of the PIO is to establish aclose working relationship with the U.S.Attorne ys' Offices in th eir judicia l districts toassist in en suring th at CI cases receive ap propriatepublicity. The P IOs have receiv ed disclosuretraining (as it relates to the disclosu re of tax returninformation under Internal Revenue Code Section6103) an d media train ing with their S ACs.

J. Recruiting N ew Specia l Agents

Criminal Investigations is taking aggressivesteps to increase the special agent workforce.Some efforts include increased recruitingactivities, ob taining ad ditional h iring auth ority

and the reestablishment of the student COOPprogram. During the next two years, 2001- 2002,CI will hire almost 600 additional special agents.

II. Geographic Structure

Headquarters: Washington, DC (See appendix B– Organizational Charts)

A. Field Structure (See appendix C – Map)

1. Six Area Director, Field OperationsOffices: Atlanta, GA; Baltimore, MD;Chicago, IL; Dallas TX; Philadelphia,PA; Laguna Niguel, CA.

2. Thirty-five Special Agent-in-ChargeOffices: CI territory offices will bealigned with the boundaries of theFederal judicial districts to enable eachU.S. Attorney's Office to have contactwith only one CI office.

3. Ten F raud D etection C enters: Fo rmerlycalled C riminal In vestigative Branc hes inthe ten IRS service centers, the FraudDetectio n Cen ters will rem ain located inthe same centers across the United States;however, th ey report to the Hea dquartersDirector, Refu nd Frau d. These ce ntersdetect fraudulent returns and preventissuance of related false refunds. Theywork clo sely with C I field offices todevelop criminal cases.

4. Criminal Investigation Foreign LiaisonOffices: CI special agents are in foreignposts-of-duty located in Canada, Mexico,Colombia, Germany, and Hong Kon g, aswell as at INTERPOL in Lyon, France.

5. CI Special Agents and support staff: Themajority of C I's front line fieldemployees are at the same location doingthe same job.

B. Changes in Field Operations

1. CI Offices are aligned with IRS areaboun daries an d U.S . Judicia l Districts toimprov e stakeho lder interfa ces and tomeet our responsibilities in the area oftax adm inistration and law enforcem ent.

2. CI has increased operational focus andaccoun tability by linkin g more d irectly


with the IRS op erating d ivisions todevelop leads and investigate tax fraud.

3. Centralized management increasesconsistency in the application of the CIcomp liance strategy.

4. Responsibility is delegated to the SpecialAgents-in-Charge (SACs) and AssistantSpecia l Agen ts-in-Cha rge (AS ACs ) inorder to increase the efficient use ofresources and eliminate duplicity in casereview and approval.

5. Centralized management as well asincreased presence by IRS Chief Counselensures that the best cases are pursuedthrou gh a co llaborative ef fort be tween CI,Chief Counsel, Department of Justice andthe Execu tive Office for U.S . Attorneys.

6. The n ew con figuration more clo selyresembles other law enforcementagencies.

C. What Does this Mean to the U.S.Attorney?

1. Crimin al Investiga tion's involv ement w iththe U.S . Attorne y's office is essen tially“business as usual.”

2. CI in each field operation is under thedirect authority of the Special Agent-in-Charge.

3. Field offices have been realigned to beconsistent with the boundaries of U.S.Judicial Districts. Therefore, U.S.Attorneys work with one IRS SAC;however, in some areas, a SAC may haveauthority over more than one JudicialDistrict (see map - Appen dix C).

4. The SA C and A SAC and Su pervisorySpecial Agent continue to establish andmaintain lia ison with the U .S. A ttorn ey'soffice.

ABOUT THE AUTHOR

�Mark E. Matthews is the Chief, IRS CriminalInvestigation (CI), responsible for investigatingcriminal violations o f the tax code. Headq uartered in W ashington, D .C., Mr.Matthews oversees a nationwide staff of

approximately 4,500 CI employees as theyinvestigate and assist in the prosecution ofcriminal tax, money laundering, and narcotics-related financial crime cases. Mr. Matthewscame to th e IRS fro m priva te law pra ctice. Hismost rece nt pub lic service w as as De putyAssistant Attorney General, responsible forcriminal tax prosecutions at the JusticeDepartment’s Tax Division. He also served as anAssistan t United States A ttorney and as Dep utyChief of the Criminal Division in theUnited S tates Attorney’s O ffice in the Sou thernDistrict of New York. He has served in othergovern mental p ositions as S pecial A ssistant toDirector William H. Webster at the FederalBureau of Investigation and the CentralIntellige nce A gency.a


IRS Creates Counsel/Special AgentTeam

Nancy Jardini

Division Counsel/Associate Chief Counsel(Criminal Tax)

Mark E. Matthews

Chief, Criminal Investigation

The ro le of the crim inal tax atto rney with inthe Internal Revenue Service’s Office of ChiefCoun sel chan ged dra matically in J uly, 200 0. Boththe organizational structure of Chief Counsel’sCrimin al Tax D ivision, also known as CT, as wellas its procedural responsibilities have been alteredto promote a stronger, more integrated andconstr uctive relation ship b etwee n CT attorne ysand the Criminal Investigation Special A gents.Assistant United States Attorneys and trialattorneys from both the Criminal Division and theTax Division should understand the redesign ofthe Counsel role, and how they can takemaximum advantage of the CT resourcesavailable to assist them in IRS investigations.

In response to Senate Finance Committeehearings in 1998, IRS Commissioner CharlesRossotti asked Judge William Webster, formerdirector of the FB I and C IA, to con duct acomprehensive review of the operations of IRSCrimin al Investiga tion (CI). In a report issu ed inApril 1999, seehttp://www.treas.gov/irs/ci/ci_structure/index.htm,Judge Webster made numerous recommendationsto improve the efficiency of CI operations. One ofthose recommendations was to restructure the waylegal service was provided to CI. Judge Webster’srecommendations were based on two fundamentalfinding s. First, a stru ctural ch ange to C T wou ldensure accessible legal advice in the complicatedarea of criminal tax to the Special Agents in thefield. Anoth er equally impo rtant reason, how ever,was to ensure that the very sensitive enforcementconcerns of th e IRS, wh ich differ from eve ry

other federal law e nforcemen t agency, areconsistently considered in every case. Therestructu ring of C T has allo wed C T to effec tivelyaccomplish the goals set forth by Ju dge W ebster.

Before the reorganization, the criminal taxservices provided by the Office of Chief Counselwere fractured. National policy was developed bya small cadre of lawyers in the national office whohad no authority to enforce it. In the field,crimina l tax work was han dled by m ulti-functional district cou nsel attorneys wh o wereresponsible for supporting and reviewing CIinvestigatio ns, as we ll as for a bro ad rang e of civiltax issues such as tax court and bankruptcyproceeding s. They were n ot full-time practitionersin the complicated criminal tax arena.

This fractured structure presented a number ofdifficulties in provid ing effectiv e legal adv ice toCI. Th e field attorn eys who w ere exp ected toprovide expert legal advice on complicatedaspects o f crimina l tax to the a gents in th e fieldalso shou ldered d iverse resp onsibilities for civiltax matters. Co nsequen tly, these attorneys wereexpected to develop a depth of expertise while atthe same time fulfilling their responsibilities in taxcourt and in U.S. District Court on bankruptcymatters. A s a result, d espite the dedicate d effortsof Counsel attorneys, the criminal tax work oftenbecame a low priority because it had less urgentdeadlines. Finally, because the national office hadno direct authority over the field attorneys,national criminal tax policy guidance and trainingwas not always effectively implemented in thefield.

The new structure of CT not only addressesthose shortcomings but also reflects the IRS’commitment to support the criminal enforcementcomp onent. E very attorne y nationw ide wh o isassigned to CT is a dedicated expert in criminaltax law and does not have any civil taxrespon sibilities. CT has a dire ct line of au thority

12 UNITED STATES ATTORNEYS’ BULLET IN JULY 2001

from the nationa l office throu gh the fie ld toestablish consisten t policy and to prov ide uniformreview, guidance, and training. CT attorneys’mandate is not only to foster criminal taxexpertise, but to be accessible and integratedmembers of the criminal investigative team. Thesefeatures of a stronger national office with directsuperv isory contro l over field o peration s ismirrored in the C I organiza tion as we ll.

The CT National Office is now directed bythe Division Counsel/Associate Chief Counsel(Criminal Tax), who reports directly to the ChiefCounsel of the IRS. Although there is no directreporting authority to CI, the Division Counseland the Chief o f CI work closely togeth er toensure consistent policy development andimplem entation . The D ivision C ounse l isresponsible for directing the entire Criminal Taxprogram, w hich includ es a national office staffand d ocket attorn eys located in thirty-five fieldoffices throughout the country. The NationalOffice mandates all CT policy and procedure,coordinates multidistrict investigations, developsand coordinates all CT training, reviews sensitiveinvestigations from the field and generally ensuresthat the CT program is im plemented effectively.

The CT field structure is designed to mirrorthe structu re of the client, CI. T hus, C T fieldoperation s are coord inated b y six region allydeployed Area C ounse l who are co-located withCI’s six directors of field operations (DFOs). CTdocket attorn eys are as signed to each of the th irty-five CI field offices where the CI Special-Agents-In-Cha rge (SA Cs) are loc ated. M ost CT fieldattorneys h ave a prim ary office loca tion withother attorn eys from th e Office o f Chief C ounse l,but hav e second ary space in the CI offic es. Thisallows the CT attorneys to maintain professionalcontact with their peers from other field divisionsof Counsel and also to develop a new, closer andmore integrated relationship with the investigatingSpecial A gents.

In addition to the structural changes, CT haseffected n umero us proc edural c hange s toaccom plish th e mission of p artner ship w ith CI.The most significant procedural change has beenthe transfer of “referral authority” of a criminalcase from Counsel to CI Special-Agents-In-

Charge. The laws regulating the disclosure oftaxpayer a nd tax r eturn in formation from IRS tooutside agencies require that there be onecentralized authority to refer criminal taxinvestigations to the Justice Department forprosecution. That responsibility, known as referralauthority, has traditionally been held by Counselbecause it was thought to ensure that the criminaltax laws were applied uniformly throughout thecountry. It w as also des igned to ensure th at boththe civil and crim inal tax implication s wereevaluated during the criminal referral process.

The practical impact of Counsel’s possessionof the referral authority was to create a significantimpediment in the relationship between Counseland C I. It created a d ynamic u nder th e oldCounsel structure whereby multifunctionalCounsel attorneys, who may not have had anysignificant expertise in criminal tax, wielded theauthority to prevent an investigation from beingreferred for prosecution. Those attorneys, whowere often con sumed w ith tax courtresponsibilities, only got involved in the criminalinvestigation on ce it was comp leted and w ereresponsible for conducting a thorough legalreview and deciding whether the case warrantedprosecution. If that attorney referred the case, thena second review was conducted by the JusticeDepartment’s Tax Division. From the CI specialagents’ point of view, the CT attorney, in mostinstances, got involved at the end of aninvestigation and was perceived only as someonewho could hurt, not help, the case. Counsel’spower to decline cases, com bined with the irinability to d edicate sig nificant tim e to assisting inperfecting the cases, created strained relationshipson occasion between C ouns el and CI.

In July, immed iately after CT and CI wererestructured, the Treasury secretary, with theendorsement of Commissioner Rossotti, Counseland CI, transferred referral authority to CI. CTattorneys are no longer the gate through whichcriminal investigations must pass in order to beprosecuted, but are vehicles to assist in developingquality cases at every stage, not just once theinvestigation has been completed. The CTattorney is still responsible to ensure that both thecivil and criminal implications of an investigationare considered. National consistency in criminal


tax enforcement is accomplished by both CTattorneys’ intimate involvement in the case atevery stage and the Justice Department’s reviewafter the investigation is referred.

Although CT attorneys no longer have referralauthority, they have taken on a broad range ofresponsibilities to assist CI in the development ofquality inv estigations . CT atto rneys are th e solelegal advisors to CI in administrative taxinvestigations, but work in partnership with CIspecial agents in both administrative and grandjury investigations. T heir role in grand juryinvestigations is to assist both the case agents andthe supervising prosecutor by providing technicalcriminal tax expertise and helping to ensure thatthe investigative means conform to both legalstandards and IRS policy requirements. Anexample is the use of search warrants in tax cases.IRS CI policy is to subject such warrants to acareful review, inv olving CT attorneys, to ensurethat a variety of factors are considered, includingwhether less intrusive means of gathering thenecessary evidence are available. By having CTattorneys assist CI agents in drafting searchwarran ts, it is hoped that a bette r produ ct willresult and that CT ’s involv ement w ill aid inreducing the burdens on the prosecutor. CTattorneys and federal prosecutors have workedcooperatively in numerous districts on searchwarrants and a variety of other issues to thebenefit of federal tax prosecutions.

CT atto rneys con tinue to co nduc t in-depthlegal analysis of all completed investigations, butalso become involved in the preparation of theSpecial Agent report long before it is finalized.This d ocum ent is not o nly relied on indetermining whether a case is referred, but also bythe Justice Department in determining whetherthey will accept a case for prosecution. TheJustice Department’s

Tax Division attorneys consider the CT review ahighly important aid in evaluating cases. CTattorneys arrange and participate in taxpayer andtaxpayer r epresen tative con ferences inadministratively investigated cases. They reviewunde rcover op eration req uests an d particip ate inthe strategic planning of those activities. Theyassist in the prepara tion of grants of imm unity,search warrants, summon s enforcement actions,and requests for the use of special investigativetechniques such as wiretaps. C T attorneys are alsoactive in CI training at both the local and nationallevel, and have two attorneys who train newSpecial Agents, deployed to the Federal LawEnforcem ent Training Center in G lynco, Georgia.

In sum, C T attorneys are invo lved at everystage of the criminal in vestigation tocooperatively assist Special Agents andprosecutors in the developmen t of quality cases.From CI Special Agents’ perspective, the CTattorney is now seen as someone who will help,rather tha n hind er an inv estigation. This sh ouldassist in avoiding missteps in investigations andrectifying promptly any case deficiencies.Althou gh too so on to eva luate, ou r earlyexperie nce ind icates that th is new p rocess w illresult in a more efficient and prompt reviewprocess, without sacrificing existing standards.�


Division Counsel/Associate Chief Cou nsel (Criminal Tax)

Division Counsel/Associate Chief Counsel(Criminal Tax)

Nancy J. Jardini

(202) 622-4460

Deputy D ivision Coun sel/Depu ty AssociateChief Counsel

(Criminal Tax)

Barr y J. Fink elste in

(202) 622-4460

Special Counsel to DC/ACC(CT)

Martin F. K lotz

Brian C. Townsend

(202) 622-4470

James W. Ruger

(912) 267-284 9 (Glynco, GA)

Bran ch C hief,

Nat’l Hqts Branch

Michele D.Palmer

(202) 622-4470

Area C ounse l,

Philade lphia

Kenn eth Ru bin

(215) 597-3416

Area C ounse l,

Baltimore

Margaret Tinagero

(410) 962-4427

Area C ouns el,

Atlanta

Stephen J. Waller

(404) 338-7860

Area C ouns el,

Dallas

Carleton Knechtel

(972) 308-7359

Area C ouns el,

Chicago

Lauren W. G ore

(312) 886-9225

x328

Area C ouns el,

Laguna Niguel

Richard J.Pietrofeso

(949) 360-2682

ABOUT THE AUTHORS

�Nancy J. Jardini is the DivisionCounsel/Associate Chief Counsel for CriminalTax within the Internal Revenue Service. She,directs a n ationwid e staff of ap proxim ately eightyattorneys deployed in thirty-five locationsnationw ide and in the na tional hea dqua rters inWash ington, D .C. Th ese crimin al tax spe cialistswork closely with the Special Agents andmanagers of IRS’ Criminal Investigation during

all stages of c riminal in vestigation s relating tocriminal violations of the Internal Revenue lawsand other statutes for which the Internal RevenueService has enforcement respon sibility. Ms.Jardini, who has been a criminal law practitionerfor over th irteen years, c ame to th e IRS in July2000, from the Criminal Division of the JusticeDepa rtment. In addition to her exp erience as botha federal prosecutor and as a defense attorney she


has writte n and lectured extensiv ely on a varie tyof topics related to criminal law and procedure.

Mark E. Matthews, as the Chief, IRS CriminalInvestigation (CI), heads the Internal RevenueService function responsible for investigatingcriminal violations of the tax code. Headquarteredin Washington, D C, Mr. M atthews oversees anationwide staff of approximately 4,500 CIemployees as they investigate and assist in theprosecution of criminal tax, money laundering,and n arcotics-relate d finan cial crime c ases. W ithfourteen years experience in the investigation andprosecution of financial crimes, Mr. Matthewscame to th e IRS fro m priva te law pra ctice. Hismost rece nt pub lic service w as as De putyAssistant Attorney General, responsible for

criminal tax prosecutions at the JusticeDepartment's Tax Division. He also served as anAssistant U.S. Attorney and as Deputy Chief ofthe C riminal D ivision in the U .S. A ttorn ey'sOffice in the Southern District of New York. Hehas served in other governmental positions asSenior Advisor to the Assistant Secretary ofEnforcement at the Treasury Department and asSpecial Assistant to Director William H. Websterat the Federal Bureau of Investigation and theCen tral Intel ligenc e Age ncy.a

New IRS Publicity StrategyMark E. Matthews

Chief, Criminal Investigation

I. Introduction

Before becoming Chief of CriminalInvestigation, I spent over ten years as a federalprosecutor, both as an AUSA and then as theDepu ty Assistan t Attorne y Gener al respon siblefor crim inal tax matter s in the Tax D ivision . Inboth of those positions, I was frustrated by the factthat dollar for dollar, tax cases did not seem togarner the same media attention (and hencedeterrence value) as similar white collar fraudcases. As a result of: (a) the IRS reorganizationeffort last year; (b ) addition al resourc es devote d toour publicity efforts; and (c) a major overhaul ofour media strategy, I am pleased to report that wehave developed the tools that are alreadydramatically improving the length, placement andtargeting of media stories about criminal taxcases. The key elements are the creation andtraining o f thirty-five Sp ecial Ag ent Pu blicInforma tion Off icers ("PIO s"), the dr amaticexpansion of our website, our institutionalcommitment to become more open and to providemore comprehensive information about our

enforcement efforts and, lastly, a press strategythat links in dividu al cases in a systematic w ay tolarger compliance issues and enforcementprograms. The website allows us to "recycle" taxcases — generate multiple press storiesnationwide about particular cases — and to targetour enfo rcemen t efforts to pa rticular m edia ou tletsor other specialized websites that reach keyaudien ces. Th is entire effo rt is accom plished withmaximum fidelity to taxpayer disclosure laws andin cooperation with United S tates Attorneys'Offices and the Tax Division.

II. Background

As part of modernization, the InternalRevenue Service commissioned Roper StarchWorldwide, Inc. to conduct a study among thegeneral pub lic to determine the ir attitudes towardincom e tax and the IRS , in particu lar. The resultsshowed that the majority of taxpayers make anhonest effort to file accurate and timely taxreturns. The survey also showed that those ho nesttaxpa yers wanted to know that everyone else pa yshis/her fair share of taxes — in fact, the surveysaid that taxpayers believe that they end up payingthe “tax” bill for tho se who ch eat.


Some of the other findings included the beliefby 88% of those polled that major taxindiscretions should be pun ished. The survey alsoasked “From the following list of people, howlikely would you be to read a newspaper ormagazine article or watch a TV news story abouttheir indictment or conviction for tax evasion?”

VeryLikely

Some-whatLikely

Not a t allLikely

Nationalcelebrity

21% 33% 23%

Localbusinesspersonsuch asyour localgas stationowner

28% 39% 15%

Aneighboror personin yourtown

44% 35% 10%

Aneighboror personin yourtown whois alsoindicted orconvictedof moneylaundering

47% 34% 9%

A politicalfigure,such asyourcongress-person

56% 28% 9%

Someonewho hasthe sameoccupationor worksin yourindustry orprofession

49% 30% 10%

These results told us several important things.First, we n eed to foc us our p ublicity on specificaudiences – or market segments, because therespondents said they wanted to know aboutsomeone in their local area or someone who had asimilar occ upation . Secon d, we lea rned th at inorder to enha nce comp liance (reach tho se who aretempted to cheat or evade their tax obligations)and to instill public confidence in the integrity ofthe tax system (reach those who believe thatTHEY pay the price for others who cheat), weneeded to do a better job of publicizing ourenforcement efforts.

Historically, when we work a case in IRSCriminal Inv estigation, we pu t 99% of o ur effortinto the lengthy, complex investigation, frominitiation to sentencing, yet we don't even spend1% of our time obtaining publicity on that case.We realized that we needed to reallocate resourcesgiven the fact that IRS CI faces the largest generaldeterrence mission in all of federal lawenforcement. We have to reach over 200 millionAmericans who encounter the tax system eachyear — both to deter the potential cheaters andassure the vast majority who are honest that theIRS is investigating those who intentionally evadetheir obligations.

When I came on the job last year, manypractitioners, members of the American BarAssociation and industry leaders kept asking me,“Mark, when is CI going to do something aboutabusive trusts? When are you going to bring somecrimina l cases in th is area?” M y reply was, “ Didyou know that we had thirty-five indictments lastyear and that we have 130 open criminalinvestigations in the area of abusive trusts?" Ofcourse, the common answer was, "No, and whyare you keeping it a secret? That informationwould h ave been u seful to us in our p ractice.”Consequen tly, we started looking a t what w e did


with those cases. We found that we were takingstandard press items from Criminal Investigationindictmen ts and/or conv ictions, writing up a shortpress release and dropping it in the court houseregular p ress box for courth ouse rep orters. W e didnot pay attention to whether those reporters ortheir readers were interested in tax stories. Ourstories got viewed in isolation, focused only onthe individual defendants, and often wound upbeing buried in the Metro or Business section ofthe papers.

III. Co mp liance S trategy Linke d to M ediaStrategy

Several features o f the modern ized IRS arehelping us solve our prob lems. One is that we areactually developing a comprehensive compliancestrategy throughout the IRS. That strategy will becombine d with a mo re compreh ensive and m oresophisticated media strategy. The goal is to allowus to provide reporters with more comprehensiveinforma tion abo ut our en forceme nt efforts an d toplace an ind ividual prosecu tion in the contex t of alarger compliance problem. The idea is that anindividual case then becomes the fresh,newsworthy element in a story that focuses on anational compliance problem and the IRS andJustice Departments’ responsive efforts. Using ourrelated web pages and the efforts of the localPublic Informa tion Off icer, we are beginn ing toprovide reporters with information about similarconvictions around the coun try, "recycling" thoseconvictio ns and sentenc es and a llowing the med iato provide a more comprehensive "trending"story. Of co urse, we are doin g all of this w ithinthe confines of Internal Revenue Code Section6103 (D isclosure of Tax Information).

IV. IRS C I Website and U.S. Attorne y PressReleases

A significant part of our media strategy wasthe development of a website,http://www.treas.gov/irs/ci, that providescomp liance-relate d enforc ement a ctivityinformation to the public. Our website includesfraud alerts in areas involving Employment TaxFraud, Non-filers, and Abusive Trusts. We will beexpanding the fraud alerts in the future to includeReturn Preparers and other key areas of non-compliance and other programs such as money

laundering and narcotics related cases. By doingthis, the m edia is ab le to obtain the mos t current,factual information about legal actions taken bythe Department of Justice on CI investigations. Touse abusive trusts as an example, we provide adescription of the foreign and domestic schemesthat are occurring in the abusive trust area. Wealso provide information about the number ofindictments, the numb er of open investigations,and the number of sentences and the averagesentence. Toward the end of the website materialon trusts, we list the five or six biggest, mostsignificant cases (w e call it "bundled " news). W ealso provide the text from the IRS brochure,Should your financial portfolio contain Too GoodTo be True T rusts , a really good example of thingsthat the public should be looking for whenconside ring a trus t.

This is a new approach for the IRS, but it doesa very effective job of reaching various marketsegmen ts and ce rtainly gives th e media a wealthof inform ation that w as previo usly not av ailable tothem from the IRS. Now, every time we get a newconviction in a particular program, we steer thereporters to the relevant webpage. We tell thereporter, "Here's a press release on a convictionregarding an abusive trust, an d if you want m oreinformation for your story, here is the website foradditional ba ckground information an d cases."We are extremely pleased that several U.S.Attorneys' Offices have begun to include our webaddres s in press re leases on our cases , giving b oththe pub lic and th e media access to th iscomp rehens ive enforc ement d ata. It is particu larlyuseful in a press release involving a guilty pleawhen the vast m ajority of the c ase-specificinformation m ay still be protected by disclos urelaws.

In addition to the website, our national pressoffice has a very active program in marketingJustice D epartm ent con victions an d senten cings tothe professional tax preparation community andtheir national periodicals. This audience is aparticularly important audience for tax-relatedprosecutions. Not only are they our partners in ourcomp liance effo rts, they hav e an econ omicinterest in sp reading informa tion abo ut con ar tistsand their tax scams. I have even been told by onepractitioner that he keeps copies of the


convictio ns from our abu sive trust w ebpag e tohand to clien ts who ask him about such schemes.

