Kathryn Keneally specializes in white-collar crime, tax controversy, and commercial litigation. In practice in New York City, she is a member of the U.S. Sentencing Commission Practitioners' Advisory Group. She is chairperson of the ABA Subcommittee of the Tax Section's Civil and Criminal Penalties Committee on Department of Justice Procedures. She is a member of The Champion Advisory Board.
In November 1996, this column reported on two cases which had imposed limitations on prosecutions in tax cases. In United States v. Tenzer,1 the district court dismissed criminal tax charges because the court found that the indictment was brought in violation of the Internal Revenue Service's (IRS's) highly publicized voluntary disclosure policy. In United States v. Hastings,2 the district court dismissed the indictment following the government's refusal to disclose its internal policies when faced with a selective prosecution claim. Within days of one another, the Second and Fourth Circuits reversed both decisions.
Tenzer Decision: The IRS and its Public Promises The defendant in Tenzer was an attorney and accountant, and indeed his practice concentrated in tax matters. It was not disputed that he failed to file his tax returns timely, or to pay his taxes, for the years 1987 through 1990. Following a series of computer-generated notices and telephone calls made by his counsel to the IRS, the defendant filed his 1987, 1988, and 1989 tax returns in February 1992. No payment was included.
The matter was assigned within the IRS to a revenue officer, whose responsibility was to seek civil enforcement and collection in connection with the delinquent returns and non-payment. The revenue officer declined to consider any proposed installment plan for payment of the taxes until all delinquent returns were filed. In November 1992, the defendant filed his 1990 and 1991 returns.3 The revenue officer assured counsel that the IRS was pursuing civil collection and not criminal enforcement.4
Through counsel, the defendant made a proposal to compromise his sizeable tax liability. The revenue officer deemed the offer inadequate. The revenue officer then transferred the matter to a different district of the IRS, and instructed the defendant's counsel not to make any additional proposals until he was contacted by the IRS that the transfer was completed. The next contact from the IRS, however, was not from a collections officer in the district to which the matter was to be transferred. Rather, the next contact was from an IRS special agent, who informed the defendant's counsel that the matter was under criminal investigation.5
It was the government's position that the criminal proceedings in Tenzer resulted from an investigation that was on-going and separate from the civil tax enforcement activities. The Second Circuit noted that the government believed that the defendant "might have been involved in some fraudulent activity" with one of his clients, and thus included him in its fraud investigation. In so doing, the investigative agents "discovered that [the defendant] himself had failed for years to timely file his tax returns."6 Notably, by the time the agents made this discovery, the returns had been filed.
The Second Circuit opinion made no subsequent mention of the outcome of the fraud investigation of the defendant's client. The district court, however, described the investigation of the defendant's client as "lengthy and elaborate," and noted that the government was unable to link the alleged fraud to the defendant.7 While overlooked by the Second Circuit, the import of the government's failed efforts to link the defendant to his client's fraud was not missed by the district court, which observed:
Most prosecutions for failure to file originate with the IRS and are sent to the Department of Justice which may decline. In this case the request to proceed against Tenzer as a non-filer originated with the DOJ, or more correctly, the local United States Attorney's Office, after it had exhausted its ability to make a case against Tenzer for his likely complicity in the JRD tax fraud. An understandable desire to make some charge of some sort stick against Tenzer appears to have influenced subsequent consideration of his case. . . .8The defendant in Tenzer argued, first in a conference before the Department of Justice, and ultimately in court, that the criminal charges of willful failure to file tax returns violated the IRS's voluntary disclosure policy.
In April 1993, the IRS revised its long-standing internal voluntary disclosure policy. As revised, the policy provided that the IRS would not pursue criminal charges of an individual who disclosed the non-filing of tax returns, filed the returns or cooperated in determining the correct tax liability, paid the liability or made bona fide arrangements toward payment, and had only legal source income -- provided that the disclosure preceded notification by the IRS that the individual was under criminal investigation.9 Prior to April 1993, disclosure was deemed voluntary under the IRS's policy only if made before any contact by the IRS, civil or criminal, and before any other event by which the individual was alerted to the likelihood of an audit. In 1995, the IRS reverted to the policy that had been in place prior to April 1993.
The Second Circuit depicted the IRS policy as an internal policy that "has been in existence, in one form or another, since 1952." The Second Circuit failed, however, to consider, as district court had done, that the April 1993 revision was accompanied by extensive publicity by the IRS in a campaign to encourage delinquent filers back into the system.10
For the district court, the central issue was whether the government could be bound by its announced policies. The government had argued that the voluntary disclosure policy was one of grace, which the government contended provided no legally enforceable rights for the defendant. Rejecting this argument, the district court concluded that the Supreme Court decision in United States v. Caceres 11 established that when a government agency adopts regulations, it is required to obey those regulations.12 Relying on Caceres, the district court held that the IRS, having not only promulgated but also widely publicized the voluntary disclosure policy, was "duty bound" by the Constitution to obey the policy, "even if the agency was not required by the Constitution to adopt [the policy] in the first instance."13
Most notably, while its interpretation and application of the Caceres doctrine was central to the district court's decision, the Second Circuit nowhere even mentioned Caceres or its principles. Rather, the Second Circuit's decision in Tenzer can be read as accepting as a given that the IRS was bound by its announced voluntary disclosure policy. The Second Circuit addressed directly, and exclusively, the factual issue of whether the defendant in Tenzer was eligible for the benefits of the voluntary disclosure policy.
