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August 29, 2017 – Law360

An unusual feature of this latest bank resolution is what the Justice Department characterizes as Prime Partners’ “voluntary and extraordinary cooperation” with the U.S. government. In early 2009, Prime Partners voluntarily implemented a series of remedial measures to stop assisting U.S. taxpayers in evading federal income taxes, before the initiation of any investigation by the U.S. government. The timing of these corrective actions is particularly notable, as the Justice Department announced its landmark deferred prosecution agreement with UBS AG, the largest bank in Switzerland, in February 2009, and the Internal Revenue Service unveiled its Offshore Voluntary Disclosure Program approximately 30 days later. In the midst of the announcement of the UBS resolution, many other Swiss banks were advising their U.S. clients to transfer their account holdings to other, smaller Swiss banks in order to avoid detection by U.S. authorities, thereby creating a class of U.S. taxpayers now labeled by authorities as “leavers.” In stark contrast, it appears that Prime Partners embarked on a different course of conduct, implementing corrective action to avoid further violations of U.S. law.

The Justice Department appears to have taken great care to describe publicly the extent of Prime Partners’ extensive cooperation, which included the following:

  • Prime Partners’ voluntary production of approximately 175 client files for noncompliant U.S. taxpayers, which included the identities of those U.S. taxpayers;
  • Prime Partners’ willingness to continue to cooperate to the extent permitted by applicable law; and
  • Prime Partners’ representation — based on an investigation by outside counsel, the results of which have been reviewed by the Justice Department — that the misconduct under investigation did not, and does not, extend beyond that described in a statement of facts accompanying the non-prosecution agreement.

Another notable aspect of this case is that while Prime Partners is a Swiss institution, it did not take advantage of the popular yet now-closed “Swiss Bank Program,” which essentially offered amnesty to any Swiss financial institution willing to come forward and make full disclosure of its cross-border activities involving U.S. citizens. Nearly 80 Swiss institutions enrolled in the Swiss Bank Program and successfully resolved their potential exposure under U.S. tax laws by paying steep financial penalties and agreeing to fully cooperate with the U.S. government’s ongoing investigations of offshore tax evasion. Instead of enrolling in the Swiss Bank Program, Prime Partners appears to have conducted an internal investigation, voluntarily disclosed its misconduct to the Justice Department, cooperated with the subsequent government investigation, and attempted to negotiate the best possible deal it could. Prime Partners may have been prompted to undertake such action based upon what the Justice Department has publicly stated is its “willingness to reach fair and appropriate resolutions with entities that come forward in a timely manner, disclose all relevant information regarding their illegal activities and cooperate fully and completely, including naming the individuals engaged in criminal conduct.”

The Justice Department’s announcement that it agreed to a nonprosecution agreement with Prime Partners is no doubt a signal to other financial institutions (both Swiss and non-Swiss) that the voluntary disclosure “window” remains open (notwithstanding the termination of the Swiss Bank Program), and that institutions voluntarily disclosing their wrongdoing and demonstrating substantial cooperation — like that of Prime Partners — will be treated leniently.

Indeed, in a press release announcing the resolution Acting Manhattan U.S. Attorney Joon H. Kim stated that “[t]he resolution of this matter through a non-prosecution agreement, along with forfeiture and restitution, reflects the extraordinary cooperation provided by Prime Partners to our investigation. It should serve as proof that cooperation has tangible benefits.” In the same vein, Acting Deputy Assistant Attorney General Stuart M. Goldberg said that “[i]n our ongoing investigations, we will continue to draw on information from a variety of sources and to provide substantial credit to those around the globe who provide full and timely cooperation regarding the identity of U.S. tax cheats and the phony trusts and shell companies they seek to hide behind.” At the same time, the Justice Department will undoubtedly seek to punish — to the fullest extent possible under U.S. laws — financial institutions that have aided and abetted tax evasion by their U.S. customers and that fail to come forward voluntarily and cooperatively.

Finally, the Justice Department’s resolution with Prime Partners stands as yet another stern warning to taxpayers with undisclosed foreign accounts that they must take corrective action immediately or face harsh consequences. In the press release, Acting Deputy Assistant Attorney General Stuart M. Goldberg said “[t]he message is clear to those using foreign bank accounts to engage in schemes to evade U.S. taxes – you can no longer assume your ‘secret’ accounts will remain concealed, no matter where they are located. In our ongoing investigations, we will continue to draw on information from a variety of sources and to provide substantial credit to those around the globe who provide full and timely cooperation regarding the identity of U.S. tax cheats and the phony trusts and shell companies they seek to hide behind.” The Internal Revenue Service’s Offshore Voluntary Disclosure Program remains available to taxpayers with undisclosed foreign assets, although the penalty for account holders at Prime Partners will now increase from 27.5 percent to 50 percent.

Reprinted with permission from Law360. (c) 2017 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.

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The Justice Department revealed its latest offshore bank resolution by announcing that it had entered into a non-prosecution agreement with a Swiss asset management firm called Prime Partners. This means that Prime Partners will not be criminally prosecuted for participating in what the DOJ characterized as a conspiracy to defraud the Internal Revenue Service and evade federal income taxes in connection with services that it provided to U.S. accountholders between 2001 and 2010. According to a press release announcing the resolution, the non-prosecution agreement was based upon Prime Partners’ “extraordinary cooperation,” including its voluntary production of approximately 175 client files for non-compliant U.S. taxpayer-clients. The non-prosecution agreement further requires Prime Partners to forfeit $4.32 million to the United States, representing certain fees that it earned by assisting its U.S. taxpayer-clients in opening and maintaining these undeclared accounts, and to pay $680,000 in restitution to the IRS, representing the approximate unpaid taxes arising from the tax evasion by Prime Partners’ U.S. taxpayer-clients.

As part of the non-prosecution agreement, Prime Partners admitted that it knew certain U.S. taxpayers were maintaining undeclared foreign bank accounts with the assistance of Prime Partners in order to evade their U.S. tax obligations, in violation of U.S. law. Prime Partners acknowledged that it helped certain U.S. taxpayer-clients conceal from the IRS their beneficial ownership of undeclared assets maintained in foreign bank accounts by using well-known mechanisms employed by offshore banks to hide funds, such as:

  • creating sham entities, which had no business purpose, that served as the nominal account holders for the accounts;
  • advising U.S. taxpayer-clients not to retain their account statements, to call Prime Partners collect from pay phones, and to destroy any faxes they received from Prime Partners;
  • providing U.S. taxpayer-clients with prepaid debit cards, which were funded with money from the clients’ undeclared accounts; and
  • facilitating cash transfers in the United States between U.S. taxpayer-clients with undeclared accounts.