V. Public Informa tion Officers

CI now has thirty-five special agents servingas full or part-time Public Information Officers,one for ea ch field o ffice. Th e PIOs w ork directlyfor the Sp ecial Ag ent-in-Charge an d incoopera tion with public in formation officers inU.S. Attorneys' offices. They have received IRSdisclosu re training , which can be a valuab leresource to the United States Attorneys as theydraft their p ress releases . Both th e Spec ial Agen t-in-Cha rge and the PIO s have rec eived m ediatraining as well. One of the key responsibilitiesfor the PIOs is to work with the Offices of theUnited States Attorneys to ensure that keyinformation is provided for press releases andpress conferences regarding CI’s investigative andenforcement efforts. Since October 2000, whenthe PIOs were selected, the publicity on CIenforcemen t activity has increased sign ificantly. Iam con fident th at the prim ary reason fo r thisincrease is a result of the positive support theyhave received from the Offices of theUnit ed Sta tes Attorney.

With the support of Department of Justice TaxDivision, the United States Attorneys and thenewly train ed spec ial agent P IOs, this n ew me diastrategy is going to have a significant impact oncompliance with the tax laws. By leveraging thegeneral deterrence impact of our enforcementactions, it also provides the taxpayers with a betterreturn on their investment in our enforcementprogram.�

ABOUT THE AUTHOR

�Mark E. Matthews is the Chief, IRS CriminalInvestigation (CI), responsible for investigatingcriminal violations o f the tax code. Headq uartered in W ashington, D .C., Mr.Matthews oversees a nationwide staff ofapproximately 4,500 CI employees as theyinvestigate and assist in the prosecution ofcriminal tax, money laundering, and narcotics-related financial crime cases. Mr. Matthews cameto the IRS from private law practice. His mostrecent public service was as Deputy AssistantAttorney General, responsible for criminal taxprosecutions at the Justice Department’s TaxDivision. He also served as an AssistantUnited States Attorney and as Deputy Chief of theCriminal Division in the United States Attorney’sOffice in the Southern District of New York. Hehas served in other governmental positions asSpecial Assistant to Director William H. Websterat the Federal Bureau of Investigation and theCen tral Intel ligenc e Age ncy.a


Prosecution of Abusive Trust CasesMartin E. Needle Attorney, National Headquarters BranchOffice of Division Counsel/Associate ChiefCounsel (Criminal Tax)Internal Revenue Service

Dora S. Welsh Senior Trial Attorney Southern Criminal Enforcement SectionTax Division Department of Justice

Beth Elfrey Trial Attorney Southern Criminal Enforcement Section Tax DivisionDepartment of Justice

I. Introduction

At the outset, it is important to recognize thatnot all trusts are abusiv e. Legal trusts arefrequen tly used in e state plan ning, to fa cilitatecharitab le transfers o f proper ty, and/or to holdproperty for minors and incompetents. No legaltrust arrangement, however, reduces or eliminatesall income tax except for certain trusts whoseincome is specifically exempted from tax bystatute. Either the trust, the beneficiary, or thegrantor, as applicable, must pay the tax on theincome realized by the trust, including the incomegenerated by property held in trust. Abusive trustarrangements typically are promoted by thepromise of tax benefits while there is nomeaningful change in the taxpayer’s control overor ben efit from the tax payer’ s incom e or asse ts. Itis in these situations where commonly acceptedtrust and income tax principles are being ignoredthat the In ternal R evenu e Service is focusin g itsenforcemen t efforts.

In recent years the Internal Revenue Servicehas detected a proliferation of promotionsinvolving abusive trust schemes aimed atfraud ulent ly reducing a taxpa yer’s tax liability.Multi-layered trusts, in combination with otherbusiness forms, are used to conceal the taxpayer’s

control over the trusts and his/her assets. The goalof this layered distributio n of inco me is togradually reduce or eliminate taxable incomethrough th e use of bogu s deduction s and offshorediversions of income. When looking at thevalidity of a trust set-up, one must determine whois spending and con trolling the income and assets.In many abusive trust schemes, the income andassets are controlled no differently than if thetaxpayer had never formed a trust. In situationslike these, the trusts are disregarded and theincome attribu ted to the true ow ners.

While a n umber of p rosecution strategies areavailable to attack these abusive trust schemes,experience has dem onstrated one of the mostsuccessful approaches is proving who controlledand spent the money rather than attacking theactual trust structure. Prosecutors have focused ontracing the flow of money and attributing it to theindividuals w ho earned and controlled it under alack of e conomic su bstan ce or sh am theory. Inthese abusive trust schemes, the government hasdirected its prosecu tion efforts towards p romotersand their clients who have willfully takenadvantage o f these schem es to evade taxes .

II. Abusive Trust Schemes

Typically abusive trust arrangements promisebenefits which may include: (1) the reduction orelimination of income subject to tax; (2)dedu ctions for p ersonal ex penses paid by th e trust;(3) depreciation deductions of an owner’spersonal residence and furnishings; (4) a stepped-up basis for property transferred to the trust; (5)the reduction or elimination of self-employmenttaxes; and (6 ) the reduction or elimination of giftand/or estate taxes.

These abusive arrangem ents often use trusts tohide the true own ership o f assets and income inorder to disguise the actual substance of thetransaction s. These arrange ments fre quen tlyinvolve multi-tiered or layered trusts, eachholding different assets of the taxpayer, as well asinterests in other trusts. A typical abusive trustscheme may involve any number of the following


trusts: bu siness trus t, equip ment or service trus t,family residence trust, charitable trust, and foreigntrust.

A business trust is created when the owner ofa business, typically a sole proprietorship,transfers the business to a trust in exchange forshares of ownership. Through nominee trustees orother con trolled en tities, the ow ner is still able tonot only run the business’s day-to-day activitiesbut also control its income stream. The businesstrust makes payments to the trust unit holders orto other downstream trusts created by the ownerwhich are chara cterized as either ded uctiblebusiness expenses or ded uctible distributions.These paymen ts purpo rt to reduc e the taxa bleincom e of the bu siness trus t to a point w here littleor no tax is due. In addition, the owner claims thearrangement reduces or eliminates the owner’sself-employment taxes on the theory that theowner is receiving reduced income or no incomefrom the ope ration of the bu siness.

An equipm ent trust is formed to holdequipment that is rented or leased to the businesstrust, often at inflated rates. A service trust isformed to provid e services to the bus iness trust,often for inflated fees. Under these abusivearrangem ents, the b usiness tru st may pu rport toreduce its incom e by mak ing allege dly dedu ctiblepaymen ts to the eq uipment or serv ice trust.Further, as to the equipment trust, the equipmentowner may claim that the tran sfer of equ ipmen t tothe equipment trust in excha nge for trust units is ataxable exchange. The trust takes the position thatit purchased the equipment for its fair marketvalue and that this value is the new tax basis forpurposes o f calculating dep reciation. The o wner,on the other hand, takes the inconsistent positionthat the value of the trust units received in theexchange cannot be determined, resulting in notaxable gain to the owner from the exchange. Theequip ment or service trus t also may atte mpt toreduce or eliminate its income throughdistributions to oth er trusts.

A family residen ce trust is formed when anowner of the family residence transfers theresidence, including its furnishings, to a trust. Thetrust claims the exchange results in a stepped-upbasis for the property, while the owner reports no

gain from the transfe r. The tru st claims to b e inthe rental business and purports to rent theresidence back to the owner, however, little or norent is actually paid. Rather, the owner contendsthe family members are caretakers or provideservices to the trust and live in the residence forthe benefit of the trust. The family residence trustoften rece ives distrib utions fro m other trustswhich are treated a s incom e. To red uce thisincome, the trust may attempt to deductdepreciation expenses and other expensesassociated with maintaining and operating theresidence, such as utilities, gardening service,pool service and food expen ditures.

A charitable trust is created when a taxpayertransfers assets or income to a purportedcharitable trust and claims either that thepayments to the trust are deductible or that thepaymen ts made by the trust a re dedu ctiblecharitable contributions. The trust pays forpersonal, educational, and recreational expenseson behalf of the taxpayer or family member. Thetrust then improperly claims the payments ascharitable deductions on its tax returns to reduceor offset taxable income.

Foreign trusts are integral to most abusivetrust arrangements. They are often located in taxhaven countries that impose little or no tax ontrusts and have strict bank secrecy laws.Typically, funds are transferred between thevarious layers of trusts and are ultimately routedoffshore to the foreign trust. The funds are thenrepatriated to the taxpayer in the United States,often in the form of sham gifts or loans or throughthe use of deb it/credit cards issued b y an offshorebank. Some trust arrangements may includemultiple layers of foreign trusts or an InternationalBusiness Corporation (IBC) that acts as thenominee donor or lender for the purported gift orloan.

III. Theories of Prosecution

In determining the validity of trustarrangements, courts look at a taxpayer’s controlover his/h er assets an d sourc es of incom e. Cou rtshave routinely invalidated abusive trustarrangements and found the income taxable to theindividual taxpayer, and not the trust, by usingone or more of the following legal theories: lack


of economic substance (sham theory), unlawfulassignment of income or the grantor trust rules.

A. Lack of Economic Substance or ShamTheory

In cases where the trust structure has noeconomic purpose and the taxpayer retainscomplete control over the trust assets, courts haveignored the trust arrangement under a lack ofeconomic substance or sham theory. It is long-settled that transactions motivated solely by taxavoidance a re disregarded for tax purpo ses. If,after considering all the facts and circumstancessurrounding a particular transaction, the finder offact determ ines that th ere is no rea l econom iceffect to the transaction other than the creation oftax benefits, and the form of the transactionaffects no cognizable economic relationship, thesubstan ce of the tra nsaction will contro l over itsform. Gregory v. Helvering, 293 U .S. 465 (1 935);Furman v. Com missioner, 45 T.C. 360, 364(1966), aff’d per curiam, 381 F.2 d 22 (5th Cir.1967). If a trust h as no econo mic substan ce apartfrom tax conside rations, th e trust entity isconsidered a “sham” and is not recognized forfederal tax pu rposes. Zmuda v. Com missioner,731 F.2 d 1417 , 1421 (9 th Cir. 198 4), aff’g, 79T.C. 7 14 (19 82); Markosian v. Comm issioner, 73T.C. 1 235, 1 245 (1 980); Christal v.Commissioner , T.C. M emo. 1 998-2 55. Th isprinciple applies even though the trust may havebeen properly formed and has a separate existenceunder applicable local law. Several criminal caseshave endorsed the lack of economic substance orsham theory including United States v. Noske, 117F.3d 1 053, 1 059 (8 th Cir. 1 997); United States v.Tranakos, 911 F.2 d 1422 , 1431 (1 0th Cir. 19 90);and United States v. K rall, 835 F .2d 71 1, 714 (8thCir. 1987 ).

The lac k of econ omic su bstance rule proh ibitsthe taxpayer from structuring a paper entity for thesole purpose of avoiding tax. Whether a particulartrust entity lacks economic substance or is a shamfor tax pu rposes is a q uestion o f fact. Paulson v.Commissioner , T.C. M emo 199 1-508, aff’d percuriam, 992 F.2d 789 (8th Cir. 1993) (citingUnited States v. Cumberland Pub. Serv. Co., 338U.S. 451 (1950)). In making this determination,the trier of fact is guided by the following

considerations: (1) whether the taxpayer’srelationship, as grantor, to the property differedmaterially before and after the trust’s formation;(2) whether the trust had a bona fide trustee; (3)whether an economic interest passed to otherbeneficiaries of the trust; and (4) whether thetaxpayer felt bound by any restrictions imposedby the trust or the law o f trusts. See Zmuda , 79T.C. at 7 20-72 2; Markosian, 73 T.C. at 1243-45;Hanson v. Com missioner, T.C. Memo 1981-675;aff’d per curiam, 696 F.2 d 1232 (9th Cir. 19 83);Buckmaster v. Comm issioner, T.C. Memo 1997-236.

To evaluate the first factor, the trier of factmust loo k behin d the tru st docum ents todetermine the identity of the true grantor. Shamtrust arrangements typically use nominee or strawgrantors to conce al the identity of the true gra ntor.The true grantor is the individual who furnishesthe trust with funds/assets, not the individual whonominally acts as gra ntor. Buhl v. Kavanagh, 118F.2d 315 (6th Cir. 1941). It is also helpful to lookat before-and-after snapshots to see if anyeconomic change occurred as a result of theformation of the trust, other than the creation oftax ben efits. The re is a lack of e conom icsubstan ce to a trust if th e taxpaye r continu es totreat the income and assets as his/her own afterpurpo rtedly transfe rring them to the trust.

With regard to the second factor, sham trustarrangements typically involve nominee trusteeswho h ave no a uthority or re sponsib ility inmanaging the trust’s income and assets. Instead,the taxpayer/grantor retains control throughvarious means. The taxpayer may control thefunds in the trust bank account by maintainingcustody of the ch eckbook, ex ercising signatureauthority over the trust bank account, or using arubber stam p with the n ominee trustee ’s signatureto issue checks from the trust bank account. Thetaxpayer may also exercise control over thetrustee, and hence the trust assets, by filing asecret wish list with the nominee trustee.Alternatively, the taxpayer may be appointed thetrust manager to handle the day-to-day activitiesof the trust, or the nominee trustee may give thetaxpayer blank signed trust minutes that thetaxpayer may use any time to justify use of theassets.


The third factor to consider when determiningif a trust arrangement is a sham is whether aneconomic interest passed to other beneficiaries ofthe trust. The original owner of the trust assets,rather tha n the na med th ird-party be neficiary, isusually the true beneficiary of an abusive trustarrangement. It is essential to trace the flow offunds through the mu ltiple layers of tru sts todetermine who is the real beneficiary. In mostinstances, the funds flow in a circular pattern backto the taxpayer. Attempts are made to conceal thatthe taxpayer is the true beneficiary by routing thefunds through offshore banks and disguising thereturn of funds as sham loans or gifts. A commonindicia of fraud occurs when the taxpayertransfers on paper his/her beneficial interest in avaluable asset for little or no consideration.

Lastly, if it is apparent from the taxpayer’sconduct that he/she did not feel bound by therestrictions imposed by the trust itself or the lawof trusts, the n the tru st is proba bly a sham . This isthe case when the taxpayer exercises unfetteredcontrol over the income and assets of the trust. Forexample, the taxpayer uses trust assets and incometo pay pers onal ex pend itures (suc h as paym entson a personal residence, vacation expen ses,educational expenses, etc.) and claims deductionsfor such paymen ts on the tru st tax return s. Thistheory has been the most widely used andaccepted in the abusive trust area.

B. Unlawful Assignment of Income

Another possible legal theory involves theassignment of income doctrine. It is a long-standin g princip le that gross income include s allincome from whatever source derived. I.R.C.§ 61(a). This includes compensation an individualreceives fo r services. F unda mental to thisprinciple is that income is taxable to the personwho ea rned it. Commissioner v. Culbertson, 337U.S. 733, 739-40 (1949). The person who earnsthe income cannot deflect the tax on it byattemptin g to assign or transfer th e incom e toanother perso n or entity. Lucas v. Earl , 281 U.S.111, 114-15 (1930). The test of taxability is notwho is the ultimate recipient of the income, butrather, who controlled the earning of the income.American Savings Bank v. Co mmissioner, 56 T.C.828, 83 9 (1971 ).

Courts routinely in validate tru st arrange mentsthat are de signed to allow a tax payer to un lawfullyassign income which he/she earns from personalservices. See Vnuk v. Comm issioner, 621 F.2d1318, 1321 (8th Cir. 1980)(medical doctor cannotassign income to trust when trust did not sup ervisedoctor’s employment, did not determine doctor’scomp ensation , and d octor wa s unde r no legal d utyto earn mon ey for or perform service s for trust);Holman v. United States , 728 F.2 d 462 (1 0th Cir.1984 ) (same); United States v. R ussell , 804 F.2d571 (9 th Cir. 1 986)(“ person al services c ontract”through w hich taxpa yers attempted to sell lifeservices to a trust was an unlawful an ticipatoryassignm ent of inc ome); United States v. K rall,835 F.2d 711 (8th Cir. 198 7)(optometristunlaw fully attemp ted to assig n busin ess receip tsto foreign trusts); Estrada v. Commissioner , T.C.Memo. 1997-180 (nurse anesthetist whoadministered anesthesia and receivedcompensation for services cannot assign suchincome to trust), aff’d, 156 F.3 d 1236 (9th Cir.1998); and Leonard v. Comm issioner, T.C.Memo. 1998-290 (taxpayer, who earned incomeas firefighte r, welder and con tractor, un lawfullyassigned inco me to trust).

C. Grantor Trust Ru les

A third theory courts use to find incometaxable to the individual grantor, rather than thetrust, is based on the grantor trust provisionsfound in sections 671-679 of the Internal RevenueCode. Generally, “if the grantor of a trust retainscertain rights or powers, then for income taxpurposes he is treated as the owner of the portionof the trust over wh ich the rights or po wersextend.” Hanson v. Com missioner, T.C. Memo.1981-675.

Under I.R.C. § 671, a grantor or other personis required to includ e in his/h er taxab le incom e allitems of income which are included in the trust’sincome if he o r she is treated as the trust’s owner.Sections 673 through 678 define thecircumstances under which a grantor or otherperson is treated as th e “owner” of a trust. SeeWesenburg v. Comm issioner, 69 T.C. 1005(1978), for an explanation of h ow the grantor trustprovisions are applied to a specific trustarrangement. The Tax Court commonly uses the


grantor trust rules to resolve civil disputes abouttrusts. The grantor trust theory, however, is nottypically used in the context of criminalprosecutions.

IV. Criminal Violations in Abu sive Trust Cases

As discussed above, many schemes utilizingdomestic and foreign trusts have been used bytaxpayers to evade taxes. So me sch emes n ot onlyseek to con ceal or mis identify the respon sibleparties, but also attempt to structure transactionsin a manner that places the taxable event at a pointwhere liability cannot be imposed. Others attemptto disguise false deductions or to conceal sourcesof income. A taxpayer utilizing an abusive trustscheme could violate a number of criminalstatutes. For example, he or she may engage in taxevasion by knowingly omitting taxable incomefrom the trust tax return, or commit tax perjury byclaiming false deductions for personal expenses orcharitable contributions that were never made orby failing to disclose the existence of a foreignbank acco unt over wh ich he or she h as signatureauthority. Additionally, a trust has independentreporting requirements for which the fiduciary hasrespon sibility. Ignorin g these req uireme nts couldresult in prosecution. Finally, any actionsundertaken in concert with any other person orentity may amou nt to a conspiracy.

As the Service increases its focus onprosecuting those involved in sophisticated taxschem es, tax ad visors ma y becom e likely targetsof investigations. In m ost abusive trust sch emes, alawyer or accountant rendered advice concerningthe und erlying tran sactions. T he Serv ice willscrutinize the practitioner’s role in anytransaction s unde r investiga tion and willrecommend p rosecution if it believes aprofessional has violated the law.

The Tax Division’s criminal tax enforcementprogram in cludes prose cuting both the promo tersof abusive trust schemes and the taxpayers whouse the sc hemes . The crim inal violatio ns usu allycharged against promoters include Klein -typeconspiracies (18 U.S.C. § 371), aiding andabetting income tax evasion (I.R.C. §7201 and 18U.S.C. § 2), aiding and assisting in the preparationof false tax returns (I.R.C. § 7206(2)), andpossibly violations of the omnibus clause of I.R.C.

§ 7212 (a). For guidan ce in prosecu ting promo tersof abusive trust sch emes, see United States v.Schmidt, 935 F.2d 1440 (4th Cir. 1991), andUnited States v. S cott, 37 F.3d 1564 (1 0th Cir.1994).

In Schmidt, the defendants promoted the useof unincorporated business organ izations (UBOs)as a means to conceal taxpayers’ income andassets from the IRS . Most of the trus t purchaserswere Fo rm W -2 wage earners w ho assign ed theirwages to UBOs, yet retained control over theincome and assets ostensibly transferred to theUBO. The government’s theory of tax fraudfocused on the use of the trust entities in thescheme of evasion and did not challenge theentities as “sham s.”

In Scott , the defendants were promoters whomarketed a multi-tiered trust scheme as a deviceto elimina te taxpaye rs’ incom e tax liabilitie s whileallowing them to m aintain co ntrol over theirincome and assets. The scheme involved fourlayers of trust: a domestic trust and three foreigntrusts. The goal of the scheme was to funnel theincome to the third foreign trust and repatriate themoney to the taxpayer tax-free in one of thefollowing ways: in the form of a sham gift under$10,000; through the use of debit or credit cards atan offshore bank; or in the form of sham loans.The government’s theory of prosecution focusedon the manner in which the trusts were operated,not on their form. The indictment alleged that thepromoters had engaged in sham transactionswhich had no economic substance or bu sinesspurpose and created the illusion that thepurch asers had relinqu ished co ntrol of the irincome an d assets, when in reality, the taxpayershad co ntinue d to exer cise contro l over theirincome and assets.

V. Indicia of Fraud

When investigating a trust structure, thepresence of several factors is suggestive ofpossible fraudulent activity warranting furtherinvestigatio n. Wh ile no sing le characte ristic isdeterm inative, th ese factors c an be u sed toidentify the existence of criminal activity. Thefactors include the deduction of personal livingexpenses, such as, school tuition, home mortgagepayments, auto payments, home utility bills and


home repairs and maintenance expenses by thetrust. These oth erwise nond eductible ex penses areimproperly deducted as disguised trust expensesagainst wages o r income.

A cl aim that a significan t por tion of a tr ust'sincome is being distributed to a charity or othernontaxable entity is often an indication offraudu lent activity. T he existe nce of a ch aritableremainder trust from which the taxpayer makesinterest free loans at his discretion could beviewed as an ind icia of fraud . Also, w hen the re isno eviden ce of charitable activity on b ehalf of aso-called "c haritable " benef iciary, the trus t couldbe facilitating the grantor's evasion of taxes.Payments to an organization that purports to be aqualified charity under the Internal RevenueCode, when in fact it is not, is one of the mostcommon vehicles used to unlawfully transferotherwise taxable income out of a trust tax free.

Fraudulent trusts generally lack trustees whoare either professional or have a personal relationto the grantor. Legitimate trusts will usually havea professional trust company acting as trustee, orone of the grantor's intended beneficiaries will benamed as trustee. Named trustees that are notrelated to the grantor and appear unqualified to actas a trustee c an be a s ign that th ey are mere lynominees. Additionally, fraudulent trusteescomm only do n ot adhe re to gene rally accepta blebusiness practices. When an unrelated individualcontrols both the trustees and the beneficiaries, thetrust may be a sham.

The control of assets and income by anunrelated "promoter" can be indicative of anabusive trust. Co-m ingling o f assets also isfrequen tly found in these situ ations. A legitimatetrustee w ill keep the assets of the various tru stsseparate. With the assets co-mingled, the promoterhopes to make particular assets untraceable, thusthwarting tax collection efforts.

Promises of tax reduction b y trust marketersare often signs that the trusts are going to be usedillegally. A legitimate trust is used for inheritanceand prob ate reasons, amo ng others, and thereusually is no appreciable change in the amount ofincome tax paid by a business owner by virtue ofplacing his/her business in a trust. Claims to thecontrary should be treated as suspicious.

Additionally, promises of protection from taxcollection shou ld raise a red flag.

Although legitimate trustees frequently makeloans to trust ben eficiaries and/or trust gran tors, apattern of loans to a large number of trustgrantors, or frequent loans to a single grantor, maybe evid ence of a n attemp t to return tru st incom e tothe grantor tax free. Additionally, the use ofanonym ous post office bo xes to com mun icatebetween the taxpayer and the trustees is indicativeof an abusive arrangemen t.

Fraudulent trusts often create a paper trail offinancial transactions supporting the alleged flowof money through the various trusts. Often theflow of funds is on paper only, as no actual moneyis transferre d betw een the v arious en tities. Thishappens with the use of foreign entities and bankaccounts as well, where the financial transactionsnever occur. Similarly, upon the creation of thevarious tru sts, the title to p roperty is ne ver legallydeeded o r assigned to the n ewly formed en tity.

Other indicia of fraud which may be presentin abusive trust arrangements include: backdatingof documents; the layering of trusts such that onetrust is made the beneficiary of another trust; theuse of units of beneficial interest rather thansimply naming the beneficiaries in the trustdocument; the deduction of “management fees” or“consulting fees” in lieu of payment of wages;promoters advising taxpayers not to talk to theIRS about the trusts; and promoters steeringtaxpayers to attorneys and accountants affiliatedwith the prom oter.

VI. Conclusion

Schem es involv ing abu sive trusts, b othforeign and domestic, have become a favorite toolof unscrupulous prom oters trying to assisttaxpayers in fraudulently reducing or eliminatingtheir tax liab ilities. It is not the tru st entity itselfthat is abusive, but rather the manner in which thetrusts are being used by taxpayers to reduce oreliminate taxes. W hen looking at the validity of atrust set-up , one mu st determ ine wh o iscontrolling the income and assets. In manyabusive trust sch emes, the inco me and a ssets arecontrolled no differently than if the taxpayer hadnever formed a trust. In situations like these, the


trusts are disregarded and the income is attributedto the true own ers.

