July 16, 2019

Tenth Circuit: Instruction Advising on Knowing and Dishonest Conduct Correctly Stated Mens Rea

The Tenth Circuit Court of Appeals issued its opinion in United States v. Sorensen on Monday, September 14, 2015.

Jerold Sorensen, an oral surgeon in California, found Financial Fortress Associates (FFA) in 2000 after an online search to develop a business plan for his dental practice. FFA offered seminars advising attendees to develop “pure trust organizations” (PTOs) in order to reduce or eliminate tax liabilities. Sorensen developed six PTOs with the help of Melissa Sugar, an attorney who spoke at the first FFA seminar Sorensen attended and opened a bank account titled “Northside Management,” which was titled in the trusts’ names. Sugar was the trustee of the trusts but Sorensen had full account privileges because he was named as Sugar’s “administrative assistant” for the trust. Sorensen retained full control over the Northside Management account. Sorensen retitled his personal residence, dental practice, and dental equipment into the trust, then had his dental practice pay the trust to “rent” his home, dental practice, and dental equipment. He deposited dental income directly into the trust and reported the rental expenses as business expenses, thereby avoiding taxes. No tax return was ever filed for the trusts, which were active from 2002 through 2008.

Soon after establishing the trusts, Sorensen approached his longtime accountant and family friend about the FFA pure trust program. Sharp researched the program and advised Sorensen that the IRS considered it a scheme, and that she could no longer provide tax services to Sorensen if he continued with the PTOs. Sorensen hired a new accountant, Wayne Paul, who was recommended by FFA, to prepare his business returns, and had his personal returns prepared by H&R Block. He never informed H&R Block about the trusts or the Northside Management account, which he explained was because they never asked.

In May 2007, an IRS special agent executed a search warrant at Sugar’s law office. By August of that year, Sorensen knew of the search but did not stop using the trust or Northside account. Sorensen later told IRS Special Agent Michelle Hagemann that although he thought he should stop using the FFA services, “he was in too deep, he couldn’t get out, and he didn’t want to pay the tax.” Also in 2007, Sorensen approached his son’s father-in-law, CPA Keith Wilcox, about the trusts. Wilcox testified that he told Sorensen the trusts were a complete sham. Wilcox prepared amended tax returns for Sorensen, but Sorensen did not file them for two more years.

Agent Hagemann sent Sorensen a certified letter in 2008 to advise him he was the subject of a criminal investigation. Sorensen refused the letter, following advice received at an FFA seminar. Later, when Agent Hagemann appeared at Sorensen’s dental offices, Sorensen refused to let her in, again following FFA advice, and sent her a public servant’s questionnaire requesting information such as her birthdate, home address, and social security number.

Sorensen’s defense theory was that he believed PTOs were completely legal. However, he admitted at trial that the payments made to the PTOs were not legitimate business deductions, and he also admitted that he underpaid his taxes by more than $1.5 million from 2002 through 2007. In November 2013, a Colorado federal grand jury indicted Sorensen, charging him with violating 26 U.S.C. § 7212(a) by corruptly endeavoring to impede administration of Internal Revenue laws.

The primary issue at trial was whether the statute required knowledge of illegality and whether Sorensen acted with such knowledge. The defense argued that Sorensen was a gullible, naive man who was unaware his conduct violated the law. Dr. Dana Cogan, a forensic psychiatrist, testified on Sorensen’s behalf that he was “law abiding” and “very naive.” Nevertheless, in 2014, the jury convicted Sorensen of corruptly endeavoring to obstruct or impede the due administration of internal revenue laws in violation of § 7212(a)’s omnibus clause. The district judge varied downward from the guidelines range and statutory maximum and sentenced Sorensen to 18 months’ imprisonment. Sorensen appealed, raising seven issues, which the Tenth Circuit addressed in turn.

Sorensen first contended that his conduct should have been charged under 26 U.S.C. §§ 7201 and 7203 because it amounted to evading taxes, and that § 7212 requires something more than tax evasion. The Tenth Circuit first noted that the government may choose what conduct to charge when the underlying conduct satisfies requirements of more than one charging statute. Because § 7212 requires that the tax evasion be done corruptly instead of willfully, the two sections address different conduct. Willfully evading taxes is the more serious crime. The Tenth Circuit noted that Sorensen used trusts created with no EIN, which prevented the IRS from tracking them and therefore obstructed and impeded the IRS from duly administering the tax code. The Tenth Circuit concluded Sorensen’s charge fit within the omnibus clause of § 7212.

