Federal District Court For The Southern District of New York Refuses to Dismiss Criminal Indictment Against U.K. Citizen-U.S. Resident For Failing to File U.S. Income Tax Returns and FBARS

By: Jerald David August

Little v. United States: No. 1:12-cr-00647

A stern message was just issued by Judge Castel of the Southern District of New York Federal District Court against a defendant, a U.S. resident and citizen of the U.K., who claimed that he could not have known he had violated the U.S. income tax laws  as well as the FBAR provisions, because of the ambiguity of the application of such laws to him and with particular emphasis on his status under the U.S./U.K. Tax Treaty. He therefore moved for partial dismissal of a (second superseding) indictment on grounds that the charges of willful failure to file individual income tax returns, failure to file FBARs as well as obstructing justice by assisting others to avoid U.S. taxes due on their assets received through inheritance held in undeclared offshore accounts, denied him due process of law in violation of his Fifth Amendment right under the U.S. Constitution. A grand jury had previously returned a 19 count (second superseding) indictment again defendant, Michael Little, on March 18, 2013.

The arguments Mr. Little were rejected by U.S.D.J. Kevin Castel, in the Court’s Memorandum and Order of May 3, 2017.  The gravamen of Little’s argument was that based on his belief that he was a “resident” of the U.K. under the U.S.-U.K. income tax convention, a person of “ordinary intelligence”, which presumably he felt was reflective of his level of intelligence, lacks notice as to what constitutes compliance with the law and therefore is unconstitutionally vague. He moved to dismissed the first eight counts of the indictment with respect to willful failure to file income tax returns and FBAR reports.

In the Memorandum, the Court started with the “void-for-vagueness” doctrine line of attack. In particular a criminal statute must define the offense with sufficient definiteness so that the ordinary person can understand what conduct is prohibited and in a manner that does not encourage arbitrary and discriminatory enforcement. See U.S. v. Rybicki, 354 F.3d 124 (2d Cir. 2003).  See also U.S. v. Kinzler, 55 F.3d 70, 74 (2d Cir. 1995).

Continuing, the Court cited a decision rendered by the Second Circuit, the appellate court to which it is required to follow its decisions as precedent under principles of stare decisis, in U.S. v. Tannenbaum, 934 F.2d 8, 12 (2d Cir. 1991), that where the “punishment imposed is only for an act knowingly done with the purpose of doing that which the statute prohibits”, the defendant can not successfully block an indictment and resulting conviction based on his lack of knowledge or inadequate warning  that the act he does is a violation of law. Citing Screws v. U.S. 325 U.S. 91, 102 (1945)(Bank Secrecy Act required reporting by financial institutions not void for vagueness as applied under the facts). when applied to an individual because the Act defined financial institutions to include "[a] person who engages as a business in dealing in or exchanging currency" and defendant knew he was "committing a wrongful act."). The Court held that applicable U.S. statutes and regulations which require alien lawful permanent residents (green card holders) to either (a) file a tax return and pay taxes on worldwide income, or (b) file a tax return reporting worldwide income and indicate that he or she is taking a particular protection under the Treaty, are not unconstitutionally vague as applied. In addition, the Court ruled that the statutes providing for criminal charges to be made against individuals who violate these obligations are not vague as applied to alien lawful permanent residents.

Background For Little v. United States: Relevant Provisions in Internal Revenue Code and Reporting Obligations For Lawful Permanent Resident Aliens

An alien individual, who is a lawful permanent resident of the United States, per  who is a lawful permanent resident of the United States is treated as a resident of the United States for tax payment and reporting purposes. 26 U.S.C. § 7701(b)(1)(A). This test can be met three ways: (i) permanent residence for immigration purposes, the “greencard” test; (ii) the “substantial presence test” or, to a limited extent, (iii) the first year election test.  Under the greencard formulation of U.S. residence it does not matter how much time during the tax year the individual is physically present in the United States provided his permanent resident status has not been revoked or administratively or judicially determined to have been abandoned. § 7701(b)(6). In 2008, §7701(b)(6) was amended to provide:

“An individual shall cease to be treated as a lawful permanent resident of the United States if such individual commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, does not waive the benefits of such treaty applicable to residents of the foreign country, and notifies the Secretary of the commencement of such treatment.” §7701(b)(6)(B).

Section 6012 provides that a U.S. resident is required to file an annual income tax return on a Form 1040. Where an individual is a resident of both the United States and another country at the same time, he is considered to be a “dual resident”. In a situation like the facts in Little, supra, the United States is a party to a bilateral tax convention with a foreign country of which the dual resident is also a resident, the treaty determines under a so-called “tie breaker”
provision the residency status of the resident in question. This is a key aspect of a tax treaty, i.e., to avoid and resolve issues of double taxation.

