On April 13, 2021, the Tax Court issued a Memorandum Opinion in the case of Flynn v. Commissioner (T.C. Memo. 2021-43). The primary issue presented in Flynn was whether the petitioner’s failure to file returns for 1999, 2000, and 2001 was fraudulent.
Tax Court’s Holding:
It’s a Damn Conspiracy (No, Really, It Is)
The petitioner took part in a bit of a criminal conspiracy, which bilked 577 suckers (investors, rather) out of $20.7 million between 1999 and 2001.
The petitioner and his co-conspirators represented to investors that their principal would be kept in guaranteed accounts in a major world bank and would not be at risk. But wait, there’s more. The “investment business” claimed to operate as a tax-free church despite having had no churchlike organization, no building, no worship services, and no activities of a religious nature. The petitioner and his co-conspirators told investors that their returns on their investments would be nontaxable if they purchased a “church sub-chapter” package from the business.
It should be noted that one of the investment caveats, however, was that investors would be “thrown out” of the program if they talked about it to their accountants or the authorities. How this was not a red flag being waved by an 800 pound gorilla, sitting on the pink elephant in the room boggles my mind, but here we are.
When some investors demanded that the company return their principal, they were told they were being “thrown out” of the program. In December 2001 Access closed its office (the basement of a founder—no joke), leaving investors with no information and no money.
Interesting Strategy Cotton, Let’s See How it Plays Out…
In or about late 2001 the Federal Government initiated a criminal investigation into the company and its participants. The petitioner was subpoenaed by the grand jury. However, he claimed that the grand jury had no jurisdiction to subpoena him, and he challenged the very validity of Federal income tax laws.
There is delusional, and then there is a housecat looking in a mirror and seeing a regal lion in his reflection delusional. The petitioner, it appears, was master level kitty-cat delusional.
The grand jury, thinking pretty damn highly of itself, returned an 83-count indictment charging petitioner and his codefendants with mail fraud, conspiracy to commit mail fraud, money laundering, conspiracy to commit money laundering, and conspiracy to defraud the United States. The court ordered petitioner, jointly and severally with his codefendants, to pay restitution of $11,700,000 to the victims that were defrauded. The District Court’s judgment was affirmed on appeal. See United States v. Flynn, 265 F. App’x 434 (6th Cir. 2008).
I pause here only to note that the trial lasted five weeks, which seems like an awful long time to prove that a fake investment church that stole millions from pensioners by telling them “Shhhhhh….don’t tell” was guilty as sin, but, again, here we are.
“Pevos a.k.a. Cheeks Bar a.k.a Thunder Lake Lodge”
I’m not going to get into the other shady dealings that the petitioner engaged in, but this is an actual caption from the Tax Court opinion. That’s funny—I don’t care who you are.
The “Copies” of the Returns
Petitioner claims that on February 14, 2003, he filed Forms 1040 for 1999, 2000, and 2001, each return being due before February 14, 2003. During his criminal trial petitioner introduced into evidence signed “copies” of these Forms 1040 for the subject years.
It should be noted that the quotes around the word “copies” is supplied by the Tax Court, and not just my sarcastic take on the petitioner’s utter disconnect from the real world.
The Substitutes for Returns
In 2013, the IRS prepared IRC § 6020(b) substitutes for returns (SFR) for petitioner for 1999 through 2001.
The petitioner “provide[d] no records documenting the purpose of the numerous wire transfers he initiated to…several individuals in Nigeria,” though the wires did “state that the petitioner is a ‘church employee.’” Seems about right.
The Fraudulent Failure to File Penalty
IRC § 6651(a)(1) imposes an addition to tax for failure to timely file a Federal income tax return. This addition to tax equals 5% of the tax required to be shown on the return for each month or fraction thereof for which there is a failure to file a return, up to 25% in the aggregate. IRC § 6651(f) increases those respective percentages to 15% and 75% where the failure to timely file is fraudulent.
In order to ascertain whether a taxpayer’s failure to timely file was fraudulent under IRC § 6651(f), the Tax Court considers whether the taxpayer failed because of fraudulent intent to timely file a return for the taxable year where there was a tax liability required to be shown on a return. See IRC § 6651(a), (b)(1), (f); Clayton v. Commissioner, 102 T.C. 632, 653 (1994); Porter v. Commissioner, T.C. Memo. 2015-122, at *44. The IRS has the burden of proving these elements by clear and convincing evidence for each year for which fraud is alleged. IRC § 7454(a); Tax Court Rule 142(b); Clayton, 102 T.C. at 646.
Determining Fraudulent Failure to File (and Other Alliterative Pursuits)
In determining whether a taxpayer had the requisite fraudulent intent for imposition of the IRC § 6651(f) addition to tax, the Tax Court considers the same elements that it considers in imposing the fraud penalty under IRC § 6663. Clayton, 102 T.C. at 653; see Granado v. Commissioner, 792 F.2d 91, 93-94 (7th Cir. 1986), aff’g T.C. Memo. 1985-237.
Fraud is established by proving that a taxpayer intended to evade tax believed to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of tax. Clayton, 102 T.C. at 647; see Pittman v. Commissioner, 100 F.3d 1308, 1319 (7th Cir. 1996), aff’g T.C. Memo. 1995-243. The existence of fraudulent intent is determined by looking at the entire record and the taxpayer’s conduct. See DiLeo v. Commissioner, 96 T.C. 858, 874 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992).
