With less than two weeks until the April 18 deadline for filing individual federal income tax returns, the Justice Department and Internal Revenue Service are issuing stern warnings to potential tax cheats. Today the U.S. Attorney for the Western District of North Carolina and the Special Agent in Charge of the IRS Charlotte Field Office issued a joint press release entitled “Federal Prosecutors Warn Potential Tax Cheats: Tax Crimes Result In Criminal Prosecution, Lengthy Prison Sentences, And Fines.” Their press release announced recent tax fraud prosecutions and sentencings, and is intended to “deliver a powerful warning to those who are thinking about breaking the law by committing tax crimes.”

“As tax filing season reaches its peak, we are putting would-be tax cheats on notice: My office will prosecute those who try to cheat the tax system at the expense of honest taxpayers who file their returns on time and pay the taxes they owe. Our tax system is built on voluntary compliance and tax criminals who do not pay their fair share increase the tax burden on law-abiding taxpayers,” said U.S. Attorney Jill Westmoreland Rose.

“The 2017 income tax filing season is soon coming to a close, however, special agents of the IRS – Criminal Investigation work year-round to combat criminal violations of the Internal Revenue Code and related financial crimes. Agents in the Charlotte Field Office have pursued, and will continue to pursue, those who prepare returns fraudulently, steal and misuse identities, and those who take extraordinary measures to conceal their income in an effort to evade their tax responsibility,” said Special Agent in Charge Thomas J. Holloman, III. “To build faith in our nation’s tax system, honest taxpayers need to be reassured that everyone is paying their fair share and we will work vigorously to pursue those who do not.”

The press release proceeds to highlight recent successes in prosecuting tax evaders and those who file false tax returns:

Matthew Moretz, 31, of Taylorsville, N.C., pleaded guilty to one count of filing a false tax return. From April 2010 to March 2011, Moretz collected unemployment income from the North Carolina Division of Employment. However, beginning in or about March 2010 and continuing through in or about 2013, Moretz was self-employed as the owner of MJM Recycling, a scrap metal business. From tax year 2010 through tax year 2013, Moretz earned additional personal income totaling approximately $529,622.44 that Moretz failed to report on his U.S. Individual Income Tax Returns Form 1040 filed with the IRS. As a result of the unreported taxable income, Moretz had additional tax due and owing of approximately $116,409.38 from 2010 to 2013. Moretz is currently awaiting sentencing.

Patrick Emanuel Sutherland, 48, of Charlotte, was convicted of filing false tax returns and obstructing a federal grand jury investigation. Court documents and trial evidence showed that, from at least 2007 to 2015, Sutherland was an actuary, and the owner and operator of numerous companies in the insurance and financial industries. Between 2007 and 2010, Sutherland engaged in an elaborate scheme to conceal a substantial amount of income, including filing false tax returns with the IRS which underreported business receipts and personal income of approximately $2 million in income received from an offshore bank account in Bermuda, as well as from domestic sources. Sutherland is currently awaiting sentencing.

Reuben T. DeHaan, 44, of Kings Mountain, N.C., was sentenced to 24 months in prison for tax evasion and possession of an unregistered firearm. DeHaan owned a holistic medicine business, which he operated out of his residence in Kings Mountain under the names Health Care Ministries International Inc. and Get Well Stay Well. During the years 2008 through 2014, DeHaan earned more than $2.7 million in gross receipts from his holistic medicine business, but failed to file income tax returns for those years and evaded approximately $678,000 in income taxes due and owing. DeHaan was also ordered to pay 567,665 in restitution to the IRS and $110,449 to the state of North Carolina.

Another area of focus for the Justice Department and IRS are unscrupulous return preparers and those who perpetrate stolen identity refund fraud:

Ramos, formerly of Lincolnton, N.C., was previously sentenced to 48 months in prison for her role in a false claims conspiracy. The conviction stemmed from Ramos’s role in a conspiracy to defraud the government by filing fraudulent tax returns seeking refunds totaling more than $5 million, by using stolen identity information of individuals in Puerto Rico. Ramos fled the United States and failed to report to federal prison after the sentencing. She is awaiting sentencing on charges of obstruction of justice and failure to report and faces additional jail time and fines.