Sorensen next raised three challenges to the jury instructions: (1) the district court erroneously refused to give an instruction on knowledge of illegality, (2) the court erroneously gave a deliberate ignorance instruction, and (3) the court erroneously gave an instruction that allowed the jury to convict on any one of the “means” alleged in the indictment. As to the first issue, the Tenth Circuit found the mens rea element was properly set forth in the court’s instruction, and therefore the district court did not err by denying Sorensen’s request for a separate instruction that knowledge of illegality is required. The Tenth Circuit further found that the district court’s instruction on Dr. Sorensen’s good faith belief of legality satisfied any question of whether the jury believed he had acted “knowingly and dishonestly” with regard to the trusts.

Sorensen also challenged the court’s deliberate ignorance instruction, because he denied only criminal intent, not knowledge of any fact. The Tenth Circuit found no error, noting the instruction assisted the jury in determining whether the government had proved Sorensen’s knowledge of facts bearing on the trusts’ illegality. The Tenth Circuit then addressed Sorensen’s argument that the district court erred by, sua sponte, providing an instruction that the jury must convict Sorensen based on unanimous agreement of any of the means provided in the indictment. Although the Tenth Circuit agreed that it was error for the district court to so advise the jury, the error benefited Sorensen and therefore was harmless.

Sorensen next argued the district court erred by refusing to allow him to present surrebuttal evidence. The Tenth Circuit found this decision well within the district court’s discretion, and noted that the court would have allowed the evidence during Sorensen’s case in chief but refused to allow it as surrebuttal because of a fear it would have devolved into back-and-forth accusations. Sorensen also contended the prosecution’s closing rebuttal argument misstated the evidence to mount an attack on Sorensen’s credibility. The Tenth Circuit analyzed each statement in turn. For the first instance, the Tenth Circuit found the court’s curative instruction resolved any potential error. For the next assertions of error, Sorensen failed to preserve them for appellate review, and the Tenth Circuit found that the prosecutor’s misstatements did not affect Sorensen’s substantial rights. The Tenth Circuit also held that there was no error in the district court’s failure to declare a mistrial based on the prosecutor’s improper remarks. Finally, the Tenth Circuit rejected Sorensen’s cumulative error argument, noting he failed to cite any conclusory authority to support his bare assertion of cumulative error.

The Tenth Circuit affirmed Sorensen’s conviction.

Tenth Circuit: A Defendant Cannot be Charged with Obstruction of Justice for Failing to Report Her Crime

The Tenth Circuit Court of Appeals issued its opinion in United States v. Kupfer on Tuesday, July 7, 2015.

Elizabeth Kupfer failed to report over $790,000 in gross income for joint tax returns filed from 2004 to 2006. She was charged with three counts of tax evasion, one for each year, and the jury found her guilty on each of the three counts. She was sentenced to three years in prison. She appealed, arguing (1) the district court’s jury instruction on willfulness was insufficient because it failed to describe particular mental states that did not constitute willfulness, such as negligence, inadvertence, mistake, or accident; (2) the trial court erroneously failed to conduct a hearing based on one juror’s affidavits averring improper conduct by another juror; and (3) the district court improperly increased the offense level based on obstruction of justice for Kupfer’s failure to disclose her crime.

The Tenth Circuit first addressed the jury instructions. The district court correctly instructed the jury that willfulness was required for a finding of guilt, and that willfulness referred to “the voluntary intent to violate a known legal duty.” Kupfer argued that although the instructions were correct as far as they went, they should have gone further and elucidated conduct that does not qualify as willfulness. The Tenth Circuit disagreed. Relying on circuit precedent, the Tenth Circuit found no error in the court’s failure to instruct on what conduct is not considered willful, and found that the district court’s decision was well within its discretion.

Next the Tenth Circuit evaluated the issue of whether the district court erred in failing to conduct a hearing on the juror’s affidavits of another juror’s misconduct. The district court received affidavits from the same juror from both the defense and prosecution, and declined Kupfer’s motions for a hearing and a mistrial. The district court could have reasonably concluded that the two affidavits relayed all the information it would have gleaned from the juror in a hearing, and it was a proper exercise of the court’s discretion to decline to hold a hearing.

The Tenth Circuit then addressed Kupfer’s argument that her sentence was improperly increased. The Tenth Circuit agreed. A defendant cannot be charged with obstruction of justice for failing to report her crime. The Tenth Circuit vacated the sentence and remanded for resentencing.

The Tenth Circuit affirmed the judgments of the district court but remanded for resentencing.

