U.S. citizens who owe more than $50,000 in unpaid federal taxes are at substantial risk of having their U.S. passports revoked within the next few months. In December 2015, Congress enacted legislation requiring the IRS to provide a list of names to the State Department of individuals with “seriously delinquent tax debt.”¹ That term was defined in the statute to mean tax debt of over $50,000, including interest and penalties. 26 U.S.C. § 7345(b). The legislation also requires that the State Department refuse to issue new passports and gives the State Department discretion to revoke currently issued passports. See 22 U.S.C. § 2714A. Continue reading
With Comprehensive Panama Papers Database to Be Released Today, and White House Call for Comprehensive Action to Combat Offshore Tax Evasion, Affected Individuals Should Consider Immediate Action to Mitigate the Risk of Criminal Prosecution
May 2016 (No. 2)
White Collar Defense and Investigations
Action Item: Today at 2:00 p.m. (EDT), a massive database of information from the leaked “Panama Papers” files will be made public for the first time, identifying the real owners behind over 200,000 offshore companies set up by the Panamanian law firm Mossack Fonseca. The database release today follows closely on the heels of President Obama’s call to tighten U.S. laws and regulations to combat tax evasion through the illicit use of secret offshore bank accounts and shell companies. Individuals who believe they may be identified in the Panama Papers as the beneficial owner of an offshore company should consider prompt action to mitigate the risk of criminal prosecution and harsh financial penalties. The Internal Revenue Service (“IRS”) currently offers a number of voluntary disclosure programs for individuals with unreported foreign financial assets, but time is of the essence and immediate action is required in order to qualify for such programs in light of the imminent release of more “Panama Papers” files.
At 2:00 p.m. (EDT) today, the International Consortium of Investigative Journalists (“ICIJ”) will release a searchable database containing information on more than 200,000 offshore entities that are part of the “Panama Papers” investigation. The database is believed to be the largest ever release of records regarding the creation and maintenance of secret offshore companies and the identities of the individuals behind those companies. The information in this database comes from the Mossack Fonseca law firm in Panama and, according to ICIJ, includes “information about companies, trusts, foundations and funds incorporated in 21 tax havens, from Hong Kong to Nevada in the United States” and “links to people in more than 200 countries and territories.” The database is expected to offer an unprecedented window into the previously-secret world of offshore tax evasion and the use of shell or nominee entities to conceal the identity of the real owner of the underlying assets.
The first release of Panama Papers records on April 3, 2016, which comprise over 11 million Mossack Fonseca files, sparked a global outcry over offshore tax evasion. In the United States, the Justice Department has opened a criminal investigation into the offshore tax schemes believed to be exposed by the Panama Papers leak, and New York’s Department of Financial Services has ordered 13 foreign banks to turn over records regarding their dealings with the Mossack Fonseca firm. Last Thursday, the Obama Administration announced significant steps to crack down on money laundering, corruption, and tax evasion in the wake of the Panama Papers leak, and called upon Congress to quickly act to pass legislation addressing these issues. In particular, the White House announced the following:
- New rules to increase transparency and disclosure requirements that will enhance law enforcement’s ability to detect, deter, and disrupt money laundering, terrorist financing, and tax evasion, including long-awaited final regulations on “Customer Due Diligence” that require financial institutions to know and keep records on who actually owns the companies that use their services;
- New regulations that expand upon existing law by adopting “Customer Due Diligence” requirements for certain prepaid credit and debit cards;
- New rules that close a loophole allowing foreigners to hide assets or financial activity behind anonymous entities established in the United States; and
- New legislation that would increase transparency into the “beneficial ownership” of companies formed in the United States by requiring that companies know and report their true owners.
The Obama Administration also called upon the Senate to finally approve tax treaties that have been pending for several years that would help crack down on offshore tax evasion.
The Panama Papers database to be released today by ICIJ is expected to include the names of thousands of offshore entities formed by Mossack Fonseca and, most importantly, the identities of the true owners behind such companies. ICIJ has stated that the database will not, however, include bank account records, emails and other correspondence, passports, or telephone numbers.
Individuals who have used offshore companies and believe they may be implicated by today’s data release by ICIJ should consider taking immediate corrective action. The Internal Revenue Service has long maintained a number of well-publicized voluntary disclosure programs that afford non-compliant U.S. taxpayers the opportunity to avoid criminal prosecution by self-disclosing their non-compliance to the IRS, explaining the facts and circumstances of non-compliance, and paying back taxes, interest, and penalties. The most popular voluntary disclosure program offered by the IRS is the Offshore Voluntary Disclosure Program (“OVDP”), which is directed at non-compliant taxpayers with secret offshore assets. U.S. individuals identified as beneficial owners of secret offshore companies may take advantage of the OVDP to avoid criminal prosecution, but only if they commence the voluntary disclosure process before the IRS learns of their non-compliance from third-party sources, including whistleblowers. The IRS may take the position that a voluntary disclosure occurring after public release of an individual’s name through the Panama Papers disclosure is too late and deem them ineligible for OVDP protection. Thus, time is of the essence, and individuals concerned about being named in the Panama Papers database should act quickly and consider whether a voluntary disclosure to the IRS is warranted. Inaction is not a viable option.
Since 2009, the United States has undertaken an aggressive enforcement campaign to combat offshore tax evasion using secret bank accounts in Switzerland and other tax havens, and the use of offshore structures to obscure the identity of the real owner of financial assets held outside of the United States. The following statistics tell the story:
- The Justice Department has criminally charged more than 100 U.S. accountholders that evaded U.S. tax laws using hidden offshore accounts, and nearly 50 individuals (mostly foreign nationals) who assisted them.
- Due to aggressive law enforcement actions, 80 Swiss banks have admitted to engaging in criminal conduct and paid more than $1.3 billion in penalties.
- Under threat of prosecution, more than 54,000 individuals have come forward to disclose their offshore accounts to the IRS through the OVDP and other voluntary disclosure programs, paying more than $8 billion in tax, penalties, and interest.
- Under the Foreign Account Tax Compliance Act signed into law by President Obama in 2010, more than 150,000 foreign financial institutions have agreed to report customer information to the United States, in an effort to ensure that tax cheats cannot hide assets offshore.
