Tax Evasion

By Balakrishna, Rajeev; Dimidjian, Karina J. et al. | American Criminal Law Review, Winter 1995 | Go to article overview
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Tax Evasion

Balakrishna, Rajeev, Dimidjian, Karina J., Ferrell, Scott J., Godsy, Michael, Goodfriend, David, Sibbald, Natalie, American Criminal Law Review

I. IRC Section 7201

Violations of the United States Internal Revenue Code ("IRC") are prosecuted under an array of criminal tax statutes.(1) The "capstone of [this] system of sanctions"(2) is the felony provision of 26 U.S.C. [sections] 7201, which provides for a maximum penalty of $100,000, a prison term of five years for a willful attempt to defeat any tax obligation, or both.(3)

A. Elements of the Offense

In order to prove a section 7201 offense, the government must prove three elements: (1) the existence of a tax deficiency; (2) an affirmative act constituting an evasion or attempted evasion of the tax; and (3) willfulness.(4) The government bears the burden of proving each element beyond a reasonable doubt.(5) Once a prima facie case is established, however, the burden shifts to the taxpayer, and "the taxpayer `remains quiet at his peril.'"(6)

1. Existence of a Tax Deficiency

Generally, for a defendant to be convicted under section 7201, the amount of tax deficiency must be "substantial."(7) The term "substantial" refers to the "amount of the tax evaded" and not to the amount of income unreported.(8)

The existence of a deficiency may be shown by the use of either direct or circumstantial evidence. The "specific item method," a direct evidence method, is the most accurate means of proving a deficiency. According to this method, the taxpayer's books and records are used as direct proof of taxable transactions.(9) However, "[p]roof of unreported taxable income by direct means is extremely difficult and often impossible."(10)

Therefore, to, establish the existence of unreported taxable income, the government usually relies on three methods of obtaining circumstantial evidence: net worth, cash expenditures, and bank deposits.(11) These circumstantial methods do not require the government to prove either the exact amount of the deficiency(12) or its source.(13) The government may choose to prosecute under any single theory of proof or a combination method, including a combination of circumstantial and direct proofs.(14)

The "net worth" theory of proof is the most common method used by the government to establish tax evasion. In it,

the Government, having concluded that the taxpayer's records are inadequate as a basis for determining income tax liability, attempts to establish an "opening net worth" or total net value of the taxpayer's assets at the beginning of a given year. It then proves increases in the taxpayer's net worth for each succeeding year during the period under examination and calculates the difference between the adjusted net values of the taxpayer's assets at the beginning and end of each of the years involved. The taxpayer's nondeductible expenditures, including living expenses, are added to these increases, and if the resulting figure for any year is substantially greater than the taxable income reported by the taxpayer for that year, the Government claims the excess represents unreported taxable income.(15)

It is essential that the government's analysis establish the taxpayer's opening net worth with "reasonable certainty,"(16) although it is not necessary to establish with certainty the opening net worth for each of the subsequent years under investigation.(17) The government must also demonstrate that it has conducted a thorough investigation and has negated reasonable alternative sources of nontaxable income.(18) Clear charges and formal instructions outlining the range of permissible inferences both for and against the accused are required.(19)

The "cash expenditures" method is a "simple variant of the `net worth method'"(20) and requires a showing that the taxpayer's expenditures were derived from taxable income which exceeded the taxpayer's reported income.(21) The government must demonstrate either a "likely source of the allegedly unreported income or that it has negated all reasonably possible nontaxable sources of income.

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