The Second Circuit determined that all versions of the IRS's voluntary disclosure policy over the years required that the taxpayer either pay or make bona fide arrangements to pay the applicable taxes and penalties.14 The court offered some potential solace to similarly situated taxpayers in future cases, noting that "[w]hile the burden of making a bona fide arrangement rests primarily on the taxpayer, . . . the government is obligated to negotiate in good faith with the taxpayer," and thus "the IRS may not withhold its assent capriciously or in bad faith."15 In the opinion's implicit endorsement of the principle that government agencies must be bound by the regulations they promulgate, the Second Circuit determined that "[t]he IRS must afford a taxpayer who has acted in reliance upon the voluntary disclosure policy a reasonable opportunity to satisfy all of the conditions of that policy, including a payment plan."16
Nonetheless, the court's statements provided little solace to the defendant in Tenzer. It was conceded that the defendant in Tenzer had not paid the taxes. The court rejected arguments that the defendant's offer to pay, or his intentions to negotiate an agreement for payment with the IRS, met the policy's requirement. The court cited evidence that the offer in compromise was far below the amount solicited by the collection officer, and that the defendant had continued to fail to pay his taxes in subsequent years.17
It should be recalled, however, that the IRS did not terminate its negotiations with the defendant and his counsel based on any determination that they would not eventually reach an agreement on a bona fide arrangement to pay the taxes. Rather, the IRS collection officer had instructed the defendant's counsel to await the reassignment of the matter to another district of the IRS before submitting a further offer in compromise. The IRS ceased its negotiations and other collection activities only when the defendant's delinquencies in filing his tax returns timely surfaced as an issue in an on-going investigation by other government agents.18 As a result, the defendant lost any opportunity to make a bona fide arrangement to pay. The Second Circuit's factual analysis of whether the defendant in Tenzer could fall within the protections of the IRS's voluntary disclosure policy was, quite simply, as apparently result-oriented as the original decision to prosecute.
Hastings Decision: The IRS and its Secret Policies The defendant in Hastings was charged with failing to file income tax returns for four years. He contended that he was improperly selected for prosecution based on his political activities. The district court held that the defendant had shown a potential selective prosecution claim sufficient to require the government to disclose portions of the IRS's Law Enforcement Manual. The court had inspected the manual in camera and described it as setting out the IRS's non-public criteria for determining when to conduct an audit and when to pursue criminal enforcement.19 When the government persisted in its refusal to disclose the Law Enforcement Manual, the district court dismissed the indictment.20
The Fourth Circuit reversed. The court acknowledged that the IRS revenue agent who referred the case for criminal investigation included in her report that the defendant had "ties to . . . a former Republican gubernatorial candidate," and that the report further noted that the defendant's "income for two of the four years at issue was 'low,' implying that it was lower than the threshold for most criminal prosecutions."21 The court also acknowledged that among the reasons listed for recommending prosecution was the defendant's "prominence in the community."22 The IRS special agent who took over the criminal investigation interviewed both the revenue agent who made the criminal referral, and an officer in the local police department; both told her that the defendant was a prominent Republican. In her memorandum of the investigation, the IRS special agent noted the defendant's "political prominence" and included a newspaper article noting his political aspirations and business affairs.23
In further support of his assertion of selective prosecution, the defendant offered the testimony of a former IRS agent. The Fourth Circuit summarized his affidavit as stating that "in his experience, most taxpayers who file returns delinquently are dealt with civilly rather than criminally" and "criminal prosecutions are only made when there are indicia of fraud on the part of the delinquent taxpayer."24
The Fourth Circuit found that the defendant in Hastings had nonetheless failed to make a showing of a selective prosecution claim sufficient to obtain further disclosure. The court summarized the defendant's "heavy burden" as requiring that he "demonstrate that the federal prosecutorial policy had a discriminatory effect and that it was motivated by a discriminatory purpose."25 The court also determined that the defendant must produce "some evidence" sufficient to make a "credible showing" of the discriminatory effect and the discriminatory intent before disclosure from the government will be required.26