Blank Rome’s Offshore Tax Compliance Team regularly advises clients as to the U.S. tax consequences of maintaining undisclosed offshore assets, and the compliance options available to such individuals to mitigate risk. Our team includes former federal prosecutors and Justice Department trial attorneys and experienced tax attorneys well-versed in the intricacies of the OVDP and other IRS voluntary disclosure options. Please contact a member of our team should you have any questions regarding the Panama Papers or any other aspect of offshore tax compliance.
The Internal Revenue Service announced that the 2016 individual income tax filing season opened on January 19, 2016, with more than 150 million returns expected to be filed. The IRS expects more than 70 percent of taxpayers to again receive tax refunds this year. Last year, the IRS issued 109 million refunds, with an average refund of $2,797.
Simultaneously sending a stern warning to would-be tax cheats, the Justice Department’s Tax Division announced that a business owner in Alexandria, Virginia, had pleaded guilty to a multi-million dollar conspiracy to defraud the IRS that could land the defendant in jail for four to five years. In that case, the defendant owned and operated a gas station and multiple Subway restaurant franchises. According to court documents, the defendant admitted that between 2008 and 2014, he and his managers failed to deposit all of the gas station and Subway franchises’ gross receipts into corporate bank accounts. Instead, the defendant and his co-conspirators skimmed those receipts and retained them for their personal use, and failed to report those funds to the IRS. IRS investigators built their case by reviewing point-of-sales records for the Subway franchises, which showed total sales of $20 million for this period, but the corporate and partnership tax returns only reflected sales of $14 million. Compounding the problem, certain of the defendant’s businesses did not file returns at all in some years. The defendant also acknowledged filing false individual income tax returns. In his guilty plea, the defendant admitted that his illegal conduct caused a tax loss to the IRS of between $1.5 million and $3.5 million.
Using this defendant’s guilty plea as an opportunity to promote general deterrence and tax compliance, the Justice Department’s press release contains the usual cautionary language typically seen around April 15:
“As we start the 2016 filing season, this case serves as a reminder that the Justice Department, working with its partners at the IRS, remains committed to identifying, investigating and prosecuting businesses and individual taxpayers who willfully fail to file accurate tax returns and pay the taxes due,” said Acting Assistant Attorney General Ciraolo. “Every taxpayer owes a duty to their fellow citizens to pay their fair share and those who choose not to do so will face the consequences.”
“Today’s plea of Obayedul Hoque for conspiracy to defraud the United States sends a clear message to would-be tax cheats,” said Chief Richard Weber of IRS-Criminal Investigation (CI). “Whether you fail to file and pay your corporate taxes or your personal income taxes, IRS-CI special agents work diligently to uncover all kinds of fraud and hold everyone accountable. U.S. citizens expect and deserve a level playing field when it comes to paying taxes and there are no better financial investigators in the world when it comes to following the money.”
It is well-known that the Justice Department’s Tax Division typically increases the frequency of its press releases announcing enforcement activity in the weeks leading up to April 15. Academic research confirms that the DOJ issues a disproportionately large number of tax enforcement press releases as “Tax Day” approaches:
Every spring, the federal government appears to deliver an abundance of announcements that describe criminal convictions and civil injunctions involving taxpayers who have been accused of committing tax fraud. Commentators have occasionally suggested that the government announces a large number of tax enforcement actions in close proximity to a critical date in the tax compliance landscape: April 15, “Tax Day.” These claims previously were merely speculative, as they lacked any empirical support. This article fills the empirical void by seeking to answer a straightforward question: When does the government publicize tax enforcement? To conduct our study, we analyzed all 782 press releases issued by the U.S. Department of Justice Tax Division during the seven-year period of 2003 through 2009 in which the agency announced a civil or criminal tax enforcement action against a specific taxpayer identified by name. Our principal finding is that, during those years, the government issued a disproportionately large number of tax enforcement press releases during the weeks immediately prior to Tax Day compared to the rest of the year and that this difference is highly statistically significant. A convincing explanation for this finding is that government officials deliberately use tax enforcement publicity to influence individual taxpayers’ perceptions and knowledge of audit probability, tax penalties, and the government’s tax enforcement efficacy while taxpayers are preparing their annual individual tax returns.
Joshua D. Blank and Daniel Z. Levin, When Is Tax Enforcement Publicized?, 30 Virginia Tax Review 1 (2010).
With the opening of the 2016 tax filing season, we can expect a steady drumbeat of DOJ press releases with increasingly stronger warnings as April 15 approaches.
Today’s blog post is authored by Jed Silversmith, a former federal prosecutor and member of the Washington State bar who recently joined Blank Rome in its Philadelphia office. Mr. Silversmith has applied to reactivate his Pennsylvania bar license and is awaiting approval of that application.
Last week, a federal jury in Miami found that Carl Zwerner had willfully failed to disclose his foreign bank account to the Treasury Department for calendar years 2004, 2005 and 2006. Zwerner now potentially owes the United States 150% of the value of his account plus an additional statutory assessment of 12% and interest. Zwerner’s account balance was roughly $1,500,000, resulting in a penalty of about $2,500,000. Another hearing is set in the case for June 6, 2014 where the district court will consider how it intends to compute a civil penalty. Zwerner will likely argue that this 150% penalty violates the Excessive Fines Clause of the Eighth Amendment to the U.S. Constitution.
By way of background, the Bank Secrecy Act requires that taxpayers who have an ownership interest in overseas bank accounts disclose those accounts to the Treasury Department. The disclosures are required to be made every year by June 30 on a reporting form commonly referred to as an “FBAR.” See 31 U.S.C. §§ 5314 & 5321. Taxpayers who willfully fail to disclose these overseas accounts face a maximum penalty which is the greater of $100,000 or 50% of the balance of the account (the “FBAR penalty”). Since the United States entered into a deferred prosecution agreement with UBS (the largest bank in Switzerland) in 2009, there has been an intense focus on identifying overseas accounts. To encourage taxpayers to disclose their accounts, the IRS has offered three amnesty programs called Offshore Voluntary Disclosure Initiatives (“OVDI”). Under the OVDI programs, taxpayers agreed to pay a penalty of between 20% and 27.5% of the balance of the account for one year plus back taxes and interest. In exchange for these payments, the taxpayer received amnesty from criminal prosecution and avoided other potential civil penalties that could be asserted.
