Economic Substance Doctrine Tax Felonies (6/1/11)

I write today to provide viewers access to Jasper Cummings' article, Jasper L. Cummings, Jr., Economic Substance Doctrine Felonies, 131 Tax Notes 977 (May 30, 2011) and 2011 TNT 104-10 (5/31/11). (This article is provided with the permission of Tax Analysts.)  Mr. Cummings writes on the use of the economic substance doctrine in criminal tax cases. Most particularly, he writes about Mr. R. J. Ruble who was convicted in the first round of Son-of-Boss criminal prosecutions. In that case, Ruble, a tax lawyer, was convicted along with John Larson and Bob Pfaff who provided financial services in the conceptualization and implementation of the shelters. Two prominent subsequent shelter prosecutions have also used the economic substance doctrine in the charges to the jury.

First, let me disclose that I represented one of the dismissed defendants in the sprawling prosecution that ended up in the conviction of Messrs. Ruble, Larson and Pfaff. Once my client was dismissed along with 12 others before trial, I no longer had an immediate interest in the case but I did observe the progress of the proceedings through conviction and appeal and now pending petition for certiorari in the Supreme Court. I was particularly interested in whether and how the economic substance doctrine would be presented to the jury.
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Economic Substance in Tax Crimes

In American Boat LLC v. United States, ___ F.3d ___ (7th Cir. 2009), the Seventh Circuit affirmed a district court's holding that a taxpayer in a Son of Boss transaction was not liable for civil penalties for claiming the tax shelter on his return (I need not differentiate the civil penalties for present purposes). The essence of the relief granted was that the taxpayer had reasonable cause because of the tax lawyer's involvement and opinion (essentially like the other opinions for Son of Boss). The shelter was Jenkens & Gilchrist shelter of the type for which the lawyers promoting it have been indicted. (See discussion of indictment here.)

Echoing the mantra in the Nixon Watergate debacle, the Court said that "Again, the focus is on what Jump [the taxpayer] knew or should have known at the time he obtained the opinion letter." Focusing on the issuer of the opinion in a criminal context, it seems to me that the issue is the same -- to paraphrase, the focus is on what the lawyer knew or should have known at the time he issued the opinion letter. I don't think my paraphrasing is particularly insightful, but I do think it is helpful to state the truism from time to time, for I think it will help focus on the issue I raised in my earlier blog yesterday (see here). Keep in mind that the lawyer is guilty of a tax crime only if he knew the law (i.e., the crime was both knowable and he knew it) and he intended to violate the law.
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Update on the Daugerdas indictment -- Guilty Plea by Defendant Greisman (BDO)

Robert S. Greisman, former DBO Seidman former partner, pleads guilty. See the USAO SDNY press release here. The plea is to three counts - (i) the (ubiquitous) defraud / Klein conspiracy (18 USC § 371), (ii) tax evasion (§ 7201), and (iii) tax obstruction (§ 7212). The parts of the press release that addresses the big issue - the lie - previously discussed in the blogs here are:
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Tax Crimes -- the Role of the Lie

In several prior blogs I have asserted that tax crimes -- particularly tax shelter crimes -- are about the lie. Some who have read the Title 26 criminal tax provisions and the common Title 18 provisions used in prosecutions of what are at the core tax crimes will not find the word lie mentioned. Some of the tax crimes do require a lie via false statement under penalty of perjury (tax perjury, §7206(1) or false document (aiding and assisting, §7206(2)), but as I develop in this blog, the lie is the common feature critical for proscution of tax crimes even where the text of the criminal provision does not have some similar meaning.

I divide the universe of the crimes usually charged in tax crimes into two categories as follows:
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The Daugerdas Indictment - Part #4 - The Lie

I have blogged before that tax shelter prosecutions are about the lie. Often, the claim is that the tax shelters lack economic substance, but in these prosecutions the real complaint is the lie that is designed to give an appearance of economic substance. The jury will not understand the complex, convoluted tax structure and byzantine legal analysis, but the jury will understand the lie. In this blog, I will look principally at the indictment's claims as to the big lie. I caution readers that I address here only my understanding of the Government's unilateral claims about the lie in the indictment. I make no attempt here to develop nuance or present defenses to those claims that the defendants may have.

The Big Lie

The big lie is the taxpayers' representations that they had a nontax business reason for participating in the shelter. "In truth and fact," the indictment asserts repeatedly, the taxpayers participated in order to achieve the touted artificial tax benefit and not for a nontax business reason (sometimes the indictment alleges "substantial" nontax business reason). And, in truth and fact, the promoters knew the taxpayers' real tax motivation, despite their formalistic reliance on the taxpayers' "representations" of business reason.
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More on the Quellos Individuals Indictment - It is About the Lie

I have now had the opportunity to review the Quellos indictment in more detail. It is all about the lie that, if the allegations are proved, a jury will understand. A jury almost certainly would not understand -- or need to understand -- the complex tax rules which might have applied if the key factual underpinning were true. The jury will understand the lie. And, the gravamen of the instructions to the jury will be that, if the jury finds that prosecutors prove the lie they allege, the defendants should be found guilty.

Let's look at the counts and the lie. At the risk of oversimplication, I simplify and thus omit much of the detail.
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Tax Shelter Crimes Are About Lies

At the Civil and Criminal Penalties Section meeting (at the larger ABA Tax Section May Meeting), a panel discussed tax crimes in a tax shelter context. Kevin Downing, a DOJ attorney heavily involved in these prosecutions, pronounced that tax shelter prosecutions are not about complex tax interpretations; rather, those prosecutions are about the "lie." The lie may appear in the context of complex tax interpretations, but it is still the lie that is the criminal problem. Of course a lie may be a flat out falsehood as to the law, but these shelters often appear in contexts that, even when they approach the too good to be true category, they have some semblance of tax superstructure to avoid being a flat out lie. Usually, in this context, it is the assumptions of the factual underpinnings for the legal interpretation superstructure that is the problem. Prominently mentioned in this context are factual representations from the taxpayer that he or she has a business or profit motive independent of the tax benefits sought and has a reasonable prospect of making a profit in excess of the transaction costs.
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