Tenth Circuit: Debtor’s Participation in Tax Evasion Scheme was Willful

The Tenth Circuit Court of Appeals issued its opinion in In re Vaughn: Vaughn v. United States on Tuesday, August 26, 2014.

In the mid-1990s, James Charles Vaughn was the CEO of FrontierVision Partners, L.P., a cable television acquisitions company. In 1999, Vaughn sold FrontierVision for roughly $2.1 billion. He received approximately $20 million cash and $11 million in the purchasing company’s stock from this transaction. Vaughn contacted KPMG LLP regarding tax planning and learned of a tax strategy called Bond Linked Issue Premium Structure (“BLIPS”), in which relatively small cash contributions were made to an investment fund with a non-recourse loan and loan premium in order to facilitate a high tax loss without a corresponding economic loss. Vaughn utilized the BLIPS strategy for his 1999 taxes. In September 2000, the IRS issued Revenue Bulletin Notice 2000-44, which specifically disclaimed BLIPS-type practices, although not naming BLIPS. Vaughn was notified of the IRS’s position by KPMG in 2000. In 2001, another BLIPS participant was audited by the IRS, and contacted Vaughn to inform him of the audit. KPMG was audited in 2002, and at that time informed Vaughn that he likely would face an audit as well. KPMG representatives suggested to Vaughn that he participate in an IRS voluntary disclosure program.

Meanwhile, Vaughn divorced his first wife, Cindy Vaughn, in 2001, and the couple’s assets were divided. Vaughn married Kathy St. Onge shortly thereafter and made large purchases with her. In 2002, three weeks before filing his voluntary disclosure with the IRS, Vaughn created an irrevocable trust for his stepdaughter and transferred $1.5 million to the trust. Vaughn and St. Onge spent large amounts of money from 2001 through 2003. When the couple divorced in 2003, St. Onge received many of the remaining assets.

The IRS notified Vaughn in 2003 that Cindy had requested innocent spouse relief for her 1999 tax return. Vaughn requested the same relief, stating that the divorces had depleted his assets but neglecting to mention the trust for the stepdaughter or the unequal division of assets in his divorce from St. Onge. In June 2004, the IRS notified Vaughn of an approximately $8.6 million tax deficiency relating to the BLIPS transaction, and notified him of a further $200,000 deficiency regarding carryover from 2000.

Vaughn filed his Chapter 11 bankruptcy petition in November 2006. The IRS subsequently filed a proof of claim in that action for the 1999 and 2000 tax deficiencies for approximately $14.3 million. Vaughn initiated an adversary proceeding, seeking to have the taxes declared dischargeable. The bankruptcy court found that Vaughn had both filed a fraudulent tax return and willfully evaded his taxes, and his tax liabilities were non-dischargeable. Vaughn appealed to the federal district court, which affirmed the bankruptcy court. Vaughn then appealed to the Tenth Circuit, arguing that the district court erroneously employed a “holistic” review to support the bankruptcy court’s determination of willful evasion of taxes, and also arguing that the bankruptcy court’s finding of willful evasion was based on conduct that was negligent, not willful.

The Tenth Circuit first addressed the “holistic” review argument, and noted that the bankruptcy court made no mention of employing a “holistic” review, instead applying a two-pronged approach. Turning next to the argument that Vaughn’s conduct was negligent, not willful, the Tenth Circuit found that the bankruptcy court made specific findings regarding Vaughn’s intentions in participating in the BLIPS scheme. The Tenth Circuit rejected Vaughn’s argument that his conduct was negligent because he did not know the exact amount of taxes due, finding instead that the assessment of tax is not required for debtor’s conduct to be willful.

The Tenth Circuit affirmed the district court and the bankruptcy court.

Tenth Circuit: Rule of Lenity Does not Apply in Plain Error Review

The Tenth Circuit Court of Appeals published its opinion in United States v. Williamson on Monday, March 17, 2014.

Defendant John S. Williamson has been protesting taxes for 30 years. In May 2008 the Internal Revenue Service (IRS) levied his wife’s wages to collect his back taxes. The IRS sent a notice of the levy, which Defendant returned, writing across the document: “Refused for cause. Return to sender, unverified bill.” In June 2008, Defendant sent an invoice for $909,067,650.00 to two IRS agents who had worked on the matter. The invoice listed the value of real and personal property allegedly seized by the IRS, added damages for various alleged torts, and then trebled the total “for racketeering.”