Cara Michelle Banks, Carmichael Cornilus Hill, and Priscilla Lydia Turner conspired with Senita Dill and Ronald Jeremy Knowles, and others, to file false federal and state tax returns using stolen personal identifying information. From 2009 to 2012, this conspiracy defrauded the United States Treasury of over $3.5 million. Banks, Hill, Turner and others stole personal identifying information and then provided it to Dill to file the false returns in exchange for payment. Dill and Knowles used stolen personal information to file over 1,000 false tax returns. Court records show that Hill provided approximately 26 percent of the stolen identifications used to file the fraudulent returns. In 2016, Banks and Hill were sentenced to 70 months and 75 months in prison, respectively. In November 2016, Turner pleaded guilty to aggravated identity theft and is currently awaiting sentencing. Senita Dill was sentenced to 324 months and Knowles to 70 in prison for their roles in the conspiracy.

Finally, an area of recent intensity for the Justice Department and IRS is employment tax fraud:

Frank Alton Moody, II, 57, of Arden, the co-founder and former Chairman of the Board of CenterCede Services, Inc., a payroll services company, was ordered to serve 30 months in prison, two years in supervised release, and to pay $2,146,380.97 as restitution, for conspiring to steal over $2 million from client companies. Moody’s co-conspirators, Jerry Wayne Overcash and John Bernard Thigpen, were previously sentenced to 46 months and 21 months in prison, respectively. The three men used the more than $2 million they stole from client companies to fund their exorbitant salaries. Overcash and Thigpen were also ordered to jointly pay $1.3 million as restitution to the victim client companies.

The press release concludes with a reminder to taxpayers to exercise caution during tax season to protect themselves against a wide range of tax schemes ranging from identity theft to return preparer fraud. Illegal scams can lead to significant penalties and interest and possible criminal prosecution. IRS Criminal Investigation works closely with the Department of Justice to shutdown scams and to prosecute the criminals behind them. The IRS has issued its annual “Dirty Dozen” which lists common tax scams that taxpayers may encounter, particularly during filing season. Taxpayers are urged look out for, and to avoid, the following common schemes:

  • Phishing
  • Phone Scams
  • Identity Theft
  • Return Preparer Fraud
  • Fake Charities
  • Inflated Refund Claims
  • Excessive Claims for Business Credits
  • Falsely Padding Deductions on Returns
  • Falsifying Income To Claim Credits
  • Abusive Tax Shelters
  • Frivolous Tax Arguments
  • Offshore Tax Avoidance

As we have written previously, it is well-known that the IRS and Justice Department typically increase the frequency of their press releases announcing enforcement activity in the weeks leading up to the filing deadline. In fact, academic research confirms that these agencies issue 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).

As “Tax Day 2017” approaches, expect to see similar announcements intended to deter would-be tax cheats from filing false tax returns.

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On Oct. 18, 2016, a federal judge sentenced a well-known Chicago restaurant owner to prison for carrying out an extensive scheme to avoid paying state sales tax collected from customers of his establishments. Two important lessons may be drawn from this criminal case. First, criminal prosecutions of business owners for avoiding payment of state sales tax, which historically have been pursued by state authorities under state law tax statutes, may now be brought by federal prosecutors using the federal fraud and money laundering statutes. Second, the sentence imposed reflects the growing tendency of judges to impose sentences in tax cases that are below the applicable range as calculated under the United States Sentencing Guidelines.

Factual Background

The defendant in the case, Hu Xiaojun (also known as Tony Hu), owns and operates nine restaurants in the Chicago area. He was charged with federal wire fraud and money laundering offenses arising from his failure to pay sales tax to the state of Illinois on nearly $10 million in cash transactions occurring at his restaurants over a four-year period. Earlier this year, Tony Hu pleaded guilty to one count of wire fraud and one count of money laundering.[1]

According to the guilty plea agreement, between January 2010 and September 2014, the defendant failed to pay sales tax on transactions in which customers paid cash. To conceal cash sales, he instructed restaurant managers and employees to provide him with daily summaries of restaurant sales, which he would in turn alter to conceal cash sales. Hu and others would destroy the daily summary reports and cash transactions receipts, replacing them with incorrect reports that omitted the bulk of each restaurant’s cash sales. To hide cash sales from the state tax authorities, the defendant instructed employees to withhold cash generated from the restaurants from the corporate bank accounts to avoid creating financial records for those cash sales. Specifically, the restaurants in question discarded cash receipts until the reported amount was approximately 15 to 20 percent of credit card sales. The “discarded” cash was used to pay restaurant employees and suppliers without recording those expenses in the corporate books and records. The defendant also deposited a portion of the cash into his personal bank account, which he then used to pay personal expenses.