A num ber of prosecu tion strategies areavailable to attack these abusive trust schemes.Past experience has show n that one of the mostsuccessful approaches in combating these schemesis proving who controlled and spent the moneyrather than attacking the actual trust structure.Juries are often left co nfused in situation s where itbecomes a battle of the experts on the question ofthe validity of the trusts. Th erefore, prosecu torshave focused on tracing the flow of money andattributing it to the individuals who earned andcontrolled it. The go vernm ent has d irected itsprosecution e fforts primarily against prom otersand their clients who have willfully takenadvantage of these egregious schemes to evadetheir taxes. In such cases, the government hasexperienced a high d egree of success.�

ABOUT THE AUTHORS

�Mar tin E. N eedle has serve d as an a ttorney inthe Criminal Tax Division of the Internal RevenueService since 1992. B efore that, Mr. Needle was asenior associate with the accoun ting firm Coo pers& Lybrand . Mr. Nee dle has don e extensive w orkin the abusive trust area includin g lectures before

IRS Criminal Investigation, Counsel, andAssistan t United States A ttorneys. A long withthese speaking engagements, Mr. Needle hasprepared the underlying course materials andparticipated in training activities.

Dora S. W elsh has been a trial attorney in the TaxDivision of the Department of Justice for overtwenty-one years. During that time she has tried anumber of complex tax cases, several of whichinvolved offshore trust issues. During the lasteleven years she has been a senior trial attorneyfor the Southern Criminal Enforcement Section ofthe Tax Division and, in that capacity, she hasworked on the 1 994 C riminal T ax M anual an d itsprevious editions, participated in trainingactivities in the abusive trust area, and served ascoordinator of abusive trust cases and issues.

Beth Elfrey has been a trial attorney in theCriminal Enforcement Section of the Tax Divisionsince October, 1992. Ms. Elfrey has litigatednumerous criminal tax cases, including abusivetrust prosecutions. During the last year, she servedas the Criminal Enforcement Section’s AbusiveTrust C oordina tor. She h as particip ated inspeaking en gagemen ts on abusive tru st mattersand developed an expert witness training programfor IRS revenue agents.a

Recycled “Redemption”: The LatestIllegal Tax Protester Scheme Jennifer E. IhloSenior Trial AttorneySpecial Coun sel for Tax Protest Matters(Crim inal)Southern Criminal Enforcement SectionTax DivisionDepartment of Justice

Melissa E. SchraibmanSenior Trial AttorneyWestern Criminal Enforcement Section Tax DivisionDepartment of Justice

The late st illegal tax p rotester sch eme tosweep the nation is a hybrid of the “redemption”scheme popular in the 1980s and the fictitiousfinancial instrument schemes popular in the1990s. The 1980s redemp tion scheme promotedthe use o f federal in come tax forms, u sually


Forms 1099, to retaliate against governmentemployees or private citizens for perceivedwrongs to the illegal tax protester. The schemewas designed to trigger an Internal RevenueService (IRS) audit, during which the Form 1099recipient would have to explain the discrepancybetween th e income rep orted on his or h er returnand that repo rted on the F orm 109 9. SeeUnited States v. Van Krieken, 39 F.3 d 227 (9thCir. 19 94); see also United States v. Lorenzo , 995F.2d 14 48 (9th C ir. 1993).

The most popular scheme of the 1990s usedfictitious financial instruments to “pay” taxliabilities and obtain erroneous IRS refunds, aswell as to “pay” private creditors. Theseinstruments – often entitled “Certified MoneyOrder ,” “Cer tified Ban kers Ch eck,” “P ublicOffice Money Certificate,” or “ComptrollerWarrant” -- were designed to deceive the IRS andfinancial institutions into treating them asauthentic checks or real money orders.

The recycled “Redemption” scheme combinesthe use of fictitious financial instruments with theuse of IRS forms for harassment purposes. Thescheme was uncovered in 1999 during theprosecution of Veral R.H. Smith and his wife,Judy, in the District of Idaho. Both had beenindicted for failing to file federal income taxreturns for the years 1992 through 1994. Thedefendants had earned gross receipts totaling over$435 ,000 d uring th e prosecu tion perio d from th eirbusiness, Lead Bullet Technologies (LBT). LBTmanufactured and sold bullet molds and otherammunition-related products. Smith operatedLBT o ut of his Mo yie Springs, Idah o, home, afairly isolated forty-acre property near theMontan a-Canada border.

Early in the prosecution, Smith canceled acourt-ord ered do ctor’s ap pointm ent for his wife toassess her physical competency to stand trial. Healso wrote to the United States Attorney“cance ling the [c riminal] p roceedin gs.” De spitenotification to both defendants that theproceedings were not canceled, neither defendantappeared in court. As a result, the court issued abench warrant for the arrest of defendant VeralSmith. Hoping to avoid execution of the benchwarran t, the Un ited States Marsh als drove to

Smith’s property in northern Idaho. They spokewith Sm ith across th e fence th at lined h is prope rtyand en courage d him to come to c ourt. Sm ithrefused and told the Ma rshals tha t he had sent aletter to the court to resolve the matter.

Subsequently, the clerk of the court received a“Sight Draft,” dated July 20, 1999, payable to theIRS in the amount of $1.5 million, signed byVeral R .H. Sm ith. The draft was purpo rtedlyissued by the U.S. Treasury. It was later learnedthat Smith had also attempted to use a “sightdraft” for over $106,000 to purchase two brandnew automobiles, a Toyota Tundra pickup truckand a Lex us LS40 0 sedan. O n Augu st 3, after ascuffle with two Deputy Marshals, Smith wasarrested as he left the M oyie Springs P ost Office.

A superseding indictment returned on October7, 1999 charged S mith with thre e counts of failureto file income tax returns (26 U.S.C. § 7203), twocounts of presenting fictitious obligations (18U.S.C. § 514), one count of resisting arrest (18U.S.C. § 111), and one count of failure to appear(28 U .S.C. § 3146 (a)(1)). D uring th e trial, Sm ithadmitted filing false IRS Forms 8300 (Report ofCash Payments Over $10,000 Received in a Tradeor Business) against one of the prosecutors andthe judge, alleging that each had been paid $200trillion dollars in foreign cu rrency. Prosecuto rsused these documents as justification for anobstruction en hancem ent at sentencin g. SeeUnited States v. V eral Sm ith, 3:99-CR-00025 (D.Idaho 2000) <http://www.id.uscourts.gov>(district court considered false Forms 8300 filedagainst prosecutors and judge as evidencesupporting obstruction enhancement). Smith wassentenced to fifty-one months in prison.

Within months of learning about the sightdrafts presented in the Smith case, the Treasu ryDepa rtment re ceived h undre ds of sigh t drafts withface valu es rangin g from as little as $1,2 00 toamounts in the trillions of dollars. The Office ofthe Comptroller of Currency and the Office of theFiscal Assistant Secretary of the Department ofTreasu ry issued A lerts to the b anking industry inAugu st 1999. See<http://www.occ.treas.gov/altlst99.htm>.Simultaneously, participants in the new


“Redemption” scheme were sending false Forms8300 b y the hund reds to the De troit Data Cen ter.

The theory behind the “Redemption” schemeis based on the erroneous premise that when theUnited States went off the gold standard in 1933,the government began to be funded with debtinstruments secured with “the energy of currentand future inhabitants.” A fictitious identity or“straw man” was created for each American, andthe value of a person’s birth certificate became thecollateral for our currency. The value of anindividual’s birth certificate is determined by thenumber of times it is traded on the world futuresmarket and the amount is purportedly maintainedin a Treasury Direct Account under that person’ssocial security num ber.

A partic ipant in th e schem e attemp ts toreclaim his or her straw man, and therefore thevalue of th e fictitious id entity, by red eeming hisor her birth certificate. The participant first files aForm UCC-1 with the Secretary of State in anystate that accepts such filings, claiming title andsecur ity intere st in his or her social security,driver’s license, and birth certificate numbers. Theindividual th en writes “acce ptance for valu e,”“non-negotiable charge back,” or other prescribedlanguage diagonally on some governmentdocument and returns it to the government officialwho issued it. The types of documents used forredemption include anything from a traffic ticketto a federal indictment. The “charge back”allegedly cre ates a Tre asury Dire ct Acco unt withthe U.S. Treasury that contains the amountassigned to the charge back, which the participantcan then d raw upon by writing “sight d rafts.”“Sight drafts” are then written for varyingamoun ts, some as high as trillions of dollars. AForm UCC -3 indicating the partial release ofcollateral in th e amou nt of each sight draf t isusually filed with the Secretary of State for thestate in which th e UCC -1 was filed.

The “sight drafts” look like checks, are ofvery high print quality, and usually contain somereference to HJR 192, the House Joint Resolutionthat took th e Unite d States o ff the gold standard in1933. These “sight drafts” purport to be drawn onthe United States Treasury Department. Since theprosecu tion of ind ividuals w ho hav e attemp ted to

pass these fictitious “sight drafts” began, thescheme h as continued to evolve: “sight dra fts” arenow sometimes called “bills of exchange,” or“trade acceptances.” All reference HJR 192.

The harassment component of the schemeusually involves filing a false Form 8300,although some Forms 4789 (Currency TransactionReports) and Susp icious Activity Reports (SARs)have also been filed. These documents report thata large amount of cash, sometimes foreigncurrency, was paid to the named recipient. IRSagents, federal and state prosecutors and judges,state troopers, and private creditors are thecommon targets. Typically, the protester will sendhis or her victim an IRS Form W -9, requesting asocial security number. Even without the target’ssocial security num ber, the protester files a F orm8300. Unless the document has already beenidentified as fraudu lent, the IR S send s a letter tothe named recipient requesting additionalinformation and warning of possible penalties forincom plete info rmation . A “frau d” indic ator isattached to the computerized record of thosedocuments identified as part of this scheme. Thefraudulent Forms 8300 are then sent to theappropriate IRS Criminal Investigation Division(CID) office or to the Treasury Inspector Generalfor Tax Administration (TIGTA) for investigation.Those who rec eive one of these fals e forms sh ouldcontact th e local CID office. CID investigate s allnon-IRS employee filings, while TIGTA hasjurisdictio n over filin gs agains t IRS pe rsonne l. Allof these cases, whether investigated by CID orTIGTA and regardless of the statutes charged,require authorization from the Tax Divisionbefore conducting a grand jury investigationand/or prosecuting.

Historically, bogus financial instrument casesinvolving private creditors were prosecuted undera variety of statutes: conspiracy (18 U.S.C.§ 371); mail fraud (18 U.S.C. § 1341); uttering afalse security (18 U.S.C. § 472); bank fraud (18U.S.C. § 1344), and possessing and uttering acounterfeit security (18 U.S.C. § 513). See,United States v. Pullman, 187 F.3 d 816 (8 th Cir.1999 ); United States v. Hanzlicek, 187 F.3d 1228,1230 (10th C ir. 1999 ); United S tates v. Wells, 163F.3d 8 89 (4th Cir. 19 98); United States v.Stockheimer, 157 F.3 d 1082 (7th Cir. 19 98).


In 1996, Congress passed a new statute, 18U.S.C. § 514, specifically in reaction to thenotorious Schweitzer/Broderick comptrollerwarrants. Noting that anti-government group s usefictitious fin ancial ins trumen ts to comm iteconomic terrorism against governmen t agencies,private businesses, and individuals, Con gressenacted Section 514 as a Class B felony, whichcarries a maximum prison sen tence of 25 years.142 Cong. Rec. S10155-02 (Sept. 10, 1996), pp.196-1 97. Se ction 51 4 provid es, in pertin ent part,that:

(a) Wh oever, w ith the inte nt todefraud–

(1) draws, prints,processes, produces,publishes, or otherwisemakes, or attempts orcauses th e same, w ithinthe United States;

(2) passes, utters,presents, offers, brokers,issues, sells, or attemp tsor causes the same, orwith like intent possesses,within the United States;or

(3) utilizes interstate orforeign commerce,including the use of themails or wire, radio, orother elec troniccomm unicatio n, totransmit, transport, ship,move, transfer, orattempts or causes thesame, to, from, orthrough the Un ited States,

any false or fic titious instru ment,document, or other itemappearing, representing,purporting, or contriving throughscheme or artifice, to be an actualsecurity or other financialinstrument issued under theauthority of the U nited States, aforeign government, a State or

other political subdivision of theUnited States, or an organization,shall b e guilty o f a class B felony.

When prosecuting a case involving the“Redemp tion” scheme, the prosecutor should firstdetermine if the protester has attempted to passany fraudulent sight drafts or other financialinstrum ents. Th is will requ ire coordin ation withthe U.S. Secret Service (USSS), Federal Bureau ofInvestigation (FBI), IRS and TIGTA. Title 18,U.S.C. § 514 is the obvious charge whenprosecuting a case involving a sight draft. To date,four trials in the District of Idaho have hadsuccessf ul results: United States v. Boone, 1:99-CR-0 0119 ; United States v. Clapier, 1:99-CR-0012 0; United States v. P ahl, 1:99-CR-00121;United States v. S mith , 3:99-CR-0025. For filingsrelating to th ese cases, s ee the Ida ho fede ral courtsweb pag e at <http://www .id.uscourts.gov >.

If the protester has filed only a few falseForms 8300 and used sight drafts, the prosecutormight consider charging the sight drafts pursuantto 18 U.S.C. § 514 and using the false Forms 8300as evidence of intent. Filing a large number offalse Form s 8300 may warr ant char ges pur suant to26 U.S.C. § 7212 (a) (omnibus clause). Section7212(a) cases require Tax Division authorizationat the De puty As sistant A ttorney G eneral lev el,unlike other ch arges in these cases that requireonly Section Chief authorization. Because theForm s 830 0 are sig ned u nder pena lties of p erjury,filing a false return in violation of 26 U.S.C.§ 7206(1) may also be a viable charge. NeitherForms 4789 nor SA Rs contain jurats, so theycannot form the basis for a Section 7206(1)charge.

Sentencing for violations of 18 U.S.C. § 514is governed by § 2F1.1 of the United StatesSentencing Guidelines (USSG), and is based onthe intended loss that the defendant wasattempting to inflict. One common concern in theprosecution of this scheme involves thesometimes great difference between “intendedloss” and “actual loss.” Often, little or no actualloss results from the use of a fictitious financialinstrument. In United States v. Ensminger, 174F.3d 1143 (10th Cir. 1999), the court was facedwith a scheme to obtain ownership in real


property through submission of bogus financialinstruments. The district court enhancedEnsminger’s sentence under 18 U.S.C. § 1001,based on an intended loss of $540,700, theuncon tested valu e of the pr operty. Th e facts inEnsminger , however, showed that there was noway the scheme could h ave succeeded, becausethe properties Ensminger attempted to obtain hadalready been sold to third parties. Based on thesefacts and two previous decisions (United States v.Galb raith , 20 F.3d 1054 (1 0th Cir. 19 94);United States v. Santiago, 977 F.2 d 517 (1 0th Cir.1992)), the Tenth Circuit held that a ten-levelenhan cemen t for the inte nded loss was cle arlyerroneous. The Ensminger court noted that theFifth, Seventh, Ninth, Eleventh, and District ofColum bia Circ uits disag ree with th is analysis, inreliance on application note 10 to section 2F1.1 ofthe guideline s. Ensminger , 174 F.3d at 1146-47.Furthermore, in cases specifically involving theuse of bo gus fina ncial instru ments, th e FifthCircuit upheld sentencing based on the face valueof the Certified M oney Orde rs even thoug h therewas no actu al loss. See United States v. M oser,123 F.3 d 813, 8 30 (5th C ir. 1997). See alsoUnited States v. Switzer, 162 F.3d 1171, Nos. 97-50265, 97-50293, 97-50442, 1998 WL 750914(9th Cir. Oct. 19, 1998) (upholding sentencebased o n intend ed loss); United States v. Lorenzo,995 F.2 d 1448 , 1460 (9 th Cir. 199 3).

Sentencing for violations of the omnibusclause of 26 U.S.C. § 7212(a) is governed byeither USSG § 2J1.2 or § 2T1.1. USSG App. A.Becau se the filing of the false F orms 83 00 isdesigned to harass targeted individuals, ratherthan generate fraudulent refunds or reduce theperpetrators’ tax liabilities, there is an argumentthat US SG § 2J1.2 (base offe nse level 1 2) shou ldbe applied . In addition, the ap plication of § 2T 1.1requires a calculation of the tax loss that was theobject of the offense. Although it can be arguedthat the targeted individual would have sustaineda loss if the false Form 8300 was accepted at facevalue by the IRS, the absurdly high amounts onthe forms could discourage courts from findingthat the defendants actually intended a tax loss.See United States v. Krau se, 786 F. Supp. 1151(E.D.N.Y . 1992) (court held there was n o tax lossfrom Forms 1096 falsely stating payments of huge

fictitious salaries to various individuals and taxreturn claiming entitlement to a refund in excessof $23 m illion because th e docum ents werespecious on their face and did not represent anactual attempt to obtain something of value fromthe governm ent), aff'd, 978 F.2 d 706 (2 d Cir.1992 ); see also United States v. Telemaque, 934F.2d 16 9 (8th Cir. 1 992). But see United States v.Dentice, 202 F.3d 279, No. 99-50101, 1999 WL1038 003 (9 th Cir. N ov. 15, 1 999) (N inth Cir cuitdeclined to follow Krause because "it was decidedunder a different guidelines scheme and unlikeDentice, Krause was a tax protestor who wasacknowledged as such by the government andwho did not actually intend to claim a refund, likeDentice”).

Sentencing for violations of 26 U.S.C.§ 7206(1) based on the filing of false Forms 8300is governed b y USSG § 2S1.3 . Section 2S 1.3provides for a base offense level of six plus thenum ber of offe nse levels from the fraud los s table(§ 2F1.1) corresponding to the amount of fundsinvolved in the false report.

The “ Rede mption ” schem e contin ues toevolve. Consequently, the best prosecutionsrequire c oordina tion of inv estigations by allinvolved agencies: IRS, TIGTA, FBI and USSS.The T ax Div ision has sample indictm ents and isavailable to help however possible. Any questionsconcerning these schemes or requests forassistance should be directed to Jennifer E. Ihlo,Special Co unsel for Tax Protest Matters(Criminal), at 202-514-5171.�

ABOUT THE AUTHORS

�Jenn ifer E. I hlo is Special Counsel for TaxProtest Matters (Criminal) in the Tax Division ofthe Department of Justice. She has been a trialattorney with the Tax Division since July, 1989.She is a two-time recipient of the Tax Division’sOutstanding Attorney Award. On July 8, 1998,she received the Attorney General’s JohnMarshall Award. She regularly lectures on thesubject of prosecuting illegal tax protesters. Ms.Ihlo is the author of The Gold Fringed Flag:Prosecuting Illegal Tax P rotesters, United StatesAttorneys' Bulletin, April 1998, and co-author of


The Pro Se Defendant, United States Attorneys'Bulletin, July 1998.

Melissa Schraibman has been a trial attorneywith the Western Criminal Enforcement Sectionof the Tax Division, Department of Justice, since

October of 1994. She received the Tax Division’sOuts tanding A ttorney Awa rd in 1 997 and 2 000 . InDecem ber of 199 9 she was n amed an “honoraryspecial agent” by the IRS Criminal InvestigationDivision for the successful prosecution of VeralSmith.a

The Internal Revenue Service’sVoluntary Disclosure PolicyStanley J. Okula, Jr.Assistant United States AttorneySouthern D istrict of New York

You receive a telephone call from a criminaldefense attorney you know and trust who tells youthe following: he represents two partners in athree–partner business concern tha t is in the midstof a nasty dissolution. The rift between thepartners stems from the partners’ discovery thatthe third partner had apparently diverted hundredsof thousand s of dollars of partnersh ip funds ov er afive-year period for personal use, and that thediverted funds w ere book ed as pa rtnershipexpenses on the partnership tax returns and thusnot picked up as income on the third partner’sperson al returns. (The atto rney kno ws thisbecause the partnership’s accountant also preparesthe partners’ personal returns.) The defenseattorney wishes to present this case to you, in thehopes that you will commence a criminal taxinvestigation of the third partner. There’s a hitch,though – the two partners represented by theattorney have their own tax problems, in that theyeach improperly deducted, as bu siness expenses,approximately $100,0 00 of personal expen ses,through the use of a partnership credit card. Theattorney explains, however, that his clients hadalready voluntarily disclosed their improperdedu ctions by filin g amen ded (an d comp letelytruthful) returns, which spanned a three-yearperiod, and that they had paid their back taxeswith interest and penalties. The attorneyconcludes by suggesting that, given his clients’

voluntary disclosures, he expects that their caseswill not be referred for criminal prosecution.

Do you give the two partners a pass becau sethey made a “voluntary disclosure”? What are thefactors you consider when making that decision?

I. Overview

Given the number of tax returns filed eachyear, and the inherent limitations of lawenforcement to police our self-reporting taxsystem, it stands to reason that many tax crimesgo und etected. In order to en courage taxpayers toremedy past failures to file tax returns, orpreviously filed false returns, the InternalRevenue Service created what has come to beknown as the "Volu ntary Disclosure P olicy."

The IRS' voluntary disclosure policy providesthat the IRS will generally take into account thefact that a tax payer cam e forward volunta rily, tofile delinq uent retu rns or corre ct false return s, indetermining whether to recommend criminalprosecution. Both the IRS’s Internal RevenueManual and the Department of Justice TaxDivision’s Criminal Tax Manual have provisionsdiscussing the policy and set out in detail therequirements that a taxpayer must satisfy in orderfor the IRS to consider the taxpayer’s filings to bea "timely," and thus truly "voluntary", disclosure.

It must be emphasized at the outset that theIRS and DOJ g uidelines regard ing voluntarydisclosures are simply that –- guidelines. Both theIRS and D OJ have mad e clear that those


guidelines do not have the force of law and thusmay not be invoked to bind the IRS or DOJ.Indeed, the guidelines also make clear that IRSand DO J may decide to prosecute eve n if avoluntary disclosure has been made. In sum, asone prominent commentator has noted, "makingor attempting to make a voluntary disclosure is amatter of judgment, not law. N o formula exists,and a taxpayer must endure the certainty of therisk that a voluntary disclosure will not beconsidered truly voluntary by the Service . . . " M.Saltzman, IRS Practice and Procedure , ¶12.03[3][c], at 12-40 (2nd ed. 1991) (hereinafter"Saltzman ").

II. The History Of The IR S Policy

Prior to 1952, the Treasury Departmentdeclined to refer tax evasion cases to the JusticeDepartment when the taxpayer had made a "cleanbreast of things" to the IRS before it had initiatedan investigation. United States v. S hotw ellManufacturing Co., 355 U .S. 233, 2 35 n.2 (1 957).This policy was never formalized in regulations,but was set forth in "various informalannouncements by Treasury officials." Id. See M.Saltzman, ¶ 12.03[3][c], at 12-35 (noting thatearly IRS voluntary disclosure policy was notrooted in any statutory authority). The SupremeCourt con strued this early version o f the voluntarydisclosure policy as an "offer of immu nity."Shotwell Manufacturing Co. v. United States, 371U.S. 34 1, 349 (1 963) ("Shotw ell II").

On Jan uary 10, 19 52, the Tre asuryDepa rtment an noun ced that it w as aban donin g thispolicy. Treasury Declaration S-2930 (Jan. 10,1952). The Treasury explained:

Litigation in the courts in recentyears has illustrated thecontroversial nature of thequestion as to what constitutes atrue volu ntary disclo sure in fac t.In the administration of the policyit has been difficult and at timesimpossible to ascertain whetherthe disclosure was made becau sethe taxpayer realized he wasunder investigation or whether thedisclosure wa s in fact voluntary

and in r eliance on the imm unityheld o ut by th e polic y.

Rather than continue to litigate this question, theTreasury abandoned the immunity policy, andannoun ced that "[i]t is the policy of the TreasuryDepa rtment to recomm end crim inal prose cution inevery case where the facts and circumstanceswarrant that action." Id.

In 1961, the IRS issued a statement which"reaffirm[ed]" the existing IRS policy: "even truevolunta ry disclosu re of a willfu l violation w ill not,of itself, guarantee prosecution immunity. At thesame time, the Service will carefully consider andweigh it, along with all other facts andcircum stances, in decidin g wheth er or not torecommend prosecution." IRS News Rel. No. 432(Dec. 13, 1 961).

The IRS put this policy into the InternalRevenue Manual ("IRM") in 197 3. The Manualprovision stated that a voluntary disclosure maybe "sign ificant" in th e IRS' dec ision wh ether torecomm end p rosecutio n, but "d oes not n ecessarilypreclude prosecution." IRM § P-9-2 (eff. Jan. 19,1973). From the 1970's through the early 1990 's,the IRS policy was essentially the same asdescribed in 1961 and 1973. The M anualprovision in effect in 1992 began by explainingthat the IRS' former immunity policy "wasaband oned" in 195 2. IRM § 342 .141 (e ff. April10, 1990). The Manual provision then stated thebasic policy: "It is the practice of the InternalReven ue Serv ice that a vo luntary dis closure w illbe considered along with all other factors in thecase in determining whether criminal prosecutionwill be recommended." Id. § 342.142(1). TheManu al emphasize d that "[a] volun tary disclosurewill not of itself guarantee immunity fromprosecution." Id. § 342 .142(2 ); see also id.§ 342.142(5) (stating, in bold type, that "avoluntary disclosure does not bar criminalprosecution"). The Manual also explained that"[t]he IRS's voluntary disclosure practice createsno substantive or procedural rights for taxpayers,but rather is a matter of internal IRS practice,provided so lely for guidance to IR S personn el."Id. § 342.1 42(7).