An unusual feature of this latest bank resolution is what the Justice Department characterizes as Prime Partners’ “voluntary and extraordinary cooperation” with the U.S. government. In early 2009, Prime Partners voluntarily implemented a series of remedial measures to stop assisting U.S. taxpayers in evading federal income taxes, before the initiation of any investigation by the U.S. government. The timing of these corrective actions is particularly notable, as the Justice Department announced its landmark deferred prosecution agreement with the largest bank in Switzerland, UBS AG, in February 2009, and the Internal Revenue Service unveiled its Offshore Voluntary Disclosure Program approximately 30 days later. In the midst of the announcement of the UBS resolution, many other Swiss banks were advising their U.S. clients to transfer their account holdings to other, smaller Swiss banks in order to avoid detection by U.S. authorities, thereby creating a class of U.S. taxpayers now characterized by authorities as “leavers.” In stark contrast, it appears that Prime Partners embarked on a different course of conduct, implementing corrective action to avoid further violations of U.S. law.

The Justice Department appears to have taken great care to describe publically the extent of Prime Partners’ extensive cooperation, which included the following:

  • Prime Partners’ voluntary production of approximately 175 client files for non-compliant U.S. taxpayers, which included the identities of those U.S. taxpayers;
  • Prime Partners’ willingness to continue to cooperate to the extent permitted by applicable law; and
  • Prime Partners’ representation – based on an investigation by outside counsel, the results of which have been reviewed by the Justice Department – that the misconduct under investigation did not, and does not, extend beyond that described in a statement of facts accompanying the non-prosecution agreement.

Another notable aspect of this case is that while Prime Partners is a Swiss institution, it did not take advantage of the popular yet now-closed “Swiss Bank Program,” which essentially offered amnesty to any Swiss financial institution willing to come forward and make full disclosure of its cross-border activities involving U.S. citizens. Nearly 80 Swiss institutions enrolled in the Swiss Bank Program and successfully resolved their potential exposure under U.S. tax laws by paying steep financial penalties and agreeing to fully cooperate with the U.S. government’s ongoing investigations of offshore tax evasion. Instead of enrolling in the Swiss Bank Program, Prime Partners appears to have conducted an internal investigation, voluntarily disclosed its misconduct to the Justice Department, cooperated with the subsequent government investigation, and attempted to negotiate the best possible deal it could. Prime Partners may have been prompted to undertake such action based upon what the Justice Department has publicly stated is its “willingness to reach fair and appropriate resolutions with entities that come forward in a timely manner, disclose all relevant information regarding their illegal activities and cooperate fully and completely, including naming the individuals engaged in criminal conduct.”

The Justice Department’s announcement that it agreed to a non-prosecution agreement with Prime Partners is no doubt a signal to other financial institutions that the voluntary disclosure “window” remains open (notwithstanding the termination of the Swiss Bank Program), and that institutions demonstrating substantial cooperation – like that of Prime Partners – will be treated leniently. Indeed, in a press release announcing the resolution Acting Manhattan U.S. Attorney Joon H. Kim stated that “[t]he resolution of this matter through a non-prosecution agreement, along with forfeiture and restitution, reflects the extraordinary cooperation provided by Prime Partners to our investigation. It should serve as proof that cooperation has tangible benefits.” In the same vein, Acting Deputy Assistant Attorney General Stuart M. Goldberg said that “[i]n our ongoing investigations, we will continue to draw on information from a variety of sources and to provide substantial credit to those around the globe who provide full and timely cooperation regarding the identity of U.S. tax cheats and the phony trusts and shell companies they seek to hide behind.” At the same time, the Justice Department will undoubtedly seek to punish – to the fullest extent possible under U.S. laws – financial institutions that have aided and abetted tax evasion by their U.S. customers and that fail to come forward voluntarily and cooperatively.

Finally, the Justice Department’s resolution with Prime Partners stands as yet another stern warning to taxpayers with undisclosed foreign accounts that they must take corrective action immediately or face harsh consequences.  In the press release, Acting Deputy Assistant Attorney General Stuart M. Goldberg said “[t]he message is clear to those using foreign bank accounts to engage in schemes to evade U.S. taxes – you can no longer assume your ‘secret’ accounts will remain concealed, no matter where they are located. In our ongoing investigations, we will continue to draw on information from a variety of sources and to provide substantial credit to those around the globe who provide full and timely cooperation regarding the identity of U.S. tax cheats and the phony trusts and shell companies they seek to hide behind.” The Internal Revenue Service’s Offshore Voluntary Disclosure Program remains available to taxpayers with undisclosed foreign assets, although the penalty for accountholders at Prime Partners will now increase from 27.5 percent to 50 percent.

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In a recent criminal prosecution of a medical doctor/entrepreneur for defrauding his company’s shareholders, the government employed a novel theory of securities fraud premised, in part, upon the defendant’s failure to pay federal employment taxes withheld from his employees’ wages. The government alleged that the defendant, Sreedhar Potarazu, an ophthalmic surgeon licensed in Maryland and Virginia, made repeated false statements to shareholders about the financial condition of VitalSpring Technologies Inc., a company he founded, including concealing the fact that the company failed to pay more than $7.5 million in federal employment taxes. Ensuring that companies are fully compliant with their employment tax obligations is one of the top priorities of the Justice Department and Internal Revenue Service, and this case stands as a rare example of the confluence of the federal securities and employment tax laws.

Potarazu served as the company’s chief executive officer and also served on its board of directors. The government alleged that from at least 2008, Potarazu provided materially false and misleading information to VitalSpring’s shareholders to induce more than $49 million in capital investments in the company. According to the government, Potarazu induced investments from shareholders by making false representations, concealing material facts, and telling deceptive half-truths about VitalSpring’s financial condition, tax compliance, and alleged imminent sale. Potarazu represented on numerous occasions that VitalSpring was a financially successful company and that a sale of VitalSpring was imminent, which would have resulted in profits for shareholders. Potarazu concealed from shareholders that VitalSpring failed to account for and pay over more than $7.5 million in employment taxes to the IRS. Potarazu provided false corporate income tax returns to some shareholders that overstated VitalSpring’s income and omitted the accruing employment tax liability. From 2011 to 2015, in addition to his salary paid by VitalSpring, Potarazu diverted at least $5 million from the investors and VitalSpring for his own personal use.