Under the U.S.-U.K. Income Tax Treaty (2001), for purposes of determining worldwide income of a dual resident of both the U.S. and the U.K., an individual will be treated as a resident of the country where he has permanent home. If such individual has a permanent home in both countries,  his country of residence will be the country with which he has closer personal and economic interests (“centre of vital interests” test). The third tie-breaker if neither of the first two tests resolve the matter, is that the individual will be considered resident of that country in which he has a habitual abode and if no habitual abode in either country or in both of them, then residency will be determined based on the country in which the individual is a citizen. If a citizen of both or neither countries, then the tax administrators of each country (“competent authority”) will settle the question by mutual agreement. U.S.-U.K. Tax Treaty, Article 4, §4.

Where a dual resident is determined to be a non-U.S. resident by application of a governing tax treaty, such individual is treated as a nonresident for U.S. income tax purposes and reports his U.S. source income on a Form 1040NR. Treas. Reg. §301.7701(b)-7(b). In addition, the individual must file with the return a filled-in Form 8833 (Treaty-Based Return Position Disclosure). Treas. Reg. §301.7701(b)-7(c). See also §6114 (obligation to disclose treaty based return position).  

Mr. Little’s Predicament on Moving to Strike 8 Counts of the Indictment: Failure to File U.S. Income Tax Returns (and FBAR returns).

The defendant maintained that the 2008 amendment to §7701(b)(6) with respect to abandoning or rescinding his green card, when read in conjunction with the tie-breaker provision in the Treaty, created an ambiguity which would require the failure to file charge to be dismissed. Little maintained he was only temporarily in the U.S. between 2005 and 2008, and that the Treaty would lead him, i.e., a person of ordinary intelligence, to conclude he was not a resident of the U.S. for tax purposes. He also argued his treatment by the United States by virtue of the indictment on failure to file U.S. income tax returns, violated the non-discrimination clause of the U.S.-U.K. Treaty, Article 25, §1. As to this last point, Judge Castel had little problem in rejecting.

The Court opined that based on the relevant sections of the Internal Revenue Code and regulations, that Mr. Little’s thought of what an individual of normal intelligence would know about his reporting obligations to the U.S. as a green card holder was false. In contrast to Mr. Little’s plea of “lack of knowledge”, Judge Castel opined that a lawful permanent resident of ordinary intelligence would know that he or she needed to either (a) file a tax return and pay taxes on worldwide income, or (b) file a tax return reporting worldwide income and indicate that he is taking a particular protection under the Treaty. An individual's obligation to pay taxes on either his income earned while in the U.S., or his worldwide income, is irrelevant to his obligation to disclose such income and report it pursuant to the above discussed statutes and regulations.

Mr. Little’s Failure to File FBARs: Little’s Motion to Strike That Portion of the Indictment Also Rejected by the Court

Both Little and the Government agreed that the U.S.-U.K. Income Tax Treaty does not affect any individual's obligation to file FBARs and that the 2007 and 2008 FBAR forms provided that FBARs were to be filed by "citizen[s] or resident[s] of the United States, or a person in and doing business in the United States." Nevertheless, Little contends that IRS announcements 2009-51 and 2010-51 suspended the requirement for a person "in and doing business in the United States" to file and FBARs.

Prior to February 24, 2011, the FBAR regulations did not define the term "U.S. resident." Internal Revenue Manual 4.26.16.3.1.2(1). For FBARs required to be filed June 30, 2011 or later, 31 C.F.R. § 1010.350(b) defines 'United States resident' using the definition of resident alien in IRC 7701(b),which includes green card holders such as Little. Internal Revenue Manual 4.26.16.3.1.2(2)(1).

For FBARs due before the June 22, 2009 announcement, the Court noted there was no ambiguity regarding the duty to file for persons 'in and doing business in the United States.' Even before the term 'United States resident' was defined by FBAR regulations, it appears likely that an alien lawful permanent resident of ordinary intelligence not 'in or doing business in' the U.S. would have understood themselves to be under an obligation to file an FBAR based on the definition of 'United States resident' in other parts of the U.S. code and regulations. To the extent that there was any ambiguity regarding this duty, that ambiguity is remedied for the purposes of this void for vagueness analysis by the fact that criminal penalties only apply to a failure to file an FBAR if such failure to file was willful, as will be discussed below.

Little Loses Again: The Relevant Criminal Statutes as Applied are not Void for Vagueness.

Little argued that Counts One through Eight of the Second Superseding Indictment must be dismissed pursuant to the void for vagueness doctrine of the Due Process Clause of the Fifth Amendment. Count One of the Second Superseding Indictment charges Little with Obstructing and Impeding the Due Administration of Internal Revenue Laws in violation of 26 U.S.C. § 7212(a); Counts Two through Seven charge Little with Failure to File Individual Income Tax Returns for Tax Years 2005-2010 in violation of 26 U.S.C. § 7203; Count Eight charges Little with Willful Failure to File Reports of Foreign Bank and Financial Accounts in violation of 31 U.S.C. § 5322(a). Because a person of ordinary intelligence would understand that these statutes impose criminal penalties on persons engaging in the conduct in which Little is alleged to have engaged, these statutes are not void for vagueness as applied to Little.