Zwerner had an interest in an undeclared Swiss bank account since the 1960s. The account was held in the name of a Liechtenstein foundation. In 2009, Zwerner tried to enter one of the OVDI programs. However, his application was rejected. The IRS (under a delegation authority from the Treasury Department) subsequently assessed Zwerner a 50% penalty for each of the four years, resulting in a total penalty equal to twice the value of his account.
Last year, the United States filed suit in federal district court to collect the unpaid assessment. Zwerner had argued that he never declared the account to the IRS because he viewed his interest as “indirect.” However, as the government notes in one of its pleadings:
Zwerner readily admits that the account was, “as far as I was concerned my secret account. And I didn’t mention it to anybody. Even my lawyer of 40 years”
In a rare jury trial on this issue, Zwerner was found to have willfully failed to disclose his foreign bank account for three years. The jury found that his failure to report the account in 2007 was not willful. (Zwerner had read about one of the voluntary disclosure programs in May 2008, about one month before the due date for his 2007 FBAR reporting requirement.) The jury also made a special finding that he did not qualify for the OVDI program in 2009.
The district court has set a hearing for June 6, 2014 to examine post-trial issues. The next phase of the proceeding involves the district court determining the precise amount of the penalty and then entering a judgment. In SEC v. Lipson, Judge Posner explained that a defendant in a civil enforcement action had a right to a jury trial on liability, but that the district court had the ultimate responsibility to determine the amount of the civil penalty. 278 F.3d 656, 662 (7th Cir. 2002) (citing Tull v. United States, 481 U.S. 412, 425 (1987)). See also SEC v. Solow, 554 F. Supp. 2d 1356, 1367 (S.D. Fla. 2008) (“Accordingly, it was Mr. Solow’s constitutional right to have a jury determine his liability, with this Court thereafter determining the amount of penalty, if any.”).
Zwerner’s lawyers will be arguing that the base penalty, 50% of the balance of his foreign account each year for three years, violates the Excessive Fines Clause of the Eighth Amendment. According to court filings, Zwerner’s FBAR penalty vastly exceeded his tax liability:
|Year||50% Penalty||Tax due and owing on unreported interest||Ratio of tax to penalty|
These tiny ratios do not even include any understatement penalties that Zwerner may have paid (there was some discussion in the record that he paid a fraud penalty for at least one of the years at issue).
Furthermore, in this case, the United States filed suit pursuant to the Federal Claims Collection Act (the “FCCA”), 31 U.S.C. § 3701 et seq. Section 3716(e) of the FCCA permits the government to collect an additional 6% surcharge on unpaid administrative assessments annually. The government made an administrative determination against Zwerner two years ago. Thus, Zwerner’s penalty has ballooned by another 12%. In its summary judgment brief, the government notes that the statutory surcharge (for all four FBAR penalties) was $465,243. The government also collects interest on the debt as well. In this case, the amount of accrued interest (again on all four penalties) was about $130,000.
Despite these daunting sums, which do not reflect the economic harm that the United Statues suffered, the government has a strong argument that the fine is constitutional. The lead case on the subject is the United States v. Bajakajian, 524 U.S. 324 (1998). In that case, the government seized $357,000 from a family as they were boarding an international flight. The U.S. Supreme Court held that the seizure violated the Eighth Amendment’s Excessive Fines Clause. The Court’s ruling provided guidance to district courts, directing them to look to Congress and the Sentencing Commission to determine the reasonableness of a fine. In interpreting Bajakajian, the Eleventh Circuit has articulated a three-pronged test to determine the constitutionality of a seizure:
(1) whether the defendant falls into the class of persons at whom the … statute was principally directed; (2) other penalties authorized by the legislature (or the Sentencing Commission); and (3) the harm caused by the defendant.
United States v. Browne, 505 F.3d 1229 (11th Cir. 2007). See also United States v. Prochnow, 2006-2 Trade Cas. (CCH) ¶ 75408 (N.D. Ga. 2006) (applying Bajakajian in an FTC penalty case).
A. Zwerner was likely in the class of people designed to be punished by this statute
The government will argue that this is not solely a reporting violation. In Bajakajian, the Court found a constitutional violation because Bajakajian’s “money was the proceeds of legal activity and was to be used to repay a lawful debt. Whatever his other vices, respondent does not fit into the class of persons for whom the statute was principally designed: He is not a money launderer, a drug trafficker, or a tax evader.” Bajakajian, 524 U.S.at 338. In contrast, Zwerner was hiding his money from the IRS. The FBAR penalty was meant to reach individuals who hide their income from the IRS. He is likely among the class of individuals designed to be punished by this statute.
B. The maximum penalty was authorized by Congress, but the advisory criminal fine under the federal sentencing guidelines would be minimal
In terms of weighing the constitutionality of a fine, courts defer to Congress in the first instance as well as the U.S. Sentencing Commission. The Eleventh Circuit has explained in a criminal forfeiture case:
Because Congress is a representative body, its pronouncements regarding the appropriate range of fines for a crime represent the collective opinion of the American people as to what is and is not excessive. Given that excessiveness is a highly subjective judgment, the courts should be hesitant to substitute their opinion for that of the people.… Consequently, if the value of forfeited property is within the range of fines prescribed by Congress, a strong presumption arises that the forfeiture is constitutional.
United States v. 817 N.E. 29th Drive, 175 F.3d 1304 (11th Cir. 1999).
Here, the government can point to the Bank Secrecy Act itself. Congress prescribed that those who willfully fail to report the existence of a foreign account are liable for penalties of the greater of $100,000 or 50% of the balance in the account at the time of each violation. 31 U.S.C. § 5321(a)(5). In the same statute, Congress further prescribed a six-year period of limitations for assessing such penalties. 31 U.S.C. § 5321(b)(1). Thus, Congress contemplated a maximum fine of six 50% penalties. Zwerner was assessed only three 50% penalties.
In contrast, an analysis under the federal sentencing guidelines would yield a dramatically lower penalty. Although this is not a criminal case, such an argument may have some appeal. In 817 NE 29th Drive, the Eleventh Circuit remarked: “although we retain a duty under the Eighth Amendment independently to examine fines for excessiveness, a defendant would need to present a very compelling argument to persuade us to substitute our judgment for that of the United States Sentencing Commission.” Under the federal sentencing guidelines, the advisory penalty would be significantly less. Zwerner’s offense level would be calculated under U.S.S.G. §§ 2S1.3(a) & 2B1.1, which would yield an advisory guideline range of either 22 or 24 (depending on whether each year was treated as a separate offense under the grouping rules). Alternatively, if the court found that Zwerner’s primary motivation was to evade taxes, it would apply U.S.S.G. §§ 2S1.3(c) & 2T4.1. This would yield a guideline range of 14. The relevant fine range would be $10,000 to $100,000 (using the fraud tables) or $4,000 to $40,000 (using the tax tables). Given the circumstances of this case, a district court would likely apply the lower tax guideline at a sentencing hearing.