Between 2007 and 2016, VitalSpring accrued federal employment tax liabilities of more than $7.5 million. The company withheld taxes from VitalSpring employees’ wages, but failed to fully pay over the amounts withheld to the IRS. As chief executive officer, Potarazu was a “responsible person” obligated to collect, truthfully account for, and pay over VitalSpring’s employment taxes. According to the government, ultimate and final decision-making authority regarding VitalSpring’s business activities rested with Potarazu. Potarazu was aware of the employment tax liability as early as 2007 and between 2007 and 2016, was frequently apprised of VitalSpring’s employment tax responsibilities by his employees. In addition, IRS special agents interviewed Potarazu in 2011 and informed him of the employment tax liability. In all but one quarter between the first quarter of 2007 and the last quarter of 2011, as well as the second and third quarters of 2015, Potarazu failed to file VitalSpring’s Employer’s Quarterly Federal Tax Return (Forms 941) with the IRS. Potarazu also failed to pay over any of the employment tax withheld from VitalSpring’s employees’ wages in all but one quarter between the second quarter of 2007 and the third quarter of 2011, as well as the third and fourth quarters of 2015. Between 2008 and 2015, instead of paying over employment tax, Potarazu caused VitalSpring to make millions of dollars of expenditures, including thousands of dollars in transfers to himself and others, the publication of his book, a sedan car service, and travel.

Potarazu eventually pleaded guilty to one count of securities fraud and one count of failing to account for and pay over federal employment taxes. In his guilty plea, Potarazu acknowledged that he provided materially false and misleading information to his company’s shareholders to induce further capital investments, including concealing the fact that the company had accrued a multi-million dollar tax liability as a result of unpaid employment taxes. On July 19, Potarazu was sentenced to nearly ten years in prison, and ordered to pay $49.5 million in restitution to shareholders and $7.6 million to the Internal Revenue Service. He was also ordered to forfeit several homes, vehicles, and bank accounts.

Aggressive criminal and civil enforcement of the federal employment tax laws has been a top priority of both the Justice Department and the IRS for the past several years. Amounts withheld from employee wages represent nearly 70% of all revenue collected by the IRS. According to a recent report from the Treasury Inspector General for Tax Administration (TIGTA), as of December 2015, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest, and penalties. The Justice Department’s Tax Division reports that as of June 30, 2016, more than $59.4 billion of taxes reported on quarterly federal employment tax returns remained unpaid. Employment tax violations represent more than $91 billion of the “Tax Gap,” which measures the difference between the total amount of tax owed to the U.S. Treasury and the amount actually paid. During fiscal year 2016, employment tax investigations were one of the few categories of tax crimes for which IRS-Criminal Investigation initiated more investigations than in the prior fiscal year.

Employment tax schemes can take a variety of forms. Some of the more common schemes include employee leasing, paying employees in cash, filing false employment tax returns, failing to file employment tax returns, and “pyramiding.” Pyramiding refers to the practice of withholding taxes from employee wages, but failing to remit such taxes to the IRS. After the employment tax liability accrues, the business owner starts a new business and begins to accrue employment tax liabilities anew.

In securities fraud cases, the government often charges that a company’s books and records are manipulated in order to falsely inflate revenue and earnings. For example, in United States v. Hyunjin Lerner (S.D. Fla. Mar. 29, 2017), the indictment alleged that the defendant and his co-conspirators engaged in a complex accounting fraud, utilizing unsupported expense accruals, improper accounting entries, misclassification of expense items, and false revenue items, in order to boost the company’s revenue and earnings. Similarly, in United States v. Joseph A. Kostelecky (N. Dakota Jan. 6, 2017), the defendant was charged with securities fraud in connection with an alleged scheme to artificially inflate his company’s revenue based upon the booking of revenue from oil and gas contracts, where such contracts did not exist or the revenue from such contracts was not collectible. In United States v. Brian Block (S.D.N.Y. Sept. 8, 2016), the indictment charged the chief financial officer of a publicly-traded real estate investment trust with securities fraud in connection with his alleged fraudulent inflation of a key metric used to evaluate a REIT’s financial performance in filings made with the Securities and Exchange Commission.

In securities fraud cases alleging materially false and misleading statements, it is rare for such statements to involve a company’s general tax compliance. Even more rare are cases involving false statements about a company’s employment tax compliance.  Indeed, the Potarazu case may be the first securities fraud case to allege that shareholders and investors were misled about a company’s employment tax compliance. With the intense focus now being paid to employment tax enforcement by the Justice Department and Internal Revenue Service, we may well see more cases, like Potarazu, where securities fraud schemes and employment tax fraud schemes are intertwined.

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2000px-Seal_of_the_United_States_Department_of_Justice_svgWith only four days remaining until “Tax Day,” the Justice Department’s well-publicized campaign to deter potential tax evaders continues with more stern warnings to taxpayers. In a bleak press release entitled “With the Individual Income Tax Filing Deadline Approaching, Justice Department Warns Willful Violations of Tax Laws Are Criminal,” the Justice Department sounds the warning once again that taxpayers who attempt to violate the federal tax laws that they face prosecution, jail, restitution and significant monetary penalties.

“Most Americans follow the tax law and rightfully expect that each of their fellow citizens will do the same,” said Acting Deputy Assistant Attorney General Stuart M. Goldberg of the Justice Department’s Tax Division. “Yet every year some taxpayers try to take a different path – they hide money offshore, declare only a small portion of their income, make up bogus deductions and lie to the IRS if they are caught. With this year’s filing deadline approaching, these taxpayers should stop, reverse course and simply pay what they owe. As the Justice Department’s recent criminal prosecutions make clear, the consequences for willful violations are severe: jail time and substantial monetary penalties.”

“The majority of Americans file their taxes without issue and they would tell you that they want strong enforcement of the tax laws to ensure that we are all paying our fair share,” said Chief Richard Weber of IRS Criminal Investigation. “For those thinking about intentionally evading the tax laws – IRS-CI has the finest financial investigators and are trained to follow the money trail wherever it may lead.”

The press release then proceeds to summarize recent tax prosecutions, starting with the following examples of individuals prosecuted for “garden variety” tax evasion or filing false tax returns:

  • In March, Denver Nichols, a Labadie, Missouri roofing contractor, pleaded guilty to filing false 2007 and 2008 income tax returns. Nichols operated his roofing business under the name Eagle Roofing Co. He late filed false 2007 and 2008 returns that underreported his business’s gross receipts by approximately $959,500 and $794,680.
  • In March, Stephen Leib, a Philadelphia, Pennsylvania tech business owner, pleaded guilty to tax evasion. Leib owned New Wave Logistics Inc. He evaded more than $800,000 in taxes by cashing a significant amount of his business’s gross receipts at a check cashing facility, lying to his accountant about the total amount of income he earned and filing false tax returns.
  • In March, Jeffrey Nowak, a Las Vegas, Nevada liquor storeowner, was sentenced to serve 41 months in prison for tax evasion and conspiring to defraud the United States. Nowak conspired with Ramzi Suliman, with whom he jointly owned and operated liquor stores in Las Vegas. Nowak and Suliman skimmed cash receipts and provided their accountant with a phony set of books that omitted nearly $4 million in cash receipts.
  • In February, Jose Echeverria, a Chelan Falls, Washington businessman, pleaded guilty to filing a false individual income tax return. Echeverria owned and operated a produce sales business. He underreported his income by approximately $564,292.
  • In December 2016, James and Mardeen Perin, former owners of Sully’s Pub in West Des Moines, Iowa, pleaded guilty to aiding and assisting in filing a false tax return. The Perins filed a false 2013 tax return that did not report cash that they earned through their business.

