Criminal Tax Manual
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31.00 NET WORTH
Updated June 2001
31.01 GENERALLY
31.02 DESCRIPTION OF NET WORTH METHOD
31.03 USE OF NET WORTH METHOD
31.03[1] Inadequate Books and Records
31.03[2] Adequate Books and Records
31.03[3] Use With Other Methods
31.04 PROOF OF NET WORTH -- GENERALLY
31.05 OPENING NET WORTH
31.05[1] Proof -- "Reasonable Certainty"
31.05[2] Thorough Investigation a Necessity
31.05[3] Evidence Establishing Opening Net Worth
31.05[4] Opening Net Worth Not Established
31.06 CASH ON HAND
31.06[1] Definition -- Need to Establish
31.06[2] Jury Question -- Burden of Proof
31.06[3] Amount of Cash on Hand
31.07 EVIDENCE OF CASH ON HAND
31.07[1] Evidence of Financial Deprivation
31.07[2] Admissions of Defendant
31.07[2][a] Pre-Offense Admissions
31.07[2][b] Post-Offense Admissions
31.07[3] Tax Returns As Admissions
31.07[4] Statements Given to Financial Institutions
31.07[5] Defendant's Books and Records
31.07[6] Statements of Accountants and Attorneys
31.07[7] Accountant's Workpapers
31.07[8] Source and Application of Funds Analysis
31.08 NET WORTH ASSETS
31.08[1] Reflected at Cost -- Generally
31.08[2] Across the Board Assets
31.08[3] Bank Accounts and Nominee Accounts
31.08[4] Assets and Liabilities of Husband and Wife or Children
31.08[5] Real Property
31.08[6] Partnership Interest
31.08[7] Errors in Net Worth Computation
31.09 LIABILITIES
31.10 NONDEDUCTIBLE EXPENDITURES
31.10[1] Added to Net Worth Increase
31.10[2] Burden on Government
31.10[3] Nondeductible Expenditures -- Examples
31.11 REDUCTIONS IN NET WORTH
31.12 ATTRIBUTING NET WORTH INCREASES TO TAXABLE INCOME
31.12[1] Generally
31.12[3] Illegal Sources of Income
31.12[4] Negating Nontaxable Sources of Income
31.13 REASONABLE LEADS DOCTRINE
31.13[1] Duty to Investigate Reasonable Leads
31.13[2] Leads Must Be Reasonable and Timely
31.14 NET WORTH SCHEDULES
31.15 JURY INSTRUCTIONS
31.16 SAMPLE NET WORTH SCHEDULE
31.01 GENERALLY
The net worth method of proof is a long-established indirect method of
proof regularly used in establishing taxable income in criminal tax cases.
This method of proof is useful in reconstructing taxable income when the
government is unable to establish income through direct evidence.
See, e.g., United States v. Johnson, 319 U.S. 503, 517
(1943), involving gambling transactions where all records had been
destroyed. The net worth method produces an approximation. Holland v.
United States, 348 U.S. 121, 129 (1954); United States v.
Giacalone, 574 F.2d 328, 332 (6th Cir. 1978). See also
United States v. Gomez- Soto, 723 F.2d 649, 655 (9th Cir. 1983);
United States v. Schafer, 580 F.2d 774, 777 (5th Cir. 1978). This
method operates on the concept that if a taxpayer has more wealth at the end
of a given year than at the beginning of that year, and the increase does
not result from nontaxable sources such as gifts, loans, and inheritances,
then the increase is a measure of taxable income for that year. Because
nondeductible expenditures are added to any net worth increase, the method
is sometimes referred to as the net worth and expenditures method.
It is important when constructing a net worth computation to include
only items or transactions which reflect tax consequences. For this reason,
nontaxable items received during a prosecution year must be eliminated from
the computation of additional taxable income under the net worth method.
A net worth computation reveals not only that the defendant had
income but how that income was spent. In essence, the computation depicts
the financial life of a taxpayer, both prior to and during the prosecution
period. Holland, 348 U.S. at 132; United States v.
Mastropieri, 685 F.2d 776, 778 (2d Cir.1982).
Although endorsing the net worth method, the Supreme Court has
cautioned that "it is so fraught with danger for the innocent that the
courts must closely scrutinize its use." Holland, 348 U.S. at 125.
