Criminal Tax Manual
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30.00 SPECIFIC ITEMS
Updated June 2001
30.01 GENERALLY
30.02 UNREPORTED INCOME -- OVERCOMING
30.03 UNREPORTED INCOME -- IDENTIFIED
30.04 FAILURE TO REPORT BUSINESS
30.05 OVERSTATED DEDUCTIONS OR EXPENSES
30.05[1] Generally
30.05[2] Individuals and Businesses
30.05[3] Return Preparers
30.06 DEFENDANT'S ADMISSIONS
30.06[1] Generally
30.06[2] Dummy Returns
30.06[3] Delinquent Returns
30.06[4] Timely Filed Returns
30.07 NO BURDEN TO FOLLOW REASONABLE LEADS
30.08 PROPER CHARACTERIZATION OF METHOD OF PROOF
30.09 CRIMINAL COMPUTATIONS
30.09[1] Method Of Accounting
30.09[2] Proper Income Allocation
30.09[3] Treatment of Known Deductions
30.10 USING MULTIPLE METHODS OF PROOF
30.01 GENERALLY
The specific items method of proof is a direct method of proof used to
establish unreported income. This method of proof differs from the indirect
methods of proof (net worth, bank deposits, and expenditures) in that it
focuses on specific financial transactions and does not attempt to
reconstruct the defendant's overall financial situation. The specific items
method primarily relies on direct evidence, although circumstantial evidence
may also be introduced. [FN1] By contrast, the indirect methods generally
rely on circumstantial evidence to prove an understatement of income. Using
the indirect methods of proof, the government shows "either through
increases in net worth, increases in bank deposits, or the presence of cash
expenditures, that the taxpayer's wealth grew during a tax year beyond what
could be attributed to the taxpayer's reported income, thereby raising the
inference of unreported income." United States v. Black, 843 F.2d
1456, 1458 (D.C. Cir. 1988). The government often resorts to indirect
methods of proof when the defendant deals in cash and has maintained
inadequate records from which to reconstruct income.
The advantages of the specific items method of proof are that it is
easy for the prosecutor to present and for the jury to understand, it
generally involves less evidence and has relatively simple criminal
computations compared to the indirect methods, and the government does not
have to follow all of the technical requirements of the indirect methods of
proof. The objective of the specific items method is to prove that a
defendant earned more money than is reflected on the defendant's tax
returns, or that reported deductions, expenses, or credits are either
nonexistent or overstated. Both testimonial and documentary evidence may be
introduced. This evidence may include admissions of the defendant, the
defendant's books and records, bank records, the testimony of inside
witnesses (e.g., the defendant's employees and ex-spouse), testimony
and documentation of witnesses engaged in the transactions which have been
reported inaccurately, and the testimony of the defendant's accountant.
There are four general categories of specific items cases:
1. Unreported income, where the evidence establishes that the total
amount of income received is greater than the amount reported;
2. Unreported income, where the evidence establishes that
identified items of income were not reported;
3. Failure to report a business or other source of income; [FN2]
4. Overstated deductions or expenses, including fictitious
deductions and legitimate deductions that are inflated.
Generally, specific item cases will deal with income rather than
deductions or expenses. The government usually attempts to produce evidence
that the defendant received income, which was either not reflected at all on
the return or which was underreported. United States v. Marabelles,
724 F.2d 1374, 1377 n.1 (9th Cir. 1984); United States v. Horton, 526
F.2d 884, 886 (5th Cir. 1976). See also United States v.
Genser, 582 F.2d 292, 295-96 n.1 (3d Cir. 1978); United States v.
Allen, 551 F.2d 208 (8th Cir. 1977); United States v. Bray, 546
F.2d 851, 856-57 (10th Cir. 1976).
As a practical matter, there are four basic steps to developing a
specific items case involving unreported income: (1) proving that the
relevant amounts are taxable income to the defendant; (2) proving the income
was received by the defendant; (3) proving the income was not reported; and
(4) showing the defendant's personal involvement in the failure to report
the income and in the disposition of the unreported income, i.e.,
willfulness.
While the government must show that the defendant received unreported
taxable income, it need not show how the defendant spent the money after it
became his or her income. United States v. Martin, 525 F.2d 703, 707
(2d Cir. 1975).
30.02 UNREPORTED INCOME -- OVERCOMING AMOUNTS REPORTED ON RETURN
In this type of specific items case, the proof establishes that the
total income received is greater than the total reported. Thus, the
evidence establishes that the defendant failed to report income by proving
more income than the amount reported on the return. It is not necessary to
show which particular items were not reported. For example, if the
defendant reports real estate commissions of $20,000 and the evidence
establishes real estate commissions of $60,000, then there is $40,000 in
unreported income. It makes no difference whether a particular commission
was reported. See, e.g., United States v. Marabelles,
724 F.2d 1374, 1378 & n.2 (9th Cir. 1984) (government proved gross receipts
from defendant's painting business substantially in excess of reported
amounts); United States v. Horton, 526 F.2d 884, 886 (5th Cir. 1976)
(amount of fees testified to by defendant's clients exceeded fees reported).