C. Zwerner’s harm to the Treasury was minimal
Zwerner’s best argument is simply one of proportionality. As noted above, the base penalty constitutes about 3% to 4% of the harm that he caused. Even that figure is overstated because Zwerner appears to have paid some understatement penalties directly to the IRS. Zwerner is also subject to the 6% annual statutory assessment under the FCCA. The total penalty simply does not bear any representation to the harm to the Treasury.
Moreover, Zwerner can point out that the IRS has, as a matter of course, apparently collected smaller penalties from pretty much every other similarly situated taxpayer. In the three OVDI programs, the Service has required that taxpayers pay only between 20% and 27.5% of the balance of their account in one year. In recent criminal cases, individuals who pleaded guilty also had to pay only 50% of the balance of the account(s) in one year. Zwerner’s penalty will be significantly higher than any of these individuals.
Zwerner does have some compelling arguments to ask the district court to mitigate his penalty. Given the focus of the IRS and the Department of Justice on FBAR penalties in general, and the novel posture of this case in particular, the district court’s decision will receive substantial attention.
A district court in the Northern District of California has held that the officer of a now-defunct corporation is personally responsible for the Trust Fund Recovery Penalty based upon the company’s failure to collect, account for, and pay over federal withholding taxes. See United States v. Guerin, 113 AFTR 2d 2014 (N.D. Cal. April 28, 2014). In 1994, Fitz William Guerin, the defendant, purchased an existing software development and advertising firm that he renamed Orbit Network, Inc. Mr. Guerin served as the company’s president and chief executive officer, and also was a minority shareholder. He was also an authorized signer on the company’s bank accounts and checks, and he also signed the company’s quarterly employment tax returns (Forms 941).
Beginning on June 1, 1998, Mr. Guerin became aware that Orbit was not making timely payments of federal employment taxes. Despite that knowledge, Mr. Guerin thereafter authorized payments to company creditors other than the U.S. Treasury, and he personally signed checks payable to creditors other than the government during that time period.
Pursuant to IRC § 6672, the IRS thereafter assessed liabilities against Mr. Guerin personally for the company’s unpaid employment taxes for numerous quarters between 1996 and 1999. The total amount of the assessments exceeded $600,000.
Section 6672(a) provides, in relevant part, that:
Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall … be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.
Under § 6672(a), an individual may be held liable for unpaid withholding taxes if (1) he or she was a “responsible person” for collection and payment of the employer’s taxes; and (2) he or she “willfully” failed to pay the tax. United States v. Jones, 33 F.3d 1137, 1139 (9th Cir. 1999). For purposes of § 6672, a “person” includes “an officer or employee of a corporation … who … is under a duty to perform the act in respect of which the violation occurs.” 26 U.S.C. § 6671(b).
Responsible Officer Analysis
The Court first addressed the question of whether Mr. Guerin was a “responsible officer.” The Court observed that district courts employ a number of factors to determine whether a person is a “responsible person” for purposes of imposing liability. Although no single factor is dispositive in evaluating whether an individual is a “responsible person” within the meaning of § 6672(a), “the most critical factor is whether a person had significant control over the enterprise’s finances.” United States v. Chapman, 7 Fed. App’x. 804, 807 (9th Cir. 2001) (citations omitted). An individual is more likely to be found responsible if he or she: (1) holds corporate office; (2) has check-signing authority; (3) can hire and fire employees; (4) manages the day-to-day operations of the business; (5) prepares payroll tax returns; (6) signs financing contracts; and (7) determines financial policy. Jones, 33 F.3d at 1140–41; Jordan v. United States, 359 F. App’x 881, 882 (9th Cir. 2002). Importantly, more than one person may be held liable under § 6672(a); an individual need not be “the most responsible.” Chapman, 7 Fed. App’x. at 806–07.
Applying these factors, the Court easily concluded that Mr. Guerin was a responsible officer based upon the following facts:
- Defendant was a founder of the company and served as President and Chief Executive Officer until October 5, 1999, when he resigned.
- Defendant was also a minority shareholder and a member of the senior management team that ran the company.
- Defendant supervised senior management, but never had a supervisor himself.
- Defendant could hire and fire employees, and was solely responsible for hiring and terminating members of Orbit’s senior management.
- Defendant was an authorized signer on Orbit’s bank accounts, there were no restrictions on his ability to sign checks on Orbit’s behalf, and he signed checks on Orbit’s behalf. While others were also authorized signers on Orbit’s bank accounts, Defendant alone was authorized to issue checks without a co-signer.
- Defendant managed the day-to-day operations of the business, such as “[d]irect[ing] an executive management staff;” “managing employees;” “signing or countersigning corporate checks;” “making or authorizing bank depots;” and “dealing with major customers.”
- Defendant had the authority to, and did, sign quarterly employment tax returns (Forms 941) on behalf of Orbit. Among others, Defendant was responsible for collecting, accounting for, and paying over federal withholding taxes for Orbit.
- Defendant had the authority to sign contracts and agreements binding Orbit, including a Binding Letter of Intent which contemplated a merger of two companies.
- Defendant represented Orbit in meetings with financial backers and potential investors.
- Defendant, among others, had the authority to, and did, determine to whom corporate disbursements would be made on behalf of Orbit, and to direct that such disbursements be made.
- Defendant testified that he was responsible for making decisions about the strategic direction of Orbit; and that he had the “final say” with respect to acquisitions.
The Court next turned to the question of whether Mr. Guerin willfully failed to collect, account for, or remit payroll taxes. A responsible person may not be held personally liable under section 6672(a) unless his or her failure to collect, account for, or remit withholding taxes was willful. Winter v. United States, 196 F.3d 339, 345 (2d Cir. 1999). Willfulness involves a “voluntary, conscious and intentional act to prefer other creditors over the United States.” Buffalow v. United States, 109 F.3d 570, 573 (9th Cir. 1997). Thus, “[i]f a responsible person knows that withholding taxes are delinquent, and uses corporate funds to pay other expenses, … our precedents require that the failure to pay withholding taxes be deemed “willful.””Phillips v. I.R.S., 73 F.3d 939, 942 (9th Cir. 1996).
