Tax Evasion & Evidence of No Tax Due

Tax evasion is a complex legal issue that can carry severe consequences, including hefty fines and imprisonment.

Unlike other crimes where the act is either committed or not, taxes can be owed in varying degrees, making it difficult to determine whether a violation of the law has occurred.

Can a defendant avoid a tax evasion conviction by proving that the underlying tax is not owed? This is a question that the recent case of United States v. Kayser, 488 F.3d 1070 (9th Cir. 2007), seeks to answer. In this case, the defendant argued that he should not be convicted of tax evasion if he could show that no tax was due.

The trial court did not allow the jury to consider offsetting provisions resulting in no tax due, and the defendant was convicted. The defendant appealed, and the appellate court weighed in on whether such evidence should be considered by the jury in tax evasion cases.

Facts & Procedural History

The defendant was convicted of tax evasion for the year 2000 in violation of 26 U.S.C. § 7201.

The charges arise out of his employment by A2Z USA, Inc. He was employed as a salesperson and later as a vice president for its Internet-based shopping mall.

The defendant was compensated as an independent contractor and paid a commission by checks made out to his name. The defendant incorporated Aspen Ventures Inc. to receive A2Z income and take business deductions related to that income.

The defendant failed to file timely tax returns for 1998 through 2000 and ultimately filed his delinquent individual and corporate tax returns for those years in August 2001.

The government alleged that the defendant improperly structured his individual and Aspen Ventures’ corporate returns for 1999 and 2000 to evade the payment of taxes on his A2Z activities. The defendant’s primary theory of defense was that he had not willfully evaded paying taxes. On the last day of trial, the defendant asked the district court to approve a jury instruction that was declined, and the jury found him guilty of tax evasion for the year 2000. The judge that hears a tax case has wide discretion in how the case is handled and, ultimately, the outcome of the case.

About Tax Evasion

Section 7201 of the tax code is a criminal tax statute that imposes penalties on individuals who attempt to evade or defeat taxes. Specifically, the statute provides that anyone who willfully tries to evade or defeat any tax or the payment of a tax shall be guilty of a felony offense.

The elements of attempted income tax evasion under 26 U.S.C. § 7201 are: (1) willfulness; (2) the existence of a tax deficiency; and (3) an affirmative act constituting an evasion or attempted evasion of the tax.

The term “willfully” in the statute means an intentional violation of a known legal duty, and not just a careless or inadvertent mistake. An attempt to evade or defeat taxes can take many forms, including but not limited to concealing income, overstating expenses, claiming false deductions, failing to report taxable income, and failing to pay taxes owed.

The penalties for violating Section 7201 can include fines and imprisonment, as well as the costs of prosecution. The maximum fine for a conviction under this section is $100,000 for individuals ($500,000 for corporations), and the maximum prison sentence is five years.

For a conviction, the government must prove that the taxpayer had a specific intent to violate the law, and not just a mere failure to comply with the tax code. This can sometimes be a difficult burden for the government to meet, and taxpayers who are charged under this statute may have strong defenses available to them, including lack of intent or mistake of law.

The Types of Tax Evasion

Section 7201 of the tax code defines two types of tax evasion: evasion of assessment and evasion of payment. Evasion of assessment occurs when a taxpayer tries to prevent the IRS from knowing that they owe unpaid taxes, typically by filing a false tax return that underreports their tax liability or by making false statements to IRS agents to conceal the tax liability. The jury instruction at issue in this article is an example of an evasion of assessment instruction.

On the other hand, evasion of payment occurs when the IRS is aware of the tax liability, but the taxpayer takes affirmative steps to prevent the IRS from collecting the tax. This can include moving assets offshore, omitting assets from a balance sheet submitted to the IRS with an offer in compromise, or deliberately giving away, spending, or wasting assets to avoid having any source from which the IRS can collect the tax.

There is some debate over whether these two types of evasion represent separate offenses or if they are simply two different ways of committing the same offense of tax evasion. While some courts treat them as separate offenses, others note that evasion of assessment is essentially an evasion of payment since every evasion of assessment involves a failure to pay.