Individuals who fail to file returns are also subject to prosecution, as the Justice Department points out with the following examples:

  • In March, James Burton and Lucretia Pecantte-Burton, two Louisiana attorneys, pleaded guilty to failing to file individual income tax returns. Burton and Pecantte-Burton were partners of the law firm Pecantte-Burton & Burton (PB&B) and regularly received cash payments. They also had a partnership interest in a tax return preparation business. Burton and Pecantte-Burton did not file 2007 through 2009 income tax returns.
  • In February, Samuel Frazier, a Gulfport, Mississippi businessman, was sentenced to serve 12 months in prison for failing to file an individual income tax return. Frazier owned two companies in Gulfport: Frazier Fire Systems LLC and EZ Haul Demolition and Construction LLC. Frazier failed to file a 2009 tax return despite earning more than $618,253 in income.
  • In December 2016, John Raschella, a former Parma, Ohio resident, was convicted at trial for failing to pay more than $1 million in income taxes, interest and penalties for 1995, 1996 and 1998 through 2012 on income earned as an insurance salesman. He also failed to timely file income tax returns between 1989 and 2012.
  • In June 2016, Carlos Cortes, a San Antonio, Texas artist, was sentenced to serve 12 months in prison for failing to file an individual income tax return. Cortes did not file tax returns for 2006 through 2009, despite earning more than $1.3 million in income during this time.

One of the Justice Department’s top priorities in tax cases is prosecuting individuals who employ nominee entities and offshore bank accounts to hide assets and income, as the following cases demonstrate:

  • In March, Casey Padula, a Port Charlotte, Florida owner of Demandblox, a marketing and information technology business, pleaded guilty to conspiracy to commit tax and bank fraud. Padula conspired to move more than $2.5 million to offshore accounts in Belize and disguised them as business expenses in the corporate records. Padula used the funds to pay for personal expenses and purchase significant personal assets.
  • In March, Masud Sarshar, a Los Angeles, California businessman, was sentenced to serve 24 months in prison for hiding more than $23.5 million in offshore bank accounts. Sarshar maintained several undeclared bank accounts at Israeli banks, both in his name and in the names of entities that he created. Between 2006 and 2009, Sarshar diverted more than $21 million in untaxed gross business income to those undeclared accounts and earned more than $2.5 million in interest income. Sarshar reported none of this income on his individual and corporate tax returns.
  • In January, three Orange County, California residents pleaded guilty to hiding millions of dollars in secret foreign bank accounts. Dan Farhad Kalili, David Ramin Kalili and David Shahrokh Azarian, willfully failed to file legally required reports, commonly known as FBARs, disclosing their bank accounts in Switzerland and Israel.
  • In January, Peggy and John DeYoung, a Missoula, Montana couple, pleaded guilty to conspiring to defraud the United States. The DeYoungs had not filed an income tax return since 1998. Peggy DeYoung earned income through her ownership interest in two companies that owned Southern California mobile home parks. The DeYoungs also established a number of purported trusts. They owned bank accounts in the names of these trusts using fabricated taxpayer identification numbers and paid personal expenses from the accounts, causing a tax loss of $376,350.

The Justice Department also prosecutes individuals who engage in obstruction of IRS efforts to assess and collect taxes:

  • In November 2016, Richard Thomas Grant, a Point Richmond, California man, was sentenced to serve 33 months in prison. Grant stopped filing income tax returns and paying income taxes despite earning significant income as a partner with an engineering company. Grant attempted to frustrate IRS collection and audit efforts by filing lawsuits against the IRS. To conceal his income, Grant used prepaid debit cards and money orders to pay personal expenses.
  • In November 2016, Steven Headden Young of St. Petersburg, Florida, was sentenced to serve 21 months in prison. Young evaded a substantial portion of his individual income taxes for 2007 through 2011 and interfered with an IRS audit. He fabricated a letter from the IRS to a bank directing the bank to send subpoenaed records to a bogus address.
  • In October 2016, Henti Lucian Baird, a Greensboro, North Carolina resident and former IRS revenue officer, pleaded guilty. Baird filed tax returns each year but has not paid since at least 1998. Baird created nominee bank accounts to hide hundreds of thousands of dollars from the IRS, submitted false information to the investigating IRS officer regarding these accounts and transferred funds from nominee accounts to avoid impending IRS levies.
  • In June 2016, Paul Tharp, a North Carolina man, was sentenced to serve 21 months in prison. Tharp failed to file tax returns for 2003 through 2006, and the IRS assessed income tax against him for those years. Tharp attempted to evade payment of his tax debt by filing false disclosures with the IRS, omitting businesses that he owned as well as bank accounts and rental income.

Ironically, the Justice Department’s press release touting its successes in prosecuting tax crimes comes at a time when the Criminal Investigation Division of the Internal Revenue Service – which is responsible for investigating potential tax crimes – finds itself more resource-constrained than at virtually any other time in its history.  IRS-CI’s most recent annual report for FY2016 reveals that the agency has only 2,217 criminal investigators, its lowest point in two decades.  During FY2016, only 889 criminal tax cases were authorized for prosecution, a substantial decrease and the lowest number of authorizations in a decade.  Of all the myriad categories of crimes investigated by IRS-CI, only four — employment tax, public corruption, healthcare fraud, and offshore tax evasion — reflected an increase in the number of investigations initiated as compared to FY2015.  In every other category, the number of investigations initiated by IRC-CI during FY2016 decreased.  A substantial decrease in the number of tax investigations initiated by IRS-CI during the past year will have a lasting impact, as such cases typically require several years of investigation followed by prosecution, if approved.  As a result, we can expect to see fewer and fewer criminal tax prosecutions in the coming years.  And only if Congress agrees to fully fund the IRS will IRS-CI be able to hire new special agents to replace the hundreds of agents who have left the agency over the last 10 years without being replaced.

 

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.

2000px-Seal_of_the_United_States_Department_of_Justice_svgOriginally published by the International Enforcement Law Reporter (Feb. 10, 2017)

By Matthew D. Lee[1]

On December 29, 2016, the Justice Department’s Tax Division announced that it had reached final resolutions with the remaining “Category 3 and 4” Swiss banks that had enrolled in the Swiss Bank Program.[2] Originally unveiled in August 2013, the Swiss Bank Program provided a path for Swiss banks to resolve their potential criminal exposure under U.S. tax laws, and to cooperate in the Justice Department’s ongoing investigations of the use of foreign bank accounts by U.S. taxpayers to commit tax evasion. The Swiss Bank Program also provided a mechanism for those Swiss banks that were not engaged in wrongful acts but nonetheless wanted a resolution of their status. Originally viewed with skepticism by some critics, the Swiss Bank Program ultimately proved to be an overwhelming success, with 80 “Category 2” banks resolving their potential liability under U.S. law and paying nearly $1.4 billion in penalties. As the program now enters its “legacy” phase, Justice Department prosecutors and Internal Revenue Agents are working closely with all banks in the program to pursue leads around the globe to further additional investigations of foreign financial institutions, professionals, and individual U.S. taxpayers for offshore tax evasion.