The Court also easily found that the defendant acted with the requisite level of willfulness, based upon Mr. Guerin’s admission that he was aware that federal withholding taxes were not being paid in 1998, but nevertheless continued to pay other creditors. The Court found that “Defendant’s deliberate decision to use corporate revenues received after he first became aware of the delinquency to pay other creditors, including himself, rather than to diminish Orbit’s tax debt falls within the literal terms of the Ninth Circuit’s definition of willfulness. Klotz v. United States, 602 F.2d 920, 923 [44 AFTR 2d 79-5709] (9th Cir. 1979) (“Willfulness” is defined as a “voluntary, conscious and intentional act to prefer other creditors over the United States.”).”
Joint and Several Liability
Finally, the Court addressed an argument advanced by Mr. Guerin that the IRS should have sought payment of the company’s unpaid employment taxes before pursuing him. Under IRC § 6672, liability may extend to more than one corporate officer, not just the most responsible. In particular, the responsible officer penalty is distinct from and in addition to the employer’s liability for these taxes. The Court rejected this argument, finding that even if there were entities or individuals other than the defendant through whom the IRS could have collected Orbit’s unpaid trust fund taxes, Mr. Guerin could not escape liability on those grounds because the government is not required to pursue collection against every responsible person, or against the corporation itself, before attempting to collect from a responsible person under § 6672.
The Court’s decision in United States v. Guerin is illustrative of the personal risks that corporate officers face when companies fail to timely deposit employment taxes. Responsible officers can face personal liability for their company’s unpaid employment taxes if the failure to pay over the taxes is determined to be willful. As the Guerin decision demonstrates, willfulness is not a difficult legal standard for the government to satisfy, especially when it is undisputed that the corporate officer in question was aware of the unpaid employment taxes and authorized payments to other creditors. In small businesses, corporate officers will almost always be aware of the fact that employment taxes are not being paid, and that company funds are being used to pay other creditors.
In addition to being held personally responsible for unpaid corporate employment taxes, corporate officers may also face criminal liability for failing to pay withholding taxes. The IRS describes the fraudulent practice of withholding taxes from employees but intentionally failing to pay over the taxes as “pyramiding”:
“Pyramiding” of employment taxes is a fraudulent practice where a business withholds taxes from its employees but intentionally fails to remit them to the IRS. Businesses involved in pyramiding frequently file for bankruptcy to discharge the liabilities accrued and then start a new business under a different name and begin a new scheme.
The IRS Criminal Investigation Division, in its most recent annual report, states that one of its top enforcement priorities in the employment tax area is combating the illegal practice of withholding employment taxes and failing to pay over those taxes to the U.S. Treasury. Two recent criminal cases illustrate the efforts of the IRS and the Justice Department in the employment tax fraud area.
On April 30, 2014, the Justice Department announced that an attorney in Oklahoma had pleaded guilty to willfully failing to pay employment taxes in connection with his law practice. See United States v. Larry Douglas Friesen (W.D. Oklahoma) (DOJ press release here). In that case, the defendant failed to pay over to the IRS the federal income and FICA taxes due and owing during three tax quarters in the 2007 calendar year in the amount of approximately $320,000.
In another case, the Justice Department announced on April 11, 2014, that a physician in Indiana had been sentenced to a prison sentence of one year and a day for failing to pay employment taxes in connection with his medical practice. See United States v. Ronald Eugene Jamerson (N.D. Indiana) (press release here). According to court pleadings, Jamerson deducted and collected from his employees’ paychecks federal income taxes and employment taxes in the amount of $63,929 over 11 tax quarters between 2006 and 2008, but failed to file the employment tax returns and pay over the related employment taxes. The defendant was ordered to pay restitution to the IRS in the amount of $541,083 for unpaid individual income taxes and employment taxes, which represented the total tax loss owed for all tax periods from 2003 through 2008, according to the plea agreement.
On November 5, 2013, the Fourth Circuit upheld the assessment of a responsible officer penalty, pursuant to 26 U.S.C. § 6672, in the amount of $304,355.90 against a wife due to her husband’s failure to pay employment taxes to the Internal Revenue Service. See Johnson v. United States, No. 12-1739 (Nov. 5, 2013) (opinion available here).
The Internal Revenue Code requires employers to withhold federal social security and income taxes from the wages of their employees. See 26 U.S.C. §§ 3102(a), 3402(a). Because the employer holds these taxes as “special fund[s] in trust for the United States,” 26 U.S.C. § 7501(a), the withheld amounts are commonly referred to as “trust fund taxes,” Slodov v. United States, 436 U.S. 238, 243 (1978) (internal quotation marks omitted). The Code “assure[s] compliance by the employer with its obligation . . . to pay” trust fund taxes by imposing personal liability on officers or agents of the employer responsible for “the employer’s decisions regarding withholding and payment” of the taxes. Id. at 247 (interpreting 26 U.S.C. § 6672). To that end, § 6672(a) of the Code provides that “[a]ny person required to collect, truthfully account for, and pay over any tax . . . who willfully fails” to do so shall be personally liable for “a penalty equal to the amount of the tax evaded, or not . . . paid over.” 26 U.S.C. § 6672(a). Personal liability for a corporation’s unpaid trust fund taxes extends to any person who (1) is “responsible” for collection and payment of those taxes; and (2) “willfully fail[s]” to see that the taxes are paid. Plett v. United States, 185 F.3d 216, 218 (4th Cir. 1999); O’Connor v. United States, 956 F.2d 48, 50 (4th Cir. 1992).
In the Johnson case, in 1969, Mr. Johnson (the husband) formed a non-profit corporation, Koba Institute, Inc., to perform various government contracts in conjunction with Koba Associates, Inc., a for-profit corporation that he owned and managed. When Koba Associates failed to pay its payroll taxes in the mid-1990s, the IRS assessed trust fund recovery penalties against Mr. Johnson pursuant to 26 U.S.C. § 6672. The outstanding payroll taxes, accompanied by the lien subsequently imposed on Mr. Johnson for the § 6672 trust fund recovery penalties, ultimately led Mr. Johnson to close Koba Associates. The presence of the lien limited Mr. Johnson’s ability to obtain credit for Koba Institute.