The proof required to overcome reported income can be fairly simple.
For example, one can call witnesses to testify as to the amount of money
they paid the defendant, add the amounts up, and compare the total to that
on the return. Although there are a number of cases that lend themselves to
this approach, it is not always practical. For example, it would
impractical to call as witnesses hundreds of a retailer-defendant's
customers. Locating enough of the customers to overcome reported income
would be doubtful at best. In such a situation, specific items is not an
available or practical method of proof. As a rule of thumb, this is usually
the case where the defendant has reported a substantial gross income and his
business is such that his income is derived from large numbers of customers,
any one of whom has only paid the defendant a relatively small amount, and
there is no available evidence beyond the testimony of the individual
witnesses, such as books and records reflecting the amounts received from
customers.
30.03 UNREPORTED INCOME -- IDENTIFIED INCOME ITEMS NOT ON RETURN
In this second type of specific items case, the items of income
reported on the return can be identified and, therefore, any other items of
income necessarily represent unreported income. The unreported income may
include an entire category of income, such as the failure to report any
capital gains income where there is evidence of capital gains income earned
during the year. See, e.g., Azcona v. United States,
257 F.2d 462 (5th Cir. 1958), where the defendant reported only his salary
from the police department and no other income, and the evidence established
that he received graft payments.
This second group of cases also may include situations where the
defendant has reported some, but not all, of the income in a particular
category, and the government can identify all of the items that make up the
reported amount. Any additional items of income necessarily constitute
unreported income.
A common approach in this type of specific items case, where the
defendant's books and records are obtained, is to reconcile the books and
records to the return so as to determine which particular items of income
have been reported. Any items of income not reflected in the books and
records necessarily represent unreported income since it has been
established that the return reports only those income items recorded in the
books and records. Often the defendant's bookkeeper, office manager,
secretary, or return preparer are the key witnesses in the case. The office
employees can testify as to the office procedures used to record income, any
instructions given to them by the defendant, and any admissions regarding
unreported income. The return preparer can testify regarding the
information used to prepare the return. Generally the return preparer has
been given inaccurate summary documents by the defendant, or incomplete
records. If the criminal case began with an examination audit, the Revenue
Agent may also be called to testify regarding the reconciliation of the
books and records to the return. Note that the government is not required
to verify or corroborate the reported amounts of income. The government may
take the defendant's reported income as an admitted amount earned from
designated sources. United States v. Burkhart, 501 F.2d 993, 995
(6th Cir. 1974). However, the reconciliation of the books and records to
the return is of great benefit to the government. If the government can
prove exactly what was reported and not reported, it lends credibility to
the government's case.
The return alone often will lend itself to this type of specific items
case. Thus, if the return fails to report any interest income, proof of the
receipt of interest income will ordinarily establish unreported income. The
prosecutor must be wary, however, of the defense that alleged unreported
items of income were in fact reported, but in the wrong category or on the
wrong line on the return. For example, assume the evidence establishes that
the defendant received $3,000 in interest income and did not report any
income designated as interest income. If, however, the defendant reported
$6,000 in miscellaneous income, and the prosecutor is not able to identify
the source of the reported miscellaneous income, then the government may
have no answer to the allegation that the defendant did in fact report the
$3,000 in interest income as part of the $6,000 reported as miscellaneous
income. For this reason, every effort should be made to document the
source(s) of reported income.
For other examples of specific items cases involving identified income
items not reported on the return, see United States v. Allen,
551 F.2d 208 (8th Cir. 1977); United States v. Venditti, 533 F.2d 217
(5th Cir. 1976); United States v. Parr, 509 F.2d 1381 (5th Cir.
1975); Swallow v. United States, 307 F.2d 81 (10th Cir. 1962).
30.04 FAILURE TO REPORT BUSINESS OR SOURCE OF INCOME
When an individual receives and does not report income from a business
enterprise during the course of a year, the specific items method of proof
can be used to show that the defendant filed a false return or failed to
file a required return. Again, the government would have to prove through
the testimony of "inside" and customer witnesses that the defendant operated
the business, prove the unreported income through the above witnesses'
testimony, bank records, and business records, and, if appropriate, show
that the defendant did not inform his return preparer of the existence of
the business. The leading opinion on this type of case is Siravo v.