Let’s Move Onto Obstruction to Impede The Administration of the Tax Code.

The law, i.e., 26 U.S.C. § 7212(a), makes it unlawful to "corruptly . . . obstruct[ ] or impede[ ], or endeavor[ ] to obstruct or impede, the due administration of" the Internal Revenue Code. 26 U.S.C. § 7212(a). "To act or endeavor 'corruptly,' within the meaning of this section, means to act or endeavor 'with the intent to secure an unlawful advantage or benefit either for one's self or for another.'" United States v. Parse, 789 F.3d 83, 121 (2d Cir. 2015) (quoting United States v. Kelly, 147 F.3d 172, 177 (2d. Cir. 1998)).

Count One, paragraph nine of the Second Superseding Indictment alleges that Little took six separate actions, in addition to failing to file FBARs and tax returns, that violated §7212(a) in connection with the alleged scheme to avoid the taxes due on their inheritance, and the government represents it intends to rely on those actions rather than on the failure to file tax returns or FBARs. A person of ordinary intelligence would understand that conduct of the type alleged in paragraph nine would expose an individual to criminal penalties for obstruction under the meaning of  § 7212(a). Thus, there is no void for vagueness issue with respect to Little's prosecution for obstruction of the internal revenue laws.

Let’s Move Onto Failure to File Income Tax Returns.

Under §7203 it is  unlawful for "[a]ny person required under [Title 26] to pay any estimated tax or tax, or required by this title or by regulations made under authority thereof to make a return, keep any records, or supply any information, [to] willfully fail[] to pay such estimated tax or tax, make such return, keep such records, or supply such information. . . ." In §7203 and other statues prohibiting tax evasion, "the word 'willfully' . . . generally connotes a voluntary, intentional violation of a known legal duty." United States v. Bishop, 412 U.S. 346, 360 (1973).  Willfull conduct is based on knowledge of the act or failure to act was violative of the statute and did not require a showing of bad faith or evil intent.

Let’ Move Onto Failure to File FBAR Reports.

It is apparent at this point that Judge Castel, in his Memorandum and Order, was simply not going to agree with Little on the defense of “ordinary intelligence” renders him incapable of not having acting willfully as a matter of law. So the Court then went from failure to file willfulness to the willful violation of the FBAR rule under 31 U.S.C.§5322(a) which makes it unlawful to "willfully violat[e]" 31 U.S.C. §§ 5311 et seq., "or a regulation prescribed or order issued" thereunder, including 31 C.F.R. § 1010.350, which requires certain individuals to file FBARs. For the government to convict an individual for violating 31 U.S.C. § 5322(a) for violating the requirement to file an FBAR, a defendant must know of his duty to file but intentionally fail to do so anyway. See U.S. v. Sturman, 951 F.2d 1466, 1476 (6th Cir. 1991) ("willfulness" in prosecution for failure to file records and reports of foreign financial agency transactions as the "voluntary, intentional violation of a known legal duty"); U.S. v. Eisenstein, 731 F.2d 1540, 1543 (11th Cir. 1984) ( For FinCEN purposes, the term “willful require[s] proof of the defendant's knowledge of the reporting requirement and his specific intent to commit the crime."); U.S. v. Granda, 565 F.2d 922, 925-26 (5th Cir. 1978) ("[T]he terms knowing and willful require proof of the defendant's knowledge of the reporting requirement and his specific intent to commit the crime; not based on strict liability); U.S. v. San Juan, 545 F.2d 314, 318 (2d Cir. 1976) ("Without proof of any knowledge of, or notice to, Mrs. San Juan of the reporting requirements, a jury could not determine beyond a reasonable doubt that she had the requisite willful intent."). But see U.S. v. McBride, 908 F. Supp.2d 1186 (2012)(FBAR civil penalty case; FBAR violation may be satisfied by establishing the individual's reckless disregard of a statutory duty, as opposed to acts that are known to violate the statutory duty; an improper motive or bad purpose is not necessary to establish such willfulness).

Judge Castel ruled that conviction under the failure to file income tax returns and FBARs requires that the government prove beyond a reasonable doubt that Little acted willfully with respect to the failure to file tax returns and FBARs, and corruptly with respect to the obstruction of the internal revenue laws. .

Holding.

The Court quashed the motion filed by defendant and held that neither the legal obligation for alien lawful permanent residents of the U.S. to file tax returns or FBARs, nor the statutes criminalizing such failure, nor the statute prohibiting the obstruction of the internal revenue laws, are vague as applied to the defendant’s alleged conduct. A person of ordinary intelligence would know if his or her actions conformed to law.


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Part Two, "Monster.Com’s Estate Wins Tax Court Decision on Decedent’s Variable Prepaid Forward Contracts"