The policy p rovide d — and p rovide s today —that to qualify as a voluntary disclosure, the


communication must be truthful, timely andcomp lete, and th e taxpaye r must co operate w iththe IRS in d etermining h is correct tax liability. Id.§ 342 .142(3 ); see also IRM 9.5 .3.3.1.2.1(04/09/99) and CCDM 31.3.3 (01/17/1996). Thepolicy defined a disclosure as timely if it wasreceived before:

a) The IRS has initiated aninquiry that is likely to lead to thetaxpayer, and the taxpayer isreasonably thought to be aware ofthat investiga tive activity;

or

b) Some event known by thetaxpayer o ccurred , which event islikely to cause an audit into thetaxpayer's liabilities, e.g., anewspaper article highlightingcommercial bribery in a particularindustry or corruption in agovernment office.

Id. § 342.1 42(4). See genera lly Saltzman,¶ 12.03[03][c], at 12-35-37 (discussing timelinessissue). In another part of the Internal RevenueManual, the IRS Chief Counsel's DirectivesManual ("CCD M") provided that to make avoluntary disclosure, "[t]he taxpayer must makebona fide arrangements to pay the applicable taxesand penalties to the extent of the taxpayer's actualability to pay." CCD M Part (3 1)330, § (4)(d) (eff.12/12/9 1).

Starting in June 1992, the IRS underCommissioner Shirley Peterson issued a series ofspeeches, press releases, and memorandapublicizing its vo luntary disclosure p olicy, as partof a program called "Compliance 2000." Toencourage individuals who had stopped filingreturns to rejoin the tax system , IRS state mentspublicized the policy and emphasized the IRS'usual practice of not prosecuting taxpayers whovoluntarily file delinquent returns. However, theIRS w as genera lly careful to m ake clear th at itsvoluntary disclosure policy was not a blanketoffer of immu nity to taxpayers and that voluntarydisclosure remained only one factor the IRSwould conside r in decid ing wh ether torecomme nd prosecu tion. See IRS News Rel. No.

92-71 (June 18, 1992) (reserving option of"criminal prosecution in appropriate cases"); IRSFact Shee t No. 92-5 (S eptember 1 992) ("[i]negregious cases, IRS will recommend criminalprosecution to the Department of Justice"); IRSNews Rel. No. 92-94 (Sept. 30, 1992) (IRS policynot "a blanket exoneration"); IRS News Rel. No.92-114 (Dec. 7, 19 92) ("volun tary disclosurepractice is n ot an am nesty or a gra nt of imm unityfrom prosecu tion").

In an IRS press release issued December 7,1992, the IRS for the first time signaled a changein the timeliness requirement for making avolunta ry disclosu re. The IRS ex plained that avoluntary disclosure would henceforth be deemedtimely if it was filed before "notification by theIRS by a telepho ne call, letter o r person al visitthat the taxpayer is u nder criminal investigation."IRS News Rel. No. 92-114 (Dec. 7, 1992)(emphasis added). In April 1993, the IRSamended the Internal Revenue Manual provisionson the voluntary disclosure policy. IRM § 342.142(eff. Apr. 5, 1993). The principal change effectedby the am endm ent was to formally ad opt thischanged definition of timelin ess. Id.§ 342.142(3)(c). The 1993 amend ment also addedto this section of the IRM a provision requiringthat the taxpayer see king volun tary disclosuretreatment must have "made full payment of theamounts due or in those situations where thetaxpayer was unable to make full payment, madebona fide arrangements to pay," id.§ 342.142(3)(e), which had previously been setout only in the Chief Counsel's DirectivesMan ual.

The 1993 amendment explained that the IRS"has a long-standing practice of notrecommending criminal prosecution arising froman individual's failure to file one or more returns"when th e taxpayer mad e a timely voluntarydisclosure. Id. § 342.142(3). However, the 1993amendm ent also mad e clear that a volun tarydisclosure was not a guarantee of immunity fromprosecution. The policy retained the IRM sectionexplaining that the IRS policy of grantingimmun ity had been "ab andoned " in 1952 . Id.§ 342 .141. T he IRM continu ed to dire ct agents towarn taxpayers that "a voluntary disclosure doesnot bar criminal prosecution," but "will be


considered with all other factors in theinvestigatio n whe n decid ing wh ether torecommend prosecution." Id. § 342.142(1). TheIRS also retained the Manual provision makingclear that "the IRS's voluntary disclosure practicecreates no substantive or procedural rights fortaxpayers, but rather is a matter of internal IRSpractice, provided solely for guidance to IRSpersonnel." Id. § 342.1 42(5).

Thus , the Ap ril 1993 amend ment, w hile itmodified the definition of a voluntary disclosure,did not change the nature of the policy. Asexplained in a memorandum signed by formerActing Assistant Attorney General for the TaxDiv ision , Jam es Bruto n, "A t bot tom, the Service 'svoluntary disclosure policy remains, as it hassince 1952, an exercise of prosecutorial discretionthat does not, and legally could not, confer anylegal rights on taxpayers." Criminal Tax Manual§ 3.00, at 3-43

Effective August 25, 1995, the IRS amendedthe voluntary disclosure section of the IRM onceagain. The 1995 revision, which was put in placewithout fanfare, Saltzman, ¶ 12.03[03][c], at S12-20 (2000 Supplement), abandoned the "Peterson"rule on tim eliness ad opted in 1993 , and resto red inlarge part the language previously in place. Thus,the policy in place tod ay require s that:

[i]n order for the disclosure to beconsidered a "true" volun tarydisclosure, the communicationmust be truthful, timely, andcomplete, and the taxpayer mu stshow a willingn ess to coop eratewith the Service (a nd actu allycooperate) in the determination ofthe taxpayer’s tax liability. Thetaxpayer’s disclosure will not betimely if the taxpayercommunicates with the Serviceonly after an event that theService believes would haveeventually led to the discovery ofthe taxpayer’s fraud. If a so-calledtriggering event has occurred, thedisclosure is motivated by a fearof detection and is inconsistentwith a voluntary act of accepting

responsibility for priormisconduct. Accordingly, theService must receive thedisclosure before either theService has "in itiated an inqu irythat is likely to lead to thetaxpayer, and the taxpayer isreasonably thought to be aware ofthat investigative activity," orsome event has occurred aboutwhich the taxpayer knows andthat event is likely to cause anaudit into the taxpayer’sliabilities.

Id. (citing IRM § 342.14 2).

As noted above, the Tax Division of theJustice Department also has a practice concerningvoluntary disclosure, which is discussed in theDepartment's Criminal Tax Manual ("CTM"). Atall re levant tim es, th e Justice Dep artm ent'spractic e has fo llowed the IRS' pre-1 993 policy.When the IRS amended its policy in 1993, theJustice Department declined to adopt the IRS'revisions, annou ncing th at it "has no t chang ed itspolicy concerning voluntary disclosure, and casesshould b e evaluated as th ey have in the p ast."CTM § 3.00, at 3-43.

Thus , the Justic e Dep artmen t's practice at alltimes was to "give [ ] consideration to a 'volu ntarydisclosure’ on a case-by-case basis in determiningwhether to prosecute." CTM § 4.01[1]. TheManual explained that the Department's practicewas "an exercise of prosecutorial discretion thatdoes not, and legally could not, confer any legalrights on taxpayers," and that "even if there hasbeen a voluntary disclosure, prosecution andconviction may still result." CTM § 4.01[3]. TheManual provid ed that a voluntary disclosure mustbe timely, a nd "the taxpayer m ust therea fter fullycooperate with the governm ent." CTM § 4.01[2 ].The Justice Department's practice at all timesfollowed the IRS' pre-1993 definition oftimeliness. CT M § 4.0 1[2].


III. Cases

A. General

Courts have been unanimous for more thanforty years in holding that the IRS policy does notgive any taxpayer im munity from p rosecution. SeeUnited States v. Hebel, 668 F .2d 99 5, 997 -99 (8thCir. 19 82) (vo luntary dis closure "d oes not in sulatethe taxp ayer from p rosecutio n"); United States v.Cho ate, 619 F .2d 21 , 23 (9th Cir. 19 80) (the re is"no longer a policy affording immunity forvoluntary disclosure," and the fact that taxpayermade a voluntary disclosure "is not conclusive"on wheth er prosecution will be authorize d);Plunkett v. Commissioner, 465 F .2d 29 9, 303 (7thCir. 1972) (rejecting argument that "United StatesAttorney was foreclosed from prosecutingPlunkett" because he had voluntarily disclosedand am ended his false retu rns); see also Crystal v.United States, 172 F.3 d 1141 , 1151 (9 th Cir.1999) ("if completing a voluntary disclosure doesnot immu nize taxpayers from prosecution, afortiori initiating a voluntary disclosure cannotimmun ize them from investigation");United States v. Knottnerus, 139 F.3d 558, 560-61n.5 (7th Cir. 1998) (concluding that defendantseeking to preclude tax evasion prosecution failedto make a timely voluntary disclosure, but notingthat even if he had , "his du e process claim wo uldbe high ly dubiou s"); Bateman v. United States,212 F.2d 61, 65 n.2 (9th Cir. 1954) ("In 1952 theTreasury D epartment an nounced that voluntarydisclosure would no longer preventrecomm endatio n for pro secution "); United Statesv. J.R. Watkins Co., 127 F. Supp. 97, 105 (D.Minn. 1 954) (taxp ayers who m ake voluntarydisclosure after 1952 act at their own risk, since"prosecution might well be recom mended"). Th us,a taxpayer may be prosecuted even if he or shemakes a volunta ry disclosu re. Som e highlyexperienced commentators have noted that, whena truly volun tary disclosu re is mad e, a taxpa yer isseldom pro secuted. E.g., S. Michel, L. Feld & R.Fink, Representing A Tax Criminal Prior To TheCriminal Tax Investigation, at C-6 (rep rinted inABA ’s Criminal T ax Fraud Seminar, F all 2000).The reason for this is plain:

Where a taxpayer makes a truevoluntary disclosure before the

Service has made anyinvestigation into his returns, thecase simply does not have thedeterrent impact desired by theService. Rather than encouragingcompliance with the tax laws,such p rosecutio n migh t wellencou rage othe r taxpayer s tocontinue to conceal whateveromissions they may already havebeen guilty of in the hope thatthey will avoid detection. Notonly do taxpayers who makevoluntary disclosures make poorexamples for deterrent purposes,but prosecu tion of such tax payerscan present significant trialhazard s, since a d isclosure isevidence from which a finder offact may determine that theoriginal act was not "willful" in acriminal sense.

Saltzman, ¶ 12.03[3][c], at 12-37.

B. Timeliness

As noted above, a disclosure will not bedeemed truly voluntary if it was made in responseto a "triggering" event. The classic triggeringevent is an investigation or inquiry by the IRS.Accordingly, "once a taxpayer has been contactedby any Service function (whether it be the Servicecenter, office exam iner, revenue a gent, or aspecial agent), the taxpayer cannot make aqualifying voluntary disclosure under IRSpractic e." Sa ltzman , ¶ 12. 03[3 ][c], at 1 2-37 . Inaddition, a triggerin g event may con sist of agovernmental investigation of others that maylead to an aud it of the taxpayer’s liabilities, e.g.,United States v. McCormick, 67 F.2d 867 (2d Cir.1933) (disclosure not timely where taxpayer knewthat others were under investigation, and filed andpaid his taxes to p ut himself in a safe r position),or even a private dispute, such as a bitter businessdissolution or a d ivorce proceed ing, Saltzman , ¶12.03[3 ][c], at 12-37. See also United States v.Zukerman, 88 F. Supp.2d 9, 14 (E.D.N.Y. 2000)(disclosure untimely where taxpayer disclosedfailure to file after being contacted by IRS specialagent w ho sou ght to inte rview tax payer abo ut his


emplo yer, but w as aware of taxpa yer’s failure tofile); United States v. Levy, 99 F. Supp. 529, 534(D. Co nn. 19 51) (IR S inqu iry relating to co rporateexecutive’s purchase of insurance p olicy "almostcertain" to disclose that insurance policy had beenpurch ased with cash, wh ich wou ld lead toevidence of cash transactions and tax evasioninvolvin g three co -workers) ; United States v.Knottnerus, 139 F .3d at 56 0 (disclos ure un timelybecause it was made in response to special agent’svisit).

C. Cooperation with the IRS

The 1993 “Peterson Policy” required thetaxpayer to pay, or make a bona fide arrangementto pay, any outstanding tax liabilities. (The currentpolicy requ ires the tax payer to “c ooperate ” withthe IRS in determination of the outstanding taxliabilities. While paying, or making anarrangem ent to pay, is lik ely to lead th e IRS toconclude that the taxpayer h as “cooperated ,” thereis no firm payment requirement in the currentpolicy. see IRM 9.5.3 .3.1.2 .1 (04 /09/9 9).) InUnited States v. Tenzer, 127 F.3 d 222 (2 d Cir.1999)(" Tenzer I"), the court held that the taxpayerdid not meet all of the requirements of thevoluntary disclosure policy because he had failedto pay, or make an arrangement to pay, taxliabilities of alm ost $1,3 00,00 0. The court fou nd itsignificant that, although a civil IRS agent advisedthat any offer-in-compromise filed by the taxpayershould b e in the $60 0,000 ran ge, the taxpayer,with the assistance of tax cou nsel, offere d only$250,000, which offer the district court deemed"laughable." (Despite this finding, the DistrictCourt had concluded that Tenzer had made a bonafide arrangement to pay, and ultimately dismissedthe inform ation ch arging T enzer w ith four co untsof failure to file. 950 F. Supp. 554 (S.D.N.Y.1996). The District Court also had held thatTenzer’s disclosure was timely, despite the factthat the IRS was investigating the clients ofTenzer’s accounting firm and had served Tenzerwith a grand jury subpoen a for client documents,which had led Tenzer to question whether hehimself was under investigation. The Governmentappealed this ruling, which led to the SecondCircuit’s reversal in Tenzer I.) Moreover, after theIRS returned the inadequate offer, rather thanoffer mo re, Ten zer indic ated that " he plan ned to

resubmit the same offer with a more detailedexpla nation attached." 1 27 F .3d at 228 . Inaddition, although the IRS revenue officer advisedTenze r that, if he w ished th e IRS to c onsider hisoffer-in-compromise he would have to becomecurrent o n his acc ruing tax es and m ake allestimated payments, Tenzer failed to makeestimated payments or pay any of his currentyear’s taxes. Finally, Tenzer disregarded therevenu e officer’s a dvice th at he dive st certainassets and begin making monthly tax payments of$7,00 0. Give n the fore going, th e Secon d Circu itconclu ded tha t Tenze r "had am ple opp ortunity" tocomply with the policy’s requirement to make anarrangemen t to pay, but failed to do so.

D. Sentencing

Following Tenzer I, the District Courtsentenced Tenzer to a year and a day in prison,rejecting Tenzer’s request for a departure based onthe IRS’s conduct in the case. Judge Brieant’sholding in this regard was premised on his beliefthat the mandate in Tenzer I precluded him fromconsidering Tenzer’s attempts to qualify for thevoluntary disclosure policy, or the IRS’s allegedimprop er cond uct, as a b asis to dep art.United States v. Tenzer, 213 F.3 d 34, 41 (2d Cir.2000) (" Tenzer II"). On ap peal, the S econd Circuitreman ded for re sentenc ing, find ing that itsopinion in Tenzer I did not preclude the DistrictCourt, in the first instance, from consideringwhether Tenzer’s attempts to qualify for thevoluntary disclosure program, and the IRS’scondu ct, were su fficiently exc eptiona l factors totake Tenzer’ s case out of the h eartland and justifya downw ard departu re. Id. at 43-44. The Tenzer IIpanel emphasized, however, that it was notdeciding whether those factors, individually ortogether, constitute an appropriate basis fordeparture; rather, it held that such a considerationwas not prec luded by the mandate o f Tenzer I, andthe District Court was in the best position to makesuch an assessment in the first instance.

Following Tenzer II, the case was reassignedto a different District Judge, who rejectedTenzer’s departure motion and sentenced Tenzerto the same year-and-a-day sentence that had beenimposed previously. In so doing, the Court cited,among other factors, Tenzer’s position as a tax


attorney and advisor, and his de minimus offers ofback tax payments.

IV. Procedure

There is no formalized procedure for makinga voluntary disclosure, there is no specific officewithin the IRS to which to direct such matters,and there is no requirement that a taxpayer contactthe IRS to put the Service on notice of his or herintention to make a volunta ry disclosu re. In fact,in its simp lest form, a ta xpayer co uld fileamended returns and pay the additional taxesowed prior to any triggering event and comewithin the p olicy. It should be no ted, howev er,that a voluntary disclosure cannot be madeanonymo usly through a tax payer's attorney. For adiscussion of how attorneys should go aboutmaking a vo luntary disclosure, see, e.g., Saltzman,¶ 12.0 3[3][c], a t 12-38 -39, and S. Mic hel, L. F eld& R. Fin k, Representing A Tax Criminal Prior ToThe Criminal Tax Investigation, at C-7 - C-9. Seealso testimon y of IRS A ttorney Ro bert M arino inUnited States v. Tenzer, 95 Cr. 10 16 (CL B),explaining the practice of one IRS DistrictCounsel in hand ling voluntary disclosures. (As awitness in the Tenzer case, Marino testified that hewould occasionally have meetings while at IRSDistrict C ounse l with attorn eys who w ouldpresent a “hypothetical” case to him and askwheth er, assum ing the fa cts in the h ypothetica l,the taxp ayer wou ld be con sidered b y the IRS tohave made a voluntary disclosure. After hearingthe hypo thetical, M arino wo uld cau cus brief lywith others at District Counsel while counselwaited, and thereafter give the attorn ey an answer.If the conc lusion w as that the hypothe tical factsdid constitute a voluntary disclosure, Marinowould emph asize that th e client’s a bility to avoidprosecution was conditioned on the IRS’s nothaving previously commenced any investigationof the taxpayer, either c ivil or criminal.)

V. Conclusion

Based on the fac ts set out at th e outset, itappears that the attorney’s clients would be goodcandidates for the voluntary disclosure program.First, they have already filed correct amendedreturns a nd pa id all of their back tax es, with

interest and penalties. Next, although the amountof tax loss attributable to their false returns wasprobably sufficient to warrant prosecution, thenum bers inv olved w ere not so e gregiou s (as inTenzer, for instance) to override the other policyconsiderations. Moreover, the tax losses for thedisclosing partners are significantly lower thanthose of th e third partner. In ad dition, alth ough itmight be argued that the bu siness dispute was a“triggering event” that prompted the disclosures(thus negating the timeliness factor), it could alsobe argued that the simple business dispute was not“likely” to cause an IRS audit of the partners’ taxreturns. (After all, any partner informing on theothers w ould h ave to disc lose the ex istence of h isor her ow n tax crim es. Thu s, there are b uilt-inincentives not to refer the matter to the authorities,no matter how bitter the dispute.) In sum,consideration of the various factors suggests thatgiving a pass to the attorney’s clients would notbe inappropriate.�

ABOUT THE AUTHOR

�Stanley J. Okula, Jr. has been an AssistantUnited States Attorney in the Southern District ofNew York since 1995. Prior to that time, heserved as an Ass istant Un ited States Attorne y inthe Eas tern Dis trict of New York fro m 199 0 to1995. H e is the author of The Volun taryDisclosure Policy, Association of the Bar of theCity of N ew Yo rk, Rep resenting Defen dants inCriminal T ax Investigations (J anuary 200 1);Venue and Federalizing Crime: Will The SupremeCourt Tell Prosecutors Where To Go?, CriminalJustice (W inter 19 99); Third-Party Cooperation:Proceed With Caution, Criminal Justice (Summer1997 ); Tracking Developments on GuidelineDealing With S kill And Abuse of T rust, New Y orkLaw Journal, Feb. 9, 1999.a

1This article has b een mod ified from its original version , Genie in a Bottle: Using the Missing

Witness Instruction, that was published in Criminal Justice, Volume 13, No. 3 (Fall 1998). It is reprinted

with permission from the American Bar Association. The views expressed here are solely those of the

author and do not necessarily reflect the position of the Department of Justice.


Missing in Action: The Absent WitnessInstruction in Tax Prosecutions 1

Thom as E. Z ehnleCounsel to the Assistant Attorney GeneralTax DivisionDepartment of Justice

Courts generally do not like to give “missingwitness” instructions, even if the evidencepresen ted at trial su pports th e charge . Judge s willfind all sorts of reasons to avoid doing so,especially in criminal cases. Usually, this entails aruling fro m the b ench th at the witn ess was eq uallyavailable to both sides, or that he or she was notpeculiarly within the power of one of the partiesto produce. Judges also refuse to give theinstruction by holding that the witness’s testimonywould have been cumulative or immaterial–thatthe evidence would not have illuminated anymatter at issue.

The courts’ reluctance to instruct juries aboutthe adverse inference that they may draw from amissin g witn ess is no t hard to fatho m. To many,the instru ction en courage s the fact fin der tospeculate about “nonevidence,” that is, evidencethat was neve r presented at trial. See, e.g.,United States v. Simpson, 974 F .2d 84 5, 848 (7thCir. 1992 ). Judges are n ot alone in this belief.Many prosecutors might agree that, once released,this genie is difficult to get b ack in the bottle.

But here is the twist: I believe that thegovernment should more frequently seek themissing witness instruction in white-collarprosecution s, partic ularly tax cases. O bviou sly,when this instru ction is sou ght against adefendant, it raises concerns about potentialviolations of the Fifth Amendment privilege andimpermissibly shifting the burden of proof to the

accused. B efore addressin g these issues, ho wever,it is important to explore the instruction’stheoretical basis.

Missing Witnesses and the Ad verse InferenceRule

The foundation for the m issing witnessinstruction in this co untry dates back well over acentury. In Graves v. U nited States, 150 U.S. 118(1893), the Supreme Court declared that such acharge is w arranted “if a party h as it pecu liarlywithin his power to produ ce witnesses whosetestimony would elucidate the transaction.” Id. at121. Essentially, the instruction advises jurors thatthey may d raw a ne gative infe rence ag ainst aparty who controls important information but whochooses not to share it at trial. (Of course, nothingprevents that side from explaining duringsummation why particular witnesses were notcalled to the stand .)

A mo re mod ern form ulation o f the rule isfound in th e case of United S tates v. Caccia , 122F.3d 136 , 138-39 (2d C ir. 1997), which exp lains:

The mo st appropriate vers ion of a“missing witness” instruction, where thefacts warrant it, permits the jury to drawan adv erse infere nce aga inst a partyfailing to call a witness when thewitness’s testimony would be materialand the witness is peculiarly within thecontrol of that party. In suchcircumstances, it is more likely than notthat the testimony of an uncalled witnesswould have be en un favorab le to the pa rtywith such control, and a jury mayreasonably draw such an inference. The


requirement that the witness be“peculiarly within the control” of theparty ensures that the inference is notavailable to be drawn against a party who,in comparison with an adversary, lacksmeaningful or pragmatic access to thewitness.

A numb er of points are worth noting. Firstand fore most, the missing witness in struction isavailable against any party. Still, it may surprisesome attorneys that this includes criminaldefendan ts. Thus, it is an op tion that prosecu torsmay consider. See, e.g., United States v. Dahdah,864 F.2d 55 (7th Cir. 1988). Indeed, the gist ofthis article is that there are particular white-collarcases (e.g., tax prosecutions) where thegovern ment sh ould p ress for suc h an ins truction inorder to level the evid entiary playing field.

Next, the proponent must show that thewitness’s testimony would have been mater ial toan issue at trial. In this context, some courts havedefined “materia l” by using langua ge similar tothat employed by the Supreme Court in Graves; –i.e., the testimony must “elucidate thetransaction.” See Un ited States v. G lenn, 64 F.3d706, 709 (D.C. Cir. 1995). Interestingly, that samecircuit pro bably gav e a better d efinition w hen itopined that there “are some persons . . . whopotentia lly have so m uch to o ffer that on e wouldexpect them to take the stand.” United States v.Pitts, 918 F.2d 197, 199 (D.C. Cir. 1990). In anyevent, it see ms fair to sa y that the testim ony is“material” and will “elucidate the transaction”when it is relevant and noncumulative.

Finally, the absent w itness instru ction isgenerally restricted to those situations where oneparty has some peculia r contro l over the witness.It is the unequal access to important testimonythat justifies the adve rse inference. Accord 1Devitt, Blackm ar, Wolff & O ’Malley, FederalJury Prac tice and Instru ctions, § 14.15, at 458-59(4th ed. 1990). However, the availability of thewitness is to be dete rmined based u pon th e factsand circumstances of that witness’s “relation[ship]to the parties, rather than merely on physicalpresence or accessibility.” United States v. Torres,845 F.2d 1165, 1170 (2d Cir. 1988)(quotingUnited States v. Rollins, 487 F.2d 409, 412 (2d

Cir. 19 73)); see also Un ited States v. Ro mo, 914F.2d 889, 893-94 (7th Cir. 1990) (witness’srelationship with a party may make his testimony“in pragm atic terms” only availab le to that side);but see Un ited States v. So rrentino, 72 F.3d 294,298 (2d Cir. 1995) (confidential informant wasnot peculiarly within the control of governmentbecause government produced witness anddefense could have calle d him to testify). In fact,one court has opined that a witness may bepeculiarly available to the other side “if thewitness would be hostile to or biased against thecalling party.” United S tates v. Hoen scheidt, 7F.3d 1 528, 1 531 (1 0th Cir . 1993 ); see alsoUnited S tates v. Add o, 989 F.2 d 238 (7 th Cir.1993) (witness who is available to both parties buthas bias towards one side may be d eemed incontrol of that party).

