Third Circuit Court of Appeals Affirms Trust Fund Tax Convictions

In United States v. DeMuro, ___ F.3d ___, available here, the taxpayers were convicted of "conspiracy to defraud the United States, in violation of 18 U.S.C. § 371, available here, commonly referred to as a “Klien” conspiracy, and 21 counts of failure to account and pay over employment taxes (employee income tax and employee FICA withheld), in violation of 26 U.S.C. § 7202, available here. The language of Section 7202 provides as follows: “Any person required under this title to collect, account for, and pay over any tax imposed by this title who willfully fails to collect or truthfully account for and pay over such tax shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $ 10,000, or imprisoned not more than 5 years, or both, together with the costs of prosecution.”

The Internal Revenue Code requires that employers withhold and pay over to the IRS income tax and social security taxes (a/k/a “FICA” taxes) collected from the employees.  These withheld  funds are referred to as "trust fund taxes" because the employer withholds the amount and keeps them “in trust” for the employee until the employer remits it to the IRS.  There is no explicit requirement that the trust fund taxes be segregated from a general operating account, all that is required is that the correct amount is remitted to the IRS on a timely basis.

There are provisions of the Internal Revenue Code that address trust fund taxes. This includes trust fund taxes penalty IRC Section 6672, available here, for responsible person to ensure that the IRS gets the trust fund taxes, and IRS Section 7512, available here, which authorizes the IRS to establish a special trust account for the employer to deposit the trust fund taxes.

As an aside, the Internal Revenue Code section 6672(a) states:

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over. No penalty shall be imposed under section 6653 [IRC Sec. 6653] or part II of subchapter A of chapter 68 [IRC Sections 6662 et seq.] for any offense to which this section is applicable.

As these statutory provisions make clear, section 6672(a) substantially tracks section 7202, and make available to the government criminal penalties for those that failure to collect and/or remit employment taxes.

But Section 7202 addresses the employer who fails to remit the trust fund taxes to the IRS.  That section is not altogether clear that an individual who did not have the direct legal obligation to remit trust fund taxes could be convicted.  In contrast, in a Klein conspiracy, all of the persons who conspired to defraud the United States “ regardless of whether the conspiracy was successful “ by failing to remit trust fund taxes would be criminally liable.  As such, a Klein conspiracy count wraps all the actors in the conspiracy without regard to individual levels of culpability and provides the government with a substantive criminal charge that has greater reach. 

In DeMuro, a IRC Section 7512 trust account was established.  The proof introduced at trial was that the taxpayers improperly disbursed funds and shut down the account without the permission of the IRS.  In the taxpayers case, the taxpayers corporation withheld the trust fund taxes, but were not remitted to the IRS.  The evidence produced at trial demonstrated that the taxpayers not only had the ability to withhold, but instead of remitting the trust fund taxes to the IRS, they spent their money on a lavish lifestyle.

On appeal, the taxpayers argued that the evidence of their lavish lifestyle was admitted in error.  However, the Third Circuit rejected that claim, holding instead that “personal spending can be relevant to rebut a defendant’s defense that he has not acted willfully."  The Third Circuit held as follows:  "the District Court did not abuse its discretion in finding the evidence of the DeMuros’ personal spending to be relevant to the jury’s assessment of willfulness in light of the DeMuros’ defensive arguments at trial."  

The Court also rejected the argument that the evidence of lavish lifestyle was unfairly prejudicial under Federal Rule of Evidence 403, available here. The Third Circuit addressed Rule 403 by quoting the D.C. Circuit in United States v. Gratmon, 146 F.3d1015, 1021 (D.C. Cir. 1998): “Rule 403 does not provide a shield for defendants who engage in outrageous acts, permitting only the crimes of Caspar Milquetoasts to be described fully to a jury. It does not generally require the government to sanitize its case, to deflate its witnesses’ testimony, or to tell its story in a monotone.”

The taxpayers also argued that the introduction of FRE 404(b) ("bad acts" evidence) was improper.  The specific evidence in dispute was that the taxpayers  had withheld trust fund taxes, but other monies that should have been remitted to third parties for the benefit of the employees, e.g.,  employees’ health insurance, retirement and child support payments.  The Third Circuit rejected this argument, detailing how the trial court did not abuse its discretion to admit this evidence.   The taxpayers additionally argued that details of their interaction with the IRS should have been admissible to show their lack of willfulness required for the Section 7202 counts.  The Court also rejected this argument, finding no abuse of discretion.

Ms. DeMuro also argued that the trial courts decision to exclude evidence supporting her “innocent spouse defense,” i.e. evidence showing that even if her husband was liable, she was not. The trial court excluded the evidence because "it was irrelevant to whether the wife was responsible for paying the trust fund taxes; 2) it had the potential to confuse the jury; and 3) the  statement was inadmissible hearsay."  The Court on appeal sustained the exclusion.

But the taxpayers were successful in their theory that the trial court improperly applied a 2-level enhancement for abuse of position of trust, pursuant to the U.S. Sentencing Guidelines § 3B1.3.  (The Sentencing Guidelines are available here.) That enhancement was based only on the taxpayers  failure to meet the obligation imposed under the special IRS trust account.  The Third Circuit stated:  "Our inquiry is whether the DeMuros were in positions of trust vis-a-vis the IRS based on their positions as signatories of the trust fund account set up to benefit the IRS."  The Court applied the following factors: (i) the special trust fund did not have the factor of difficulty to detect the breach of trust; (ii) the taxpayers had little authority (they had power, but not authority) over the trust fund; and (iii) the IRS did not rely upon the integrity of the taxpayers, having established the special trust fund because it did not rely upon their integrity.  Based on the analysis of these factors, the Court reversed for resentencing without the enhancement.

The attorneys at Fuerst Ittleman, PL have extensive civil and criminal tax litigation experience before the U.S. District Courts, the U.S. Tax Court, and the U.S. Circuit Courts of Appeal.  You can contact us by calling 305.350.5690, or by emailing us at contact@fuerstlaw.com.

This entry was posted on Tuesday, May 8th, 2012 at 7:25 am and is filed under Tax, White Collar Defense.

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