Background Regarding the Swiss Bank Program

The Swiss Bank Program, unveiled on August 29, 2013, provided a path for Swiss banks to resolve potential criminal liabilities in the United States. Swiss banks eligible to enter the program were required to advise the Justice Department no later than December 31, 2013, that they had reason to believe that they had committed tax-related criminal offenses in connection with undeclared U.S.-related accounts. Banks already under criminal investigation related to their Swiss-banking activities and all individuals were expressly excluded from the program.

Under the program’s terms, participating banks were required to: make a complete disclosure of their cross-border activities; provide detailed information on an account-by-account basis for accounts in which U.S. taxpayers have a direct or indirect interest; cooperate in treaty requests for account information; provide detailed information as to other banks that transferred funds into secret accounts or that accepted funds when secret accounts were closed; agree to close accounts of accountholders who fail to come into compliance with U.S. reporting obligations; and pay appropriate penalties.

Any Swiss bank meeting all of the above requirements was eligible for a non-prosecution agreement, ensuring that it would not be subject to criminal prosecution in the United States.

Categories of Swiss Banks

The Swiss Bank Program established four categories of Swiss financial institutions based upon their perceived liability for potential violations of U.S. laws. “Category 1” included Swiss banks already under investigation when the program was announced; such institutions were not eligible to participate in the program. Banks in this category included UBS AG, Credit Suisse AG, Wegelin & Co., and Zurcher Kantonalbank, among others.

“Category 2” was reserved for banks that advised the Justice Department by December 31, 2013, that they had reason to believe that they had committed tax-related criminal offenses in connection with undeclared U.S. related accounts. To obtain a non-prosecution agreement, Category 2 banks were required to make a complete disclosure of their cross-border activities, provide detailed information on accounts in which U.S. taxpayers have a direct or indirect interest, cooperate in treaty requests for account information, provide detailed information as to other banks that transferred funds into hidden accounts or that accepted funds when those secret accounts were closed, and cooperate in any related criminal and civil proceedings for the life of those proceedings. Category 2 banks were also required to pay financial penalties based upon the number of U.S.-related accounts they serviced.

“Category 3” was designed for banks that established, with the assistance of an independent internal investigation of their cross-border business, that they did not commit tax or monetary transaction-related offenses and had an effective compliance program in place. Category 3 banks were required to provide the Justice Department with an independent written report that identified witnesses interviewed and a summary of each witness’s statements, files reviewed, and factual findings and conclusions. In addition, Category 3 banks were required to appear before the Justice Department and respond to any questions related to the report or their cross-border business, and to close accounts of accountholders who failed to come into compliance with U.S. reporting obligations. Upon satisfying these requirements, Category 3 banks were entitled to receive a non-target letter.

“Category 4” was reserved for Swiss banks that were able to demonstrate that they met certain criteria for deemed-compliance under the Foreign Account Tax Compliance Act (FATCA), a U.S. anti-tax evasion law enacted in 2010. Category 4 banks also were eligible for a non-target letter.

Category 1 Bank Resolutions

To date, a number of “Category 1” banks have reached resolutions of their potential criminal exposure under the U.S. tax laws with the Justice Department. The largest Swiss bank, UBS AG, entered into what was then considered a landmark deferred prosecution agreement in February 2009, agreeing to pay nearly $800 million, revamp its cross-border business, and hand over the identities of certain U.S. clients. The second largest Swiss bank, Credit Suisse, pleaded guilty in federal court to conspiracy to defraud the United States and paid $2.6 billion, the largest fine ever imposed in a criminal tax case. Other notable Category 1 banks which have reached resolutions with the U.S. include Wegelin Bank (Switzerland), Bank Leumi (Israel), and Bank Julius Baer (Switzerland). To date, a total of eight Category 1 financial institutions have resolved their criminal exposure under U.S. law, and several others remain under criminal investigation at this time.

Category 2 Resolutions

Between March 2015 and January 2016, the Justice Department executed non-prosecution agreements with 80 Category 2 banks and collected more than $1.36 billion in penalties. The Justice Department also signed a non-prosecution agreement with Finacor, a Swiss asset management firm, reflecting what the Justice Department described in a press release as its “willingness to reach fair and appropriate resolutions with entities that come forward in a timely manner, disclose all relevant information regarding their illegal activities and cooperate fully and completely, including naming the individuals engaged in criminal conduct.”[3]

Category 3 and 4 Resolutions

The Justice Department’s announcement in late December revealed that between July and December 2016, four banks and one bank cooperative satisfied the requirements of Category 3, making them eligible for non-target letters. No banks qualified under Category 4 of the program. The Justice Department did not announce the names of any of the qualifying Category 3 banks, nor did it release the names of the banks which failed to qualify as Category 4 institutions. Earlier this year Swiss bank Thurgauer Kantonalbank announced that it had received a non-target letter from the Justice Department, thus qualifying as a Category 3 institution.[4] The identities of the remaining Category 3 banks have not yet been made public.

Reflections on the Swiss Bank Program as it Enters “Legacy” Phase

The Swiss Bank Program has been an unqualified success for the U.S. government’s aggressive campaign to crack down on offshore tax evasion. Never before had the Justice Department offered what is essentially a tax evasion “amnesty” program to an entire country’s financial industry, leading some critics to initially question whether any Swiss banks would come forward given the historical secrecy that enveloped that sector. Those critics have been resoundingly proven wrong, given the overwhelming demonstration of interest in the program by Swiss banks and the significant amount of information that the program has generated for the Justice Department and Internal Revenue Service.

The Justice Department’s announcement of final resolutions with Category 3 and 4 banks does not, however, mark the conclusion of the Swiss Bank Program. Instead, the program is now enters what Justice Department calls its “legacy phase,” pursuant to which all participating Swiss banks are cooperating with ongoing civil and criminal investigations in the United States. The Swiss Bank Program is undoubtedly affording U.S. prosecutors and IRS agents a wealth of leads that they will use to “follow the money” around the globe in a continued effort to hold financial institutions, advisors, and account holders liable if they engage in evasion of U.S. tax laws. At the same time, the resolution of the Swiss Bank Program further ratchets up the pressure on non-compliant taxpayers, as the price of admission to the Offshore Voluntary Disclosure Program (OVDP) has dramatically increased for those who maintained secret accounts at any of the Swiss banks that have now resolved their potential liabilities with the U.S.

