Check the Tax Loss Numbers: A Tale of Ineffective Representation

We have a cautionary tale of woe in a recent case, Baxter v. United States (E.D. Ill. 6/25/09), available here. In the opinion, the court holds that defense counsel's representation in a tax case was constitutionally ineffective where the defendant counsel failed to engage the tax expertise to verify the tax loss number in the plea agreement that was used for sentencing purposes. The tax loss number is the principal driver of the Sentencing Guidelines calculations, setting the base offense level under the Tax Table at S.G. §2T4.1. (The Baxter court said: "in tax cases the magnitude of the tax loss for which the defendant is liable is a primary factor in determining the sentencing guidelines range.") Without getting into the complexities of the Guidelines calculations, suffice it to say that the tax loss number is the principal component of those calculations in tax cases.

Baxter, a CPA, was involved with the Aegis Trust system that, subsequent to the events involved in the Baxter case, the Government has prosecuted in several high prosecutions. The Government prosecuted Baxter also, charging in the original indictment "eleven counts of criminal income tax violations." The opinion is not more specific as to the charges in the original indictment. By plea agreement, Baxter pled guilty to a single count of § 7212 (tax obstruction) in a superseding information, admitting that she had submitted a false document to an IRS agent. Baxter further agreed in the plea agreement that, for sentencing purposes, "the offense involved a tax loss of more than $ 550,000 but less than $ 950,000." Apparently at some point in the plea agreement, the specific number $576,000 was used. The Government sought then to increase the tax loss amount by supposed relevant conduct to $5.1 million, thus trying to force a sentencing range above the 3-year statutory maximum for § 7212, which would mean that the Guidelines sentence would be 3 years. The claimed relevant conduct was Baxter's overall knowing participation in the fraudulent Aegis Trust system. At the original sentencing, the sentencing court determined that the Government had failed to prove that, at the time of her conduct of conviction, Baxter knew the system was fraudulent, thus rejecting the Government's claimed $5.1 million tax loss. But, at sentencing, the Sentencing Court assumed the correctness of the $576,000 tax loss stipulated in the plea agreement.

As it turns out, however, in reaching the plea agreement, Baxter's counsel did not engage tax expertise necessary to test the $576,000 figure which he had counseled Baxter to agree to in the plea agreement. In truth, much and perhaps even all of that figure was not related to the crime of conviction and was included in the $5.1 million relevant conduct figure that the sentencing court had rejected. In short, it was clear that the actual tax loss which should have been included in the sentencing calculations was far less than the agreed $576,000.

Baxter sought post-conviction relief under 28 U.S.C. § 2255. (Section 2255 is the statutory descendant of the common law writ of habeas corpus. For a good summary, see Allan Ellis and James H. Feldman, Jr., A 2255 and 2241 Primer, 26 Champion 26 (2002).) Baxter alleged that her counsel's failure to engage the necessary tax expertise to test the amount of tax relief related to her crime of conviction only constituted ineffective representation. The court agreed. For the court's analysis, you can read the opinion. The following are the key points:

1. The tax loss could include only the loss attributable to the count of conviction plus any relevant conduct.

2. The court found at the original sentence that the Government had failed to prove the claimed relevant conduct which must be criminal conduct. There was no criminal conduct because at the time of the offense of conviction, Baxter did not know the Aegis system was illegal.

3. Based on the expert testimony presented in the § 2255 hearing, the court found that the tax loss agreed upon of $576,000 included loss attributable to relevant conduct and not the count of conviction. According to that defendant's expert, the loss attributable to the count of conviction was $22,853, which would have resulted in a change of the Guidelines range from 24-30 months to 8-14 months.

4. A criminal defense attorney is charged with responsibility to perform "a good faith analysis of all the relevant facts and applicable legal principles." (Internal citations omitted.)

5. This particular defense attorney proceeded without the aid of expert advice and merely assumed that the $576,000 related to the use of the system rather than to the offense of conviction.