Despite the possible pitfalls inherent in the method, the Supreme Court has
approved its use a number of times. See, e.g., Massei v.
United States, 355 U.S. 595 (1958); United States v. Calderon,
348 U.S. 160 (1954); Smith v. United States, 348 U.S. 147 (1954);
Friedberg v. United States, 348 U.S. 142 (1954); Holland, 348
U.S. 121; Johnson, 319 U.S. 503.
For an example of a net worth computation, see Section 31.16,
infra.
31.02 DESCRIPTION OF NET WORTH METHOD
The First Circuit described the net worth method as follows:
The Government makes out a prima facie case under the net worth method
of proof if it establishes the defendant's opening net worth (computed
as assets at cost basis less liabilities) with reasonable certainty
and then shows increases in his net worth for each year in question
which, added to his nondeductible expenditures and excluding his known
nontaxable receipts for the year, exceed his reported taxable income
by a substantial amount. The jury may infer that the defendant's
excess net worth increases represent unreported taxable income if the
Government either shows a likely source, or negates all possible
nontaxable sources.
[T]he jury may further infer willfulness from the fact of
underreporting coupled with evidence of conduct by the defendant
tending to mislead or conceal.
United States v. Sorrentino, 726 F.2d 876, 879-80 (1st Cir. 1984)
(citations omitted). See also Holland v. United
States, 348 U.S. 121, 125 (1954); United States v. Terrell, 754
F.2d 1139, 1144 (5th Cir. 1985); United States v. Wirsing, 719 F.2d
859, 871 (6th Cir. 1983); United States v. Greene, 698 F.2d 1364,
1370 (9th Cir. 1983); United States v. Goldstein, 685 F.2d 179, 182
(7th Cir. 1982); United States v. Goichman, 547 F.2d 778, 781 (3d
Cir. 1976); United States v. O'Connor, 273 F.2d 358, 361 (2d Cir.
1959).
The Fifth Circuit summarized the steps necessary to establish income
when applying the net worth method of proof:
The government established its case through the "net worth" approach,
a method of circumstantial proof which basically consists of five
steps: (1) calculation of net worth at the end of a taxable year, (2)
subtraction of net worth at the beginning of the same taxable year,
(3) addition of non-deductible expenditures for personal, including
living, expenditures, (4) subtraction of receipts from income sources
that are non-taxable, and (5) comparison of the resultant figure with
the amount of taxable income reported by the taxpayer to determine the
amount, if any, of underreporting.
United States v. Schafer, 580 F.2d 774, 775 (5th Cir. 1978).
31.03 USE OF NET WORTH METHOD
31.03[1] Inadequate Books and Records
The net worth method of proof frequently is used when it would be
difficult or impossible to establish the defendant's taxable income by
direct evidence. United States v. Dwoskin, 644 F.2d 418, 423 (5th
Cir. 1981); Often, the defendant's books and records are inadequate, false,
or not available to the government. See, e.g., United States v.
Shetty, 130 F.3d 1324 (9th Cir. 1997); United States v. Notch,
939 F.2d 895, 897-98 (10th Cir. 1991); United States v. Stone, 531
F.2d 939, 940 n.1 (8th Cir.1976); United States v. Hom Ming Dong,
436 F.2d 1237, 1240 (9th Cir. 1971). Although a defendant's books and
records can be helpful, they are not essential. "[I]n a typical net worth
prosecution, the Government, having concluded that the taxpayer's records
are inadequate as a basis for determining income tax liability," seeks to
establish taxable income by the net worth method. United States v.
Schafer, 580 F.2d 774, 775 (5th Cir.1978). See also
Holland v. United States, 348 U.S. 121, 125 (1954); accord
United States v. Terrell, 754 F.2d 1139, 1144 (5th Cir. 1985).
Similarly, the net worth method can be used when the defendant has no
books and records. In such a case, "willfulness may be inferred by the jury
from that fact coupled with proof of an understatement of income."
Holland, 348 U.S. at 128. See also Campodonico v.
United States, 222 F.2d 310, 313 (9th Cir. 1955).