The Fourth Circuit held that the defendant had failed to meet the evidentiary burden on either prong. Although the IRS's memoranda described the defendant as "a prominent businessman, an active Republican, and someone with connections to certain Republican candidates for office," the court rested on its observation that "none of the memoranda actually state that [the defendant's] political affiliation is the reason for pursuit of the case against him."27 The court also noted that "there is no evidence that the government official who actually made the decision to prosecute the case was motivated by impermissible considerations," adding that "[w]e will not impute the unlawful biases of the investigating agents to the persons ultimately responsible for the prosecution."28
The defendant in Hastings argued that the IRS improperly considered his prominence in the community in deciding to prosecute him, and that it was particularly egregious to do so when his prominence resulted from political activity. The Fourth Circuit agreed that it was "likely" that the defendant's prominence was "a factor that supported, if not actually motivated," the decision to refer the case for criminal investigation.29 Rather than consider this as evidence of selective prosecution, however, the Fourth Circuit credited the government's contention that "a person's public renown may be properly considered among other factors when deciding whether to pursue criminal sanctions for a violation of the law," particularly because the prosecution of prominent figures is viewed by the government as having an increased deterrent effect.30
In an effort to show a discriminatory effect, the defendant in Hastings offered statistical evidence suggesting that of over 37,000 delinquent filers, the IRS had referred only 12 for prosecution.31 The Fourth Circuit's response to this evidence demonstrates the astounding burden placed on a defendant who seeks to raise a selective prosecution argument. First, the court noted that the statistical evidence was not presented to the district court, but rather was developed from information disclosed by the government pursuant to the district court's orders. In a patent Catch-22, the Fourth Circuit suggested that it therefore "should not consider these statistics when deciding whether [the defendant] made the requisite showing to prove he is entitled to discovery."32 Moreover, the court observed that other factors supporting the prosecution in Hastings included "a lavish lifestyle, a significant tax debt, substantial earnings and property holdings, and clear knowledge of the tax laws and obligations," and that the defendant had not shown "that any of the thousands of persons not prosecuted had the same characteristics militating in favor of prosecution."33
Because the defendant could not show his claim without further disclosure from the government, he was denied the right to obtain any such disclosure. Yet, given the statistical scarcity of criminal non-filing prosecutions that he was able to demonstrate, the impression remains that in Hastings, as in Tenzer (which was itself one of the statistically few non-filer prosecutions), there was at least some undisclosed consideration driving the result.
Notes
1. 950 F. Supp. 554 (S.D.N.Y. 1996), rev'd and rem'd, 127 F. 3d 222 docket no. 96-1653, 1997 U.S. App. LEXIS 25263 (2d Cir. September 19, 1997). (Page citations to reported decision were not available before this column went to print.)2. 5:95 CR 37 (May 9, 1996), rev'd and rem'd, 126 F. 3d 310 docket no. 96- 4462, 1997 U.S. App. LEXIS 24981 (4th Cir. September 17, 1997). (Page citations to reported decision were not available before this column went to print.)
3. The Second Circuit rejected a contention that the count that related to the 1990 tax return should be dismissed on the separate ground that it violated the IRS's policy that prosecution should not be brought when the return is solicited by the Service and received before the taxpayer is contacted by criminal investigators. On this issue, the court observed that "[a]lthough an individual might be entitled to relief where an agency fails to adhere to its rules or regulations," it was the court's assessment that the policy at issue was not a rule or regulation, but rather an internal policy that merely provided guidance as to factors to be considered in making a recommendation for prosecution. Tenzer, slip op. at 19-20.
4. Tenzer, slip op. at 3-5.
5. Id., slip op. at 5-9.
6. Id., slip op. at 9.
7. 950 F. Supp. at 556, 559.
8. Id. at 559.
9. Internal Revenue Manual 342.142 (April 5, 1993) (subsequently modified as described above).
10. 950 F. Supp. at 563.
11. 440 U.S. 741, 751 n.14 (1979).
12. Tenzer, 950 F. Supp. at 555.
13. Id. at 555, 562-63.
14. Tenzer, docket no. 96-1653, slip op. at 13-14.
15. Id., slip op. at 17.
16. Id.
17. Id., slip op. at 17-18.
18. Id., slip op. at 5-9.
19. Hastings, criminal docket no. 5:95 CR 37, slip op. at 18, n.8.
20. Id., slip op. at 32.
21. Hastings, docket no. 96-4462, slip op. at 4. Notably, at the district court, the government had offered that, in lieu of disclosing portions of its Law Enforcement Manual, the government would stipulate that the dollar amounts at issue in the case for two of the years were below the thresholds set out in the Law Enforcement Manual for prosecution in tax cases.
22. Id.
23. Id., slip op. at 4-5.
24. Id.
25. Id., slip op. at 8, quoting United States v. Armstrong, 116 S. Ct. 1480, 1487 (1996).
26. Id., slip op. at 9 (citations omitted).
27. Id., slip op. at 10.
28. Id., slip op. at 11.
29. Id., slip op. at 12.
30. Id., slip op. at 12-13.
31. Id., slip op. at 17.
32. Id., slip op. at 16.
33. Id., slip op. at 17.
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