Mr. Johnson thereafter approached Mrs. Johnson (his wife) about restructuring Koba Institute so as to facilitate a continuation of their business. In 1998, Koba Institute converted to a for-profit corporation under Maryland law, with Mrs. Johnson as its sole shareholder. Because Mrs. Johnson was not encumbered by a lien like Mr. Johnson, her status as the corporation’s owner enabled Koba Institute to enter into leases and other contracts, as well as obtain lines of credit.
As the sole shareholder of Koba Institute, Mrs. Johnson elected herself as chair of the corporation’s board of directors in 2001. According to the Johnsons, because they had agreed that Mrs. Johnson would be the primary caregiver of the couple’s children, Mrs. Johnson “delegated” and “entrusted” her authority in the corporation to Mr. Johnson, and thereafter elected Mr. Johnson president of Koba Institute on February 20, 2001, notwithstanding the contrary bylaw requirement. Mrs. Johnson, in turn, served as the corporation’s vice president.
Koba Institute’s board of directors — comprised of the Johnsons and an unrelated corporate secretary — unanimously approved a resolution authorizing Mr. Johnson (as president) and Mrs. Johnson (as vice president) to sign corporate checks and conduct financial transactions on behalf of the organization. In addition, Koba Institute’s payroll account provided that Mrs. Johnson had the power to “sign singularly” on that account.
Having “delegated” her authority to Mr. Johnson, Mrs. Johnson’s actual involvement at Koba Institute was limited during the 2001 through 2004 period. She did maintain an office at Koba Institute and received an annual salary ranging from approximately $100,000 to $193,000, as well as a corporate car and cell phone. In addition, the rent for Mrs. Johnson’s residence, shared with Mr. Johnson, was provided by Koba Institute.
In the 2001 to 2004 period, Mrs. Johnson only came to work once per month. When she did so, she would approve any board resolutions, such as ratification of Mr. Johnson’s acts as president, or perform tasks in the human resources department. Mr. Johnson made the ultimate decisions regarding the hiring and firing of employees. Indeed, because Mr. Johnson oversaw the corporation’s day-to-day operations, other employees viewed him as “the one who decides everything” and went to Mr. Johnson – rather than Mrs. Johnson – with any questions that arose in the business, including financial matters such as the payment of payroll taxes.
When Mr. Johnson was out of the office, he left explicit instructions for Mrs. Johnson to follow on Koba Institute business, including which checks to sign in his absence. Because of her limited involvement with the corporation’s daily operations, however, Mrs. Johnson was unaware of “the background or the context” for these checks and did not feel comfortable signing any checks that Mr. Johnson had not authorized. Accordingly, from 2001 through 2004, she never attempted to write checks that Mr. Johnson had not already approved.
Near the end of 2004, Mrs. Johnson received a notice from the IRS that Koba Institute had not paid its payroll taxes for several quarters from 2001 through 2004. Prior to that time, Mrs. Johnson was unaware that the payroll taxes were unpaid. Upon receipt of the notice, she had “a serious talk” with Mr. Johnson and “told him” that the situation was “unacceptable” and that Koba Institute had “to take steps to make sure that it [did not] happen again.” Mrs. Johnson then fired the finance director, who had been tasked with making payroll tax payments, and “directed Mr. Johnson to personally handle all future tax payments as of January 2005.” She “required” Mr. Johnson to provide her with “visual proof” of all withholding tax payments that Koba Institute subsequently made. Additionally, at least with regard to the payroll account, Mrs. Johnson no longer followed the prior procedure for check authorization; that is, she no longer required instruction from Mr. Johnson before writing checks herself from the payroll account for payment of the taxes.
Due to Mrs. Johnson’s “revamped oversight of tax payments,” Koba Institute began remitting its post-2004 payroll taxes to the IRS in full and, generally, on time. The corporation did not, however, pay the outstanding delinquent payroll taxes for the 2001 through 2004 delinquent periods although it continued to pay its other business debts, such as employee wages and Mrs. Johnson’s compensation. Subsequently, the IRS assessed trust fund recovery penalties against Mr. and Mrs. Johnson individually, pursuant to 26 U.S.C. § 6672.
Mrs. Johnson later paid $351.00 toward her assessed penalty, and filed a refund suit in district court, asserting that the § 6672 assessment against her was erroneous.
After the district court upheld the responsible officer penalty assessments, the Johnsons filed an appeal to the Fourth Circuit. The court of appeals first addressed whether Mrs. Johnson was a “person responsible” for the payment of Koba Institute’s withholding taxes. The Code defines a “responsible person” as one “required to collect, truthfully account for, and pay over any tax.” 26 U.S.C. § 6672(a). The Supreme Court has interpreted this statutory language to apply to all “persons responsible for collection of third-party taxes and not . . . [only] to those persons in a position to perform all three of the enumerated duties.” Slodov, 436 U.S. at 250. Thus, the Code deems anyone required to “collect” or “account for” or “remit” taxes a “responsible person” for purposes of § 6672.
The Fourth Circuit found the following facts relevant to the determination of whether Mrs. Johnson was responsible for the payment of withholding taxes:
Mrs. Johnson had been the corporation’s sole shareholder since 1998 and consequently had the effective power to change the officers and directors as she chose and thereby direct the business of the corporation. Separately as both vice president and chair of the board of directors since early 2001, Mrs. Johnson enjoyed considerable actual authority at Koba Institute.
The corporation’s bylaws, board resolutions, and banking documents demonstrate that Mrs. Johnson was a “responsible person,” as it is clear that she had effective control of the corporation, including its finances. . . . The foregoing corporate documents indicate that Mrs. Johnson, while serving as chair of the board, would also serve as president of the corporation, a role that included authority to manage Koba Institute’s daily affairs and to execute checks and other legal documents on its behalf. Although Mrs. Johnson “delegated” and “entrusted” this authority to Mr. Johnson prior to 2005, . . . remaining only minimally involved in the corporation’s affairs as board chair and vice president, delegation of such authority does not relieve a taxpayer of responsibility under § 6672. . . . A taxpayer may be a “responsible person” if she “had the authority required to exercise significant control over the corporation’s financial affairs, regardless of whether [s]he exercised such control in fact.” . . . Thus, despite delegating her authority to Mr. Johnson and permitting him to run the corporation’s daily affairs, Mrs. Johnson remained a “responsible person” because she had effective control of the corporation and the effective power to direct the corporation’s business choices, including the withholding and payment of trust fund taxes.
