In a 7-2 decision, the Supreme Court ruled Wednesday in favor of a business owner who didn't file tax returns and destroyed some of his banking records, finding the omnibus obstruction clause in the Tax Code was overly broad.
The ruling promises to limit the use of a tool that has been widely used by prosecutors in tax cases -- a section of the code that makes it broadly a crime to "obstruct or impede the due administration" of tax laws, without specifying what constitutes obstruction. The case at hand involved Carlo J. Marinello II, the former owner of a courier service in Buffalo, N.Y., who was convicted in 2014 of obstructing the IRS (see Supreme Court to decide if failure to file taxes is obstruction). Prosecutors convinced jurors that Marinello spent little time maintaining his business records, and he admitted that he was too busy trying to keep his business running to do the bookkeeping or file tax returns. He also admitted to destroying some of his old bank statements and mixing his business and personal income. But the Supreme Court found that the use of the obstruction clause was overly broad and there has to be a connection with a specific administrative proceeding at the IRS, such as a tax audit, for it to apply.
“Just because a taxpayer knows that the IRS will review her tax return annually does not transform every Tax Code violation into an obstruction charge,” wrote Justice Stephen Breyer in the majority opinion. “In addition to satisfying the nexus requirement, the Government must show that the proceeding was pending at the time the defendant engaged in the obstructive conduct or, at the least, was then reasonably foreseeable by the defendant.”
However, Justice Clarence Thomas in a dissenting opinion worried that the ruling might allow too many business owners to avoid paying taxes. “The Court, in its effort to exclude hypotheticals, has constructed an opening in the Omnibus Clause large enough that even the worst offenders can escape liability,” he wrote.
Marinello’s attorneys were happy with the high court’s decision. “We’re pleased that the Court has rejected the government’s broad view of the obstruction statute,” said Jenner & Block partner Matthew Hellman, co-chair of the firm’s Appellate and Supreme Court Practice, who argued the case, as quoted by the National Law Journal. “As the court recognized, the government’s interpretation of felony tax obstruction was boundless and created an uber felony for any civil or criminal tax violation.”
"This is a tremendous victory, not only for Carlo Marinello, but for all taxpayers," said Joseph M. LaTona, Marinello's defense lawyer, according to the Buffalo News.
The Omnibus Clause has been widely used in tax cases. Officially known as 26 U. S. C. §7212(a), the Omnibus Clause forbids “corruptly or by force or threats of force . . .obstruct[ing] or imped[ing], or endeavor[ing] to obstruct or impede, the due administration of [the Internal Revenue Code].”
“Historically, 7212 is the one-man obstruction section,” said Jim Mastracchio, a partner and tax attorney with Eversheds Sutherland (US) LLP in Washington, D.C. “What it said was you couldn’t intimidate an IRS agent or other U.S. government official while conducting official business, whatever it might be, whether it’s an audit or whatever their jurisdiction was to look at your tax issues. Then there was this piece of the statute that prohibited you from obstructing the general work of the IRS. The question on the table in the Supreme Court was whether or not just in the ordinary administration of the tax laws, if you took steps to hide your business records or you didn’t file tax returns, were you obstructing the ability of the IRS to conduct its business?”
Mastracchio was not involved in the Marinello case but has been watching similar cases closely. “In the last few years there have been several cases that came out where there wasn’t proof that the taxpayer knew they were under an IRS examination, yet there were still criminal charges brought under 7212(a), in essence an obstruction charge,” he told Accounting Today. “In this particular case the facts laid out that there was a civil audit and then it was closed and then it was reopened. During that time, the way the facts were laid out, the taxpayer did not know that the examination or investigation was going on until he was interviewed at some point in time. Criminal charges were brought of tax evasion. He had not filed his income tax returns and the facts showed that he had shredded some of his business records, so he was charged with tax evasion, and he was charged with the 7212 charge as well. He appealed the 7212 charge, saying he wasn’t aware of the investigation, so how could he be obstructing the investigation if he wasn’t aware it was taking place. It went to the Second Circuit [Court of Appeals] and his conviction was upheld, and he went to the Supreme Court.”