United States, 377 F.2d 469 (1st Cir. 1967). Siravo reported wage
income on the tax returns he filed for three of the prosecution years and
did not file a return for the fourth year. He did not report gross receipts
from a jewelry company he operated. Siravo was charged with one count of
failing to file a return, in violation of 26 U.S.C., Sec. 7203, and with
three counts of subscribing to a false return, in violation of 26 U.S.C.,
Sec. 7206(1), in that he "failed and omitted to disclose . . . substantial
gross receipts from a business activity . . . ." Siravo, 377 F.2d at
471-72.
As to the false return counts, Siravo argued that the failure to
attach a Schedule C to his return reporting his gross receipts was not a
false statement or misrepresentation of his taxable income but merely an
omission. Rejecting this argument, the court said:
[W]e hold that a return that omits material items necessary to the
computation of income is not "true and correct" within the meaning of
section 7206. If an affirmative false statement be required, it is
supplied by the taxpayer's declaration that the return is true and
correct, when he knows it is not.
Siravo, 377 F.2d at 472
Regarding the failure to file count, the trial court "correctly
instructed" the jury that total receipts must be reduced by the cost of
goods sold and other costs representing a return of capital to arrive at
gross income for a manufacturing business, and that it was sufficient if the
government showed that receipts exceeded cost of goods sold by at least
$600. But there was no evidence as to the amount of costs except some
testimony that substantially all materials were supplied by the defendant's
customers. Siravo, 377 F.2d at 473. Siravo argued that the
government did not carry its burden since labor costs are part of the cost
of goods sold and there was testimony that the volume of business was
impossible for one man to handle. Siravo, 377 F.2d at 473. Holding
that the government had no such burden, the court said that ". . . [t]he
applicable rule here is that uniformly applied in tax evasion cases -- that
evidence of unexplained receipts shifts to the taxpayer the burden of coming
forward with evidence as to the amount of offsetting expenses, if any."
Id. at 473 (citations omitted).
Note that if the defendant does come forward with evidence of
offsetting costs or expenses in a failure to file case involving a
manufacturing business, then the government would have the burden of
establishing that the costs and expenses either were not allowable or were
insufficient to reduce gross income below the level triggering the filing
requirement. On the other hand, where the charge is filing a false return,
as were three of the counts in Siravo, defense evidence as to
offsetting costs and expenses would not "go to the materiality of the
omitted receipts, but to the lack of mens rea in their omission." United
States v. Taylor, 574 F.2d 232, 237 (5th Cir. 1978).
In Taylor, the defendant did not file Schedules F for the first
two prosecution years and filed a false Schedule F which understated his
livestock receipts for the third year. The court held that proof of
unreported gross receipts was sufficient to sustain the conviction, stating:
[R]equiring the government to prove the omission of gross income comes
near to requiring the proof of additional tax liability. Such a
definition of "material" . . . would imperil the self-assessment
nature of our tax system.
Taylor, 574 F.2d at 236.
In a failure to file case, United States v. Schutterle, 586
F.2d 1201, 1205 (8th Cir. 1978), the Eighth Circuit held that evidence of
bonus or commission payments from a corporation to the defendants, as local
supervisors, was sufficient to establish gross income necessary to trigger
the filing requirement. In Schutterle, the government did not prove
that the defendants actually sold any products, but proved only that the
defendants received bonuses or commissions based on the volume of products
purchased, presumably for resale. In response to the defense that these
payments from the corporation were merely discounts or rebates on volume
purchases, the court stated the defendants had performed services for the
corporation, as local distributors, and the payments were made in
recognition of these services. Thus, the payments represented commissions
and should have been reported.
In United States v. Francisco, 614 F.2d 617, 618 (8th Cir.
1980), the statement that the government has the burden of establishing
"that gross receipts exceed the cost of goods sold by an amount sufficient
to trigger the reporting requirements" appears, at first blush, to be
contrary to Siravo's holding (377 F.2d at 473), that the government
need prove only gross receipts and not the cost of goods sold.
Francisco, however, relied on Siravo and the language in its
opinion merely sets forth the burden on the government and not the evidence
required to meet this burden. Thus, the case is not contrary to the
proposition that once the government establishes gross receipts sufficient
to trigger the filing requirement, the burden of going forward with
offsetting expenses is on the defendant. Note that in Francisco, the
court did not have to reach this issue since the parties stipulated to
figures representing total sales less the cost of goods sold, with the court
holding that the burden of coming forward with any expenses not stipulated
shifted to the defendant. Francisco, 614 F.2d at 618.