During the 2010 to 2014 time period, Hu instructed others to submit fraudulent sales figures to the Illinois Department of Revenue on monthly sales tax returns. Each month, the defendant directed his employees to provide false sales figures to his accountants, who in turn provided those figures to the state. In all, the defendant underreported his sales to the state by nearly $10 million, resulting in his underpayment of sales taxes by more than $1.1 million.

The wire fraud charge to which the defendant pleaded guilty is based upon his sending of an email containing false sales figures for the month of May 2014. The money-laundering charge to which the defendant pleaded guilty is based upon a series of financial transactions that he conducted using proceeds of his scheme to defraud the Illinois Department of Revenue. Specifically, the defendant deposited over $72,000 in cash into his personal bank account, which he knew consisted of funds derived from cash sales at his restaurants that were concealed from the state tax authorities. The defendant thereafter withdrew $60,000 from that account and purchased an official bank check, which he then deposited into a different business account. The defendant used the funds in that second bank account to purchase a restaurant and equipment, which he subsequently operated.

Sales Tax Fraud: No Longer Just a State Crime

At first glance, the facts of United States v. Xiaojun read like a typical criminal tax case and include the all-too-common attributes of tax fraud in the restaurant industry: the concealment of cash sales and the use of diverted cash to pay employees, purveyors and personal expenses of the restaurant’s owners. Indeed, the Justice Department’s website is replete with press releases announcing criminal tax charges against restaurant owners who engaged in conduct similar to that of this defendant, mostly commonly filing of false income tax returns in violation of 26 U.S.C. § 7206 or tax evasion in violation of 26 U.S.C. § 7201.

What makes United States v. Xiaojun notable is that the Justice Department did not assert a single federal tax charge against the defendant. The defendant’s payment of his employees in cash alone could have led to employment tax-related charges. Instead of charging Title 26 offenses, the government transformed what otherwise appears to be a garden-variety criminal tax case into a wire fraud and money laundering case by focusing on the defendant’s failure to pay state sales taxes.

The government’s case against Hu was premised upon a Justice Department policy titled Tax Directive No. 128, “Charging Mail Fraud, Wire Fraud or Bank Fraud Alone or as Predicate Offenses in Cases Involving Tax Administration.” This directive provides federal prosecutors with significantly expanded authority to use the mail and wire fraud statutes to charge additional crimes, and seek correspondingly increased penalties, in tax-related cases. Under a preceding policy, prosecutors were generally not permitted to use the fraud statutes where the use of the mails or wires was only incidental to a violation arising under the Internal Revenue laws.

Tax Directive No. 128 now authorizes prosecutors to use mail and wire fraud offenses and, more importantly, state tax violations where the mails or wire communication facilities are used, to transform cases that traditionally would be prosecuted under the tax laws into fraud and money laundering prosecutions. By charging mail and wire fraud in tax cases, the government can significantly change the charging and plea bargaining process. The mere threat of a mail fraud or money laundering charge may well cause targets of government investigations to plead guilty more willingly, and to agree to cooperate against other targets, than would have been likely under the prior policy where the charges were likely limited to federal tax offenses absent exceptional circumstances. In addition, the ability to include mail or wire fraud charges in a tax-related case provides prosecutors with an additional tool not previously available in traditional tax cases — the ability to seek forfeiture of the proceeds of the fraudulent scheme.

By relying upon the authority conferred by Tax Directive No. 128, the government can significantly ratchet up the pressure on targets of criminal tax investigations. By bringing charges under Title 18 rather than Title 26, the government can seek a longer prison sentence: the statutory maximum sentences available for mail fraud and money laundering, 20 years each, are significantly higher than the statutory maximum sentences available for tax fraud or tax evasion, which are three years and five years, respectively. In addition, the U.S. Sentencing Guidelines for mail fraud and money laundering crimes typically call for longer sentences than those applicable to tax offenses.

Charging mail fraud and money laundering also enables the government to seek restitution to be paid to the state agency that was defrauded. Had the government only charged federal tax crimes under Title 26, restitution could only have been ordered to the Internal Revenue Service. The government is also able to seek forfeiture of the funds that constitute proceeds of the mail fraud and money laundering offenses, an additional punishment that is not available for tax offenses. As part of his plea agreement, Hu agreed to pay at least $1 million in restitution to the Illinois Department of Revenue and to entry of a forfeiture judgment in an amount to be determined by the court at sentencing.