It should be noted here that some believe thata modif ied versio n of the in struction isapprop riate whe re the witn ess is equ ally availableto both parties, but neither side calls her. Underthese circums tances, it is argued th at the courtshould instruct the jury that an adverse inferencemay be draw n against either or b oth parties. Seegenerally United States v. Bahna, 68 F.3d 19, 22(2d Cir. 1995) (discussing trial court’s chargingoptions). Frankly, permitting a negative inferenceto be drawn in such cases does not make muchsense, Professor Wigmore’s viewsnotwithstand ing. Compare 2 Wigmore, Evidence§ 288, at 2 08 (Ch adbourn Rev. 197 9) withUnited S tates v. Aden iji, 31 F.3d 58, 65 (2 d Cir.1994). Simply put, if a witness has importanttestimon y to offer and is available to both sid es, itdoes no t seem w ise to enco urage th e jury tospeculate about it when the real thing could havebeen prese nted. See Bahna, 68 F.3d at 22 (notingthat if any instruction is to be given in suchsituations, the majority of circuits favor advisingthe jury th at no inference may be drawn again steither side).

Apprehension about the Instruction

Many de fense attorneys, and some jud ges, areuneasy about an argument that seeks to expand theprosecution’s use of the missing witnessinstruction. The anxiety stems primarily from twosources: concern regarding potential violations of


the defe ndan t’s Fifth A mend ment p rivilege toremain silent; and the related issue of thegovernm ent’s burd en of proof vis-a-vis thedefendan t’s right not to prod uce any eviden ce. Athird reason – that the missing witness instructionallows jurors to speculate – may also be aconcern , but cou rts freque ntly allow fa ct finders todraw adverse inferences in analogous situationswitho ut similar worry.

The Fifth Amendmen t “forbids eithercomment by the prosecution on the accused’ssilence or instructions by the court that suchsilence is evidence of guilt.” Griffin v. California,380 U .S. 609, 6 15 (196 5). Accord ingly, aconstitutional violation occurs only where theprosecutor’s co mmen t (or, a fortiori, the court’sinstruction) “was manifestly intended or was ofsuch ch aracter tha t the jury w ould n ecessarilyconstrue it as a comment on the failure of theaccused to testify.” See United States v. Ch irinos,112 F.3d 1089 , 1099 (11th Cir. 1997) (quotationmarks o mitted). C are mus t be taken , therefore , todistinguish between a comment or an instructionwhich relates to the failure of the defense–asopposed to the failure of the defend ant– to counteror explain the evidence. An adverse inferencebased o n the form er is perm issible; on the latter, itis not. Chirinos, 112 F .3d at 11 00; see alsoUnited S tates v. Castillo, 866 F.2d 1071, 1083(9th C ir. 1988 ) (comm ent on fa ilure of de fense isnot an in fringem ent of the accused ’s FifthAmen dment p rivilege).

Accordingly, a judge may instruct jurors thata negative inference may be drawn against thedefense for its failure to produce a materialwitness within its control. The decision to socharge the jury lies within the sound discretion ofthe trial court. United S tates v. Mittelstaed t, 31F.3d 12 08, 121 5 (2d C ir. 1994). It is only wh erethe witness and the accused are one and the same– whe re the exp lanatory ev idence would naturallyand necessarily have to come from the defendanthimself – that th e instruction is forbid den. AccordUnited S tates v. Gom ez-Olivas, 897 F.2d 500, 503(10th Cir. 1990) (“[a]s long as evidence can besolicited other than from the mouth of theaccused, it is prop er to comme nt upon th e failureof the defense to produce it”).

Und erstanda bly, some will have trouble w iththe missing witness charge being used against anaccused because it is difficult to reconcile thegovernment’s burden of proof with thedefendan t’s right not to presen t a case. See, e.g.,Gomez-Olivas, 897 F.2d at 503-04. At first blush,the situation presents an apparent paradox. Theanswe r lies in the fa ct that the ju ry is free toaccept or reject the a dverse in ference. T hat is tosay, the permissive nature of the inferenceundercuts any argument that the burden has beenuncon stitutionally sh ifted to the defend ant.Niziolek v. Ashe, 694 F.2 d 282, 2 92 (1st Cir.1982 ). The b urden of proof a lways rem ains withthe prosecution. The inference is simply a way ofallowing the government to carry that burden “andno more ch anges it than d oes damn ing evidenc e.”United S tates v. Sblend orio, 830 F.2d 1382, 1391(7th Cir. 1987). The Supreme Court has held thatpermissive inferences in general place noobligation of an y kind on the d efendant. Cou ntyCourt of Ulster County v. Allen, 442 U.S. 140,157 (19 79).

Although he has no burden of proof, theaccused does run the risk of an adverse inferencebeing drawn against him based upon thenonproduction of a material witness if thegovernment establishes that the defendant had thepeculiar power to produ ce the ind ividual inquestion. See 8 Wigmore, Evidence § 2273, at 450(Chad bourn Rev. 1 979). T he difficu lty indistingu ishing b etween these con cepts pro bablyaccounts for the view of some courts that theinstruction should not be given if the defense hasnot presented any evidence. See Manual of ModelCrimin al Jury Instru ctions for th e District C ourtsof the Eighth Circuit, Instruction N o. 4.16 (19 96).It goes without saying that where the defenseseeks to employ a missing witness argumentagainst the government, the Fifth Amendment andrelated b urden -shifting co ncerns are not pr esent.

Finally, many attorneys, prosecutors, anddefense lawyers alik e, are squ eamish about th isinstruction because they believe that it allowsjurors to speculate about “nonevidence.” No oneactually testifies, but the fact finder mayneverth eless infer w hat the m issing witn ess wou ldhave said on the stand. However, upon closerinspection, this is really nothing new. Courts have


long permitted jurors to make such ad verseinferences when the surrounding circumstanceswarrant it. For example, when an accused will notprovide handwriting exemplars so that they maybe com pared a gainst a q uestione d docu ment, it ispermissible to instruct the jury that they may drawa negative inference regarding the defendant’srefusal. United S tates v. Stone, 9 F.3d 934, 942(11th C ir. 1993 ). In such a case, no expert h as infact testified that the defendant drafted thedocument, yet the jury may conclude this basedon his refusal to give the writing samples.Likewise, where a defendant declines to speak foridentification purposes at a police line-up,evidence of this refusal does not violate theaccused’s co nstitutional rights. Higgins v.Wainw right, 424 F .2d 17 7 (5th C ir. 1970 ); seealso Un ited States v. Fra nks, 511 F.2d 25, 35-36(6th Cir. 1975) (appropriate to instruct jury thatdefendant’s refusal to provide voice exemplarmay be viewed as consciousness of guilt). TheSuprem e Court has stated that eviden ce of adefendant’s refusal to submit to a blood-alcoholtest does not violate his Fifth Amendmentprivilege. South D akota v. N eville, 459 U.S. 553,562-63 (1983).

Indeed, even though the government maybenefit from permissive inferences such as these,the prosecutors would almost certainly prefer theactual evidence. As noted in Neville , a positivetest result would be far stronger evidence ofintoxication than any adverse conclusion whichmight be draw n from th e defen dant’s re fusal totake the test. Neville , 459 U.S. at 563-64.Similarly, in a missing witness situation, thegovern ment’ s lawyers w ould ce rtainly prefe r tocross-exa mine th e material w itness un der oathrather tha n simp ly argue an inferenc e insumma tion.

Missing Foreign W itnesses in Tax Cases

In what typ e of white -collar cases s houldprosecutors consider seeking a missing witnessinstructio n? A nswer: W here the missing witness isa foreign nominee, bank official or executive whois transactio nally associa ted with the defen dant.The assistant U.S. attorney or Department ofJustice trial a ttorney sho uld no t overlook this

possible strategy where the accused’s actions haveotherwise stone walled the gov ernment’ s case.

Let us start with the rather basic premise thatpeople are more sophisticated today than in thepast in th e way they h andle (a nd hid e) theirmoney. To this end, those up to no good haveincreasin gly utilized fo reign corp orations a s shellsand deposited their funds in financial institutionswhere the host country maintains strict banksecrecy laws. Obviously, not everyone who has anoffshore account or who has dealings with aforeign co mpan y is engage d in nef arious co nduc t.Indeed, most of these relationships are forlegitimate busin ess purpose s. But, as always, the reare those who use these services to violate federaland state crimin al laws.

In true white-collar prosecutions, such as taxevasion, the use of overseas nominees and foreignbanks can prove to be a substantial roadblock.(These cases should be distinguished from moneylaundering prosecutions, where there has beensignifican t internatio nal coop eration, at le ast incombating narcotics trafficking.) Traditionaltechniq ues em ployed b y criminal in vestigators toobtain tes timony an d docu ments a re often fu tile inthese circu mstanc es. If the foreig n jurisd iction isnot cooperative, the chances of procuring thenecessa ry evidenc e to succe ssfully try the ca se isdramatically decreased.

An example of some of the hurdles that facethe government may be enlightening here.Assume that a physician with a lucrative medicalpractice decides to skim profits from his businessand evad e paying taxes on this income. O r,assume that the case involves a politician whoaccepts bribes for his services. In either case,rather than placing the money in a domestic bankor broke rage hou se wher e the IRS or FBI co uldsubpoena the records and the account executive,he sends it overseas. Just parking the money in theCaribbean, for example, does nothing to enhancethe lifestyle of our ne’er-do-well defendant. So heforms, through nominee directors, a foreigncorpora tion wh ich pur chases su bstantial a ssets(such as buildings) in the United States. He then“leases” th ese build ings, thu s sendin g more o f hismoney offshore to himself, since he is the foreigncorporation.


Now let us assume that the governmentsomehow gets wind of this scheme, either througha disgruntled former employee at the medicalpractice or a suspicious secretary at thepolitician’s office. Not surprisingly, the defendantdenies maintaining any foreign bank account andcontends th at the relationship w ith the offshorecorporation is legitimate. Despite having a broadoverview of the operation, incriminating recordsare lacking and the witnesses who have first-handinformation are overseas and seemingly notsubject to examination under oath. What optionsare availab le to the gov ernme nt?

More than likely, the prosecutor will firstdetermine whether the foreign country has enteredinto a mu tual legal as sistance tre aty (MLA T) withthe United States. These treaties create formalcontracts to provide legal assistance in criminalmatters – assistance which includes, among otherthings, taking testimony and providingdocuments. The problem is that although MLATsoften encompass a broad range of felonies, someforeign co untries sp ecifically exc lude co verage inthose m atters that th ey consid er to be pu rely“fiscal,” such as tax evasion. It is no secret thatmany jurisdictions continue to serve as tax havensfor U.S . citizens. In o ur hypo thetical, the n, there isno formal treaty by which the government canobtain this important evidence.

The trial attorney may next examine thepossibility of employin g a letter roga tory, which isnothing more than a formal request from theAme rican cou rt in whic h the cas e is pend ing tothe foreign court seeking judicial assistance.(Prior to the expansion of MLATs, lawenforcement officials and private parties oftenrelied on this method to obtain evidence.) Here,we will as sume th at the pro secutor se eks todepose certain witnesses, such as a nomineecorporate director and a bank account executive.In addition to having to secure the Americancourt’s permission, the real problem is that theforeign co urt has n o obligatio n wha tsoever tohonor the req uest – especially if that cou ntryallows for no exceptions to its financial secrecylaws. M oreover, th e letter rogato ry proced ure isuncoord inated and subject to serious time delays.

Both these channels appear futile. Theprosecu tor next c onsider s using su bpoen as toobtain the testimony of (and documents from) theforeign corporation and the defendant’s suspectedbanker. There are, of course, major difficultieswith this strategy as well. If the foreign witnessescannot be located – even temporarily – within thejurisdiction of the United States, the subpoenaswill not work. See generally In re Gran d JuryProceed ings (Field), 532 F.2 d 404, 4 07 (5th C ir.1976). Further, issuing a grand jury or trialsubpoena to the domestic branch of a foreign bank(assuming there is one) is very controversial andoften creates serious jurisdictional disputesbetween countries. Furthermore, the unilateralapproach can be ineffective even when permissionto issue the subpoena on the branch is granted.See, e.g., In re Grand Jury Proceedings (Bank ofNova S cotia), 691 F.2 d 1384 (11th Cir. 1 982).

Not to be deterred, the trial attorney may seeka “comp elled directive,” wh ere the court orde rsthe alleged accou nt holder ( i.e., the doctor orpolitician) to direct the foreign bank or otherinstitution to disclose any information it hasconcerning the accused . These directive s aresometimes referred to as “Ghidoni waivers.” SeeUnited S tates v. Ghid oni, 732 F.2 d 814 (1 1th Cir.1984). The Supreme C ourt has held that an orderdirecting the alleged foreign ac count h older toexecute a hypothetically-framed disclosure doesnot violate his Fifth A mendm ent rights. Doe v.United S tates, 487 U .S. 201, 2 06-18 (1 988).Without such a waiver, the information would beprotected by the host country’s financial secrecylaws. Unfortunately, some foreign jurisdictionshold that com pelled directives are n ot voluntaryand freely-given con sent, therefore, Ghidoniwaivers often fail to satisfy the relevant country’sstrict privacy laws.

Instruction, Not Just Argument

Wha t can be d one wh en legitim ateinvestigative avenu es are foreclosed or areimprac tical and th e defen dant w ill not volu ntarilyconsen t to havin g a foreign witness u nder h ispeculiar control release potentially relevantinformation? Assuming that it can otherwise makeout a prima facie case, the g overnm ent shou ldseek, and the court should grant, the missing


witness instruction against the accused.Otherwise, the wrongdoer may prevail through asophisticated handling of his financial affairs –condu ct which at its very heart is designe d toprevent disclosure of the incriminating evidenceto the authorities. We should never countenancejustice being dispensed according to suchgamesmanship.

No doubt, some will contend that thedefendant could not have subpoenaed the foreignwitnesses and that, therefore, they were not underhis control. However, this would be adisingenuous argument under circumstancessimilar to those set forth above. A witness’sphysical amen ability to subpoen a is only one of anumber of factors to be analyzed in determiningwhether the absent witness is peculiarly within thepower of on e of the parties to prod uce. SeeUnited S tates v. MM R Corp . (LA), 907 F.2d 489,502 (5th Cir. 199 0) (“[t]hat the potential witnessis physically p resent at trial o r accessib le toservice of subpoena by the court does not makethe witness eq ually available to both sides”); seealso U nited Sta tes v. Ma rtin, 696 F .2d 49 , 52 (6thCir. 1983). In our exam ple, the businessrelationship between the accused and the directorof the nominee corporation would certainly makethat perso n more available to the defen dant tha n tothe prosecution. Similarly, a family tie orconne ction often makes a witness m ore likely tofavor on e party over the other and, thu s, be with inthe peculiar power of that party to produce.

Others may grant that something should bedone, but believe that a missing witnessinstructio n is dan gerous, e ven in o ur hypo thetical.For these people, a middle ground may bepossible ; i.e., simply pe rmit the p rosecuto r tomake the missing witness argument during his orher summation. The government has been allowedto do so in other c ases. See Nicho ls v. Scott, 69F.3d 1 255 (5 th Cir. 1 995); United States v.Santan a, 877 F.2 d 709 (8 th Cir. 198 9);United S tates v. Glan tz, 810 F.2 d 316 (1 st Cir.1987).

As every experienced trial attorney knows, thelawyer’s closing argument “does not bring to bearthe same force as would a pronouncement on theissue from the bench. . . .” Mittelstaedt, 31 F.3d at

1215. In cases such as these, where an ingeniousdefendant can arrange his affairs so as to precludethe government from obtaining crucial foreigneviden ce, a cou rt’s instruc tion on th e matter iswarranted.

The argument presented herein is not madelightly. It is by no means intende d to circu mven t adefendan t’s right to remain silen t or to requireanything less than the government fully meetingits burde n of proo f beyond a reasona ble dou bt.Indeed, no prosecutor should ever seek to obtain aconviction “by artfully or unintentionally inducinga jury to find a defendant guilty on improper andunconstitutional grounds.” Castillo , 866 F.2d at1084. However, advising the jury that they maydraw an adverse in ference a gainst the accused isnot un constitutio nal und er these circ umstan ces – itis just. A s crimina ls becom e more so phisticate d intheir financial dealings and transactions, thegovernment must become more resourceful, andthe courts more open-minded.�

ABOUT THE AUTHOR

�Tho mas E. Zeh nle has been Counsel to theAssistant A ttorney Genera l for Criminal M attersat the U.S. Department of Justice, Tax Division,since January 2000. As such, he participates in thedevelopment and implementation of criminal taxpolicy on a national level. Prior to that, he servednine years as a senior trial attorney prosecutingtax violatio ns and other fina ncial crim es on be halfof the Department of Justice. Over the years, hehas written numerous articles and has beenpublished on topics such as criminal law, tax, andevidence. In addition, he has been a frequentlecturer at seminars presented by the JusticeDepartment, the American Bar Association, andthe Internal Revenue Service.a


Obtaining Foreign Evidence and OtherTypes of Assistance for Criminal TaxCasesJames P. SpringerSenior Cou nsel for International Tax M attersTax DivisionDepartment of Justice

I. Introduction

This article provides a detailed analysis of themeans available to federal prosecutors forobtaining foreign evidence and other types ofinternational assistance in criminal tax cases. Themeans analyzed here include mutual legalassistance treaties (MLATs) and similarprocesse s, tax infor mation exchan ge agreem ents(TIEAs) and tax treaties, court-sponsoredprocedures for taking foreign depositions,including letters rogatory, and the use of unilateralcompulsory measures, such as subpoenas, forobtaining foreign evidence.

Obtaining foreign evidence and other types ofinternational assistance usually requiresconsiderable amoun ts of time and can causesignificant delays in an investigation or trialproceed ing. Th us, a pro secutor sh ould in itiateseeking such evidence or assistance through theappropriate process as soon as possible.

No United States investigator or prosecutormay contact foreign authorities or witnesses,whether by telephone or other means, orundertake foreign travel, without obtaining theproper clearan ces or authorization s. Prosecutorsunder the jurisdiction of the Department of Justiceare required to coordinate and clear all suchcontacts and travel through the Office ofInternational A ffairs ((202) 51 4-0000 ).

II. Obtaining Foreign Evidence or O ther Typesof Assistance under Mu tual Legal AssistanceTreaties

A. Background

Mutual Legal Assistance Treaties create aroutine channel for obtaining a broad range oflegal as sistanc e for crim inal m atters ge nerally,including, inter alia, taking testimony orstatements of persons, providing documents andother physical evidence in a form that would beadmissible at trial, and executing searches andseizures. These treaties are concluded by theDepartment of Justice (primarily the CriminalDivision) in conjunction with the Department ofState. An MLAT creates a contractual obligationbetween the treaty partners to render to each otherassistance in crimin al matters in accorda nce withthe terms of the treaty. It is d esigned to facilitatethe exchange of information an d evidence for usein criminal investigations and prosecutions.Unfortunately, while many of the MLATscurrently in force cover most U.S. tax felonies,several oth ers have o nly limited coverage , at best,for tax offenses.

B. MLA Ts Currently in Effect

As of March 10, 2001, the United States hasMLA Ts with the following jurisdictions:Anguilla, Antigua & Barbuda, Argentina,Australia, Austria, the Bahamas, B arbados,Belgium, Brazil, the British Virgin Islands,Canada, the Cayman Islands, the Czech Republic,Dominica, Estonia, Grenada, Hong Kong,Hungary, Israel, Italy, Jamaica, Latvia, Lithuania,Luxembourg, Mexico, Montserrat, Morocco, theNetherlands (including the Netherlands Antillesand Aruba), Panama, the Philippines, Poland,South Korea, S pain, S t. Christo pher an d Nev is, St.Lucia, St. Vincent & the Grenadines, Switzerland,Thailand, Trinidad & Tobago, Turkey, the Turks


and Caicos Islands, Ukraine, the United Kingdom,and U ruguay.

C. The Extent of Tax Coverage in MLATs

The MLA Ts with Antigua & Barbuda,Argentina, Australia, Austria, Barbados, Belgium,Brazil, Canada, the Czech Republic, Dominica,Estonia , Grena da, Ho ng Ko ng, Hu ngary, Israel,Italy, Jamaica, Latvia, Lithuania, Luxembourg,Mexico, Morocco, the Netherlands (excluding theNetherlands An tilles and Aruba), the Philippines,Poland, South Korea, Spain, St. Christopher andNevis, St. Lucia, St. Vincent & th e Grenadines,Thailand, Trinidad & Tobago, Turkey, Ukraine,and the United Kingdom cover all criminal taxfelonies under the Internal Revenue Code. Theremaining MLATs contain a variety of restrictionsregarding assistance for tax offenses. Thus, theSwiss MLAT excludes tax and similar fiscaloffenses from its scope except in cases involvingorganize d crime. How ever, assista nce is ava ilablefrom the Swiss under one of their domestic mutualassistance statutes (refe rred to as an “IMA C”) inany tax matter where a foreign tax authority canestablish "tax fraud" as the term is used underSwiss law. Historically, the Swiss had consideredthe conduct underlying most U.S. criminal taxfelonies as civil in nature, and establishing "taxfraud" as the term is used under Swiss law hadbeen a c onsider ably difficu lt task. How ever, withthe adv ent of the new Inc ome T ax Trea ty withSwitzerland, the concept of tax fraud has beenexpan ded an d this ex pansion applies to requestsmade for mutual legal assistance under an IMAC.The C ayman a nd B ahamia n ML ATs g enerallyexclude offenses relating to tax laws except fortax matters arising from unlawful activitiesotherwise covered by the MLATs. Furthermore,each of th ese three tre aties conta ins spec ificlimitations on the use of evidence obtained forcovered offenses. Thus, evidence obtained forsome other offense is generally not available fortax purposes in subsequent civil or criminalinvestigations or pro ceedings.

D. Desig nation o f a Cen tral Auth ority toAdm inister the M LAT for Ea ch Trea tyPartner

Every M LAT specifies ce ntral auth orities toact on behalf of each treaty partner to makereques ts, to receive a nd ex ecute req uests, an d togenerally administer the treaty relationship. Thecentral authority designated for the United Statesis the Director, O ffice of International A ffairs(OIA), Criminal Division, U.S. Department ofJustice. 2 8 C.F .R § 0 .64-1. T he centr al autho rityfor the treaty partner is generally an entity locatedwithin the ministry of justice or its equivalentagency.

E. Matters fo r Which A ssistance IsAvailable under MLATs

Assistance is available under the MLAT oncean investigation or prosecution has been initiatedby an appropriate law enforcement or judicialauthority in the requesting state. Thus, theUnited States may initiate a request for assistanceunder an MLAT when a criminal matter is at thetrial stage, or is under inv estigation by (1) aprosecu tor, (2) a gra nd jur y, (3) an ag ency withcriminal law enforcement responsibilities, such asthe Criminal Investigation Division of the InternalRevenu e Service, or (4) an agency with regu latoryresponsibilities, such as the Securities andExchange Commission.

F. Types of Assistance Ava ilable underMLATs

Generally, MLATs provide for the followingtypes of assistance:

1. serving documents in the requestedstate;

2. locating or identifying persons oritems in the requested state;

3. taking testimony or statements frompersons in the requested state;

4. transferrin g person s in custo dy ineither state to the other for testimonyor other purp oses deeme d necessaryor useful by the requesting state;


5. providing documents, records, andarticles of evidence located in therequested state;

6. executing requests for searches andseizures in the requ ested state;

7. immobilizing assets located in therequested state;

8. assisting in proceed ings related toforfeiture and restitution; and

9. any other form of assistance notprohibited by the laws of therequested state.

MLA Ts are d esigned to override local laws inthe requested states pertaining to bank secrecy andto ensure the admissibility in proceedings in therequesting state of the evidence obtained. Thu s,for example, MLATs typically contain provisionswhich, in co njunction with certain statutes, aredirected at securing the admissibility of businessrecords, or establishing chain of custody over anevidentiary item, without having to adduce thein-court testimony of a foreign witness.

G. Procedures for Making Requests forAssistance

To make a request for assistanc e under aparticular MLAT, a prosecutor or investigatorshould contact O IA at (20 2) 514 -0000 , reques t tospeak to the attorn ey in charge of the co untryfrom which assistance will be requested, andcollaborate on preparation of the request. Once theDirector of OIA signs a request, it must betranslated into the official language of therequested state, unless the particular MLATprovides otherwise. The request will then besubmitted in both language versions (English andthe official language of the requested state) to thecentral authority of the requested state.

H. Limitations on Use of Evidence orInformation O btained

Generally, MLATs have provisions restrictingthe use of information or evidence furnishedunder their provisions, including conditions ofconfidentiality. Accordingly, the law enforcementauthoritie s of the req uesting s tate mus t complywith these restrictions in using the information or

evidence in the course of an investigation orprosecution. A lthough som e MLA Ts are morerestrictive, generally, once the information orevidence properly used in the investigation orprosecu tion bec omes a m atter of pu blic record inthe requesting state, it may be used for anypurpose.