Contrary to the teaching of the foregoing cases as to the burden of
producing evidence, the Tenth Circuit in United States v. Brewer, 486
F.2d 507, 509-10 (10th Cir. 1973), reversed one count of a failure to file
conviction due to insufficient evidence that the defendant earned enough
income to trigger the filing requirement. The court stated that the
evidence of a $17,000 sale "does not establish anything more than the fact
that the defendant was a person of some means. It fell short of
establishing that any part of these proceeds constituted income".
Brewer, 486 F.2d at 509. Contra United States v. Bahr,
580 F. Supp. 167, 171 (N.D. Iowa 1983), holding that where the government
establishes the existence of unexplained receipts sufficient to give rise to
the filing requirement and follows up reasonable leads as to the cost of
goods sold, then the government has made out a prima facie
case of failure to disclose gross income and it is up to the defendant to
establish any offsetting expenses. See also United States v.
Gillings, 568 F.2d 1307 (9th Cir. 1978) (distinguishing Brewer).
In this vein, care should be taken to frame the indictment so as to
conform exactly to the evidence to be offered. If the government can only
prove the failure to report "gross receipts", then the indictment should
allege that the defendant failed to report "gross receipts" and not charge
that the defendant did not report "income." See, e.g.,
Taylor, 574 F.2d at 236.
An unusual variation on this type of specific items case appears in
United States v. Vario, 484 F.2d 1052 (2d Cir. 1973). The defendant
was charged with violating section 7206(1), "in that he had failed to
disclose the fact that he was engaged in a gambling or 'policy' operation
which produced gross income for him." Vario, 484 F.2d at 1054. The
government did not attempt to show specific amounts of income the defendant
received, that he spent more than he reported on his returns, or that he had
large bank deposits during the prosecution years. The government only
sought to establish that the defendant was actively engaged in a gambling
operation, and that the gambling operation produced income, which the
defendant failed to report. The court held that this was sufficient to
support a jury verdict of guilty under section 7206(1). Vario, 484
F.2d at 1054.
30.05 OVERSTATED DEDUCTIONS OR EXPENSES
30.05[1] Generally
Cases involving overstated deductions or expenses fall into categories
similar to cases involving understatements of income. In some, the evidence
will establish specific deductions claimed on a return, to which the
defendant was not entitled. In other cases, the evidence simply will show
that the defendant was entitled to a lesser deduction than that claimed on
the return. [FN3]
There are a limited number of cases dealing with false or overstated
deductions. Since deductions are subtracted from gross income in arriving
at taxable income and the tax due and owing, they are material to the
contents of an income tax return. United States v. Warden, 545 F.2d
32, 37 (7th Cir. 1976). Generally, false deduction cases are proven by
introducing evidence from the witnesses involved with the defendant in the
transaction which is the subject of the deduction and comparing the records
maintained by that witness with records maintained by the defendant. Often,
the defendant's bank records prove that the deductions claimed were
overstated. Many defendants attempt to support their false deductions by
altering the amounts of checks or their payee and supplying the checks to
the IRS, often with other false documentation, i.e., phony invoices,
receipts, and letters. Forensic analysis of these items generally
establishes their falsity with relative ease, particularly in the case of
checks which have altered amounts. Most defendants fail to realize that
when checks are negotiated by the bank, the bank encodes the amount of the
check on the face of the check, making it easy to determine the actual
amount paid. Some false deductions cases, however, entail problems of proof
which are greater than those routinely encountered in cases involving the
omission of income, because the government must prove a negative,
i.e., that the expense was not incurred at all or not in the amount
claimed.
30.05[2] Individuals and Businesses
Cases involving individual taxpayers and businesses fall into many
different fact patterns. The cases with the greatest jury appeal are those
in which the defendant has diverted corporate funds to his or her personal
use and deducted the diversions on the return as some form of corporate
expenses. The tax benefit to the defendant in these cases is twofold: the
corporation's tax liabilities are reduced because personal expenses are
improperly deducted as business expenses on the corporate tax returns and
the individual receiving the corporate diversion reduces his or her
individual tax liabilities by failing to report the diversions as income on
his or her individual returns. This pattern was followed in United
States v. Helmsley, 941 F.2d 71 (2d Cir. 1991) (corporation's
expenditures on its owner's personal estate renovation project improperly
deducted as business expenses); United States v. Black, 843 F.2d 1456
(D.C. Cir. 1988) (checks drawn on corporate accounts to pay personal
expenses sufficient to sustain tax evasion conviction); United States v.
Garcia, 762 F.2d 1222 (5th Cir. 1985) (defendant improperly claimed
personal expenses as business deductions); United States v.
Greenberg, 735 F.2d 29 (2d Cir. 1984) (corporation's payment of its
owner's personal expenses improperly deducted as business expenses);
United States v. Nathan, 536 F.2d 988 (2d Cir. 1976) (defendant
expensed Subchapter S corporation's checks that in fact he cashed for
himself).