The Supreme Court decided there needs to be a closer connection, a “nexus,” with a specific administrative proceeding at the IRS for the obstruction clause to apply.
“What the Supreme Court just ruled was that in order to secure a conviction under 7212(a) there had to be a connection, or a nexus, between the person’s conduct and what they call a ‘particular administrative proceeding,’” said Mastracchio. “What the government had argued was even filing income tax returns, doing the regular administrative duties that occur when everyody files a tax return, if you’re taking steps not to participate in that, that was obstructing that function of the IRS. What the court has said is no, it’s not the general administration duties of the IRS and the administrative function of the IRS, but more specifically a particular administrative proceeding.”
The high court gave three examples: an investigation, an audit, and a targeted administrative action.
“What they’re saying is that the conduct was you had to be trying to obstruct an IRS audit, trying to obstruct a criminal investigation, or trying to obstruct some other targeted investigation or review of you and your tax return,” said Mastracchio. “If you were taking steps once you were aware of the audit or the investigation or a targeted review for whatever that target might be, because the IRS has a lot of different functions, that’s what’s needed here. Since it was determined that the defendant didn’t know about the IRS examination or investigation of him at the time that he was non-filing and the time when they’re alleging he was destroying records, that nexus wasn’t there between the conduct and the knowledge of the investigation."
Another legal expert sees a parallel with previous rulings by the high court. “The decision is consistent with prior Supreme Court decisions that have read these types of statutes narrowly—particularly in white collar cases—and requires the government to prove that the defendant either knew of a pending tax-related proceeding or could reasonably foresee that such a proceeding would commence,” said Harry Sandick, a partner at Patterson Belknap Webb & Tyler LLP and former Assistant U.S. Attorney for the Southern District of New York. “The Court is continuing its role in policing the enforcement obstruction-related statutes to make sure that they do not become a trap for the unwary.”
The Supreme Court may well be acting as a check on the executive and legislative branches.
“The Supreme Court continues to express concern that the government cannot be trusted to ‘do justice’ when it comes to enforcing the obstruction of justice statutes,” said Sandick. “Going back many years, the Court seems to believe that Congress enacts overly broad statutes that will have the unintended consequence of punishing innocent conduct if the statute is given a strictly literal reading. The Court also specifically mentions a memorandum by the Jeff Sessions Department of Justice calling for the prosecution of defendants for the most punitive count available for specific conduct, so it might be the case that the Court is beginning to react to how it fears the department will operate under the Trump administration.”
The case will probably make it more difficult for prosecutors to pursue felony charges for tax evasion rather than just a misdemeanor for failing to file tax returns. “If the government wants to pursue a felony, they would need to prove that there was willfulness and an intent to evade U.S. taxes,” said Mastracchio. “Once you get there, then you have tax evasion.”
Under 7212, prosecutors were able to turn a misdemeanor charge of failing to file tax returns into a felony if there was an unknown audit going on at the time of the non-filing. “That was the concern that either there’s evidence of evasion or there isn’t,” said Mastracchio. “There’s either a misdemeanor charge for the non-filing, but if there’s an unknown audit there’s the risk that unknown audit could turn what would ordinarily be just a misdemeanor charge into a felony simply because there was an unknown audit going on. That would only occur where you didn’t have sufficient evidence to establish tax evasion. I think that’s why from a practitioner’s standpoint, the practitioners were watching these cases that were allowing charges under 7212 where the taxpayer didn’t know there was an examination taking place. In the older situations, they would have said there has to be some knowledge of that, so it was an unknown. But more and more of the cases were coming out with conditions for 7212 where the taxpayer just did not know about the examination, so when the court took this up, a lot of people were following it to see what the Supreme Court would say.”
The ruling could have far-reaching implications for tax practitioners and their clients. "It’s a case that redefines the parameters of when 7212 can be used against a defendant," said Mastracchio. "This decision says there has to be knowledge of that audit or targeted investigation before the government can bring a charge under 7212(a).”
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