No more ‘one-person conspiracies’

Register now

The U.S. Supreme Court on March 21, 2018, reversed the Second Circuit in a 7-2 decision in Marinello v. United States, holding that to convict a defendant under the Omnibus Clause of Code Section 7212(a) the government must prove that the defendant was aware of a pending tax-related proceeding, such as a particular investigation or audit, or could reasonably have foreseen that such a proceeding would commence.

The decision “applies the brakes to this one-person conspiracy statute,” according to Nathan Hochman, a partner in the Litigation Practice Group at Morgan Lewis and former head of the Tax Division at the Department of Justice.

“With the DOJ mandate to charge the most serious offence in all cases, the government would have charged felonies in virtually every misdemeanor tax case,” he said. “This decision reins in the government’s efforts to felonize any action relating to your tax returns. The Supreme Court now requires the government to prove under Tax Code Section 7212(a)’s obstruction statute that you knew, or it was reasonably foreseeable to know, that you were under IRS investigation or audit when you committed obstructive acts like failing to give your accountant records, paying cash to your employees, or destroying records. With its Marinello decision, the Supreme Court has steered the DOJ back onto properly defined constitutional roads of prosecution.”

Tax Code Section 7212(a) is one of many federal statutes that include a “catchall” residual clause designed to apply to conduct that might not be covered by the specific language in the rest of the statute.

The phrase in question imposes a criminal penalty on one who “corruptly … obstructs or impedes or endeavors to obstruct or impede the due administration of the Internal Revenue Code.”

For Carlo J. Marinello II, this clause had the effect of turning his failures to file tax returns over a period of years from misdemeanors into a felony.

Marinello owned and operated a freight service that couriered items between the United States and Canada. From 1992 to 2010, he did not keep business records or file personal or business tax returns. He shredded and discarded records, paid his workers in cash, and issued no W-2s or 1099s. He ignored advice from his accountants and attorneys to maintain records, and ignored a phone inquiry from an IRS agent. He was eventually turned in via an anonymous letter to the IRS.

Marinello was indicted by a grand jury on nine counts of tax-related offenses, and a jury found him guilty on all counts. Eight of the counts were misdemeanors under Code Section 7203 for willfully failing to file personal income and corporate tax returns for the years 2005 through 2008. The remaining count charged him with violating Code Section 7212(a)’s residual clause. The district court instructed the jury that proof beyond a reasonable doubt of any one of the eight obstructive acts alleged in the indictment, including omissions, would be sufficient to find Marinello guilty under Section 7212(a).

Marinello was found guilty, and the Second Circuit affirmed. Marinello petitioned the Supreme Court, arguing that under the Second Circuit’s interpretation, “a defendant who does not maintain records at a time when the IRS does not have a pending action against him – let alone undertaking an action of which he is aware – can nonetheless be convicted of a felony of obstructing the administration of the Tax Code.”

What it means
“The Supreme Court was asked to resolve an apparent disagreement among the federal circuits,” said David De Jong, CPA, Esq., a partner in Stein Sperling. “The Sixth Circuit Court of Appeals agreed with the defendant that he can only be convicted if he knowingly interfered, which would require knowledge of an investigation. Three other Courts of Appeal had disagreed.”

The Marinello case continues an approach over the past two decades that the court has taken to other omnibus clause statutes, according to Hochman.

“Before this decision, if you lived in the Sixth Circuit Court of Appeals – Kentucky, Michigan, Ohio and Tennessee – then the DOJ had to show you knew there was a pending IRS investigation or audit before it could bring a felony tax obstruction case against you,” said Morgan Lewis’ Hochman. “If you lived anywhere else in the country, the DOJ had no such requirement. Now, this requirement is mandated across the country in every jurisdiction. By resolving this split, the Supreme Court wanted to send the DOJ a message that the government’s expansive view of the tax obstruction statute to include all actions a taxpayer takes at any time related to routine tax returns would not be permitted, since such a view did not provide fair warning to the taxpayers as to where the felony line was that could not be crossed.”

“This was an issue that’s been closely watched and of great concern to the defense bar,” said Barbara Kaplan, co-chair of theGlobal Tax Practice at Greenberg Traurig. “Everyone was hoping for this outcome.”

“The use of this statute to indict people has been growing, and we on the defense bar can see that the Department of Justice keeps finding ways to penalize conduct that might not be considered a criminal act,” she added. “The elevation of conduct from a misdemeanor to a criminal act is of great concern.”

The dissent alluded to the fact that the government stopped its investigation for a while because it had a hard time proving Marinello’s income, observed George Abney, a partner on Alston & Bird’s tax controversy team and a former prosecutor in the Department of Justice Tax Division.

“They could have charged felony tax evasion instead of obstruction under the omnibus clause, but if they charged evasion they would have had to prove an actual tax due and owing,” he said. “That can be very difficult to prove if a taxpayer didn’t keep records, which explains why they used the omnibus obstruction statute. … But the government has plenty of other ways to prove income, such as the net worth method, the bank deposit method, and the expenditures method. These are ways to show income by the surrounding facts and circumstances in the absence of accurate records.”

“The IRS may have been a little lazy in its approach,” he said. “They probably could have charged other felonies had they put in the time and effort to dig into his financial affairs. Charging under the omnibus clause may have been the easy way out.”

For reprint and licensing requests for this article, click here.
Tax-related court cases Tax fraud Tax returns Tax records SCOTUS