The court then reasoned (citation omitted):

It was objectively unreasonable for Mr. Spielfogel to agree during the plea negotiations that there was a factual basis for the $ 576,000 tax-loss amount, but no factual basis for the $ 5.1 million tax-loss amount. Both amounts were based on the use of the Aegis Trust System by Baxter's clients. If Baxter did not wilfully and knowingly engage in the unlawful use of the Aegis Trust System, as argued by Mr. Spielfogel at the 2005 Hearing and as found by this court in its April 27, 2006 opinion, the government's factual predicate for attributing the tax loss amount of $ 576,000 to Baxter did not exist. By accepting the government's assertion that the $ 576,000 was attributable to Baxter's crime of conviction without performing an independent analysis of the relevant sentencing provisions, Mr. Spielfogel misled both his client and the court and "failed to engage in the type of good-faith analysis of the relevant facts and applicable legal principles" that is required of constitutionally effective counsel.

6. The Court found the defendant was prejudiced. (See paragraph 3, above.)

7. The Court concluded: "The court believes that had the facts and analysis that have now been presented by Baxter's tax expert, who was retained by her new counsel after her sentencing, been presented to the court prior to Baxter's 2006 sentencing, the court would have imposed a lower sentence."

JAT Note: This is a cautionary lesson for practitioners. Most criminal tax defense attorneys I know have it as virtually the first order of business to determine the tax loss numbers that could apply and to engage the necessary expertise immediately to undertake the analysis. Even if that attorney is engaged at the early stages of a CI investigation, it is important to quickly determine the range of potential tax loss numbers not only for eventual use at sentencing, but also to keep the client informed as to possible outcomes and to work with the CI agent in shaping the quantum of tax loss numbers that the Government will claim. How the latter is done requires more time than this blog can spend on it for now. Maybe I'll come back to that issue in the future. But, it is at least conceptually possible that by working the numbers, the indicated tax loss for sentencing can be moved so low that the indicated lack of any incarceration at the end of the process may influence the Government in its exercise of prosecutorial discretion not to prosecute. In this regard, the Government has limited prosecution resources relative to the number of poeple who actually commit some federal tax crime, and the Government generally perceives that it should devote those resources to defendants who committed significant crimes in terms of dollars. So the drill is to work the numbers, and work them hard. That can only be done with forensic tax accounts with the expertise to do it. I will have a posting at some point to discuss some aspects of how this is done and some of the concepts used. In the Baxter case, given how the Government felt about the relevant conduct, I doubt that the Government could have been dissuaded from prosecution by a real tax loss of $22,853 or, alternatively, instead of agreeing to an obstruction plea, the Government might have required a plea to one of the substantive counts that would have cemented its ability to include that relevant conduct. (In this regard, I think the Government had every expectation of its ability to include the claimed relevant conduct amount in the sentencing calculation, for after all it had charged that conduct in the substantive counts that were effectively dismissed, thus at least presumably imagining that it could prove the conduct beyond a reasonable doubt which is much higher than the preponderance of the evidence standard of proof at sentencing.)

Civil Tax Arcania Related to Voluntary Disclosure Program

The expanded FAQs published June 23, 2009 has the following Q&A:

31. How can the IRS propose adjustments to tax for a six-year period without either an agreement from the taxpayer or a statutory exception to the normal three-year statute of limitations for making those adjustments?

Going back six years is part of the resolution offered by the IRS for resolving offshore voluntary disclosures. The taxpayer must agree to assessment of the liabilities for those years in order to get the benefit of the reduced penalty framework. If the taxpayer does not agree to the tax, interest and penalty proposed by the voluntary disclosure examiner, the case will be referred to the field for a complete examination. In that examination, normal statute of limitations rules will apply. If no exception to the normal three-year statute applies, the IRS will only be able to assess tax, penalty and interest for three years. However, if the period of limitations was open because, for example, the IRS can prove a substantial omission of gross income, six years of liability may be assessed. Similarly, if there was a failure to file certain information returns, such as Form 3520 or Form 5471, the statute of limitations will not have begun to run. If the IRS can prove fraud, there is no statute of limitations for assessing tax.