III. Mutual Legal Assistance under ForeignStatu tes Wh ere No Form al Trea ty Rela tionsh ipNeed Exist

New a pproac hes hav e been re centlydeveloped for obtaining assistance from countrieswhether or not there is a treaty relationship. As aresult, letters rogatory issued by a court are nolonger the exclusive means of securing formallegal assistan ce outsid e an M LAT . Such requeststypically follow a format similar to that employedunder MLAT s, and are sometimes referred to as"MLA T-Type" requests. Legal assistance in thesecircumstances is provided to the extent permittedby relevan t domes tic legislation . Coun tries in thiscategory include Ireland, Japan, New Zealand,Channel Islands, Isle of Man, Liechtenstein,Switzerland, and the United Kingdom. Contact theappropriate OIA Team at (202) 514-0000 forfurther details.

IV. Obtaining Foreign Evidence under TaxInformation Exchange Agreements and TaxTreaties

A. Background

Tax in formation exchan ge agreem ents(TIEAs) and income tax treaties are also meansfor obtaining foreign-based documents andtestimony, often in admissible form, for criminaland civ il tax cases, a nd inv estigations . These pactsare concluded by the United States Department ofTreasury, with the assistance of the InternalRevenue Service and the Tax Division of theDepartment of Justice, and are administered bythe Director, International, of the IRS. For thepurposes o f obtaining foreign evidence, T IEAs aremore specialized and effective than tax treaties.

B. Tax Inform ation E xchan ge Agr eemen ts(TIEAs)

TIEA s are agreem ents wh ich spec ificallyprovide for mutu al assistanc e in crimin al and civ il


tax inve stigations a nd pro ceedings. Thisassistance comprises obtaining foreign-baseddocuments, including bank records, and testimonyin admissible form. TIEAs are statutory creaturesof the Internal Re venue C ode. See 26 U.S.C.§§ 274 (h)(6)(C) an d 927(e). T his statutoryframework initially authorized the Secretary of theTreasu ry Depa rtment to conclu de agree ments w ithcountries in the Caribbean Basin (therebyqualifying such co untries fo r certain b enefitsunder the Caribbean Basin Initiative), but laterexpan ded this authority to c onclud e TIEA s withany cou ntry.

C. TIEAs C urrently in Effect

As of March 10, 2001, the United States hadTIEAs in effect with the following coun tries:Barbados, Bermuda, Costa Rica, Dominica, theDominican Republic, Grenada, Guyana,Honduras, Jamaica, Marshall Islands, Mexico,Peru, St. Lucia, and Trinidad & Tobago.

D. Information Exchange under TaxTreaties

The U nited S tates has in come tax treaties withmore than fifty countries. There are two principalpurposes of these treaties: (1) to reduce oreliminate double taxation of income earned byresidents of either country from sources within theother country; and (2) to prevent avoidance andevasion of the income taxes of the two countriesto the treaty. To address the latter purpose, almostall U.S. income tax treaties contain a provision forexcha nging in formation , similar in c oncep t toTIEAs. The Treasury Department places greatimportance on information exchange in these taxtreaties and will not en ter into a treaty re lationshipwith any country that cannot meet the minimumstandards of information exchange.

E. Tax Treaties Currently in Effect

As of March10, 2001, the Un ited States hadincome tax treaties in force — including exchangeof information provisions — with the followingcountries: Australia, Austria, Barbados, Belgium,Bermuda, Canada, China, Cyprus, CzechRepublic, Denmark, Egypt, Estonia, Finland,France, Germany, Greece, Hungary, Iceland,India, Indonesia, Ireland, Israel, Italy, Jamaica,Japan, Kazakhstan, Korea, Latvia, Lithuania,

Luxemb ourg, Mexico, M orocco, Netherlands,New Zealand , Norway, Pakistan, Philippines,Poland, Portugal, Romania, Russia, SlovakRepublic, South Africa, Spain, Sweden,Switzerland, Thailand, Trinidad & Tobago,Tunisia, Turkey, Ukraine, the United Kingdom,and Venezuela.

F. Scope of TIEAs and Income TaxTreaties

Und er most of the TIE As and tax treaties towhich the United States is a party, requests forassistance may be made for any civil or criminaltax investigation or proceeding regarding any taxyear not barred by the statute of limitations of thestate seeking the information.

G. Desig nation o f a Co mpe tent Au thorityto Administer TIEAs and Tax Treaties forEach Treaty Pa rtner

Every TIEA and tax treaty specifiescompetent authorities to act on behalf of eachtreaty partner to make requests, to receive andexecute requests, and to administer generally thetreaty relationship. The Director, International(DI), Internal Revenue Service, has beendesignated to act as the competent authority forexchanging information under TIEAs and taxtreaties under the authority of the Secretary ofTreasury. The specific office acting under thedirection of the D I to make a nd rece ive requ estsfor information under TIEAs and income taxtreaties is the Exchange of Information Team. Thecomp etent auth ority for the trea ty partner isgenerally an entity located within the ministry offinan ce or its e quivalent agency.

H. Procedures for Making Requests ForInformation

If you wish to explore making a request forevidence or information under a TIEA or taxtreaty, call the general number for the Exchangeof Information Team ((202) 874-1624) in theOffice of the DI and ask to speak to the ExchangeAnalyst wh o is responsible for th e country wh erethe information is located. Usually, theinvestigator or prosecutor in charge of the casewill draft the initial version of the request andforward this draft to the Exchange Analyst, or theRevenue Service Representative (RSR) in charge


of the country where the information is located,for review . Subs equen tly, the requ est isformalized and sent to the foreign competentauthority for execution.

I. Confidentiality of Information O btained

All of our TIEAs, and virtually all of our taxtreaties, currently in effect contain languagerequiring that information obtained under suchagreements be used on ly for tax purposes.Obviously, such language can raise troublesomeissues for a prosecu tor conductin g a grand ju ryinvestigation directed at both tax and non-taxcrimes. Indeed , recently certain treaty partnershave resisted executing requests for informationmade in such cases based on their view that theobliga tion of confid entialit y forbid s use b y agrand jury considering non-tax crimes. T o addressthis situation, the Treasury Department and theJustice Department jointly decided to undertakeusing cautionary instructions to the grand andpetit juries in such cases.

Und er this app roach, th e prosecu tor wou ldcaution the grand jury, as the trial judge would thepetit jury, that the evidence obtained under the taxagreement could not be utilized to draw inferencesof guilt rega rding th e non-tax offenses. Thisapproa ch wou ld also req uire the tria l judge toignore the evid ence for the pu rposes of adefendant's motion to dismiss under Fed. R. Crim.P. 29.

J. Possible Problems with ExchangingInformation under TIEAs and Income TaxTreaties

Although exchanging information underTIEA s and tax treaties has b een relativ elysuccessful, there are a variety of problems whichcan arise. For example, officials of some countrieshaving civil law systems balk at executing taxtreaty reque sts in crimin al tax cases , especiallythose arisin g from gr and ju ry investigatio ns. Th ishesitancy arises from the belief that tax treaties,which they consider to be part of anadministrative governmental process, should notbe used for judicial matters. This problem can beaggravated where non-tax offenses are also underinvestigatio n, given the ever-p resent pr ovision inthese a greem ents d ealing with confid entialit y.

Also, certain cou ntries will provide treaty p artnersonly with informa tion wh ich curre ntly exists intheir tax files regardin g a given taxpayer, a nd willnot undertake to gather information from othersources, including third parties. Finally, sometreaty partne rs, even if th ey will und ertake togather in formation from sou rces other than the irtax files, will not obtain and provide financialinformation, such as bank records, because ofbank secrecy laws.

V. Using Letters Rogatory and Other JudicialProcedures to Obtain Evidence in CriminalTax Cases

A. Background

Before the advent of tax treaties, MLA Ts,TIEAs, and other types of mutual assistanceagreements, law enforcement authorities (just asprivate litigants) primarily relied u pon the lettersrogatory, or letter request, procedure to obtain theassistance of foreign a uthorities. See Fed. R.Crim. P. 15.

A letter rogatory is a formal request from acourt in which an action is pending, to a foreigncourt, to perform some judicial act. If the foreigncourt honors the request, it does so based oncomity rather than any sort of strict obligation. Asthis definition suggests, a letter rogatory canusually only be used in a proceeding which hasactually commenced, such as in thepost-indictment stages of a criminal case or thepost-complaint stages of a civil case. The route ofa letter rogatory is quite circuitous and involvesmany diverse entities in an uncoordinated proce ss.Typically, a litigant initiates the process byapplying to the court before which the particularaction is pending, for the issuance of a letterrogatory, supporting the application with a set ofcomplicated and forma listic pleadings.

Upon signature by the court, the letterrogatory m ust be tran smitted th rough diplom aticchann els, whic h involv es not on ly the U.S . StateDepartment but also the foreign ministry of thecountry involved . The foreign ministry deliversthe request to the country's ministry of justice,which in tu rn delivers it to the foreign courtoriginally contemplated to execute the letter


request. If the request is successfully executed, theeviden ce mus t retrace the p ath of the request.

B. Procedures for Obtaining Assistance byLetters Rogatory

The proc edures for utilizing the lettersrogatory process, once a prosecutor has securedthe court's leave to do so underFed. R. Crim. P. 15, are not as well defined andstandardized as those for obtaining assistanceunder MLAT s, TIEAs, and tax treaties. Forexamp le, the cha nnel for s endin g a "letter req uest"to certain countries is the State Department, asgenerally described above. However, for somecountries, such as the United Kingdom and HongKong, OIA has developed an expedited channelfor transmitting letter requests, thereby speedingup the overall process.

The form of the letter request can varyaccording to the country of destination. Thus, thebest app roach for initiating a le tter reque st is tofollow the initial phase of the MLAT procedure,namely, c ontact O IA (20 2-514 -0000 ) and ask tospeak to the attorn ey in charge of the co untryfrom w hich ass istance is so ught.

C. Problems w ith the Letters RogatoryProcess When U sed in Criminal Tax C ases

While the letter rogatory procedure is thetraditional method of obtaining assistance abroad,it is not without its flaws. For example, there is noobligation on the foreign country to honor therequest; the foreign country's enabling legislation,if any, may not provide any exceptions to thatcountry's bank secrecy laws; there may be nomutually agreed upon p rocedures w hich ensu rethe obtaining of evidence in admissible form; themultiple stages of the process, involving diverseentities, generate serious time delays; and, theprocedure may not be available at all crucialstages of a proceed ing, e.g., the investigation of acrimina l offense, w here it ma y be need ed mos t.To address these critical problems, lawenforcement authorities developed new methodsto gather foreign evidence, such as the MLAT.

In addition to the problems which afflict theletters rogatory process gen erally, prosecutorsseeking to obtain foreign ev idence through thisprocess fo r tax cases h ave faced problem s in

jurisdictions following the common law traditionof the United Kingdom (UK). The num ber ofcountrie s which follow B ritish com mon law isquite large, since both the present and formerdepen dencie s of the U nited K ingdom fall into thiscategory. For example, the Bahamas, Singapore,the Caym an Island s, and H ong K ong follo w thislegal preceden t. The prob lems, which areoccurring less frequently as a result of a decisionof the UK House of Lords (see discussionimme diately infra), are related to the internationalrule of comity that one nation will not directly orindirectly enforce the revenue laws of anothernation.

In its most basic form, the rule is that thecourts of one country will not enforce a judgmentfor taxes issued by th e cour t of ano ther co untry.Her Majesty, Queen in Right, Etc. v. Gilbertson,597 F .2d 11 61 (9th Cir. 19 79). T he rule se ems tohave orig inated in two opin ions of Lo rd Ma nsfieldin 1775 and 177 9. Gilbertson, 597 F.2d at 1164. However, the modern basis of the rule seems to bethe House of Lords' decision in Government ofIndia v. Taylor, [1955] 2 W.L.R. 303 (cited in Inre State of Norway's Application, [1987] 1 Q.B.433, 4 45-46 (C.A.) ; R. v. Chief MetropolitanStipen diary M agistra te, [1988] 1 W.L.R. at 1207,1214-15; and United States v. F irst Natio nal CityBank, 379 U .S. 378, 3 95-96 & n.16 (19 65)).While most common law jurisdictions, includingthe United States, seem to acce pt this basic formof the rule witho ut dispute (S ee, e.g., First Nat'lCity Bank, 379 U.S. at 396 (Harlan, J., dissentingon othe r groun ds); Gilbertson, 597 F.2d at1163-66), its application beyond this realm hasvaried.

In R. v. Chief Metropo litan StipendiaryMag istrate , [1988] 1 W.L.R. at 1207, 1214-15,the En glish Co urt disting uished permiss ibleextradition of a Norwegian national for tax-relatedcharges from impermissible assistance in therecovery of ta xes for a fo reign state. W hereas, inIn re State of Norway's Application, [1987] 1 Q.B.at 448, the En glish Co urt of Ap peal (wh ich wou ldlater be reverse d) app lied the rule m ore bro adly,stating that providing evidence to another state forits civil determination of a tax liability is theenforcement, albeit indirect, of that state's revenuelaws. On the other hand, in Re Request for


International Judicial Assistance, [1979] 102D.L.R.3d 18, 38, the Canadian Cou rt rejectedbroader application of the rule and stated thatgranting assistance to the United States in acriminal tax case is not tantamount to thecollection of taxes for that state.

Until the decision was overturned, there wasserious fallout from the decision of the UnitedKingdom Court of Appeal in In re State ofNorway's Application, where that Court construedthe rule to operate in the broader sense. Thus, theUnited Kingdom and the comm on law countrieswhich follow its legal precedent were rejecting theletter rogatory requests of U.S. tax authoritiesbased on the dicta in that decision. Fortunately forU.S. prosecutors seeking foreign evidence in taxcases, the House of Lords, the highest court of theUnited Kingd om, reve rsed the C ourt of A ppeal inIn re State of Norway's Application, [1989] 1 A.C.723 (con solidated app eals and cross ap peals),holding that simply providing evidence to anotherstate for that state to use to enforce its revenuelaws does not constitute the direct or indirectenforcem ent of an other state's rev enue law s. Thisdecision has dramatically enhanced mutualassistance from countries following EnglishCommo n Law in civil and criminal tax cases,especially between governmental authorities.

VI. U sing C ompulso ry M easures to O btainForeign Evidence

A. Background

The United States tax authorities do notalways have an effective mutual assistance meansavailable to them for obtaining evidence abroad.For example, in a "pure tax" case involvingevidence in the Cayman Islands or the Bahamas,United States au thorities can not use a tax treaty(no such agreement is in effect with suchjurisdictions), and the current MLA Ts with thesecountries exclude assistance for pure fiscalmatters. T hus, the United States m ay have toresort to un ilateral action , such as a subp oena, toobtain the needed evidence. While there are otherunilateral measu res, the two princ ipal method s arethe use of subpoenas or summonses to obtain theevidence d irectly, and the use of d isclosuredirectives.

B. The Use of S ubpo enas or S umm onses toObta in For eign E viden ce Directly

One form of process used by governmentattorneys to obtain evidence abroad is thesubpoena power applied directly to adomestically-based entity having somerelationship to the foreign-based entity holdingthe records. See, e.g., Matter of Marc Rich& Co. A.G. v. United States, 707 F.2d 663(2nd Cir. 1983), later proceeding, 731 F.2d 1032(1984), later p roceeding, 7 36 F.2d 864 (19 84),later proceeding , 739 F.2 d 834 (1 984);United States v. Vetco, Inc., 691 F.2d 1281(1981 ); United States v. Toyota Motor Corp., 561F.Supp. 354, 355-56, 358 (C.D. Cal. 1983), laterproceed ing, 56 9 F. Su pp. 11 58 (19 83); In ReGrand Jury Proceedings (Bank of Nova Scotia),722 F.2 d 657 (1 1th Cir. 19 83), appeal followingremand, 740 F .2d 81 7 (198 4); In Re Gran d JuryProceedings (Bank of Nova Scotia), 691 F.2d1384 (1 1th Cir. 19 82).

If a Department of Justice attorney or anAssistant United States Attorney wants to use agrand j ury or crim inal trial sub poena to obtainevidence located in a foreign country, theprosecutor must obtain the concurrence of theOIA, Criminal Division, before both issuing andenforcing such subp oena. United States Attorneys'Manual (USAM) 9-13.525. In determiningwhether to co ncur in such actions, OIA considersthe following factors: (1) the availability ofalternative methods for obtaining the records in atimely manner, such as use of mutual assistancetreaties, tax treaties or letters rogatory; (2) theindispensability of the records to the success ofthe investigation or prosecution; and (3) the needto protect against the destruction of recordslocated abroad and to protect the Un ited States'ability to prosecute for contempt or obstruction ofjustice for such destruction. Once the concurrenceof OIA to issue and enforce a subpoena forforeign records has been obtained, the prosecutorwill then be requ ired to ple ad a so-calle d comityanalysis (assuming that there has not beencompliance with the subpoena) and theenforcement court will be required to balance thecomity factors in favor of th e governm ent beforethe subpo ena can be properly enforced . SeeSection 442(1)(c) of the Restatement (Third) of


Foreign Relations Law of the United States(1987). See also Societe N ationa le Indu strielleAerospatiale v. United S tates District Court,482 U .S. 522 , 543-4 4 & n. 2 8 (198 7); RichmarkCorp . v. Timb er Fallin g Co nsultan ts, 959 F.2d1468, 1 474-79 (9th Cir. 19 92).

C. The Use of C omp elled Directiv es toObtain Disclosure of Financial M attersCovered by Foreign Secrecy Laws

Prosecutors can obtain court orders compelling anaccount holder to direct a foreign bank or otherinstitution to disclose to th e prosecutor m attersprotected by foreign financial secrecy laws. See,e.g., Doe v. United States, 487 U .S. 201 (1 988);United States v. D avis , 767 F.2 d 1025 (2d Cir.1985 ); In Re Gran d Jury Proceedin gs, WesternDistrict of Louisiana (Juan A. Cid), 767 F.2d1131 (5th C ir. 1985 ); United States v. Ghidoni,732 F.2 d 814 (1 1th Cir. 19 84). But see In ReGrand Jury Proceedings, 814 F.2 d 791 (1 st Cir.1987 ); In Re ABC Ltd., 1984 CILR 130 (GrandCourt o f the Caym an Island s, 1984 ); Garpeg, Ltd.v. United States, 583 F. Supp. 789, 799 (S.D.N.Y.1984). The Supreme C ourt has ruled that an orderdirecting an account holder to sign ahypothetically-framed disclosure directive doesnot violate his Fifth Amendm ent privilege againstself-incrimination. Doe v. United States, 487 U.S.at 206-18.

Foreign courts ha ve had mixed reactions tothese directives. A court of the Ca yman Islands, adependency of the United Kingdom, has held thatsuch directives do not constitute voluntary andfreely given consent for disclosure as requiredunder the se crecy laws of that jurisd iction. In ReABC Ltd., 1984 C ILR 130 , 134-35 (Grand C ourtof the Cayman Islands, 1984). For other countrieswhich do not have such stringent secrecy statutesand wh ich follow the B ritish commo n law, thereis authority that such disclosure directives doconstitute valid consent under the common lawduty of a banker to keep the financial affairs of anaccount ho lder confiden tial. Tournier v. NationalProvincial & Union Bank of England, 1 K.B. 461(C.A. 19 24).

Prosecutors have enjoyed widesp read successin using compelled disclosu re directive s to obtainfinancial records from most countries, and,

indeed, have used voluntary disclosure directivesto gather financial rec ords from virtua lly everycountry. T he use o f disclosu re directive s ispreferred over the use of compulsory processdirected against U.S.-based branches or offices offinancial institutions to obtain financial recordslocated abroad , because usin g disclosuredirectives in volves n o real jurisd ictional co nflicts(except when seeking evidence in countries likethe Cayman Islands) and lessens the inclination ofmost foreign countries to block production of theevidence.

D. Jurisdictional Conflicts Arising from theUse of Certain Unilateral Measu res

The use of certain of these unilateralmeasu res, espec ially the sub poena s on dom esticfinancia l institution s for foreign -based re cords, iscontroversial and often leads to protractedlitigation w hich fails to secure th e intend ed result.Indeed, these jurisdictional controversies led theJustice Department to adopt USAM 9-13.525,which requires the conc urrence of OIA for boththe issuance and enforcement of such subpoenasin Department criminal matters. When U.S.authorities resort to the enforcement of suchmeasures, they often encounter strong oppositionfrom many different quarters. For example, thefinancia l institution s served w ith proce ss typicallyresist strenuously and raise every possible issue,including the bedrock of their position, thejurisdictional conflict between the laws of the twocountries involved. Even when these institutionssuffer an adverse decision of the U.S. courts, theyoften choose to be subject to sizeable contemptsanctions rather than produce the subpoenaed orsummo nsed record s. See, e.g., In re Grand Ju ryProceedings (Bank of Nova Scotia), 691 F.2d1384 (11th Cir. 1982). Officials of foreignjurisdictions also object to the use of thesemeasu res, by instru cting their foreign m inistries tocomplain to the U.S. State Department, enteringamicus appearances in the protracted litigation,and sometimes directing their own lawenforcement authorities to take blockingmeasures, which may include the seizure of theforeign-based re cords to thwart p roduction. See,e.g., In re Marc Rich & Co., A.G. v. United States,707 F.2d 663 (2d C ir. 198 3). N eedless to say,production of the evidence sought by the use of


these unilateral measures is not a foregoneconclusion.

At all events, as mentioned above, before aBank of Nov a Sco tia-type subpoena can beauthorized by the Criminal Division (see USAM13.525 ) or enforced b y a district court, aprosecutor will need to establish that noalternative methods exist for obtaining the foreignrecords so ught.

VII. Conclusion

New la w enfor cemen t treaties and agreem entsare continually being negotiated and concluded bythe va rious re spon sible au thoritie s. Acc ordin gly,new means for obtaining foreign evidence mayappear on the horizon following publication ofthis analysis. For further details regarding thematters set fo rth herein , or for dev elopmentsfollowing pu blication, contact Ja mes P. Sp ringer,Senior Counsel for International Tax Matters, TaxDivision, Department of Justice, at (202) 514-2427.�

ABOUT THE AUTHOR

�James P. Spring er has served as the SeniorCounsel for International Tax Matters in the TaxDivision of the Department of Justice since 1985.He previously served as a trial attorney in the TaxDivision from 1975 to 1985, both as a prosecutorand as an appellate attorney. He is the author ofHouse of Lo rds Clears Way for U se of LettersRogatory and Hague Evidence Convention in TaxCases, 5 I.E.L.R. 180 (1989), and An Overview ofInterna tional E vidence and Asset G atherin g inCivil and Criminal Tax Cases , 22 Geo. Wash. J.Int'l & Econ. 27 7 (1988 ).a

Character Evidence in Tax (and Other)CasesRobe rt MiskellAssistant United States AttorneyDistrict of Arizona

“Much of this law [of character evidence] isarchaic , parado xical and full o fcompromises and compensations by whichan irrational advantage to one side is offsetby a poorly reasoned counter-privilege tothe other.”

Michelson v. United States, 335 U.S. 469, 486(1948).

“The modern rules governing theadmiss ibility of character evidence at trialare counterintuitive and enigmatic vestigesof an ancien t time . . . .”

United States v. Monteleone, 77 F.3d 1086,1089 (8th Cir. 1996 ).

Tax cheats an d other w hite collar cr iminalsgenerally portray themselves as indiv iduals of“good character.” The prosecution of suchindivid uals freq uently involves the introduction, bythe defense, of a parade of charac ter witnes ses. Th isarticle addresses what c haracter e videnc e isadmissible, as well as what actions may be taken bythe prosecutor in response to such evidence.

I. Limitations on Wh at Character Evidence aDefendant C an Introduce

A. Limita tion on T ype of Chara cter Traits

Under Federal Rule of Ev idence 40 4(a)(1), adefendant may elect to offer evidence of “apertinent trait of character.” If a defend ant offerssuch evidence, the prosecution may offer evidence“to rebut the sam e.” Fed. R . Evid. 404 (a).

In attempting to limit a defendant’s introductionof character evidence, the first issue to consid er is


whether the propos ed evid ence is “pertinent” to thecrimes charged in th e indictmen t. In Rule 40 4(a)(1),“pertin ent” is “read as synonym ous with ‘relevant.’”United States v. Angelini, 678 F.2d 3 80, 381 (1stCir. 1982 ).

The pertinen ce of a par ticular cha racter traitmay depend on the crime charged. For example,when the defendant does not testify, the defendant’scharacter for truthfulness would be pertinent in aprosecution for a crime involving deceit orfalsification. United States v. Darland, 626 F.2d1235, 1237 (5th Cir. 1980). Such character evidencewould not be relevant, however, in a prosecution fora drug offense. United States v. Jackson, 588 F.2d1046, 1055 (5 th Cir. 197 9). Of course , if thedefendant testifies, his character for truthfulnesswould be pertinent regardless of the crime charged.Darland, 626 F.2d at 1237.

