No Criminal Fraud, But Civil Fraud Penalty Applies

Tax fraud is a serious crime that carries severe penalties, including substantial fines and imprisonment.

But what happens when a criminal court finds that the conduct in question does not rise to the level of tax fraud, yet a civil court later determines that it does? This was the dilemma faced in Maciel v. Commissioner, No. 04-75716 (9th Cir. 2007), where the Ninth Circuit Court of Appeals considered whether a civil court could make a contradictory finding that the same conduct amounted to tax fraud.

Facts & Procedural History

During an audit in 1994, the IRS discovered that the taxpayer had understated his income on several tax returns. It was a routine tax audit. The IRS agent made a referral for criminal prosecution.

The taxpayer was initially charged with two felony counts of tax evasion, but was later charged with two felony counts of willfully filing a false return.

The taxpayer entered a plea agreement in which he pled guilty to both counts and admitted signing tax returns he knew to be inaccurate for the 1991 and 1992 tax years. The plea agreement stated that one of two Sentencing Guidelines calculations would apply, and the government agreed to recommend that any sentence imposed be satisfied by home detention and electronic monitoring.

The presentence report (“PSR”) concluded that the taxpayer had intended to evade taxation and was subject to a higher sentencing guideline. However, at his sentencing hearing, the taxpayer urged the district court to reject the PSR’s conclusion that he had fraudulently intended to evade taxation, and the government agreed with the taxpayer that his adjusted offense level should be no higher than eight.

The judge explained that:

I think on balance I am satisfied that the intent here was not primarily to avoid payment of tax. I think the intent may well have been to divert corporate money to personal use which is not a good thing and certainly is not something that the Court should countenance and particularly since it did have a consequence in terms of the accuracy of Mr. Maciel’s tax returns. But I don’t think that the conduct looked at in its totality suggests that the reason Mr. Maciel diverted the money was to avoid paying money to the Internal Revenue Service.

The taxpayer was sentenced to three months of home detention and three years of probation.

The IRS Civil Fraud Determination

The IRS then sent the taxpayer a Notice of Deficiency in 2000 reflecting $300,000 in back taxes for 1990-92 and nearly $250,000 in civil fraud penalties.

The taxpayer petitioned the U.S. Tax Court and argued that the IRS could not impose a fraud penalty when the prior court said that he did not commit fraud and, absent fraud, the time period that the IRS had to assess the additional tax had expired.

The U.S. Tax Court rejected the taxpayer’s arguments, noting the following:

Maciel regularly commingled funds among his various businesses, engaged in large unexplained cash transactions, mislabeled certain transactions as loans, failed to report any earnings from certain unincorporated business ventures, failed to keep adequate business records, and failed to inform his accountants and bookkeeper of his activities.

The taxpayer raised the same arguments before the Second Circuit Court of Appeals and it affirmed the tax court decision. The second circuit stated:

It is apparent that the government had virtually no incentive to litigate the fraud issue at sentencing [in the criminal trial]. In some cases, the government’s obligation to seek a sentence consonant with a criminal defendant’s culpability will be incentive enough to ensure that relevant issues are litigated vigorously.

In other words, paradoxically, if the taxpayer’s tax liability would have been larger, the IRS would be precluded from having a second court find that he committed fraud, even though the first court said that he didn’t commit fraud.

Criminal Tax Fraud and Civil Tax Fraud

Criminal tax fraud and civil tax fraud are two distinct legal concepts that differ in their purpose, burden of proof, and potential penalties.

Criminal tax fraud involves a willful attempt to evade or defeat the payment of taxes due. It requires proof beyond a reasonable doubt that the taxpayer knowingly and intentionally made false statements on their tax return with the purpose of evading taxes. The government must show that the taxpayer acted with fraudulent intent, which can be difficult to prove. Criminal tax fraud is a felony offense that carries severe penalties, including substantial fines and imprisonment.

On the other hand, civil tax fraud involves a lower burden of proof than criminal tax fraud. The consequence of civil tax fraud is the civil tax fraud penalty. This penalty requires only clear and convincing evidence that the taxpayer intentionally filed a false tax return or underpaid their taxes. Unlike criminal tax fraud, civil tax fraud does not require proof of intent to evade taxes. Civil tax fraud penalties may include monetary fines, interest, and penalties, but do not involve imprisonment.

Inconsistent Fact Positions

The issue of inconsistent fact positions is distinct from the U.S. Tax Court’s Ballard case, though there are some similarities.

In Ballard, a tax court judge who presided over a case wrote a report on the facts found during the trial, only to have a second judge who did not hear the case rewrite the facts in the original report. The case eventually went to the U.S. Supreme Court, which criticized the Tax Court for violating the law.

The Ballard case emphasizes the importance of a court following the factual decision made by the judge who presided over a case. This principle is related to, but distinct from, the doctrine of stare decisis, which requires courts to respect and apply prior legal decisions and precedents. Although higher courts are not necessarily bound by the findings of lower courts under stare decisis, this principle promotes consistency and predictability in the law, ensuring that similar cases are decided in a similar manner.

However, the application of these principles raises questions about the delivery of justice in cases like the present one. In this case, a trial court judge found no fraud for criminal purposes, and the fraud required for a criminal conviction is similar to that required for civil fraud tax penalties. Despite this, the U.S. Tax Court appears to be able to disregard the prior court’s findings. This raises concerns about the consistency and predictability of legal decisions, and the potential for injustice in cases where a court’s decision on factual matters is disregarded.

The Takeaway

This case highlights the complexities of the legal system when it comes to tax fraud, particularly the differences between criminal and civil tax fraud. The case also raises questions about the consistency and predictability of legal decisions, as well as the potential for injustice when a court disregards a prior court’s findings on factual matters. This case not only illustrates the differences between criminal and civil tax fraud, but also raises concerns about the consistency and predictability of legal decisions.