Given the tremendous success of the Swiss Bank Program, it remains to be seen whether the Justice Department will offer a similar program to banks in other countries or regions. Regardless of whether a formal program akin to the Swiss Bank Program is announced, financial institutions around the globe would be well-advised to take affirmative steps to attempt to resolve any potential exposure they may have under U.S. criminal laws. The Justice Department has long said that it would entertain voluntary disclosures of potential criminal activity from any bank, and that such self-corrective action – assuming it is timely and constitutes a full and complete disclosure – would be viewed favorably by the government officials in determining whether criminal prosecution is warranted.

[1]      Matthew D. Lee is a partner at Fox Rothschild LLP in Philadelphia and a member of his firm’s White-Collar Compliance and Defense practice group. A former U.S. Department of Justice trial attorney, Mr. Lee is the author of The Foreign Account Tax Compliance Act Answer Book 2016 (Practising Law Institute).

[2]     See Department of Justice Press Release, “Justice Department Reaches Final Resolutions Under Swiss Bank Program” (Dec. 29, 2016).

[3]     See Department of Justice Press Release, “Swiss Asset Management Firm Finacor SA Reaches Resolution with Justice Department” (Oct. 6, 2015).

[4]     See https://www.tkb.ch/tkb/medien/medienmitteilungen.htm?go1CDIccbRxIYVr4qeDJyxIIAoxlk7CxJxlD (last visited Feb. 1, 2017).

2000px-Seal_of_the_United_States_Department_of_Justice_svgEnsuring that employers collect and pay over to the Internal Revenue Service taxes withheld from their employees’ wages is one of the highest priorities of the Justice Department’s Tax Division. Unpaid employment taxes are a substantial problem for the U.S. government, as amounts withheld from employee wages represent nearly 70 percent of all revenue collected by the IRS. As of June 30, 2016, more than $59.4 billion of federal employment taxes remained unpaid, and employment tax violations represent more than $91 billion of the “Tax Gap,” which represents the difference between the amount of taxes owed to the U.S. Treasury and the amount actually collected. In this context, several recent criminal prosecutions demonstrate the perils businesses, and their officers, face if they fail to carry out their legal duty to remit employment taxes to the IRS.

Background

Employers have a legal responsibility to collect and pay over to the IRS taxes withheld from their employees’ wages. These employment taxes include withheld federal income tax, as well as the employees’ share of social security and Medicare taxes (collectively known as FICA taxes). Employers also have an independent responsibility to pay the employer’s share of FICA taxes. The IRS takes the position that when employers willfully fail to collect, account for, and deposit with the IRS employment tax due, they are stealing from their employees and ultimately, the U.S. Treasury. The IRS also contends that employers who willfully fail to comply with their obligations and unlawfully line their own pockets with amounts withheld are gaining an unfair advantage over their honest competitors.

The Justice Department’s Tax Division pursues civil litigation to enjoin employers who fail to comply with their employment tax obligations and to collect outstanding amounts assessed against entities and responsible persons. In the last two years, in an effort to send a clear message to delinquent employers who treat taxes withheld from employee wages as a personal slush fund or loan that can be put off or ignored entirely, the Justice Department filed 55 injunction complaints in federal courts across the country and obtained 47 permanent injunctions. These injunctions require the timely deposit of employment tax and filing of employment tax returns, prompt notice to the IRS after each deposit, and notice to the IRS if the employer begins operating a new business. In addition, the injunctions preclude employers from assigning property or making payments to other creditors until the company’s employment tax obligations are paid.

The Tax Division also investigations and prosecutes individuals and entities who willfully fail to comply with their employment tax responsibilities, as well as those who aid and assist them in failing to meet those responsibilities. According to former Principal Deputy Assistant Attorney General Caroline D. Ciraolo, “[t]he willful failure to comply with employment tax obligations is a crime – plain and simple. Stealing employee withholdings and failing to pay them over to the U.S. Treasury, gives dishonest employers an unfair advantage over their law-abiding competitors. The department will continue to work with the Internal Revenue Service to prosecute these offenders and level the playing field.”

Recent Employment Tax Criminal Cases

On January 26, 2017, two West Virginia business owners were sentenced to prison for failing to pay over employment taxes. Michael Taylor and his wife, Jeanette Taylor, were sentenced to serve 21 months and 27 months in prison, respectively. According to documents filed with the court, from 2000 through 2010, the Taylors owned and operated a construction business that transported steel and sold gravel and concrete throughout West Virginia and Kentucky. The Taylors changed the name of the business several times, though the operations of the business remained the same. From 1999 to 2004, the business was operated as Taylor Contracting & Taylor Ready-Mix LLC. In 2004, the name changed to Taylor Contracting/Taylor Ready-Mix LLC. In 2010, the name changed a third time to Bluegrass Aggregates. Both Michael Taylor and Jeanette Taylor were responsible for collecting, accounting for, and paying over to the IRS federal income taxes and social security and Medicare taxes that were withheld from the wages of their employees. From July 2007 through 2010, the Taylors withheld over $850,000 from their employees’ paychecks, but instead of paying over the withheld taxes to the IRS, the Taylors used the funds to purchase property and finance their horse farm. The Taylors also failed to pay over $490,000 in employment taxes for their prior business. The total tax loss for the Taylors’ conduct is $1.4 million. In addition to the term of prison imposed, Michael Taylor was ordered to pay $1,440,130 in restitution to the IRS. Jeanette Taylor was ordered to pay $766,273 jointly and severally with Michael Taylor to the IRS.

On January 12, 2017, a Pittsburgh tax attorney was sentenced to four years in prison for failing to remit employment taxes to the IRS. According to court documents and the evidence presented at trial, between 2004 and 2015, Steven Lynch co-owned and operated the Iceoplex at Southpointe, a recreational sports facility located in Washington County, Pennsylvania. Iceoplex included a fitness center, ice rink, soccer court, restaurant and bar. Lynch controlled the finances for these businesses and was responsible for collecting, accounting for, and paying over tax withheld from employee wages, and timely filing quarterly employment tax returns. The jury found that between 2012 through 2015, Lynch failed to timely pay over to the IRS more than $790,000 in taxes withheld from the wages of the employees for these businesses. In addition to the prison term sentence, the Court ordered Lunch to pay $793,145 in restitution to the IRS.

On December 15, 2016, an Iowa businessman was sentenced to 13 months in prison after pleading guilty to failing to pay employment taxes. Darrell Smith was the president and general partner of Energae, which was a minority investor in Permeate Refining LLC., an ethanol-production business in Hopkinton, Iowa. In his position at Energae, Smith had significant control over the finances of Permeate and was responsible for paying over to the IRS employment taxes on behalf of Permeate’s employees. From the first quarter of 2011 through the third quarter of 2012, Smith failed to pay over $502,863. After Smith discovered that a subordinate employee had made some payments to the IRS, Smith stopped that employee from making further payments.