United States v. Bliss, 735 F.2d 294, 301 (8th Cir. 1984),
provides a good example of how to use the specific items method to prove
that the defendant has claimed false deductions. The defendant wrote checks
on his business bank account to a fictitious company, prepared phony
invoices, and had his employees cash the checks, returning most of the money
to the defendant. The government introduced the checks, false invoices
prepared by the defendant, and the testimony of the employees who admitted
that the checks were not for purchases claimed by the defendant. The
employees also testified that the defendant told them the money generated by
the scheme was "tax free money" and instructed them to lie to the IRS after
the investigation began. The defendant challenged the sufficiency of the
evidence that he had filed false tax returns. The Eighth Circuit upheld the
conviction, stating the evidence was "overwhelming." Bliss, 735 F.2d
at 301.
Relatively simple examples of overstated deductions or expenses may be
found in United States v. Ragen, 314 U.S. 513 (1942) (corporate
profit distributions (dividends) were falsely expensed on the corporation's
books and returns as commissions, resulting in an understatement in the
taxable income and tax liability of the corporation); United States v.
Pacheco, 912 F.2d 297 (9th Cir. 1990) (false partnership deductions);
Spinney v. United States, 385 F.2d 908 (1st Cir. 1967) (dentist
overstated deductions for dentures, dental supplies, and other professional
expenses); United States v. Wilkins, 385 F.2d 465 (4th Cir. 1967)
(defendant claimed $10,000 in deductions, government proved $7,000 were
fictitious); United States v. Pechenik, 236 F.2d 844 (3d Cir. 1956)
(corporation's capital expenditures improperly deducted as operating
expenses, thereby understating taxable income); Eggleton v. United
States, 227 F.2d 493 (6th Cir. 1955) (defendant overstated costs of used
cars he purchased for resale); United States v. Berger, 325 F. Supp.
1297 (S.D.N.Y. 1971), aff'd, 456 F.2d 1349 (2d Cir. 1972) (domestic
parent corporation improperly deducted expenses of its foreign subsidiary).
30.05[3] Return Preparers
A large category of specific items cases with false deductions
involves return preparers who falsely claim itemized deductions or expenses
for their clients and who are prosecuted under section 7206(2). As with the
other false deduction cases, these may include deductions that are totally
fictitious or legitimate deductions that are inflated. United States v.
Damon, 676 F.2d 1060 (5th Cir. 1982) (false Schedules C overstating
business expenses); United States v. Haynes, 573 F.2d 236 (5th Cir.
1978) (false itemized deductions); United States v. Warden, 545 F.2d
32 (7th Cir. 1976) (false itemized deductions). These cases often involve
false charitable deductions, child care credits, and business expenses.
30.06 DEFENDANT'S ADMISSIONS
30.06[1] Generally
The importance of the defendant's admissions cannot be overestimated
in a tax case. Admissions regarding income are available from many sources.
Defendants often boast to friends, spouses, and co-workers that they are
"cheating on their taxes". Many defendants leave a paper trail of
admissions which present a view of their financial situation drastically
different from that reflected on the income tax returns filed with the IRS.
For example, most defendants file financial statements with lenders to
obtain mortgages, loans, credit cards, and credit accounts with retailers.
In these situations, it is in the best interest of the defendant to portray
his financial situation as favorably as possible. Consequently, these
financial statements can be very helpful in proving that the defendant was
well aware he had more income than was reported.
Often, the most important admissions are those made on the defendant's
income tax returns. The government frequently uses admissions made on
income tax returns (1) which the defendant had prepared but which were never
filed with the IRS ("dummy returns"), or which were filed delinquently or
(2) which were timely filed and are used to prove income, deductions, and
expenses.
30.06[2] Dummy Returns
Many lenders require that tax returns be submitted with credit
applications. Defendants often submit "dummy" returns which have not been
filed with the IRS and report income substantially in excess of that
reported to the IRS. These dummy returns often provide leads as to
unreported sources of income, as well as income from known sources that has
been underreported. Dummy returns are also extremely valuable in proving
that the defendant acted willfully.
30.06[3] Delinquent Returns
A rare type of specific items case is one based on the defendant's own
admissions as to income and expenses, corroborated by independent evidence.
In a failure to file case, for example, if the defendant has filed
delinquent returns, which are determined to be correct, the government may
be able to sustain its burden of proving that the defendant earned
sufficient income to require the filing of returns by introducing the
delinquent returns and independent corroborative evidence of the income
figures reported on the returns. United States v. Bell, 734 F.2d
1315, 1317 (8th Cir. 1984).