Although Mrs. Johnson maintains that any authority she held was merely technical in nature, the undisputed evidence establishes that she possessed both legal and actual authority over Koba Institute. . . . Mrs. Johnson’s voluntary minimal involvement in daily corporate affairs before 2005, however, and assertions that Mr. Johnson exercised all daily operating authority fail to create a genuine dispute of material fact regarding limitations on her effective power as to the trust fund taxes. Any deferral by Mrs. Johnson in the exercise of her authority never altered the fact that she possessed “effective power” over Koba Institute at all times. . . . Indeed, Mrs. Johnson’s actions immediately after learning of the tax delinquencies in December 2004 – a period that “cast[s] light” on her responsibility from 2001 through 2004 – demonstrate that her actual authority was co-extensive with the legal authority she possessed. . . . Mrs. Johnson admits in her pleadings that she “fired the finance director,” the employee tasked with making payroll tax payments, as soon as she discovered that Koba Institute had not remitted these taxes as required by law. She also “directed Mr. Johnson to personally handle all future tax payments as of January 2005” and “required” him to provide her with “visual proof” of all tax payments the corporation made. These admissions indicate that Mrs. Johnson’s status in the corporation during the quarters at issue enabled her to have “substantial input into [its financial] decisions [from 2001 through 2005], had [s]he wished to exert [her] authority.”
Moreover, the fact that, from 2001 through 2004, Mrs. Johnson followed the corporation’s internal policy and did not write checks without knowing that Mr. Johnson had previously approved them does not negate § 6672 “responsible person” status. . . . Although she followed corporate procedure without exception during that time, it is undisputed that Mrs. Johnson ceased following this policy almost immediately upon learning of the 2001-2004 payroll tax deficiencies and could have done so at any earlier time. Following her “revamped oversight of tax payments,” Mrs. Johnson would write checks from the payroll account without any instruction from Mr. Johnson. . . . Accordingly, the fact that Mrs. Johnson previously chose not to write checks without Mr. Johnson’s approval does not show that she was prevented earlier from doing so other than by her own choice. . . . The record also indicates that Koba Institute opened several operating accounts between 2001 and 2005, and that on each of those accounts, Mrs. Johnson was fully authorized to write checks and execute other bank documents.
While she may not have been running the day-to-day operations of the corporation between 2001 and 2004, Mrs. Johnson had a non-delegable responsibility to monitor Koba Institute’s financial affairs. . . . Mrs. Johnson had the effective power to exercise authority when she chose to do so, even though she chose at times to voluntarily limit her involvement in corporate affairs. Although Mrs. Johnson often chose not to exercise the authority which she possessed, such a decision is insufficient to permit a taxpayer to avoid § 6672 responsibility. . . . Moreover, after 2004, while the prior periods’ payroll taxes remained unpaid, Mrs. Johnson actively exercised her authority over the affairs of Koba Institute while continuing to receive substantial compensation and benefits from the corporation.
We therefore conclude that the Government presented undisputed evidence that established as a matter of law that Mrs. Johnson was a “responsible person” under § 6672 during the relevant tax periods because she had the effective power to pay the trust fund taxes of Koba Institute.
Having found Mrs. Johnson a “responsible person,” the Fourth Circuit then turned to the other necessary element of § 6672 liability — whether she “willfully” failed to collect, account for, or remit payroll taxes to the United States. This inquiry focuses on whether Mrs. Johnson had “knowledge of nonpayment or reckless disregard of whether the payments were being made.” Plett, 185 F.3d at 219. The Court readily found evidence of willfulness, as follows:
The record demonstrates that Koba Institute continued to make payments to other creditors using unencumbered funds following Mrs. Johnson’s receipt of the IRS notice in December 2004. The Government has produced numerous salary checks that the corporation issued to Mrs. Johnson in 2005, which Mrs. Johnson readily cashed. Yet it is undisputed that Mrs. Johnson, a “responsible person,” knew that payroll taxes for numerous quarters from 2001 through 2004 remained unpaid. Mrs. Johnson’s failure to remedy the payroll tax deficiencies upon learning of their existence in December 2004, while directing corporate payments elsewhere, including to herself, constitutes “willful” conduct under § 6672. This is particularly so given that, at Mrs. Johnson’s direction, Koba Institute paid other creditors during this period. And, as noted earlier, during the 2001 to 2004 delinquent tax periods, Mrs. Johnson received well in excess of $500,000 in compensation and benefits from the corporation while the payroll taxes went unpaid. . . . Even viewing the evidence in the light most favorable to Mrs. Johnson, we conclude that the record allows no conclusion other than that the failure to pay the payroll taxes was willful on Mrs. Johnson’s part.
Based upon its finding that Mrs. Johnson was a “responsible officer” and that the failure to pay employment taxes was willful, the Court affirmed the assessed penalties.
The Johnson case illustrates that personal liability may be assessed against corporate officers where a company fails to pay over employment taxes, even if the corporate officer was unaware of the failure to pay in prior periods. Once the corporate officer learns of the tax delinquency, he or she has a duty to ensure that corporate funds are used to pay off those liabilities. If the corporate officer fails to do so, personal liability for those taxes may be asserted.
The Treasury Department’s Inspector General for Tax Administration (TIGTA) has issued an audit report sharply criticizing the IRS correspondence audit process. The report, entitled “The Correspondence Audit Selection Process Could Be Strengthened,” studied the effectiveness of the correspondence audit process utilized by the IRS. In contrast to a traditional “field audit” when an IRS revenue agent meets the taxpayer face-to-face, correspondence audits are generally conducted through the mail and are less instrusive, more automated, and conducted by examiners who are trained to deal with less complex tax issues. During a correspondence audit, agents do not perform “required filing checks” which are used during field audits in order to determine whether the same pattern of non-compliance identified on the audited tax return is present on prior and/or subsequent year tax returns.