31.03[2] Adequate Books and Records
Although early cases held that the government could not use the net
worth method in situations in which the defendant had "adequate" books and
records, the Supreme Court rejected this view in 1954, stating:
The net worth technique, as used in this case, is not a method of
accounting different from the one employed by defendants. It is not a
method of accounting at all, except insofar as it calls upon taxpayers
to account for their unexplained income. Petitioners' accounting
system was appropriate for their business purposes; and admittedly,
the Government did not detect any specific false entries therein.
Nevertheless, if we believe the Government's evidence, as the jury
did, we must conclude that the defendants' books were more consistent
than truthful, and that many items of income had disappeared before
they had ever reached the recording stage. . . . To protect the
revenue from those who do not `render true accounts,' the Government
must be free to use all legal evidence available to it in determining
whether the story told by the taxpayer's books accurately reflects his
financial history.
Holland v. United States, 348 U.S. 121, 131-32 (1954). Thus, the
state of the defendant's records has no bearing on whether the net worth
method of proof may be used.
In the wake of Holland, the Fifth Circuit rejected a
defendant's claim that the government's use of the net worth method of proof
was improper because the government did not make a preliminary showing
regarding the state of the defendant's records. McGrew v. United
States, 222 F.2d 458, 459 (5th Cir. 1955); [FN1] accord United
States v. Vanderburgh, 473 F.2d 1313, 1314 (9th Cir. 1973) (government
may use the net worth method of proof even where the defendant contends that
he maintained an allegedly complete and adequate set of books of account);
United States v. De Lucia, 262 F.2d 610, 614 (7th Cir. 1958).
31.03[3] Use With Other Methods
The government is not limited to a single method of proof and may use
the net worth method in conjunction with other methods of proof.
See, e.g., United States v. Abodeely, 801 F.2d 1020,
1023 (8th Cir. 1986). In Abodeely, a tax evasion prosecution in
which the defendant received unreported income from gambling and
prostitution, the Eighth Circuit discussed the net worth, cash expenditures,
and bank deposits methods of proof:
The government may choose to proceed under any single theory of proof
or a combination method, including a combination of circumstantial and
direct proofs.
Abodeely, 801 F.2d at 1023. See also United States
v. Smith, 890 F.2d 711, 713 (5th Cir.1989) (net worth and specific items
methods of proof combined in a section 7201 prosecution).
31.04 PROOF OF NET WORTH -- GENERALLY
In using the net worth method, the government must:
1. Establish an opening net worth with reasonable certainty,
i.e., the defendant's net worth at the beginning of the
prosecution year.
2. Establish the defendant's net worth at the end of the
prosecution year, with any excess over opening net worth
representing the net worth increase.
3. Establish a likely source of taxable income from which the jury
could find the net worth increase sprang; or, in the
alternative, negate nontaxable sources of income.
4. Negate "reasonable explanations" by the taxpayer inconsistent
with guilt.
Holland v. United States, 348 U.S. 121 (1954). See
also United States v. Massei, 355 U.S. 595 (1958); United
States v. Notch, 939 F.2d 895, 898 (10th Cir. 1991); United
States v. Blandina, 895 F.2d 293, 301 (7th Cir. 1989); United States
v. Koskerides, 877 F.2d 1129, 1137 (2d Cir. 1989); United States v.
Scrima, 819 F.2d 996, 999 (11th Cir. 1987); United States v.
Tracey, 675 F.2d 433, 435 (1st Cir. 1982); United States v.
Scott, 660 F.2d 1145, 1147 (7th Cir. 1981); United States v.
Dwoskin, 644 F.2d 418, 420, 422 (5th Cir. 1981); United States v.
Grasso, 629 F.2d 805, 807 (2d Cir. 1980); United States v.
Hamilton, 620 F. 2d 712, 714 (9th Cir. 1980); United States v.
Goichman, 547 F.2d 778, 781 (3d Cir. 1976); United States v.
Bethea, 537 F.2d 1187, 1188-89 (4th Cir. 1976).
31.05 OPENING NET WORTH
31.05[1] Proof -- "Reasonable Certainty"
Net worth increases are determined by establishing a taxpayer's net
worth (assets minus liabilities) at the beginning of a given year and then
comparing this beginning net worth with the taxpayer's net worth at the end
of the year. December 31 of the year preceding the first prosecution year
(the opening net worth) is the point from which net worth increases are
measured. For example, if the first prosecution year, or the year to be
measured, is 1993, then the defendant's net worth as of December 31, 1992,
would be the opening net worth from which to determine whether the
defendant's net worth increased or decreased in 1993. The defendant's 1993
ending net worth would in turn become the opening net worth for 1994, and so
on.