In Bell, the defendant was the sole proprietor of a business
that provided tip sheets to bettors at racetracks. On appeal, the court,
relying on United States v. Smith, 348 U.S. 147 (1954), recognized
that the government cannot prove an essential element of a crime through
only uncorroborated post-offense extrajudicial admissions of the defendant. [FN4]
The court held, however, that testimony from various witnesses about the
defendant's sale of tip sheets and receipt of income was "enough
corroboration to render the income statements on his late-filed tax returns
admissible." Bell, 734 F.2d at 1317. See also United
States v. Marshall, 863 F.2d 1285, 1287 (6th Cir. 1988) (narcotics).
30.06[4] Timely Filed Returns
The foregoing should be distinguished from the situation in an evasion
or false return case where the defendant has timely filed returns. In such
cases, the government "may take the taxpayer's reported income as an
admitted amount earned from designated sources" and need not corroborate
this reported income. United States v. Burkhart, 501 F.2d 993, 995
(6th Cir. 1974). Corroboration is not required because the statements in the
defendant's return constitute pre-offense admissions and pre-offense
admissions do not have to be corroborated. Warszower v. United
States, 312 U.S. 342, 347 (1941). See United States v.
Marshall, 863 F.2d 1285, 1290-91 (6th Cir. 1988) (dissent); United
States v. Pennell, 737 F.2d 521, 536-37 (6th Cir. 1984) (narcotics and
firearms); United States v. Soulard, 730 F.2d 1292, 1298 (9th Cir.
1984) (false income tax returns).
Similarly, in most cases, the government can rely on the deductions
and expenses claimed on the defendant's tax return to prove the statutory
offsets to gross income. Deductions claimed on a tax return are admissions
and can be used to make a prima facie case. Fed. R. Evid. Rule 801(d)(2);
United States v. Northern, 329 F.2d 794, 795 (6th Cir. 1964).
Once the government allows the deductions and expenses claimed on the
tax return as filed, and any additional deductions the government can
calculate without the defendant's assistance, the burden of going forward
falls on the defendant to show any additional allowable deductions not
claimed on the return. United States v. Marabelles, 724 F.2d 1374,
1383 (9th Cir. 1984); United States v. Lacob, 416 F.2d 756, 760 (7th
Cir. 1969); Elwert v. United States, 231 F.2d 928, 933 (9th Cir.
1956); United States v. Bender, 218 F.2d 869, 871-72 (7th Cir. 1955);
United States v. Link, 202 F.2d 592, 593-94 (3d Cir. 1953).
See also United States v. Pacheco, 912 F.2d 287, 303-04
(9th Cir. 1990) (district court did not err in refusing to allow defendant
to introduce evidence regarding unclaimed deductions where deductions were
not allowable as a matter of law); United States v. Garguilo, 554
F.2d 59, 62 (2d Cir. 1977); United States v. Nathan, 536 F.2d 988,
991 (2d Cir. 1976)..
30.07 NO BURDEN TO FOLLOW REASONABLE LEADS
In specific items cases, the government has no burden to follow
reasonable leads provided by the defendant, as it does in indirect method of
proof cases. United States v. Marabelles, 724 F.2d 1374, 1379 n.3
(9th Cir. 1984); United States v. Lawhon, 499 F.2d 352, 356-57 (5th
Cir. 1974); United States v. Suskin, 450 F.2d 596, 598 (2d Cir.
1971); United States v. Shavin, 320 F.2d 308, 311 (7th Cir. 1963);
Swallow v. United States, 307 F.2d 81, 84 (10th Cir. 1962); United
States v. Nemetz, 309 F. Supp. 1336, 1339 (W.D. Pa. 1970), aff'd,
450 F.2d 924 (3d Cir. 1971). "[W]here the government's case is based on
evidence showing specific items of unreported income, the
safeguards required for indirect methods of proof are not necessary, as the
possibility that the defendant may be convicted because non-taxable income
is mistakenly presumed to be taxable income, or because cash expenditures
are mistakenly assumed to be made from taxable income, is not present.
United States v. Black, 843 F.2d 1456, 1459 (D.C. Cir. 1988)
(emphasis added.)
30.08 PROPER CHARACTERIZATION OF METHOD OF PROOF
The government must be careful to characterize the method of proof
properly in cases where unreported income is proven by bank records. In
many cases, the unreported income is proven by the introduction of checks
which the defendant received or converted but did not report on the tax
return. If the government can show by direct proof that each check was
taxable income to the defendant, the method of proof is properly termed
"specific items."
