Spies v. United States – When Failure to File Becomes Tax Evasion
The Internal Revenue Code (IRC) forms the basis of all criminal tax prosecutions in the United States. The code covers various criminal acts by a tax payer. The most common sections for prosecution fall under 26 U.S.C. § 7203 (willful failure to file a return, supply information, or pay tax), 26 U.S.C. § 7206 (filing fraudulent information in a return), and 26 U.S.C. § 7201 (attempt to evade or defeat the payment of taxes).
Each of these sections carries a distinct punishment range and elements of proof. Failure to file is a misdemeanor offense which carries a maximum punishment of one year in prison and a $25,000 fine. Filing a fraudulent return under § 7206 is a felony offense which carries a maximum punishment of three years in prison and a $100,000 fine. Attempting to evade the payment of taxes is a felony offense which carries a maximum punishment of five years in prison and a $100,000 fine. In the world of criminal tax, the harshest sentences are available for those found guilty of tax evasion. This felony offense is the one that must be avoided when defending criminal tax defendants.
The line between failure to file and tax evasion from a punishment standpoint is simple to see. A misdemeanor offense with a cap of one year in prison is a far more workable starting point than a felony offense which carries up to five years in prison. However, the line between these two offenses from an elemental standpoint is far less clear. Tax evasion requires the government to prove the defendant “willfully attempted to evade or defeat any tax imposed” under the IRC. Failure to file requires the government to prove the defendant “was required to pay a tax or supply information” and “willfully failed to pay such tax or provide such information.” It seems at first glance a criminal tax defendant will commit both offenses by simply failing to file a 1040 with the Internal Revenue Service in April. After all, a person must be attempting to evade an imposed tax when they make the decision to forego filing a return.
That last sentence encompassed the government’s position on tax evasion cases for decades. To the government, nothing more than a failure to pay taxes needed to be shown before a conviction for evasion was appropriate. After a split in the Courts of Appeals, the Supreme Court handed down direction for criminal tax litigants in their opinion in Spies v. United States, 317 U.S. 492 (1943). In this case, the Supreme Court set out the requirements for the government to prove tax evasion when a defendant fails to file a return. Spies may be the most important Supreme Court case in the criminal tax arena. And understanding the differences in proof between evasion and failure to file is crucial to successfully defending those charged with criminal tax violations.
Criminal Tax Evasion under Spies v United States
In Spies, the defendant failed to file a tax return for one year. The government charged him with one count of tax evasion. The misdemeanor of failure to file was not alleged in the charges. At the beginning of trial, the defendant admitted he had a duty to file a return and pay a tax, and he failed to do both. This was an admission to each element under the failure to file statute. The government’s evidence throughout trial revolved around the defendant’s accounting practices and how he handled income. At the close of evidence, the defendant requested an instruction from the trial court that “you may not find the defendant guilty of a willful attempt to defeat or evade income taxes, if you find only that he had willfully failed to make a return of taxable income and has willfully failed to pay tax on that income.” The trial court refused to allow the instruction before the jury.
The trial court instead charged the jury that “if you find the defendant had a net income in 1936 upon which some income tax was due, and the defendant willfully failed to pay the tax due for that year, you may find the defendant willfully attempted to evade or defeat the tax.” The defendant was found guilty on one count of tax evasion. He appealed the trial court’s instruction to the Court of Appeals. The Court of Appeals overruled the defendant’s challenge and affirmed the conviction.
The defendant then applied for, and obtained, review in the Supreme Court of the United States. Before the Supreme Court, the government contended that a willful failure to file a return, together with a willful failure to pay the tax, constituted an attempt to defeat or evade taxes. In other words, a failure to file a return is always a felony offense regardless of the plain language of the failure to file statute.
The Supreme Court was quick to take notice of the apparent absurdity of defining acts which neatly fall under the misdemeanor statute as felonies under the IRC. The Court looked for a defining characteristic in the evasion statute which separated its requirements of proof from the failure to file statute. They found that separation in the evasion statute’s use of the word “attempt.” This addition to the statute required the government to prove some affirmative act of deception whereas the misdemeanor statute only required omission. Put differently, sitting idly by while April comes and goes is not a felony offense. The defendant must take some willful action to attempt to defeat or evade tax liability before conviction under the evasion statute is appropriate.
The Court then goes on to discuss actions which would appropriately fall under the umbrella of tax evasion, including keeping a double set of books, making false entries, concealing assets overseas, or any other conduct which would have the likely affect of concealing or misleading. The Court overturned the defendant’s conviction and remanded the case for a new trial with a proper jury instruction.
The Impact of Spies on Criminal Tax Prosecutions
The Spies case set the standard for tax evasion cases throughout the United States. Following their decision, the government had to show willful, affirmative acts by the defendant before lawfully obtaining a felony conviction under the evasion statute. Many criminal tax cases are born out of a defendant’s failure to file their returns. We have had numerous cases where small business owners, large companies, or personal filers have failed to file tax returns for multiple years. Whether their conduct will fall under the misdemeanor or felony framework hinges on the acts of deception which were carved out in Spies. A criminal tax lawyer must look at each action taken by the defendant to formulate a defense to tax evasion. If successful, this challenge could be the difference between the criminal tax defendant spending a long sentence in prison or getting probation for a misdemeanor offense.
In a later post, we will look at where Spies has gone since the decision in 1943. Spies was the starting point for our interpretation of tax evasion. However, litigants and courts of appeals have been fine tuning the outer bounds of the Spies decision for the last 75 years. Defining what acts of deception are required under the evasion statute will continue to be a hot area of litigation in the criminal tax world for the foreseeable future.