The IRS relies heavily on the correspondence audit process to identify possible underreporting on individual tax returns. For example, during FY2012, the IRS audited a total of 1.5 million tax returns. Of that number, 1.1 million, or 73%, were conducted through correspondence audits, and additional taxes of $9.2 billion were recommended from correspondence audits alone. Correspondence audits are generally more economical to conduct than field audits, with the average cost per correspondence audit of $274 as compared to an average cost per field audit of $2,278.
During its review of the IRS correspondence audit process, TIGTA reviewed a statistical sample of single-year correspondence audits where the taxpayers involved agreed that they had understated thair tax liabilities by at least $4,000. TIGTA found that similar tax issues existed for the prior and/or subsequent years tax returns for many of the sampled taxpayers, yet the IRS did not audit their prior and/or subsequent year returns, leading to significant lost revenue for the U.S. Treasury. TIGTA projected that the IRS could generate approximately $69.4 million in additional revenue if the correspondence audit process were strengthened by focusing on prior and/or subsequent tax years.
As of result of these findings, TIGTA recommended that the IRS develop and implement procedures in the Interal Revenue Manual to instruct examiners how current year correspondence audit results are to be used in deciding whether the prior and/or subsequent year returns warrant an audit. IRS management agreed with TIGTA’s recommendation and plans to develop an IRM section to provide examiners with direction on expanding correspondence audits, where appropriate, to prior and/or subsequent years.
The correspondence audit process is a key enforcement tool used by the IRS to detect underreporting on individual tax returns. The correspondence audit process is efficient, economical, and provides significant return to the IRS. As a result of TIGTA’s findings and criticism of the correspondence audit process, we expect to see IRS revenue agents more frequently expanding current year audits to include prior and/or subsequent years.
When making a voluntary disclosure pursuant to the IRS Offshore Voluntary Disclosure Program (OVDP), the first step involves sending a letter requesting pre-clearance to make a voluntary disclosure. The letter includes a taxpayer’s identifying information, including the taxpayer’s name and social security number. The IRS then runs the taxpayer’s information through an IRS database to ensure that the IRS has not already received offshore account information with respect to the taxpayer or that the taxpayer is not already under audit or investigation. If the taxpayer’s information is not in the IRS database, the taxpayer is ordinarily preliminarily accepted into the OVDP. The taxpayer then must complete a questionnaire, and absent extenuating circumstances (e.g., non-compliance with the terms of the program, such as the funds in the offshore accounts being derived from criminal activity), the taxpayer’s matter is transferred from the IRS Criminal Investigation Division to the IRS Civil Division for processing.
Several dozen taxpayers who were prior customers of Bank Leumi in Israel completed this process and, in many cases, were both pre-cleared to make a voluntary disclosure and transferred from the IRS Criminal Investigation Division to the IRS Civil Division. These taxpayers were apparently fully compliant with the terms of the OVDP.
Last March, however, the IRS abruptly kicked out these taxpayers from the OVDP. Practitioners believe that the IRS had received information from Bank Leumi with respect to the taxpayers but had yet to update its database. As a result, the IRS preliminarily accepted the taxpayers into the OVDP, despite the fact that the IRS was already in receipt of their offshore account information.
The IRS actions caused an uproar among (1) practitioners, who were advising their clients that they had cleared a huge hurdle in being preliminarily accepted into the OVDP, and (2) taxpayers, who were faced with the possibility of the severe civil (and perhaps criminal) penalties that the taxpayers originally sought to avoid by entering into the OVDP.
Perhaps as a response to this uproar, the IRS last week reversed its decision, and readmitted the taxpayers into the OVDP. The OVDP has been a huge success for the IRS, with the IRS collecting approximately $5.5 billion through the program. However, abruptly kicking taxpayers out of the program likely jeopardized the continued success of the OVDP because taxpayers were more hesitant to enter the program knowing that the IRS may remove taxpayers from the program at any time. The IRS actions last week should provide taxpayers with some measure of comfort that they will be treated fairly within the OVDP.
The Internal Revenue Service has released its annual data book, which it describes as a “snapshot of agency activities for the fiscal year.” The time period covered in the FY 2012 Data Book is October 1, 2011, through September 30, 2012.
Among the data presented in the FY 2012 Data Book are audit rates for the past year. The overall audit rate for individual tax returns was 1.03 percent, which is generally consistent with prior years. The audit rates for wealth taxpayers, however, saw a slight decrease. The following chart nonetheless illustrates that the audit risk dramatically increases for taxpayers reporting large amounts of adjusted gross income:
|IRS Audit Rates||FY 2010||FY 2011||FY 2012|
|AGI $1 to $25,000||1.18%||1.22%||1.05%|
|AGI $200,000 to $500,000||1.92%||2.66%||1.96%|
|AGI $500,000 to $1 million||3.37%||5.38%||3.57%|
|AGI $1 million to $5 million||6.67%||11.80%||8.90%|
|AGI $5 million to $10 million||11.55%||20.75%||17.94%|
|AGI over $10 million||18.38%||29.93%||27.37%|
The overall audit rate for estate tax returns is nearly 30 percent, with 12,582 estate tax returns filed during calendar year 2011. The audit rate for estate tax returns where the size of the gross estate is between $5 million and $10 million is 58.6 percent.
On the enforcement front, the IRS assessed nearly $26.9 billion in civil penalties during FY 2012, and initiated 5,125 new criminal tax investigations. 2,466 taxpayers were convicted of a tax crime during FY 2012, and 2,009 of those individuals (or 81.5 percent) received a sentence of incarceration. The number of IRS Special Agents (who are responsible for conducting criminal investigations) employed by the agency is down, from 2,730 in FY 2011 to 2,657 in FY 2012.
On the international enforcement front, Acting Commissioner Steven T. Miller offers the following assessment:
The IRS in 2012 made significant progress on international enforcement, specifically in our efforts against the practice of illegally hiding assets and income in offshore accounts. We have continued our two-pronged approach: offering a voluntary disclosure program for those who want to come in and get right with the government, while at the same time pursuing tax evaders and the promoters and banks assisting them.
Although not discussed in the FY 2012 Data Book, the IRS Offshore Voluntary Disclosure Program remains open and provides a mechanism for taxpayers with undisclosed foreign bank accounts and unreported income from such accounts to obtain amnesty from criminal prosecution through the payment of back taxes, interest, and penalties. To date, more than 35,000 individuals have enrolled in the OVDP since 2009 and more than $5 billion in additional revenue for the U.S. Treasury has been generated. Details on how to enroll in the OVDP are available here.