On October 24, 2016, the owner of several Nevada landscaping and rock hauling businesses was sentenced to 10 months in prison for failure to pay over employment taxes. In addition, the company’s bookkeeper was sentenced to five years’ probation with three months home confinement for willful failure to file an employment tax return. According to documents filed with the court, Kyle Archie was the part owner of Reno Rock Inc., GKPA Inc., and D Rockeries Inc. Kyle Archie admitted that he was responsible for the day-to-day operations of the businesses and that from 2003 through 2009, he had a legal duty to collect, truthfully account for, and pay over employment taxes to the IRS. He further admitted that although he collected these taxes from his employees’ wages and held them in trust, he failed to pay them over to the IRS for the third quarter of 2008. Linda Archie, who is Kyle Archie’s mother, worked as the bookkeeper for Reno Rock Inc., GKPA Inc., and D. Rockeries Inc. and was responsible for maintaining the books and records of the companies and filing documents with various government agencies. She admitted that between 2003 and 2009, she failed to file employment tax returns on behalf of these businesses to account for the taxes that were withheld from the employees’ wages. The Court also ordered both Kyle and Linda Archie to pay restitution to the IRS in the amount of $1,235,528.

Conclusion

These criminal cases demonstrate the harsh consequences that employers face if they willfully fail to comply with their legal duty to collect and remit employment taxes. Such cases will not simply be addressed civilly by the IRS with back payment of taxes and penalties by the employer, but instead may be criminally prosecuted and with responsible corporate officers facing prison sentences. This is particularly the case if the withheld taxes are used to pay personal expenses of the business owners and/or to fund luxurious lifestyles. The Justice Department and IRS are especially focused on “pyramiding,” which refers to the common practice of repeatedly filing bankruptcy once a substantial employment tax liability has accrued and opening a new business entity so as to avoid the payment of employment taxes, as occurred in the Taylor case described above. And the “willfulness” legal standard is not particularly difficult for prosecutors to satisfy, as nearly all employers are aware of their obligation to remit taxes withheld from their employees’ paychecks. Employers must take special care to ensure that withheld employment taxes are property remitted to the IRS given the intense focus now being paid to this area by the Justice Department and IRS.

The Internal Revenue Service opened the 2017 tax filing yesterday, announcing that more than 153 million returns are expected to be filed this year. The tax filing deadline for this season is not April 15 – the date universally viewed as “Tax Day” – but is instead Tuesday, April 18, 2017. Taxpayers are afforded three extra filing days this year because April 15 falls on a Saturday, and the next business day (April 17) is a holiday observed only in the District of Columbia. By law, holidays observed in District of Columbia are treated as federal holidays nationwide for purposes of the filing deadline, thereby moving the tax deadline to April 18.

As is typically the case, the opening of the tax filing season was accompanied by several well-publicized enforcement actions by the Justice Department intended to warn potential tax cheats of the perils of filing a false tax return. The enforcement actions target “return preparer fraud,” previously identified as one of the IRS’ “Dirty Dozen Tax Scams for 2016.” According to the IRS, about 60 percent of taxpayers use tax professionals to prepare their returns. While the vast majority of tax professionals provide honest, high-quality service, the IRS is focused on dishonest preparers who perpetrate refund fraud by promising their clients overly large refunds utilizing unscrupulous tactics in preparing tax returns.

In the first action, the Justice Department announced that it had filed a civil lawsuit seeking to shut down a tax return preparer in Broward County, Florida. The suit, filed in federal court in Fort Lauderdale, asks the court to permanently bar the preparer, Billy Philippe, from preparing federal tax returns for others and asks the court to order Philippe to turn over a list of all the tax returns he has prepared since January 1, 2012. In its complaint, the Justice Department alleges that Philippe prepares federal income tax returns for customers that fraudulently overstate the amount of the refunds due by falsely claiming refundable credits, including the Earned Income Tax Credit (EITC) and credits for education expenses. The complaint further alleges that Philippe frequently claims fraudulently inflated wages or self-employment income in order to maximize the amount of EITC a customer claims. The IRS previously penalized Philippe over $24,000 for failure to exercise the due diligence required to claim the EITC for his customers and the failure to properly identify himself as the paid return preparer, according to the complaint. From 2011 to 2015, Philippe prepared at least 899 returns, according to the complaint. The complaint alleges that audits of 44 returns prepared by Philippe in 2014 and 2015 revealed that he claimed credits his customers were not entitled to take and/or understated their correct tax liability by more than $300,000 in the aggregate.

In the second action, the Justice Department announced that it had successfully convinced a federal judge to shut down an unscrupulous return preparer located in Sterling, Illinois. The court’s order permanently prohibits the preparer, Daria Emma Valdivia, from preparing federal tax returns for others and requires her to turn over to the IRS a list of all persons for whom she prepared federal tax returns since 2012. According to the lawsuit, the preparer routinely prepared tax returns for customers that falsely claimed unqualified individuals as dependents, such as persons who did not live in the United States or a country contiguous to the United States. The complaint also alleged that the preparer also improperly reported her customers’ filing status as “Head of Household” when the customers were ineligible for that status. The complaint further alleged that the preparer continued to engage in this conduct even after the IRS assessed her with $132,000 in penalties for similar misconduct. Finally, the complaint alleged that IRS audits of 65 returns show that the preparer underreported her customers’ tax liabilities on 89 percent (58) of them by more than $285,000 collectively.

Both press releases contain identical warnings to taxpayers to be careful in selecting a return preparer so as to avoid falling prey to a fraudulent return preparer:

The IRS is reminding taxpayers that the 2017 individual income tax return filing season begins today, Jan. 23, 2017, and there is information available on the IRS’s website. Return preparer fraud was one of the IRS’s Dirty Dozen Tax Scams for 2016 and taxpayers seeking a return preparer should remain vigilant. The IRS has some tips on their website for choosing a tax preparer and has launched a free directory of federal tax preparers. In the past decade, the Tax Division has obtained injunctions against hundreds of unscrupulous tax preparers. Information about these cases is available on the Justice Department’s website. An alphabetical listing of persons enjoined from preparing returns and promoting tax schemes can be found on this page. If you believe that one of the enjoined persons or businesses may be violating an injunction, please contact the Tax Division with details.

In a third action, the Justice Department announced that the owner of multiple tax preparation businesses located in Illinois, Kansas, and Missouri was sentenced to 27 months in prison for tax evasion. According to the press release announcing the sentence, the defendant, Semere Tsehaye, owned 20 Instant Tax Service franchise locations between 2005 and 2011, and during certain of those years he substantially unreported his gross receipts by providing his return preparer with fraudulent financial summaries. The defendant underreported his gross receipts by nearly $550,000 in 2010, and by over $1 million in 2011. In addition to a jail sentence, the court required the defendant to pay nearly $300,000 in restitution to the IRS.