Fraud is never presumed and must be proven by independent evidence. Zell v. Commissioner, 763 F.2d 1139, 1143 (10th Cir. 1985), aff’g T.C. Memo. 1984-152; Beaver v. Commissioner, 55 T.C. 85, 92 (1970). Fraud need not be established by direct evidence, which is rarely available, but may be proved by circumstantial evidence and reasonable inferences drawn from the facts. Niedringhaus v. Commissioner, 99 T.C. 202, 210 (1992); see Pittman, 100 F.3d at 1319.
In determining whether there was fraudulent intent, the Tax Court looks at a nonexclusive list of factors. See Pittman, 100 F.3d at 1319; Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), aff’g T.C. Memo. 1984-601; Niedringhaus, 99 T.C. at 211; Recklitis v. Commissioner, 91 T.C. 874, 910 (1988). Under Bradford, 796 F.2d at 307 and Niedringhaus, 99 T.C. at 211, these factors include:
- failing to file income tax returns;
- filing false documents, including false income tax returns;
- understating income;
- concealing income or assets;
- engaging in illegal activity;
- failing to cooperate with tax authorities; and
- asserting frivolous arguments and objections to the tax laws.
While no single factor is determinative for establishing fraud, the existence of several “badges of fraud” may constitute compelling circumstantial evidence of fraud. Bradford, 796 F.2d at 307-308; Niedringhaus, 99 T.C. at 211.
Failing to File Income Tax Returns
While the mere failure to file a return, standing alone, is not sufficient to support a finding of fraud, Niedringhaus, 99 T.C. at 211, an extended pattern of failing to file returns is a badge of fraud and may be persuasive circumstantial evidence of the intent to evade tax, see Bradford, 796 F.2d at 308; Petzoldt v. Commissioner, 92 T.C. 661, 701 (1989). The petitioner failed to file Federal income tax returns for 1999, 2000, and 2001. This factor weighs against the petitioner for each of the years in issue.
Filing False Documents
Filing false documents with the IRS constitutes an “affirmative act” of misrepresentation sufficient to justify the fraud penalty. Zell, 763 F.2d at 1146. The petitioner never filed Federal income tax returns for the years in issue, and there is no evidence he filed with the IRS false documents that he used to obtain various loans. But filing false documents with a third party supports an inference of fraud. See Isaacson v. Commissioner, T.C. Memo. 2020-17, at *54. In light of the petitioner’s repeated use of false employment and Federal tax documents with multiple financial institutions, this factor indicates fraudulent intent.
A pattern of substantially underreporting income for several years is strong evidence of fraud, particularly if the understatements are not due to innocent mistake or are not otherwise satisfactorily explained. See Holland v. United States, 348 U.S. 121, 137-139 (1954); Pittman, 100 F.3d at 1319-1320; Marcus v. Commissioner, 70 T.C. 562, 577 (1978), aff’d without published opinion, 621 F.2d 439 (5th Cir. 1980). The petitioner at his criminal trial provided his purported Forms 1040 for 1999 through 2001, which admitted that he failed to report significant amounts of income received from the investment church as income for 1999, 2000, and 2001. He did include that income on loan applications, and that inconsistency weighs against the petitioner. He also failed to report gambling income for 1999, 2000, and 2001. This factor weighs against the petitioner for 1999, 2000, and 2001.
Concealing Income and Assets
An intent to evade tax may be inferred from “concealment of assets or covering up sources of income.” Spies v. United States, 317 U.S. 492, 499 (1943). Concealing assets coupled with a failure to file tax returns is a strong indication of fraud. Freidus v. Commissioner, T.C. Memo. 1999-195, *10. A taxpayer’s use of nominee corporations is evidence of asset concealment. See Bennett v. Commissioner, T.C. Memo. 2014-256, *12, aff’d, 690 F. App’x 934 (9th Cir. 2017).
The bank accounts that the petitioner opened, the loans he received, and the assets he purchased were used, at least to a significant extent, to conceal the amounts he received from his participation in the Access scheme. This factor weighs against the petitioner for each of the years in issue.
Engaging in Illegal Activity
Engaging in an illegal activity is a badge of fraud. See Niedringhaus, 99 T.C. at 211. In each of the years in issue, the petitioner participated in an illegal pyramid scheme for which he was prosecuted and convicted. The petitioner played an active role in convincing victims to invest their savings, including retirement savings, in the scheme. The petitioner used the funds he received to purchase his personal residence, two bars, and three airplanes as well as to pay for construction of a new bar and to generally support his lifestyle. This factor weighs against the petitioner for each of the years in issue.
Failing to Cooperate with Tax Authorities
Failure to cooperate with revenue agents during an audit is a badge of fraud. Grosshandler v. Commissioner, 75 T.C. 1, 19-20 (1980); Zell, 763 F.2d at 1146; Toushin v. Commissioner, 223 F.3d 642, 647 (7th Cir. 2000), aff’g T.C. Memo. 1999-171. The petitioner gave inconsistent and misleading testimony during his Federal criminal trial. And his testimony during trial in this case was implausible and unreliable. He also submitted additional false Federal income tax returns for years 1999 through 2001 into evidence during the criminal trial. This factor weighs against the petitioner.
Asserting Frivolous Arguments
Frivolous, irrelevant, and meritless arguments, coupled with affirmative acts designed to evade Federal income tax, support a finding of fraud. See Kotmair v. Commissioner, 86 T.C. 1253, 1259-1261 (1986); see also Toushin, 223 F.3d at 647. The petitioner asserted frivolous arguments to criminal investigators, and he has consistently maintained those arguments in the Tax Court proceeding. This factor weighs against petitioner.
The petitioner is like a fat kid on a seesaw. The weight is bearing down, and only on one side. Gravity and guilt, both cruel mistresses, won the day in the end.Add to favorites