Frequently, defendants will attempt to introduce“good” character traits that are not re levant to thecrimes charged. Generally, the courts haverecognized that such evidence is not admissible. Forexample, the First Circuit has held that the traits ofbravery, attention to duties as a police officer, andcomm unity spirit were not relevant in theprosecution of a police officer for con spiracy tocomm it mail fraud and perjury. United States v.Nazzaro , 889 F.2d 1158, 1168 (1st Cir. 198 9).Simil arly, the District of Colum bia Circ uit has held,in a drug prosecution of corrupt police officers, thata defendant’s “dedication, aggressiveness andassertiveness” in investigating drug dealing andcarjacking was not “pertinent” under Fed. R. Evid.404(a)(1). United States v. Washington, 106 F.3d983, 999 (D .C. Cir. 199 7). See United States v.Scho ll, 166 F.3d 964, 975 (9th Cir. 1999) (in aprosecution of state judge for filing false tax returns,defense counsel’s question to a character witnessabout whether defendant was doing his job wasirrelevant).

The First Circuit also has recognized that thetrait of being a good fa mily man was no t relevant ina prosecution for criminal violations of theimmigration laws. United States v. Santana-Camacho, 931 F.2 d 966, 9 68 (1st Cir. 1 991).Likewise, evidence that the defendant's son sufferedfrom cerebral palsy and that the defendant wouldnever do anything to risk disabling himself from

caring for the boy properly was not relevant in aRICO prosecution. United States v. Paccione, 949F.2d 11 83, 120 1 (2d C ir. 1991).

On the other hand , courts have held thatevidence of the general character trait of “lawabidingness” is pertinen t no matte r what crim e ischarged in the indictm ent. Angelini, 678 F.2d at381-82; United States v. H ewitt , 634 F.2d 277, 279-80 (5th C ir. 1981 ); United States v. Diaz, 961 F.2d1417, 1419 (9th Cir. 1992) (equatin g “pron eness tocriminal activity” with “la w abiding ness”).

A defend ant, how ever, is no t allowed tonarrow ly define the pertinent character trait in amanner that wou ld be mislead ing. For examp le, inDiaz, 961 F .2d at 14 19, the defend ant attem pted tointroduce evidence of his “p ropens ity to engage inlarge scale drug dealing.” Th e Ninth Circuit h eldthat the distr ict court did not err in excluding suchevidence becau se “[s]u ch an inqu iry would bemisleading if address ed to a defend ant with a recordof crimin al offen ses oth er than drug dealin g: Ifanswered in the negative, the impression may begiven that the defendant is a law-abiding personeven though he has a record of other crimes.” Id.

B. Limitation on How a Defendant CanProve Good Character

A second issue to con sider in atte mpting to limita defendant’s introduction of charac ter eviden ce iswhether the defendant is using the proper method ofproving character. The manner in which adefend ant's character may be proved is controlledby Fed. R. E vid. 405. Under Rule 405, thedefendant generally can prov e character only byreputation and opinion evidence. A defendant mayintroduce specific instances of conduct only in caseswhere character or trait of character “is an essentialelement of a charge, claim, or defense.” Fed. R.Evid. 405(b). As the Advisory Committee Notesexplain (Fed. R. Evid. 405 Advisory CommitteeNotes (19 72)):

the rule confines the use ofevidence of [specific instances ofcondu ct] to cases in whichcharacter is, in the strict sense, inissue and hence deserving of asearching inquiry. When characteris used circumstantially and hence


occupies a lesser status in the case,proof may be only by reputationand opinion.

Rule 405(b)’s “permissive use of evidence ofspecific acts is regula rly misinte rpreted by triallawyers. It is allowed only wh en char acter itself isan issue un der sub stantive law.” United States v.Doyle , 130 F.3d 523, 542 (2d Cir. 1997) (quoting J.Weinstein, M. Berg er & J. McLau ghlin, 2Weinstein’s Federal Evidence § 405.0 5[4] (199 7)).An example of a case in which specific acts areadmiss ible is where an employer is being sued forretaining, as a taxi driver, a known alcoholic with anextensive accident record. In such a case, thedriver’s character is directly at issue, and evidenceof specific acts – the prior accidents – may beintroduced . Id.

In a criminal case, the Nin th Circuit hasconcluded that when the defendant raises anentrapment defense, a defendant may introducespecific acts of good conduct to attempt to showthat he was not predisposed to commit the crime.United States v. Thomas, 134 F .3d 97 5, 980 (9thCir. 1998). The Court reasoned that to findpredisposition beyond a reason able doub t, the jurywas required to con sider the defen dant’s chara cter,thus making his character an “essential element.” Id.

In most cases, how ever, Rule 4 05 precludes adefendant from introducing specific acts to attemptto establish good character. Specific good deedscannot be introduced by a defendant to disproveknowledge or intent elements of crimes. Doyle , 130F.3d at 542; United States v. Ma rrero, 904 F.2d251, 26 0 (5th Cir. 1 990).

For examp le, in a drug prosecution, thedefendant attempte d to introduce, to negate criminalintent, evidence that he had turned down an offer tobecome involved in another dru g smugglin g ventureand repeatedly advised the smuggler who made theoffer of the dam age the sm uggler w as doing tosociety. The Eleventh Circuit held that the districtcourt properly exclud ed the ev idence unde r Rule405(b): “Evidence of good conduct is notadmiss ible to negate crimina l intent. . . . [Thewitn ess's ] proffered testimony was merely anattempt to portray [the defendant] as a goodcharacter through the use of prior ‘good acts.’ Thetrial judge p roperly ex ercised h is discretion in

excluding this testimony as inadmissible characterevidence.” United States v. C amejo , 929 F.2d 610,612-13 (11th Cir. 1 991) (citations o mitted).Simil arly, in United States v. H ill, 40 F.3d 164, 169(7th Cir. 1994), the court concluded, in a caseinvolving theft of m ail by a postal employee, thatthe defendant’s failure to steal “test letters” was notadmissible p ursuant to R ule 405(b ).

C. Limitation On the Num ber of CharacterWitnesses

The third issue to consider in attemp ting to limitcharacter eviden ce is to attempt to limit the numberof such witne sses. The trial court has discretion tolimit the number of character witnesse s. Michelsonv. United States, 335 U.S. 4 69, 480 (1948).App ellate courts have found no error when a trialcourt has limited the n umber of a defenda nt'scharacter witnesses. United States v. S choll , 166F.3d at 972 (three w itnesses); United States v.Johnson, 730 F.2d 683, 688 (11th Cir. 1984) (threewitnesses); United States v. Koessel, 706 F.2d 271,275 (8th Cir. 1983) (three witn esses); United Statesv. Henry , 560 F.2d 963, 965 (9th Cir. 1977) (twowitnesse s). The fa ctor to conside r is the cumulativenature of the character evidence. Scho ll, 166 F.3d at972.

II. The Prosecutor’s Response to Defendant’sIntroduction of Cha racter Evidence

A. Cross Examination of CharacterWitnesses

1. Bias, Prejudice and Knowledge

One method of attacking character witnesses isto question them about their relationship with thedefend ant. If the witness is too close to thedefend ant, such as his mother, the suggestion is thatthe witness’s opinion and testimony should bediscounted because of the overly close relationship.On the other han d, if the witness is n ot particu larlyclose to defen dant, th e sugges tion is that thewitness’s opinion and testimony should bediscounted because the witnesses do not really knowthe defendant. Moreover, you can usually get thecharacter witness to admit that nobody can knoweverything about another individual’s life.

2. “Guilt Assuming” Hypothetical QuestionsAre Not Allowed


A prosecu tor shou ld not ask a defense characterwitness whether, assuming the defendant hadcommitted the act ch arged in the indic tment, h istestimony regardin g the def endan t’s charac ter wouldchange. Virtually every court that has consideredthe issue has concluded that “guilt-assuming”hypothetical questions are improper. United Statesv. Guzman, 167 F.3d 1350, 1352 (11th Cir. 1999);United States v. Mason, 993 F.2d 406, 408-09 (4thCir.1993 ); United States v. Oshatz , 912 F.2d 534,539 (2d C ir.1990 ); United States v. Barta , 888 F.2d1220, 1224-2 5 (8th Cir.1 989); United States v.Page, 808 F.2d 72 3, 731 (1 0th Cir. 19 87);United States v. McGuire , 744 F.2d 1197, 1204 (6thCir.1984 ); United States v. Williams, 738 F.2d 172,1 7 7 ( 7 th Cir .1984 ); Uni ted S ta tes v .Candelaria-Gonzalez , 547 F.2d 291, 294-9 5 (5thCir.1977 ). The prim ary reasoning of th ese cases isthat such guilt-assuming hypothetical questionscreate too great a risk of impairing the presumptionof innocenc e. E.g., O shatz , 912 F.2d at 539.

The District of Columbia Circuit appears toallow guilt-assum ing hypo thetical qu estions tocharacter witnesses who provided their opinion of adefendant’s character. United States v. W hite, 887F.2d 267, 274-75 (D.C. Cir. 1989). The Court statedthat the “[c]ross-examination of witnesses whotestify only to the defend ant’s com mun ity reputationwith hypotheticals assuming guilt may beimproper.” Id. at 274. The Court concluded,however, that similar cross-examination ofwitnesses who give their opinion of the defendant’scharacter is not error. Id. at 274-75.

Some courts have made a distinction betweenguilt-assuming hypothetical questions and questionsthat simply ask the character witness to interpretconduct of the defendant that the defendantconcedes happened. In United States v. Velasquez,980 F.2d 1275, 1277 (9th Cir. 1992), the defensecounsel concede d that the defend ant, cha rged withbank robbery, had entered a bank and displayed ahand grenade, but claimed the defendant did notintend to rob the ban k. During the cross-examination of defendant’s character witnesses, theprosecutor asked th e charac ter witnes ses how theiropinion that defen dant w as not violent would beeffected by the fact th at defendant had displayed ahand grenade in the bank. The Ninth Circuitconcluded that the district court d id not ab use its

discretion in allowing tho se questions. T he courtreasoned that the prosecutor did not ask thewitnesses to assume anything about the defe nda nt'sintent, but rath er only aske d the w itnesses tointerpret the acts that defense counsel had concededin his opening statement had occurred. Id. Simila rly,in United States v. Wilson, 983 F.2d 221, 223 -24(11th Cir. 1993), the defendant admitted sellingcredit card numbers to an undercover agent, butdenied having any fraud ulent inte nt. The Eleven thCircuit concluded that allowing questions of thecharacter witnesses about this admitted transactionwas not an abuse of discretion. The court concludedthat the questions, which did not mention thedefendant’s intent, did nothing more than ask aboutan event that defendant had admitted. Id. at 224-25.

3. Cross-E xamin ation ab out Specific Instancesof Conduct

On the cross-examination of characterwitnesses, the prosecutor is allowed to ask about“relevant specific in stances of conduct.” Fed. R.Evid. 405(a). The Supreme Court has explained thebasis for allowing such questioning:

Another hazard is that [thedefendant’s] own [chara cter]witness is subject to cross-examination as to the contents andextent of the hearsay on which hebases his conclusions, and he maybe required to disclose rumors andreports that are current even if theydo not affect his own conclusion . Itmay test the suff iciency of h isknowledge by asking what s torieswere circulating concerning events,such as one’s arrest, about whichpeople normally comment andspeculate. Thus, while the lawgives defendant the option to showas a fact that his repu tation reflec tsa life and h abit incom patible w ithcommission of the offense charged,it subjects his proof to tests ofcredibility designe d to prev ent himfrom profiting by a mere parade ofpartisans.

Michelson v. United States, 335 U.S. 469, 479(1948) (foo tnote omitted).


In cross-examining a character witnessregarding specific acts of misconduct, theprosecutor is attempting to attack the witness’scredibility in two ways. First, to the extent thewitness is not aware of the prior act, the suggestioncan be mad e that the c haracter w itness’s testimonyis of little value because he is not familiar enoughwith the defendant’s actions. Second, to the extentthat the witness claims that knowledge of the prioract does not change his testimony regarding thedefendant’s character, the suggestion is that thecriteria that the witness uses to judge an individual’scharacter are not credible. The Supreme Court citesas a classic ex ample o f the latter the cross-examination of a character witness in a murderprosecution. Michelson, 335 U.S. at 479 n.16. Thewitness, who te stified that the defendant had areputation for peace and quiet, was asked on cross-examination if she had heard that the defendant hadshot anybody. She replied that the defendant hadshot three or four people, provided the names of twovictims, and said she could not remember the namesof the other victims. Despite this knowledge, sheinsisted that the defendant was of “good character.”As the Supreme Co urt noted , the jury ap parently“valued her information more highly than herjudgm ent,” and con victed the defen dant. Id.

Thus, to achieve the goal of demonstrating thatthe character witness either lacks knowledge or haspoor standards for judging credibility, theprosecutor is allowed to ask cha racter witnessesabout the defendant’s prior arrests, even arrests thatdo not result in conviction . E.g., Michelson, 335U.S. at 482 (“character witness may be cross-examined as to an arrest whether or not itculminated in a conv iction, according to theoverwhelming weight o f authority” ); United Statesv. Wellon, 32 F.3d 117, 120 n.3 (4th C ir. 1994);United States v. Grady, 665 F. 2 d 831, 8 35 (8th C ir.1981); United States v. Bermudez, 526 F.2d 89, 95(2d Cir.19 75); United States v. Cummings, 468 F.2d274, 28 1 (9th Cir. 1 972).

The specific acts of misconduct that a characterwitness may be cross-examined about are notlimited to prior arrests. For example, in theprosecution of a state court judge for filing false taxreturns, the Nin th Circu it decided that it was notimproper for the pro secutor to ask the ch aracterwitnesses about: (1) an undisclosed loan that the

judge had accepted from an attorney who had a casepending before the judge, and (2) a complaintbrought by the Commission on Judicial Conductwhich alleged that the defendan t had filed a falsestate financial disclosure form. Scho ll, 166 F.3d at974-75.

Often, material for the cross-examination ofcharacter witnesse s can be found in civil laws uitsinvo lv ing defendan t; proceedin gs beforeadministrative agencies, such as the Securities andExchange Comm ission; an d the files o f stateagencies that may reg ulate the defendant’s businessor profession. At least one court has indicated thata character witness should not be asked about otherproceedings that involve the same alleged conductas the criminal prosecution. In United States v.Bush, 58 F.3d 482, 489 (9th Cir. 1995), theprosecutor asked whether the character witness hadheard that a civil RICO suit had been filed againstthe defendant. Although not clear from the phrasingof the prosecutor's question, the civil RICO actionactually involved the same conduct for whichdefendant was on trial. Id. The Ninth Circuitconcluded that the district court com mitted error,albeit harm less , in a llow ing the p rosecuto r'squestion, because the question suggested that theRICO charges represented a separate incident ofmisconduct somewhere in the defendant's past,which w as a false inference. Id. at 489-90.

Another potential problem area withquestioning a character witness a bout sp ecific actsof conduct may arise when the character witnesstestifies only abou t the de fendant’s r eputa tion. InUnited States v. Monteleone, 77 F.3d 1086, 1089(8th Cir. 19 96), the Eighth Circuit conclu ded tha t itwas improper to question a character witness, whohad testified only to the defendant’s reputation,about alleged p erjured statemen ts the defendant hadmade before the grand jury. The court explainedthat the reasons for allowing a “reputation witness”to be questioned abou t specific acts is to test thereliability and credibility of the reputation witness.Id. at 109 0. Ac cordin gly, the court reasoned that theprosecutor must possess a good faith belief that thedescribed events are of a type likely to have becomea matter of gen eral kn owled ge in th e com mun ity. Id.The court noted th at because of grand jury secrecyrules, it is unlikely that the defendant’s allegedperjury wou ld be know n in the com munity. Id.


The Sixth Circuit has re ached the opp ositeconclusion. In United States v. Frost, 914 F.2d 756,772 (6th Cir. 1990), defendant argued that becausehe “presented character evidence by way ofreputation evidence ra ther than opinion evidence,the only acts permitted to be mentioned in cross-examination ques tions a re thos e acts lik ely to havebeen known in the community.” Id. The S ixthCircuit rejected that argument, noting that such across-examination is “a textbook application of Fed.R. Evid. 405(a).” Id.

The cross-examina tion of character witnesseswho testify as to their opinion about the defendantis not limited to specific a cts of miscondu ct likely tobe known in the com mun ity. That is, the act wo uldbe relevant to the witness’s opinion, regardless ofwhether the act w as well know n in th e com mun ity.United States v. Bruguier, 161 F.3d 1145, 1149-50(8th Cir. 19 98); Scho ll, 166 F.3d at 975(“knowledge in the community” was not a “materialpredicate” to cross-examination of character witnesswho testified to his o pinion).

On occasion, a defendant may quibble with thephrasing of cross-examination questions, citingMichelson, 335 U .S. at 48 2. In that c ase, theSupreme Court stated that in cross-examining acharacter witness who testified as to reputation, “theform of inquiry, ‘H ave you heard?’ has generalapproval, and ‘Do you know?’ is not allowed.” Id.Courts have indicated , however, that either form ofquestion is appropriate in light of Federal Rule ofEvidence 405. Government of the Virgin Islands v.Roldan, 612 F.2d 775, 780 (3d Cir. 1979) (citingFed. R. Evid. 405 Advisory Committee Notes(1972)); Scho ll, 166 F.3d at 974 (same). TheAdvisory Committee Notes to Rule 405 state that“these distinctions [in the form of the questions] areof slight if any practical significance, and the secondsentence of subdivision (a) eliminates them as afactor in formulatin g questions.”

Prior to cross-examining a character witnessabout any specific acts, the prosecutor mustestablish that the acts are relevant to the charactertrait at issue and that he has a good faith basis forthe question. Monteleone, 77 F.3d at 1089-90;United States v. West, 58 F.3d 133, 14 1 (5th Cir.1995); United States v. Smith , 26 F.3d 739, 755 (7 th

Cir. 1994 ); United States v. A dair , 951 F.2d 316,319 (11 th Cir. 199 2).

Moreove r, when a characte r witness is cross-examined about specific instances of miscon duct,the defend ant is entitled to a limiting instructio n tothe jury. Roldan, 612 F .2d at 78 1; see O’M alley,Grenig, & Lee, Federal Jury Practice andInstructions § 11.15 (5th ed. 20 00).

The sp ecific acts of conduct which defendant’scharacter witnesses are questioned about on cross-examination, however, cannot be proven byextrinsic evidence unless it is an essential elementof the charge. Fed. R. Evid. 405(b ); United States v.Bened etto, 571 F.2d 1246, 1250 (2nd Cir. 1978)(“while a character witness may be asked on cross-examination about ‘specific instan ces of condu ct,’such acts may not b e proved by extrins icevidence”).

B. Rebuttal Witnesses

Once a defendant has produced characterwitnesses and placed his character in issue, theprosecutor also is entitled to call witnesses to testifyabout defendant’s bad character. United States v.Murphy, 768 F.2d 1518, 1 535 (7th Cir. 1985 ). Suchwitnesses generally are limited, by Rule 405( a), toopinion and repu tation testimony. United States v.Reese, 568 F.2 d 1246 , 1251 (6 th Cir. 197 7).

III. Practical A spects

One may ask, “what does all this have to dowith tax prosecutions?” The an swer is that in taxprosecutions, it is very likely that th e defen se willattempt to introduce character evidence. Theprosecutor in a tax case should be as comfortab lewith the rules regarding character evidence as he orshe is with the rules governing the admissibility ofdocum entary evidence. Moreover, in the close case,being able to limit defendant’s character evidence,or effectively attack such evidence through cross-examination, could make the difference between aguilty verd ict and an acquittal.

One advantage that a prosecutor in a taxprosecution has is that the Special Agents of theInternal Revenue Service u sually do a good job ofdiscovering facts that may form the basis for cross-examination questions for character witnesses. Thisinformation generally is contained in the sections of


the Specia l Agen t’s Rep ort entitled "Repu tation inthe Community, Criminal Actions, and BusinessHistory."

Once it appears that a defendant will introducecharacter evidence, motions in limine are usefulboth to limit the d efense to in troducin g pertinentcharacter traits, and to advise th e court of p ossibleareas of cross-ex aminatio n. Such motion s serve toremind the judge about the law regarding characterevidence. �

ABOUT THE AUTHOR

�Bob Miske ll spent his formative years as a trialattorney (1984-1990) in the Criminal Section of theTax Division, United States Department of Justice.Since 1990, he has been an Assistant United StatesAttorney in Tucson, Arizona.a

Holding the Defendant Responsible forthe Loss in a Criminal Tax Prosecution:Is Restitution the Answer?Mitchell J. BallwegAssistant ChiefWestern Criminal Enforcement SectionTax DivisionDepartment of Justice

Karen QuesnelSenior Appellate AttorneyCriminal Appeals & Tax Enforcement PolicySectionTax DivisionDepartment of Justice

I. Introduction

Nearly every criminal tax prosecution relieson the basic premise that the Internal RevenueService was harmed in its ability to perform abasic function - its ability to assess and collect thecorrect amount of taxes owed. This underlyingconcept invades nearly all aspects of our criminalprosecutions, including our selection of criminaltax cases for prosecution (which cases promote ageneral deterren t effect, thus enha ncing volun tarycompliance), our ability to establish the falsity ofa tax return (the provisions of the InternalReven ue Co de that req uire the tra nsaction s inissue to be reported), our proof that a defendantacted willfully (the primary motivation was greed,

i.e., the defendant decided not to pay taxes thatwere owed), and even, ultimately, the court’sdetermination of the appropriate sentence afterconviction (the base offense level is determinedby the amount of the tax loss per United StatesSentencin g Guide lines (U.S.S .G.) § 2T 1.1).

Given the considerable overlap betweencriminal tax prosecutions and the InternalRevenue Service’s d uty to collect income taxes,we, as pr osecuto rs, may ask w hether w e can he lpensure payment of some of the taxes due andowing by the de fendan ts. At first, a se eming lysimple solution would be to includ e a broad clausein a plea agreement requiring the defendant to paya fixed d ollar amo unt to reso lve all of her or histax liabilities. For the reasons discussed below,these so-ca lled “glob al settlemen ts” are rarelyapproved by the Tax Division.

A second common m ethod is for a pleaagreement to include a clause requiring thedefendant to cooperate fully with the InternalRevenue Service to determine the correct amountof tax that is due an d to pay that amo unt. Adistrict court will sometimes include a similarprovision as a special condition of probation orsupervised release, either on its own or at therequest of the go vernmen t. Some cou rts, however,decline to include such a condition at sentencing,stating that the Internal Revenue Service already


is armed with a statu tory schem e design ed toascertain and collect the correct amount of taxowed b y the defen dant.

Thus, it wo uld seem th at there is a need for adifferent s olution, o ne that req uires a de fendan t topay some of the taxes owed, meets the approval ofthe Tax Division, and calls for minimalinvolvement by the court. Is restitution theanswer? While not the perfect solution forresolving the defendant's tax liabilities as part ofthe criminal tax prosecution, an appropriate orderof restitution to the Internal Revenue Service aspart of the criminal sentence allows the InternalRevenue Service to recover at least some of thelost tax reve nue, w ithout jeo pardizin g its ability topursue civil remedies of any matters that were notgermane to the prosecution. In addition, seekingan order of restitution does not require TaxDivision ap proval and, h opefully, will requireonly minimal involvement of the court aftersentencing. This article briefly notes the problemswith global settlements in tax cases, describes ourcurrent restitution scheme, and then addresses thespecifics of restitution in criminal tax cases.

II. Globa l Settlemen ts

It is not unusual for a defendant to approachthe prosecutor, whether an Assistant United StatesAttorney or Tax Division trial attorney, andattempt to convin ce her or h im that it is ineveryone’s best interest to wrap-up the criminalcase and civil tax liability into one package dealwith a guilty plea and payment of an agreed-uponamount to the Internal Revenue Service. An offerto pay a large amoun t of additio nal taxes issometimes dangled as a carrot in the face of theprosecutor and the Internal Revenue Service aspart of an attempt to negotiate a plea to lessercharges in the criminal case.

While such a defense proposal may soundappealing, the Tax Division will generally notapprove a plea agreement containing a globalsettlement. United States Attorneys' Manual(USAM ) 6-4.360. The reasons behind the long-standin g policy prohibitin g such a greeme ntsinclude the fact that criminal tax investigationstypically involve the analysis of only a limitedportion of a taxpayer’s financial matters. Forexample, the investigation is likely to focus on

only unreported gross receipts for a particularSchedule C business or false itemized deductionsreported on Schedule A. None of the other itemsreported on the retu rn are typica lly brough t ontothe criminal playing field. Thus, there may be anum ber of ap propriate civil adju stments that aprosecutor is unaware of, ill-equipped to address,and unwittingly may deal away as part of theglobal settlemen t. In addition, a ma jor concernattendin g global se ttlements is the pote ntial pub licperception that a wealthier defendant is beingallowed to bu y his way out of jail time. See PaulaM. Jun ghans and Thom as E. Zehn le, Glob al Pac tsin Criminal Tax Prosecutions: Why The DOJ‘Just Says N o,’ BUS. CRIMES, Oct. 2000, at 1.

Some of these same con cerns are alsoattendant to any plea agreement or sentenceimposing an order of restitution in a tax case. Toprotect th e overall in terests of the governm ent,prosecutors need to ensure that provisions forrestitution do not, in any manner, affect theInternal R evenue Service ’s ability to pu rsue allcivil remedies. After all, the “government’sprimary o bjective in criminal ta x prose cutions isto get the maximum deterrent value from the casesprosecuted. To achieve this objective, thegovernment’s tax enforcem ent activities mustreflect uniform en forcement of th e tax laws.”USAM 6-4.010. In light of the potential impact oncriminal tax cases overall, we should not allowwhat m ay be ben eficial in on e isolated c ase tocause us to lose sight of the reason criminal taxcharges are brought in the first instance.