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, we can expect similar — and more frequent — announcements intended to deter would-be tax cheats from filing false tax returns.

2000px-Seal_of_the_United_States_Department_of_Justice_svgIn December, the Justice Department announced criminal charges against John Yin, a software salesman who worked for a Canadian company that sells point of sale (POS) software programs that enabled restaurants to underreport their sales, thereby lowering their tax liability.[1] Commonly called “zapper” programs, these revenue suppression software (RSS) programs are used to delete some or all of a restaurant’s cash transactions and then reconcile the books of the business.

The result is that the company’s books appear to be complete and accurate, but are in fact false because they reflect fewer sales than were actually made. State authorities have been trying to combat the use of zappers by cash intensive businesses like restaurants for years, and the Yin case is significant because the government’s investigation revealed that the defendant marketed and sold zapper software throughout the Seattle area to multiple restaurants over the course of several years.

Yin pleaded guilty to a widespread scheme to defraud federal and state tax authorities, resulting in the avoidance of more than $3.4 million in taxes. This case is undoubtedly only the tip of the iceberg, as charges against other defendants will almost certainly result from Yin’s guilty plea.

The Alleged Offenses

According to the publicly-filed charging document and guilty plea agreement, Yin worked as a salesman for Profitek, a British Columbia company selling POS systems for hospitality and retail industries, from at least 2009 through mid-2015. In addition to its Canadian headquarters, Profitek has offices in China and a growing dealership network across North America.

Profitek designed, marketed, sold, and supported revenue suppression software as an “add-on” to its Profitek point-of-sale software. The RSS functioned only with the Profitek POS software. POS software creates a database of transactions that is used to calculate a business’ tax obligations. RSS is used to modify a business’ POS database for the sole purpose of hiding cash skimming.

When executed, the RSS program deletes all or some of the business’s cash transactions, and then reconciles the books of the business. The result is business records that appear to be complete and accurate but, in fact, are false and fraudulent in that they show less than total income earned.

Yin acknowledged in his guilty plea agreement that he successfully sold the POS software, and assisted in the widespread distribution of the zapper software, to dozens of customers in and around Seattle over the course of several years. The zapper software could only be ordered from a supplier in China, so Yin would put his clients in touch with the Chinese company and facilitate their purchase of the software. Yin also serviced the zapper software once his clients purchased and installed it.

Yin further admitted that his clients’ use of zapper software allowed them to consistently and significantly underpay their various federal, state and local taxes, including business and occupation taxes, Social Security and Medicare taxes and federal income taxes.

The plea agreement states that eight restaurants in the Seattle area were audited by the Washington State Department of Revenue and found to be using Yin’s zapper software. The total amount of state sales and federal income taxes avoided by these establishments during the period 2010 through 2013 were determined as follows:

Restaurant 1 $218,447.75
Restaurant 2 $498,666.75
Restaurant 3 $302,222.25
Restaurant 4 $472,222.25
Restaurant 5 $565,952.75
Restaurant 6 $332,433.00
Restaurant 7 $145,319.75
Restaurant 8 $910,324.50

These amounts do not include unpaid Social Security and Medicare taxes. The grand total of unpaid taxes attributable to zapper software sold by Yin is $3,445,589.00.

Yin entered a guilty plea on Dec. 2, 2016, to two federal charges: (1) wire fraud; and (2) conspiracy to defraud the U.S. government. The wire fraud charge is based upon Yin’s use of email to communicate with the Chinese supplier of the zapper software purchased by many of his clients. The conspiracy charge is based upon Yin’s efforts to facilitate the use of zapper software by his clients for purposes of underreporting taxable income required to be reported on federal income tax returns.

Based upon the agreed-upon tax loss of $3.4 million, at sentencing Yin is facing a potential sentence of 37 to 46 months in prison as calculated by the United States Sentencing Guidelines. As part of his guilty plea, Yin agreed to make full restitution, in the amount of $3,445,589, to the IRS and Washington State. Sentencing is scheduled for Feb. 24, 2017.

The publicly-filed court documents are silent as to whether Yin is cooperating with ongoing federal and state investigations of restaurants suspected of using zapper software. Given the widespread use of such software by Yin’s clients and the substantial jail sentence he is facing, it is reasonable to assume that he is cooperating in order to earn leniency at sentencing. As a result, charges against additional defendants are likely.

State Efforts to Combat Use of Zapper Software

Historically, state law enforcement agencies, not the U.S. Department of Justice or the Internal Revenue Service, have taken the lead in cracking down on the use of revenue suppression software. In early 2016, the attorney general of Washington state filed what he called a “first-of-its-kind” criminal case against a restauranteur, Yu-Ling Wong, for allegedly using sales suppression software to avoid paying nearly $400,000 in state sales tax.[2]

That case, which evidently spawned the federal prosecution of Yin, began as a routine audit by the Washington State Department of Revenue, which trains its auditors to detect the use of revenue suppression software. Auditors noted an unusual change in cash receipts, as compared to the restaurant’s historical cash receipts, determined that the restaurant’s point-of-sale system could not be trusted, and eventually uncovered the use of zapper software provided by Yin.

The case was thereafter referred for criminal prosecution, and state attorney general executed a search warrant at Yin’s residence. During a law enforcement interview conducted during execution of that search warrant, Yin admitted he sold the zapper software in approximately 2007 and trained a purchaser in how to use it.

Many states have passed laws outlawing the use of revenue suppression software, including Washington, Michigan, Florida, Georgia, Utah and West Virginia, and others are considering proposals to enact such laws. And the problem is not just confined to the United States. In a 2013 report entitled “Electronic Sales Suppression: A Threat to Tax Revenues,” the Organisation for Economic Co-operation and Development concluded that revenue suppression software “facilitate[s] tax evasion and result[s] in massive tax loss globally.”

Increasing Federal Attention to Zapper Software?

The Yin case suggests that federal authorities may take a greater interest in prosecuting restaurants and other cash intensive businesses that make use of revenue suppression software. The investigation of Yin and his subsequent guilty plea have opened a window into what appears to be widespread and longtime use of zapper software by restaurants throughout the Seattle area, and additional charges are expected.

The IRS has trained revenue agents to look for evidence that zapper software may be used, and its “Cash Intensive Businesses Audit Techniques Guide” specifically instructs agents to focus on point-of-sale software when auditing restaurants and bars. In addition, increasing vigilance by state auditors of cash intensive businesses will likely spawn additional federal prosecutions just as occurred in the Yin investigation.

Reprinted with permission from Law360. (c) 2017 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.