United States v. Xiaojun illustrates well how Tax Directive No. 128 provides federal prosecutors with significantly more leeway in charging offenses in what are viewed as traditional tax cases. No longer confined to the criminal offenses enumerated in Title 26, federal prosecutors can significantly increase the pressure on defendants by charging mail fraud and money laundering, seeking longer sentences and extracting substantial financial penalties by requiring defendants to pay both restitution and forfeiture. Prosecuting state sales tax fraud is no longer the exclusive domain of state authorities.

Downward Trends: Tax Offenders Often Receive Below-Guideline Range Sentences

As a result of his guilty plea, Hu was facing a possible prison sentence of 41 to 51 months as calculated under the applicable Sentencing Guidelines. Since the Supreme Court ruled in United States v. Booker, 543 U.S. 220 (2005), that the sentencing guidelines are no longer mandatory and binding, the applicable guideline range is but one of numerous factors that sentencing judges must consider in fashioning an appropriate sentence pursuant to 18 U.S.C. § 3553(a). Other considerations are the nature and circumstances of the offense and the history and characteristics of the defendant. After taking account of these factors, as well as the advisory guidelines range, the sentencing judge imposed a significantly below-guideline sentence, of one year and a day. With credit for good-time served, Hu will likely serve only 10 and one-half months in prison.

Far from aberrational, the sentence imposed on Hu fully comports with recent trends in tax fraud cases. According to the United States Sentencing Commission, in fiscal year 2015, 648 offenders were sentenced for tax fraud offenses.[2] Nearly two-thirds of those defendants were sentenced to imprisonment, with the average sentence being 17 months in jail. However, nearly half of those offenders received a sentence below the applicable Sentencing Guidelines range. And the percentage of below-range sentences — commonly referred to as “downward variances” — is steadily increasing, from 41.8 percent in FY 2011 to 49.2 percent in FY 2015. The average sentence for tax offenders has also decreased over the past five years.

Notably, the Northern District of Illinois — the judicial district in which Hu was prosecuted — had the most tax prosecutions of any district in the United States during FY 2015. That district also served as the venue for one of most significant downward variances in a tax case ever granted by a district court judge. In United States v. Ty Warner, the defendant pleaded guilty to evading about $5.6 million in federal income taxes.[3] Warner, who gained fame as the creator of the Beanie Baby toys, had secret Swiss bank accounts in which he hid over $100 million. Based upon the amount of taxes evaded, Warner faced a sentence of 46 to 57 months under the sentencing guidelines. Notwithstanding the significant tax loss, the district court judge imposed a sentence of probation — a downward variance of virtually unheard-of magnitude — based upon what it considered to be an exemplary lifetime of charitable good works by Warner as well as the fact that the defendant was a first-time offender who posed a low risk of recidivism.

The sentencing judge’s decision to grant a substantial downward variance to Hu was undoubtedly influenced by several important considerations. By pleading guilty, the defendant accepted responsibility for his misconduct — always an important factor at sentencing — but demonstrated further acceptance by making full restitution to the state of Illinois of all sales taxes evaded, nearly $1.1 million, prior to sentencing. In addition, the judge ordered Hu to annually perform 200 hours of community service for two years following his release from prison, reflecting a growing judicial trend toward considerations of alternatives to incarceration.

Conclusion

Two important lessons can be learned from the government’s case against Hu. First, the prosecution of sales tax fraud no longer falls solely within the purview of state authorities. Tax Division Directive 128 permits federal prosecutors to charge mail fraud, wire fraud, and even money laundering based upon a scheme to avoid paying state sales tax, exposing a culpable business owner to significantly longer jail sentences than could result from prosecution by state prosecutors under state law tax statutes. Second, below-guideline range sentences continue to be a feature that distinguishes tax cases from other white collar offenses. Nearly half of all tax offenders receive a sentence below the applicable range specified in the Sentencing Guidelines. This trend may be attributable to the view, held by some, that tax crimes are less serious than other types of white collar offenses, or to a general distaste for the formulaic approach to sentencing reflected in the Sentencing Guidelines, or both. In any event, tax offenders who accept responsibility for their misconduct by pleading guilty and making full restitution, and who have otherwise lived a commendable life and been productive members of society, can take comfort in the fact that their odds of receiving a below-range sentence are favorable, even if they are charged with fraud or money laundering offenses rather than straightforward tax charges.

Reprinted with permission from Law360. (c) 2016 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.

[1] See United States v. Hu Xiaojun, No. 16-cr-316 (N.D. Ill.).

[2] United States Sentencing Commission, “Quick Facts – Tax Fraud Offenses” (August 2016).

[3] See United States v. H. Ty Warner, No. 13 CR 731 (N.D. Ill.).