In December 2008, Defendant and Mrs. Williamson filed with the clerk of Bernalillo County, New Mexico, a claim of lien against the agents’ real and personal property for the same amount as the invoice. A grand jury indicted Defendant and Mrs. Williamson on two counts: (1) “corruptly endeavor[ing] to impede the due administration of the Internal Revenue Code by filing a false and fraudulent Claim of Lien,” in violation of 26 U.S.C. § 7212(a); and (2) “fil[ing] . . . a false lien and encumbrance against the real and personal property [of the IRS agents] on account of the performance of [their] official duties,” in violation of 18 U.S.C. § 1521.

Defendant’s defense at trial was essentially that he genuinely believed his lien was proper. A forensic psychologist testified that Defendant suffered from a delusional disorder that prevented him from abandoning his beliefs even when confronted with overwhelming evidence that he was wrong. Defendant requested instructions that would support his “genuine belief” defense to both charges, but the court rejected them and the jury returned verdicts of guilty on the two charges.

Defendant argued on appeal that the jury instruction concerning § 7212 should have informed the jury that he could be guilty only if he intentionally violated a known legal duty. The Tenth Circuit reviewed for plain error because at trial, defense counsel only argued the instruction should also contain a definition of “unlawful.” The court held that there was no plain error and that the rule of lenity did not apply because the “doubt required for the rule of lenity must be doubt raised by an adequately preserved argument.”

The court also rejected Defendant’s challenge to the § 1521 jury instruction for not including his requested good-faith defense. The § 1521 statute prohibits filing a false lien “having reason to know” it was false as well as knowingly filing a false lien. “Having reason to know” includes an objective component. A reasonable person knowing what Defendant knew would know the lien Defendant filed was false. Therefore, Defendant was not entitled to a good-faith defense instruction. The court affirmed his convictions.

Tenth Circuit: Actions of Tax Court Invalidating Offshore OPIS Shelter Upheld

The Tenth Circuit Court of Appeals published its opinion in Blum v. Commissioner of Internal Revenue on Wednesday, December 18, 2013.

This case came to the Tenth Circuit on appeal from a decision of the Tax Court upholding the actions of the IRS Commissioner invalidating a financial transaction as lacking economic substance and imposing two penalties for underpayment of taxes. The Tenth Circuit concluded that the intricacies of this offshore financial transaction and the fog of plausible deniability surrounding it could not make up for the clarity of the big picture: this was a transaction designed to produce nothing more than tax advantages, and the Tax Court was right to uphold the Commissioner’s actions.

The taxpayer, Mr. Blum, was a successful businessman who founded Buy.com. In August 1998, he made two sales of Buy.com stock resulting in $45 million in capital gains. A KPMG accountant who previously worked on Mr. Blum’s tax returns who was aware of Mr. Blum’s possible capital gains referred him to Carl Hasting, also of KPMG. Mr. Hasting pitched to Mr. Blum a transaction called OPIS (Offshore Portfolio Investment Strategy). The transaction, it is now widely acknowledged, is a tax shelter. However, KPMG recommended the transaction to Mr. Blum before the IRS revealed this information to the public.

The OPIS shelter was designed to create large, artificial losses for taxpayers by allowing them to claim a large basis in certain assets. These artificial losses offset actual capital gains, reducing the tax liability of the taxpayer.

Because of OPIS, Mr. Blum claimed $45 million in losses on his 1998 income tax returns, and it caught the attention of the IRS. The IRS disallowed OPIS and similar transactions in 2001. Rather than individually prosecute each OPIS scheme, the IRS settled with over 90 percent of OPIS purchasers. Mr. Blum did not accept the settlement offer. In 2005, the IRS sent a deficiency notice to Mr. Blum regarding his 1998 and 1999 federal income tax returns. Mr. Blum challenged this notice in the Tax Court. The Tax Court rejected his challenge and Blum appealed.

In his appeal to the Tenth Circuit, Mr. Blum made three arguments: (1) the Tax Court erred when it disallowed the OPIS losses under the economic substance rule; (2) the Tax Court erred by imposing a penalty for a gross valuation misstatement after it concluded the underlying transaction lacked economic substance; and (3) the Tax Court erred by imposing penalties for negligent underpayment, because Blum relied in good faith on KPMG’s representations.