Establishing an opening net worth can be equated to the process
followed when a person goes on a diet. One of the first things that a
doctor does is weigh the patient to have a starting point from which to
determine whether the patient has gained or lost weight. The patient is
thereafter weighed at intervals, and comparisons are made with the weight at
the previous weighing to determine whether or not the diet is working. The
same process basically is followed in a net worth computation, except that
the "weighing" is of the defendant's net worth or wealth on an annual basis.
The Supreme Court described the need to establish an opening net
worth, and the standard of proof required to do so:
Establishing a Definite Opening Net Worth. We agree with petitioners
that an essential condition in cases of this type is the
establishment, with reasonable certainty, of an opening net worth, to
serve as a starting point from which to calculate future increases in
the taxpayer's assets. The importance of accuracy in this figure is
immediately apparent, as the correctness of the result depends
entirely upon the inclusion in this sum of all assets on hand at the
outset.
Holland v. United States, 348 U.S. 121, 132 (1954).
While every effort should be made to obtain all of the assets and
liabilities of the defendant at the starting point, the government does not
have to establish the starting point, or opening net worth, "to a
mathematical certainty and each case presents its own peculiar
difficulties." Smith v. United States, 236 F.2d 260, 266-67 (8th
Cir. 1956); United States v. Gardner, 611 F.2d 770, 775 (9th Cir.
1980). It is sufficient if the government establishes the defendant's
opening net worth with reasonable certainty -- more than this is not
required. Holland, 348 U.S. at 132; United States v.
Terrell, 754 F.2d 1139, 1145 (5th Cir. 1985); United States v.
Sorrentino, 726 F.2d 876, 879 (1st Cir. 1984); United States v.
Greene, 698 F.2d 1364, 1372 (9th Cir. 1983); United States v.
Goldstein, 685 F.2d 179, 181 (7th Cir. 1982); United States v.
Breger, 616 F.2d 634, 635 (2d Cir. 1980); United States v.
Carriger, 592 F.2d 312, 313 (6th Cir. 1979); United States v.
Honea, 556 F.2d 906, 908 (8th Cir. 1977); United States v.
Goichman, 547 F.2d 778, 781 (3d Cir. 1976);.
Once the government has established the defendant's opening net worth
with reasonable certainty, the defendant remains silent "at his peril."
United States v. Stone, 531 F.2d 939, 942 (8th Cir.1976); see
also Holland, 348 U.S. at 138-39. For more information
concerning the defendant's burden to come forward with reasonable leads,
see Section 31.13, infra, regarding the "reasonable leads
doctrine."
Finally, the government is not required to prove every item in a net
worth statement submitted in a bill of particulars. Items included in the
starting point prior to trial may vary somewhat from the evidence admitted
at trial. The Seventh Circuit stated that:
This net worth statement, which was introduced into evidence as
Government's Exhibit 8, was, in essence, a bill of particulars. There
is no merit in defendant's assertion that these items must be included
in the starting point. There were several items contained in this
statement, some of which favored defendant and some Government, which
were not substantiated during the trial by admissible evidence.
Government's starting point must be based upon items which are
supported by evidence introduced during trial. It is certainly not
unusual in cases of this type for the starting point as proved during
the trial to vary from the bill of particulars or indictment which are
prepared prior to trial.
United States v. Mackey, 345 F.2d 499, 505 (7th Cir. 1965).
31.05[2] Thorough Investigation a Necessity
An extremely thorough investigation is crucial in proving that the
government established the defendant's opening net worth with reasonable
certainty. As the Ninth Circuit noted, when the government chooses to
proceed against a defendant using the net worth method of proof, "the
Government assumes a special responsibility of thoroughness and
particularity in its investigation and presentation." United States v.
Hall, 650 F.2d 994, 999 (9th Cir. 1981). The burden on the government
has been described as follows:
The Government must affirmatively prove an initial amount available to
the taxpayer, with evidence that excludes the possibility that the
defendant relied on previously accumulated assets rather than
unreported taxable income, United States v. Marshall, 557 F.2d
527, 530 (5th Cir. 1977), without refuting all possible speculation as
to sources of funds, however.