For example, in Black, 843 F.2d 1456, 1459 (D.C. Cir. 1988),
the defendant wrote checks on corporate accounts for personal expenses. The
defendant claimed that these corporate diversions were not taxable income
but were nontaxable loans. Although the government's method of proof was
specific items (the specific items being the company checks diverted for the
defendant's personal use), the defendant argued that the method of proof was
actually bank deposits/cash expenditures and that his conviction should be
reversed because the government did not prove that the expenditures were not
made with funds from non-taxable sources. The D.C. Circuit rejected
defendant's argument even though the expert witness and trial judge referred
to the method of proof as the "expenditures method." Black, 843 F.2d
at 1461. "In the Government's view, Black received taxable income each time
he wrote a check . . . to cover his personal expenses . . . [and] at no
point in the trial was it suggested to the jury that evidence of personal
expenditures, without more, would be sufficient to convict . . . ."
Black, 843 F.2d at 1459-61. See also United States v.
Wilson, 887 F.2d 69, 77 (5th Cir. 1989) (district court properly refused
to give bank deposits instruction in specific items case in which proof of
unreported income was based on the "transfer of specific and substantial
funds" to defendants' bank accounts).
Similarly, direct evidence as to cash transactions could, in some
circumstances, be a specific item of unreported income. For example, if
witnesses testified that they paid the defendant in cash for services, those
items could be included as income. The mere deposit of cash into a bank
account, without direct evidence that the cash was income to the defendant,
however, would not be sufficient to prove unreported income in a specific
items case.
30.09 CRIMINAL COMPUTATIONS
30.09[1] Method Of Accounting
In computing the defendant's taxable income and tax for each
prosecution year, the government generally is required to follow the
accounting method used by the defendant. If the defendant was on the cash
basis during the prosecution year, then the government's proof also must be
computed on the cash basis, with income being reported when it is received
and expenses deducted only in the year they are actually paid. See
United States v. Wiese, 750 F.2d 674, 677 (8th Cir. 1984) (a bank
deposits case which states the general rule that a cash basis taxpayer must
report income in the taxable year of actual or constructive receipt).
See also Treas. Reg. § 1.446-1(a)(1) & (c)(1)(i) (26
C.F.R.).
Similarly, if the defendant used a hybrid method of accounting, with
some items treated on a cash basis and other items treated on an accrual
basis, then the government also must use the same hybrid method in doing its
computations. United States v. Marttila, 434 F.2d 834, 837 (8th Cir.
1970).
The defendant also is bound to adhere to the accounting method used
during the prosecution year when preparing computations for trial. In
Clark v. United States, 211 F.2d 100 (8th Cir. 1954), the defendant
had reported income during the prosecution years on the cash basis. The
trial court excluded testimony from the defendant's expert on what the
effect would have been had the returns been prepared on the accrual basis,
instead of the cash basis, on the ground that such testimony had no
probative value. The court's ruling was upheld on appeal. Clark,
211 F.2d at 105. Similarly, in United States v. Helmsley, 941 F.2d
71, 85 (2nd Cir. 1991), the defendant followed one depreciation method
during the prosecution years but argued at trial that allowable deductions
would have offset tax deficiencies under another method. The court held
that having selected a particular depreciation method, the defendant was not
free to recalculate her taxes under another depreciation method. See
also Fowler v. United States, 352 F.2d 100 (8th Cir. 1965).
Similarly, in United States v. Lisowski, 504 F.2d 1268, 1274-75
(7th Cir. 1974), the defendant had used a hybrid method of accounting and
the court did not permit hypothetical questions to the defense expert on a
purely accrual treatment of the alleged unreported income, saying that
"[w]hen the taxpayer has employed a hybrid or unauthorized accounting
method, he is hardly in a position to complain when the computation
employing that method is introduced to prove specific items of omitted
income." Lisowski, 504 F.2d at 1275 (citations omitted).
30.09[2] Proper Income Allocation
The government cannot establish a tax deficiency by attributing income
to a year in which it does not belong. United States v. Wilkins, 385
F.2d 465, 469-71 (4th Cir. 1967).
30.09[3] Treatment of Known Deductions
Although there is no requirement in a specific items case that the
government follow all reasonable leads provided by the defendant, the
situation where the government discovers additional, unclaimed deductions or
offsets during the course of the investigation, such as additional
purchases, salaries paid, interest expenses, or errors in the books and
records in the defendant's favor, must be distinguished. These known
deductions or offsets, even though not reflected on the return, must be
allowed in the government's criminal computations of the amount of tax due
and owing. See United States v. Link, 202 F.2d 592, 593-94
(3d Cir. 1953).
30.10 USING MULTIPLE METHODS OF PROOF
Proof of specific items of omitted income may be corroborated by
circumstantial proof, such as the net worth method of proof. Holland v.
United States, 348 U.S. 121, 126 (1954), and cases cited; United
States v. Cramer, 447 F.2d 210, 218 (2d Cir. 1971); Eggleton v.