JAT Comments:

1. The question addressed here is the IRS's authority to collect tax beyond if an applicable statute of limitations prohibits the assessment that justifies the collection. For the income tax, penalties and interest (as opposed to the FBAR penalty) under the Areement, Section 6501(a) of the Code unequivocally requires assessment within three years, unless certain exceptions apply. The applicable potential exceptions are (i) the 6 year 25% gross income omission expanding the statute of limitations to year years, and the fraud exception eliminating the statute altogether.

2. If neither of these exceptions apply and depending upon when the taxpayers filed their returns in the early years, some of the early return years statute of limitations is closed depending on when they filed and the IRS is prohibited from making the assessment. If the 6 year statute applies, it would appear that all of the relevant years would be open, provided that the IRS assessed the tax, penalties and interest promptly. And, of course, if the IRS determines there to have been fraud, there is no statute of limitations. We do not understand, however, that, for those participating in the program, the IRS is going to require an admission of fraud nor that they IRS will even make a determination of fraud.

3. In the cases affected (i.e., those where the 3 years statute would otherwise apply), how can the IRS do this? Stated another way, what is to prevent the taxpayer from joining the program and making the payments and then, within the refund period (2 years) seeking a refund? That is the question FAQ 31 answers, albeit cryptically. Basically, the IRS says that it is going to be a settlement, period, in which the taxpayer pays and doesn't get back (in a process similar, I suppose, to the binding effect courts put on Forms 872-AD even where they are not the statutorily authorily authorized closing agreement). By analogy to the Form 872-AD, the agreement is a contract reflecting the parties' bargain, and the parties will be held to the bargain -- the taxpayer pays and does not get back.

4. Focusing on the IRS side of the equation, at least for those taxpayers not subject to the 6 year statute, the IRS has no determination of fraud, so how does it post the payments for the years otherwise barred by the statute of limitations, particularly since the statute is so clear that an assessment outside the normal 3-year period is prohibited absent one of the exceptions. I suppose that the IRS could hold the money in a suspense account and, upon the refund period expiring, move the amount to the excess collections account. Cf ILM 200915034 (3/5/2009), reproduced at 2009 TNT 68-16 (involving the abatement of an erroneous assessment that was beyond the refund limitations period; note that, in this case, the refund limitations period will not have expired upon the payment, but the contract (similar to the Form 872-AD will foreclose the taxpayer from getting a refund, so that ultimately, presumably, barring an assessment, the money would go to the excess collections fund). Another way of solving the problem might be to have the contract say that the IRS potentially had a claim for fraud (which, if sustained would open the statute of limitations and subject the taxpayer to a 75% fraud penalty), but which claim is being settled by the taxpayer agreeing that the statute is open for the assessment and getting the benefit of a 20% penalty rather than a 75% penalty. Either way, taxpayer's entering the program should assume that their payments are gone forever.

Sentencing Memoranda in U.S. v. Madoff

For good examples of advocacy in the workings of the post-Booker sentencing, including the necessary Sentencing Guidelines calculations, in a white collar crime case of some current noteriety, I provide links to the Madoff sentencing submissions where the parties are poles apart as to an appropriate sentence. For my students, this might be a good drill to also test the workings of the Setencing Guidelines. The Madoff case is white collar rather than tax, but both are financial crimes where the base offense level is driven by the loss numbers with parallel adjustments to the base offense for similar activity and characteristics.

Madoff Attorney's Letter (from the White Collar Crime Prof Blog) here. For a related NY Law Journal article, click here.

USAO SDNY Memorandum (from the NY Law Journal site) here.

Addition on 6/29/2009: Peter Henning, law professor at Wayne State, has guest summary in the WSJ Law Blog here of the sentencing arguments.

UPDATE ON 6/29/09:

Madoff Got 150 Years. I am sure that readers have already gotten bottom line and much of the details from other sources. I do like this particular comment from Jonathan Turley's blog here:

Sentences of this length often make me think of the judge who sentences a middle aged man to 30 years only to have the defendant say “Judge, I am already 50, I can’t do that amount of time.” The judge looked down kindly upon the man and said, “That’s okay, just do as much as you can.” Bye, bye Bernie.