The distinction between evasion of assessment and evasion of payment may also affect the “units of prosecution” in a tax evasion case. Evasion of assessment usually fits into a one-year, one-count framework, where the actions involved in the evasion of assessment relate to the understatement and underassessment of the unified tax for a particular year. On the other hand, evasion of payment often involves a single act after the date(s) of assessment that is intended to evade the payment of several years of tax due, allowing a single count to relate to multiple years.

However, there may be instances where multiple evasion of assessment counts could apply to a single year’s tax liability if there were multiple acts with the purpose of avoiding that year’s tax. The determination of the appropriate units of prosecution can affect the severity of the penalties imposed on the defendant. Therefore, tax evasion cases require careful analysis of the facts and legal issues involved to ensure that the defendant’s rights are protected and that the appropriate legal strategies are employed to achieve a favorable outcome.

The Jury Instruction

Here is the jury instruction that is in question in this appeal: “If the defendant had unclaimed deductions which would have offset his tax liability such that there was no tax due and owing, then there is no tax deficiency.”

The government argued that this instruction was unwarranted because the defendant had introduced no evidence of previously “unclaimed” deductions. The government also argued that the defendant’s theory of defense was improper under United States v. Miller, 545 F.2d 1204 (9th Cir.1976), which the government read as precluding the defendant from arguing that the business deductions he reported on Aspen Ventures’ returns could be used to negate his individual tax deficiency.

On appeal, the appeals court summarized the existing case law as follows:

A defendant may negate the element of tax deficiency in a tax evasion case with evidence of unreported deductions. See United States v. Marabelles, 724 F.2d 1374, 1378-79 (9th Cir.1984); Elwert v. United States, 231 F.2d 928, 933 (9th Cir.1956). Both Marabelles and Elwert involved small business owners who (among other things) under-reported their income for one or more years. Marabelles, 724 F.2d at 1378-79; Elwert, 231 F.2d at 933-34. At trial for criminal tax evasion, the defendants introduced evidence of deductions for labor costs that had not been claimed on their returns in order to disprove the element of tax deficiency. Marabelles, 724 F.2d at 1378-79; Elwert, 231 F.2d at 933-34. In rejecting the defendants’ challenges to the sufficiency of the evidence supporting their respective convictions, we held that “the burden is on the defendant to prove that he had allowable deductions that were not shown in his return, once the Government establishes unreported income and allows the deductions claimed by the defendant in [his] return and others that it can calculate without his assistance.” Marabelles, 724 F.2d at 1379 n. 3; Elwert, 231 F.2d at 933.

Given this case law, the court held that the defendant was entitled to demonstrate at trial that he had deductions that could offset this previously unreported income. 

The court then considered whether the defendant presented sufficient evidence to warrant an instruction to the jury on this defense theory. The court notes that the defendant must show that the deductions were legitimate and that they were allowable under the tax code. The court found that the defendant’s evidence was sufficient to support the instruction, despite weak and inconsistent testimony, and that the district court erred in failing to give it.

Other Defenses to Tax Evasion

There are a number of other potential defenses against tax evasion charges that also have to be considered. For example, defendants may be able to argue that they lacked the intent to commit tax evasion or that they made an honest mistake in their tax reporting. In some cases, a defendant may also argue that they were coerced or misled into filing an incorrect tax return.

Another potential defense is to challenge the government’s calculation of the tax owed. This could include arguing that certain deductions were not allowed, or that the government overestimated the amount of taxable income.

Additionally, defendants may argue that they relied on the advice of a tax professional, and that any errors on their tax return were the result of that professional’s negligence or malpractice. While relying on a tax professional’s advice is not a complete defense, and defendants may still be held responsible for errors on their tax returns, it can help sway the judge or jury.

The Takeaway

Defendants facing charges under 26 U.S. Code § 7201 for tax evasion may be able to avoid conviction by demonstrating that the underlying tax is not owed. This case adds an important nuance to this defense, allowing a defendant to negate the element of tax deficiency by presenting evidence of previously unclaimed deductions. This case highlights the generous legal standard for presenting a theory of defense and the importance of demonstrating sufficient evidence to support it. As tax evasion carries significant penalties, including fines and imprisonment, defendants facing these charges should consult with experienced tax attorneys to explore all available defenses.