United States, 227 F.2d 493, 497-98 (6th Cir. 1955); Lloyd v. United
States, 226 F.2d 9 (5th Cir. 1955); Heasley v. United States, 218
F.2d 86, 90 (8th Cir. 1955), and cases cited. The specific items method
also may be corroborated by the bank deposits method, United States v.
Tafoya, 757 F.2d 1522, 1528 (5th Cir. 1985); United States v.
Horton, 526 F.2d 884, 886-87 (5th Cir. 1976); Canton v. United
States, 226 F.2d 313, 322-23 (8th Cir. 1955), or the expenditures method
of proof, United States v. McGuire, 347 F.2d 99 (6th Cir. 1965).
See also United States v. Abodeely, 801 F.2d 1020, 1023
(8th Cir. 1986) (the government may also use a combination bank deposits and
expenditures method of proof).
When an indirect method is used as corroboration only, it has been
held that the government may not have a duty to comply with all of the
technical requirements of the indirect method, such as tracking down all
leads in a net worth analysis. Tafoya, 757 F.2d 1522; Cramer,
447 F.2d at 218. Furthermore, it has been held that the use of an indirect
method of proof as corroboration is permissible even though the government
has stated in a bill of particulars that it would rely on the specific items
method. Horton, 526 F.2d at 887; McGuire, 347 F.2d at 101.
Common sense dictates, however, that the corroborating method of proof be
designated as such in a bill of particulars so as to avoid needless argument
and the possibility of an adverse ruling.
When an indirect method of proof is used to corroborate specific
items, the jury should be instructed to limit its consideration of the
indirect analysis to corroboration of the specific items proof only.
Horton, 526 F.2d at 887-88. Although failure to give such a limiting
instruction may later be determined to be harmless error, there is always
the risk that an appellate court could find otherwise.
The government also may use direct and indirect methods of proof in
combination with each other in the same case. For example, in a three-year
case, the government could prove unreported income in the first year by the
specific items method, with unreported income for the next two years being
proved by the net worth method. United States v. Dawson, 400 F.2d
194, 203 (2d Cir. 1968). Additionally, both direct and indirect methods can
be used for the same year. United States v. Scott, 660 F.2d 1145,
1147-48 (7th Cir. 1981) (specific items and net worth); United States v.
Rodriguez, 545 F.2d 829 (2d Cir. 1976 ) (specific items and
expenditures methods); United States v. Meriwether, 440 F.2d 753 (5th
Cir. 1971) (net worth and specific items); United States v. Lacob,
416 F.2d 756 (7th Cir. 1969) (bank deposits and specific items); Chinn
v. United States, 228 F.2d 151 (4th Cir. 1955) (net worth and specific
items for one year, specific items alone for another year); United States
v. Bahr, 580 F. Supp. 167 (N.D. Iowa 1983) (bank deposits and specific
items, with a percentage computation to calculate cost of goods sold).
In Meriwether, the government used two separate and distinct
methods of proof in attempting to establish corrected taxable income -- the
net worth and specific items methods of proof. [FN5] Neither method was
used only as corroboration for the other, and the jury was instructed that
it could rely on either method. The government failed to establish the
defendant's opening net worth with reasonable certainty and the conviction
was reversed because there was no way to determine the method upon which the
jury relied. Meriwether, 440 F.2d at 755, 757. But cf.
Griffin v. United States, 502 U.S. 46 (1991) (general jury verdict of
guilty on multiple-object conspiracy does not have to be set aside when
evidence is inadequate to support the conviction as to one object).
FN 1. See United States v. Marcus, 401 F.2d 563, 565 (2d Cir.
1968) (defendant's income from check cashing service determined by
multiplying standard check fee by amount of checks cashed).
FN 2. See Section 12.00 False Returns, infra, for a discussion
of cases in which a defendant reports a false source of income, but
accurately reports the amount of income and is prosecuted for filing a false
income tax return under 26 U.S.C. § 7206(1). United States v.
DiVarco, 484 F.2d 670, 673 (7th Cir. 1973).
FN 3. Just as reporting a false source of income is prosecutable under
section 7206(1) (see Section 30.01 n.1, supra), so, too, is a
willful misstatement on a return as to the source of claimed deductions.
United States v. Bliss, 735 F.2d 294, 301 (8th Cir. 1984).
FN 4. The justification for this rule is that post-offense statements made
to an official charged with investigating the possibility of wrongdoing are
often unreliable. See Smith v. United States, 348 U.S. 147,
152-55 (1954). Bell involved delinquent tax returns filed after the
defendant had been interviewed by special agents of the IRS concerning
failure to file his returns. Bell, 734 F.2d at 1317.
FN 5. Where two methods of proof are used, the jury must be properly
instructed on each method.