First, Blum maintained that the OPIS transaction presented a reasonable probability of generating a profit, and that the Commissioner was therefore wrong to disallow the losses he claimed as a result of the transaction. The Tenth Circuit was unconvinced, and held that the OPIS transaction was a sham designed to reduce Mr. Blum’s tax liability. First, the $45 million loss associated with the transaction was grossly disproportionate to the $6 million Mr. Blum invested. Moreover, Mr. Blum did not lose $45 million; the loss was fictional. Second, the OPIS transaction was planned and executed in a way that was designed to generate a massive tax loss. Third, the evidence showed OPIS did not provide a reasonable expectation of profit. Fourth and finally, what profit potential OPIS presented was de minimis when compared to the tax benefits of declaring capital losses of $45 million. This disparity indicated a lack of economic substance. Further, Mr. Blum’s actions during and after the OPIS transaction indicated that his sole motive was tax avoidance. For these reasons, the OPIS transaction lacked objective economic substance and the Tax Court was correct in disallowing the loss.

Second, the Commissioner assessed penalties against Mr. Blum for his underpayment of taxes associated with OPIS. One of these penalties was a gross-valuation misstatement penalty. Blum argued that the penalty was inapplicable because the underlying transaction had been invalidated by the economic substance doctrine. The Supreme Court resolved the split on this issue: invalidation of a transaction under the economic substance doctrine does not prohibit the imposition of the penalty. Therefore, the Tenth Circuit upheld the Tax Court’s decision allowing the penalty.

Finally, the Commissioner imposed a 20 percent penalty on Mr. Blum for negligent underpayment of taxes on his 1999 return. Section 662(b)(1) of the Tax Code allows the IRS to impose a 20% penalty if the taxpayer’s underpayment resulted from negligence. Mr. Blum recited a litany of reasons why his reliance on KPMG’s advice should excuse him from paying this penalty. The court stated that although KPMG may have acted nefariously, that did not excuse Mr. Blum’s negligence.


Tenth Circuit: In Tax Evasion Case, Conviction Affirmed, Sentence Reversed

The Tenth Circuit Court of Appeals published its opinion in United States v. Melot on Monday, October 21, 2013.

After a jury trial, appellant Bill Melot was convicted of one count of corruptly endeavoring to impede the administration of the Internal Revenue Code, one count of attempting to evade or defeat tax, six counts of willful failure to file, and seven counts of making false statements to the Department of Agriculture. Melot was sentenced to a term of sixty months’ imprisonment, a significant downward variance from the advisory guidelines range of 210-262 months. He was also ordered to pay $18,493,098.51 in  restitution to the Internal Revenue Service.

On appeal, Melot argued the Government presented insufficient evidence of willfulness to support his convictions and erred in the calculation of the tax loss and the amount of restitution. The Government cross-appealed, arguing the district court committed clear error by applying a two-level reduction to Melot’s offense level for acceptance of responsibility.

Regarding Melot’s conviction, the Tenth Circuit held that the Government’s evidence demonstrated overwhelmingly that Melot engaged in behavior consistent with an individual who had actual knowledge of his obligation to file returns and pay tax. The Government’s evidence showed Melot routinely concealed income and assets from the IRS; used cash extensively, informing others that this was a means to avoid the payment of income taxes; and acted in a manner inconsistent with his asserted belief he was not subject to federal income taxes because he was not a citizen of the United States. All of the Government’s evidence, together with the reasonable inferences that could be drawn from it, was amply sufficient to support the jury’s finding that Melot was aware of his obligation to file returns and pay federal taxes and negated any inference Melot acted in good faith.

On the issue of Melot’s sentence, Melot argued some evaded state fuel excise taxes did not qualify as relevant conduct because they were not groupable with his offenses of conviction. However, the court concluded the offenses of conviction and the evasion of fuel excise taxes were part of a common scheme or plan because both had a common purpose—the defeat of taxes owed.

In its cross-appeal, the Government argued the district court clearly erred in granting Melot a two-level decrease in his offense level for acceptance of responsibility. The Sentencing Guidelines provide that a defendant can meet his burden by showing, inter alia, he truthfully admitted the conduct comprising the offense of conviction or voluntarily paid restitution prior to adjudication of guilt. U.S.S.G. § 3E1.1. A review of the record confirmed Melot did neither of these things, nor did he engage in any other conduct demonstrating an acceptance of responsibility for his offenses. Because the record contained absolutely no evidence supporting the application of the acceptance-of-responsibility reduction but, instead, clearly demonstrated Melot did not accept responsibility for his criminal conduct, the district court’s determination that he was entitled to the § 3E1.1 decrease was clearly erroneous and Melot’s sentence had to be reversed.

The Tenth Circuit AFFIRMED Melot’s convictions and REVERSED his sentence.