III. Overview of Restitution

The ability of a court to impose an order ofrestitution as part of the sentence in a criminalcase does not fall under the court’s inherentauthority. United States v. Gottesman, 122 F.3d150, 1 51 (2d Cir. 19 97); United States v.Helmsley, 941 F.2 d 71, 10 1 (2d C ir. 1991).Rather, the authority to impose restitution must beconferred on the court by Co ngress. Helmsley,941 F.2d at 101.

Generally, prior to the enactment of theVictim and Witness Protection Act (VWPA), 18U.S.C. § 3663, in 1982, restitution could only beordered as a condition of probation pursuant to theFederal Probation Act, formerly codified at


§§ 3651-3656 and repealed effective November 1,1987. Helmsley, 941 F.2d at 101. With theenactm ent of the VW PA, a c ourt was permitted toorder the payment of restitution as part of thesentence for all violations under Title 18 of theUnited States Code, as well as certain otherstatutory violations. In 1996, Congress enacted theMandatory Victim Restitution Act, 18 U.S.C.§ 3663A, wh ich made restitution mandatory formany of the offenses covered by 18 U.S.C.§ 3663, specifically reaching any offense againstproperty under Title 18, including an y offensecommitted by fraud or deceit (18 U.S.C.§ 3663A(c)1)(A)(ii)). Because there is no case lawdealing with the applicatio n of section 3663 A inthe con text of a tax case, how ever, this ar ticle willlimit discussion of restitution as part of thesentence to restitution imposed under 18 U.S.C.§ 3663. Discussion of concepts under 18 U.S.C.§ 3663 seem equally applicable to restitutionunder 18 U.S.C. § 366 3A, as both sections covermuch the same ground. (For a history ofrestitution dating back to the Code of Hammurabiand the O ld Testame nt, see United States v.Vakn in, 112 F.3 d 579, 5 82-83 (1 st Cir. 1997 )).

The VW PA emp owers courts, in certain cases,to impose restitution as part of a sentence ratherthan as a special condition of probation orsupervised rele ase. See 18 U.S.C. §§ 3663, 3664;United States v. Minneman, 143 F.3d 274, 284(7th C ir. 1998 ); United States v. M artin , 128 F.3d1188 , 1190 (7th C ir. 1997 ); Helmsley, 941 F.2d at101. The purpose of the VWP A is "to ensure thatwrong doers, to th e degree possible , make th eirvictims whole." United States v. P atty, 992 F.2d1045, 1050 (10th Cir. 1993), quotingUnited States v. Rochester, 898 F.2d 971, 982-83(5th C ir. 1990 ); see Va knin , 112 F.3d at 582;Virgin Islands v. Dav is, 43 F.3d 41, 46-47 (3d Cir.1994 ); see also United States v. H arris , 7 F.3d1537 , 1539 (10th C ir. 1993 ) (purpo se of VW PA isto compensate victims of crime). In enacting theVWP A, Congress "strove to encourage greater useof a restitutionary remedy." Vakn in, 112 F.3d at587; see Minneman, 143 F .3d at 28 4-85; Martin ,128 F.3d at 1190 (VW PA designed to ensure thatcourts do not relegate victim restitution to "anoccasional afterthou ght") (citations om itted). A"victim" under section 3663 is any person

"directly and proximately harmed as a result of thecommission of an offense." 18 U.S.C.§ 366 3(a)(2); Martin , 128 F.3 d at 1190 .

To evalu ate whe ther a cou rt has the a uthorityto impose restitution in any given case, theanalysis relies on one, or more, of the followingfactors: the offense of conviction; the type ofsentence imposed; and the terms of any pleaagreement. Depending on the offense ofconviction, restitution may be imposed eitherdirectly or as a condition of supervised release orprobation. The court is permitted to impose anadditional direct sanction of restitution under 18U.S.C . § 355 6. Sectio n 355 6 states tha t the cour t,in imposing a sentence, may order restitutionunder 18 U.S.C. § 3663. This provision is theauthority for a court to impose a direct order ofrestitution to any victim of the offense as part ofthe criminal sentence, similar to a court’simposition of a term of imprisonment. The VWPAauthorizes a court to impose a direct order ofrestitution to victims of the offense, afterconsidering several mandatory factors (see 18U.S.C. § 3663(a)(1)(B)(i)), only when sentencinga defendant convicted of an offense under Title 18U.S.C., certain sections of the ControlledSubstances Act (21 U.S.C.), and certain sectionsof Title 49 . 18 U .S.C. § 3663 ; see Helmsley, 941F.2d at 101.

The co urt’s auth ority to order re stitution isalso dependent on the sentence imposed. Underthe Sentencing Guidelines, an individualconvicted of a crim e must be sen tenced to a termof probation, a fine, or a term of imprisonment. 18U.S.C. § 3551(b) (fine may be in addition to anyother sentence). If the defendant is sentenced to aterm of probation under 18 U.S.C. § 3561, thecourt is req uired to e xplicitly pro vide certa inmandatory conditions of probation. 18 U.S.C.§ 3563. Restitution in accordance with sections3663 and 3664 , among other provisions, is one ofthese mandatory conditions of probation. 18U.S.C. § 3563(a)(6). In addition to the specifiedmandatory conditions of probation, a court mayalso provide discretionary conditions of probationafter considering certain factors (see 18 U.S.C.§ 356 3(b)). A s one of th e permis siblediscretionary conditions, a court can require adefendant to make restitution to a victim of the


offense under 18 U.S.C. § 3556. Such an order ofrestitution as a furthe r conditio n of prob ation isnot subject to th e provision (18 U.S.C.§ 3663(a))limiting restitution to only certain offenses ofconviction. 18 U.S.C. § 3563(b )(2).

Similarly, there are provisions for restitutionif the defendant is sentenced to a term ofimprisonment under 18 U.S.C. § 358 1. As notedabove, 1 8 U.S .C. § 3 556 p rovides fo r restitution ifthe offen se of conviction is sp ecified insection 3663(a). If the offense of conviction is onethat is not specified in section 3663(a), an order ofrestitution may piggyback on the court’s orderimposing a term of superv ised release. A co urtsentencing a defendant to a term of imprisonmentmay include a requirement that the defendant beplaced on a post-imprisonment term of supervisedrelease. 18 U.S.C. § 35 83(a). A court may imposeas a discretionary condition of supervised releaseany of the cond itions provided as discretionaryconditions of probation “in section 3563(b)(1)through (b)(10) and (b)(12) through (b)(20), andany other condition it considers to beappropriate.” 18 U.S.C . § 3583(d). A s is the casewith proba tion, these discretion ary conditions arenot limited by the nature of the offense ofconviction. 18 U.S.C. § 3583(d ).

Finally, different rules apply if the defendanthas neg otiated a gu ilty plea with the gove rnmen t.If the defendant has entered a guilty plea, thesentencing court may order restitution to theextent agreed to in the plea agreement. Thecourt’s authority to order agreed-upon restitutionin a case re solved b y plea agree ment ap plies “inany criminal case” and is not restricted by theoffense of conv iction. 18 U .S.C. § 36 63(a)(3).See, United States v. Blake, 81 F.3 d 498 , 506 (4 thCir. 19 96); United States v. Schrimsher, 58 F.3d608, 6 09 (11 th Cir. 1 995); United States v.Silkowski, 32 F.3d 682, 68 8-89 (2d Cir. 1994 ).Prosecutors in the Ninth C ircuit should b e awareof the decision in United States v. Baker, 25 F.3d1452, 1457 (9th Cir. 1994), in which the court ofappeals held that an agreement to pay "heightenedrestitution" must be in exchange for a promise bythe government to drop or not pursue otheroffenses.

IV. Restitution in Tax Cases

A question frequently asked of the TaxDivision is wheth er restitution is legallypermiss ible in a tax case and , if so, how to do itcorrectly. Historically, it was a widely held beliefthat restitution was not available in criminal taxprosecutions. After conducting a cursory reviewof the restitution scheme, many people dismiss thepossibility of restitution in a pure tax prosecutionbecause 18 U.S.C. § 3663(a) does not authorizerestitution for Title 26 offenses. See Minneman,143 F .3d at 28 4; United States v. Joseph, 914 F.2d780, 783-84 (6th Cir. 1990). Th e analysis,however, sh ould not en d with section 3 663(a).

A. Title 26 Violations

Althou gh Title 2 6 offens es are not in cluded inthe list of offe nses in 1 8 U.S .C. § 3 663(a )(1) withrespect to which the court may sentence adefendant to pay direct restitution, section 3663(a)is not the only source of authority for an order ofrestitution . As no ted prev iously, a cou rt isauthorized to impose any “discretionary conditionof probation in section 3563(b)(1)through (b)(10)” as a condition of supervisedrelease or probation . See 18 U.S.C. §§ 3556,3563(b )(2), 3583 (d); U.S.S .G. § 5E 1.1(a),§ 5E1 .1, com ment. (b ackg'd); United States v.Daniel, 956 F .2d 54 0, 543 -44 (6th Cir. 19 92); Helmsley, 941 F.2d at 101. Accordingly, asrestitution is one of the listed discretionaryconditions of probation (see 18 U.S.C.§ 3563(b)(2)), a court is authorized to orderrestitution for violations of Title 26 as a conditionof a term of supervised release following a term ofimprisonmen t (see, e.g., United States v. Bok, 156F.3d 157, 166-67 (2d C ir. 1998)) or as a conditionof probation when the court imposes a sentence ofa term of probation.

B. Title 18 Violations

If the charged tax crimes are not broughtunder the offenses included in Title 26, a districtcourt may order restitution as a sanction atsentencing. Consider a case in wh ich the offensecharged is a conspiracy to defraud the InternalRevenue Service in violation of 18 U.S.C. § 371or the filing of a false claim in violation of 18U.S.C. § 287 where the false claim is a fictitious


income tax return claiming a refund ofpurportedly overpaid taxes. Under the VWPA,section 3663 provides that restitution may beordered to any victim of the offense. Nolimitations are placed on the term victim . Agovernment agency, including the InternalRevenue Service, can be a victim for purposes ofrestitution. Minneman, 143 F .3d at 28 4; Martin ,128 F .3d at 11 90-92 (collecting cases); Helmsley,941 F .2d at 10 1; United States v. Salcedo-Lopez,907 F.2d 97, 99 n.2 (9th Cir. 1990). The VWPAexplicitly allows restitution for any violation ofTitle 18, inclu ding section 3 71. Minneman, 143F.3d a t 284 (se ction 37 1); United States v.Woodley , 9 F.3d 774, 7 80 (9th Cir. 19 93) (m ailfraud); Helmsley, 941 F.2 d at 101 (sec tion 371).Thus, a district court may impose restitution in atax case involving Title 18 offenses, so long as thecourt complies with the requirements of theVW PA. Minneman, 143 F.3d at 284-85. Underthe VWPA , the district court may order restitutionso long as paymen t is made to an iden tified victimin a definite amount and the amount of restitutionis limited by the actua l losses of the victim. SeeVirgin Islands v. Dav is, 43 F.3 d at 45; Woodley ,9 F.3d at 7 80 (citations om itted).

C. Determining The Amount

Regardless of the provision under which theorder of restitution is imposed, the amount ofrestitution ordered must be determined by thecourt pursu ant to notice and a hearing. SeeMinneman,143 F .3d at 28 5-86; Woodley , 9 F.3d at780-8 1; United States v. Jordan, 890 F.2d 247,253 (10th Cir. 1989) (considering restitutionordered as a condition of supervised release). Thecourt may not delegate the responsibility to theInternal Revenue Service or the Probation Office.See United States v. Porter, 41 F.3d 68, 71 (2dCir. 1994) (district court's order that ProbationOffice w ould h ave the d iscretion to s et sched uleof repayment of restitution amount constitutedimproper delegation of judicial functions inherentin the grant of restitution). In the absence of a pleaagreement, the amount of court-determinedrestitution is limited to the actual loss to theInternal Revenue Service resulting from theunderlying offense of conviction. The VWPAprovides guidance regarding the calculation of theamoun t of restitution to be orde red. Hughey v.

United States, 495 U .S. 411 , 418 (1 990); Minneman, 143 F .3d at 28 5-86; United States v.Mullins, 971 F.2 d 1138 , 1146-4 7 (4th Cir. 1 992).For purposes of determining the amount ofrestitution, section 3663(a)(1)(A) requires ashowing o f actual loss. United States v.Germosen , 139 F.3d 120, 130 (2d Cir. 1998). Theloss must directly result from the offense ofconviction. See Hughey , 495 U .S. at 42 0; Germosen , 139 F .3d at 13 1; Daniel, 956 F.2d at543. Section 366 3(b)(1) provides that "in the caseof an offense resulting in damage to or loss ordestruction of p roperty of a victim of the o ffense,"the restitution order may require return of theproper ty or, if that is imp ossible or im practical,payment of an amount equal to "the value of theproperty on the date of sentencing." In a criminaltax case involving a conspiracy to defraud theUnited States, in violation of 18 U.S.C. § 371, theoffense generally results in the loss of governmentproperty, that is, the money to which thegovernment was entitled under the tax laws butwhich w as not paid b y the defenda nt. In the raresituation in which a tax case involves violations of18 U.S.C. § 1341 (mail fraud) or 18 U.S.C.§ 134 3 (wire fra ud), care should be exerc ised indetermining the victim and the am ount of the losssuffered.

The calculation of the amount of loss forpurpo ses of restitu tion wh en the IR S is the vic timis closely related to the calculation of the tax lossused to d etermin e a defen dant's bas e offense level.The district court may rely upon the same"quantity and quality of evidence" to determinethe amou nt of loss in both c ontexts. See Germosen , 139 F .3d at 13 0; United States v.Corpus, 110 F.3 d 1529 , 1537 (1 0th Cir. 19 97).The Government must establish the amount ofloss for restitution by a preponderance of theevidence. See M cMillan v. Penn sylvania , 477 U.S.79 (19 86); Minneman, 143 F .3d at 28 5; Vakn in,112 F.3d at 587 (a restitution award "cannot bewoven solely from the gossamer strands ofspecula tion and surmise "); United States v. Boney,977 F .2d 62 4, 636 (D.C. C ir. 1992 ); United Statesv. Lowden , 955 F.2 d 128, 1 30 (1st Cir. 1 992);Mullins, 971 F.2d at 11 47 (governmen t mustestablish amount of restitution by preponderanceof evidence if am ount is dispu ted).


In arriving at an order of restitution,depending on the circuit, the district court mayneed to set forth its findings concerning restitutionin detail. In some circuits, it is sufficient if therecord reflects that the court "has considered thestatutorily mandated factors." See Germosen , 139F.3d a t 131 (c itations om itted); Minneman, 143F.3d a t 285; United States v. Broyde, 22 F.3d 441,442 (2 d Cir. 1 994); United States v. Springer, 28F.3d 23 6, 239 (1 st Cir. 1994 ). Those factorsinclude the a mou nt of loss , the defe nda nt'sfinancial resources, the financial needs andearning ability of the defendant and his or herdependents, and any other factors the court deemsappropriate. 18 U.S.C. § 3663(a)(1)(B)(i). In othercircuits, the district cou rt must m ake exp licitfindings in areas including: (1) the amount of theloss actually sustained by the victim; (2) how theloss is connected to the offense of conviction; and(3) the defendant's financial needs and resources.United States v. Seligsohn, 981 F.2d 1418, 1421,1423 (3d C ir. 1992 ); Mullins, 971 F.2d at 114 8. Ifthe district court does not provide detailedfindings, the court runs the risk that the court ofappeals may remand the restitution order as basedon "inadequate explanation and insufficientreasoning." United States v. Men za, 137 F.3d 533,538 (7th Cir. 1998 ).

Prosecutors should also be aware of anunpu blished opinion of the Te nth Cir cuit,United States v. Jacobs, No. 99-2327, 2000 WL1694 300, a t *4 (10th Cir. No v. 13, 2 000), inwhich the court concluded that if the governmentwishes restitution of back taxes in a criminalaction for ta x evasion withou t first civillylitigating the exact amounts due, it must givenotice of its inte nt to est ablish (by apreponderance of the evidence) the amount dueand obtain a special jury verdict as to the exactamount. (Unpublished judgments of the court ofappeals are not binding precedent. 10th Cir. R.36.3(a)). The Tax Division does not agree with theTenth Circuit's conclusion. There is nothing aboutrestitution in a tax case that requires that it betreated differently from restitution in any otherkind of case.

Of course, the amount of restitution due maybe agreed to by the parties. The parties to a pleaagreement may authorize the imposition of

restitution in an amount greater than the lossattributable to the offense of conviction. 18 U.S.C.§ 3663 (a)(3). See, Blake, 81 F.3 d at 506 ; Schrimsher, 58 F.3 d at 609 ; Silkowski, 32 F.3d at688-8 9; Baker, 25 F.3d at 1457. The parties to theplea agreement may also agree that the court mayorder restitu tion to pe rsons oth er than th e victimof the offense. 18 U.S.C. § 3663(a)(1)(A). When adefendant agrees to pay heightened restitution, thegovernment must still prove that the loss to berepaid resulted from the defendant's criminalconduct. See Pa tty, 992 F.2d at 1050 (heightenedrestitution agreed to by defendant includedamounts and victims not charged in theindictment, but only to the extent that thedefendan t's fraudulent cond uct caused th e losses).The plea agreement must be specific as to both theagreement to pay restitution and the amount ofrestitution. Gottesman, 122 F.3 d at 152-5 3 (courtnot empowered to impose restitution where theplea agreement merely provided the defendant“will pay past taxes due and owing ... on suchterms and conditions as will be agreed uponbetween [defendant] and the IRS”). The districtcourt may order a defendant to pay restitutiononly in an amount not to exceed that agreed uponby the parties. 18 U .S.C. § 36 63(a)(3). SeeUnited States v. Bartsh , 985 F .2d 93 0, 933 (8thCir. 19 93) (dis trict court m ay order d efenda nt topay amo unt of res titution w ithin ran ge agreed toin plea agreement). If the plea agreement does notprovide for heightened restitution, the court maystill order restitution to any victim to the extent ofthe loss caused by an offense of co nviction. SeeUnited States v. Broughton-Jones, 71 F.3d 1143,1148 (4th Cir. 1995). The general rulesconcerning restitution would then apply and theamount of the restitution would be limited by thelosses caused by the offense or offenses ofconviction. See Hughey , 495 U.S. at 418.

D. Preserving The Right to Collect AnyAdditio nal Civ il Tax Lia bility

Any amount paid as restitution to the InternalRevenue Service must be used to offset theultimate c ivil tax liability of the defen dant.Helmsley, 941 F.2d at 102. Liability for restitutionmay be im posed jointly and severally by a c ourt.Because of the possible civil implicationsresulting from an order of restitution, the


government must be careful to ensure that anyorder of restitution or plea agreement provisionfor restitution does no t prohib it further civ ilactivity by the Internal Revenue Service. Pleaagreements, in particular, should include languagespecifically sta ting that th e agreem ent torestitution is not a final determination of thedefendant’s civil tax liability and does notpreclude the Internal Revenue Service fromfurther efforts to determine and collect taxes fromthe defe ndan t.

V. Other Methods to Collect Tax

Restitution is not the only means by which adefend ant can b e made to satisfy, in w hole or inpart, his or her tax liabilities. Whether thedefendan t pleads guilty or is conv icted after atrial, a district court may order, as a condition ofprobation or supervised release, that the defendantpay all bac k taxes th at have b een con clusivelyestablished. District courts retain broad discretionin tailoring conditions of probation and supervisedrelease. See U.S.S.G . §§ 5B 1.3(b), 5D 1.3(b);United States v. E dgin , 92 F.3 d 104 4, 104 8 (10thCir. 1996 ). Any cond itions imposed , however,must take into consideration the factors spelledout in 18 U .S.C § 3 553(a)(1) a nd (a)(2) (see 18U.S.C . §§ 356 3(b), 358 3(d)(1), (d)(2 ), (d)(3)),generally relating to the nature and circumstancesof the offense and the history and characteristicsof the de fendan t, the need "to afford a dequ atedeterrence to criminal conduct," "to protect thepublic from further crimes of the defendant," and"to provide the defendant with needed educationalor vocational training, medical care, or othercorrectional treatment in the most effectivemanner." See United States v. Coenen, 135 F.3d938, 9 40 (5th Cir. 19 98); United States v. Bass ,121 F.3 d 1218 , 1223 (8 th Cir. 199 7);United States v. Ritter, 118 F .3d 50 2, 504 (6thCir. 19 97); United States v. Abrar, 58 F.3d 43, 46(2d Cir. 19 95).

An o rder to pay back taxes is esse ntially arequiremen t that a defenda nt obey the law. SeeUnited States v. H atchett , 918 F .2d 63 1, 644 (6thCir. 19 90); United States v. S chiff, 876 F.2d 272,275 (2 d Cir. 1 989); United States v. Tonry , 605F.2d 144, 147 (5th Cir. 1979). A requirement thata defendant pay back taxes is directly related to a

defendant's tax crimes. The payment of back taxespreven ts a defen dant from deriving any ben efitfrom pa st tax crim es and p rotects the p ubliccoffers. Moreover, the obligation to pay backtaxes may deter a defendant from evading orignoring federal tax obligations in the future. Thepayment of back taxes does not jeopardize adefendant's liberty. Furthermore, the specialcondition of payment of back taxes does notconflict with any pertinent SentencingCom missio n poli cy.

The order to pay back taxes as a condition ofprobation or supervised release need not belimited to amounts owed for the years for whichthe defe ndan t was con victed, as is the case w ithrestitution. Hatch ett, 918 F.2d at 644.Nevertheless, the taxes ordered paid can only befor amounts due that the defendant has admittedor that ha ve otherw ise been conclu sivelydetermined . See id. (order to pay back taxescannot be taken to require the payment of taxdebts that are legitimately in contest). Thepayment of tax obligations for other years thathave b een red uced to judgm ent is app ropriatesince such debts represent definite legalobligations. See id. (collecting cases).

A court may include as a condition ofprobation or supervised release a direction that thedefendant cooperate with the Internal RevenueService in the determination of his or her taxliability and pay any am ounts u ltimatelydetermined to be due an d owing. SeeUnited States v. Thomas, 934 F .2d 84 0, 845 (7thCir. 19 91); United States v. Taylor, 305 F.2d 183,187 (4th Cir. 1962 ). Such a con dition, how ever,may not str ip a defen dant of h is or her righ t tofairly question and litigate the amount of civil taxliability. See United States v. Stafford , 983 F.2d25, 28 (5 th Cir. 199 3).

VI. Conclusion

Restitution does not provide the governmentwith a ve hicle to reso lve all of a de fendan t’s civiltax liabilities as part of a criminal prosecution. Forpolicy reasons associated with the overall criminaltax enforcement program, any global resolution ofcivil and crimin al tax liabilities is discouraged . Aproperly crafted ord er of restitution, how ever,does provide the government with a unique


opportunity to obtain at least a partial payment ofa defendan t’s ultimate tax liability as part of acriminal tax prosecution. Prosecutors needingassistance in this area, including any questionsconcerning the applicability of 18 U.S.C.§ 3663A , should contact the Criminal A ppeals &Tax Enforcement Policy Section of the TaxDivision at (202) 514-5396

Practice Note: Before you begin seekingrestitution orders in these types of cases, youshould consult with the IRS CriminalInvestigation Special Agent-in-Charge office foryour district as well as your Financial LitigationUnit. It is important that the restitution order notlimit or r estrict IR S’ co llection ability.�

ABOUT THE AUTHORS

�Mitchell J. Ballweg is an Assistant Chief in theTax Division’s Western Criminal EnforcementSection. Mr. Ballweg served as Associate SpecialCounsel to the Criminal Investigation DivisionReview Task F orce assem bled by th e Hon orableWilliam H. Webster at the request of theCom mission er of the Inte rnal Re venue Service in1998. He also served as an Assistant United StatesAttorney for the Western District of Wisconsin.

Karen Qu esnel is a Senior Appellate Attorneywith the Criminal Appeals and Tax EnforcementPolicy Section of the Tax Division of theDepartment of Justice and has been with the TaxDivision since 1989. Before she joined theDepartm ent of Justice, M s. Quesne l worked for ayear a nd a half for th e Internal Reven ue S ervice'sDistrict Counsel's office in Las Vegas Nevada.

As this special tax issue of the United States Attorneys’ Bulletin goes to print, the Tax Divisionproudly announce s the availability of a new edition of its Criminal Ta x Man ual (G reen M anua l), therecognized "bible" in criminal tax prosecutions. Most chapters of the new Green M anual, including thechapters dealing with Title 26 offenses, Methods of Proof, and Foreign Evidence, are available. Theremaining chapters and other materials, including certain Title 18 offenses, specialized chapters on TaxProtestors and 6103 tax confidentiality, and form indictments and jury instructions, will be madeavailable as they are com pleted. A fina l completion d ate of Octobe r 1, 2001 , is anticipated. Th ereafter,an ongoing revision process is expected to highlight new developments as they occur. The Green Manualwill be available on the Tax Division’s internet web site at www.usdoj.gov. Anyone with questions aboutthe new Green Manual" should contact Michael E. Karam, Senior Trial Attorney, CATEPS , Tax Divisionat 202-51 4-5166 .

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September 2001 Forensic Evidence Issue

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