McFee v. United States, 206 F.2d 872, 874 (9th Cir. 1953), vacated
and remanded, 348 U.S. 905 (1955), aff'd, 221 F.2d 807 (9th
Cir.1955).
In United States v. Smith, 890 F.2d 711, 713 (5th Cir. 1989),
the Fifth Circuit stated that "[w]e join the Seventh Circuit in observing
that sloppy or mediocre financial and accounting evaluation upon which a
conviction is obtained can be the genesis for reversal." See
also United States v. Terrell, 754 F.2d 1139, 1145 (5th Cir.
1985) (the government must conduct a meticulous investigation, and the
investigation techniques and figures are subject to close scrutiny);
United States v. Breger, 616 F.2d 634, 635-36 (2d Cir.1980).
A good example of a thorough and detailed investigation is found in
United States v. Terrell, 754 F.2d 1139 (5th Cir.1985), in which the
defendant was convicted of evasion for the years 1976 through 1979, and the
government began its investigation of Terrell's funds with the year 1967.
Noting that "we can only be surprised by appellant's attack on the
thoroughness of the Government's investigation", the court described the
investigation as follows:
The investigation consumed three and one-half years. Approximately
20 agents canvassed public records to determine the extent of
appellant's holdings. Thirty banks were contacted, and 20 banks
produced documents or witnesses. Nearly 300 potential witnesses were
interviewed, many of them several times. IRS agents identified in
excess of 70 assets purchased and sold by Terrell, and questioned
third parties involved in these transactions. Additionally, every
expenditure made by Terrell was traced including all cashier's checks
traced back to their sources to determine how they were purchased.
Terrell, 754 F.2d at 1147-48. For another example of the detailed
steps required to conduct a net worth investigation, see United
States v. Sorrentino, 726 F.2d 876, 880 (1st Cir. 1984).
When using the net worth method, the scope of the investigation and
the evidence developed must be carefully examined with the goal of
ascertaining whether the evidence establishes to a reasonable certainty all
of the defendant's assets and liabilities. If the investigation failed to
establish an opening net worth with reasonable certainty, the investigation
must be continued until sufficient additional evidence has been developed.
31.05[3] Evidence Establishing Opening Net Worth
A legally sufficient opening net worth computation requires an
extensive and thorough investigation by the Internal Revenue Service agent.
The opening net worth must include all of the defendant's assets that are
reasonably discoverable, including assets derived from nontaxable sources of
income, such as gifts, loans, and inheritances, as well as assets derived
from taxable income. It would distort taxable income for the year in which
taxable income is being computed if assets derived from nontaxable sources
were omitted from the starting point.
For example, assume that the prosecution year is 1995 and in 1994 the
taxpayer inherited or borrowed $100,000, which is not accounted for in the
opening net worth. If the defendant purchases a house with the $100,000 in
1995, which is reflected on the defendant's 1995 net worth as an asset, the
net worth computation would incorrectly attribute a net worth increase of
$100,000 to the defendant in 1995. The effect of this error would be to
overstate the defendant's income for 1995 because he had the $100,000 at
the beginning of the year. It is important that gifts, inheritances, and
other nontaxable sources of income acquired during the year for which
taxable income is being computed are subtracted from the calculated net
worth increase in order to correctly compute the taxable income under the
net worth method.
In United States v. Breger, 616 F.2d 634 (2d Cir.1980), the
defendant was convicted of evasion and filing false income tax returns for
the years 1972 through 1974. In upholding the starting point established by
the government at trial, the court commented:
We think the Government met its burden here. It used information
gleaned from a 1969 mortgage application, traced a real estate and
cash inheritance from appellant's mother in 1968, and investigated
bond statements and checking accounts in order to ascertain
appellant's access to funds as of January 1, 1972. We note that
appellant adduced no specific evidence, such as a cash hoard, to
suggest that the starting point was inaccurate or misleading.
Breger, 616 F.2d at 634.
Prior income tax returns of a defendant are relevant and can play a
significant role in developing a defendant's opening net worth. Thus, in
United States v. Mackey, 345 F.2d 499, 504 (7th Cir. 1965), the
starting point of the net worth computation was December 31, 1955, and the
court upheld the use by the government of "the income tax returns of
defendant and his wife from 1929 through December 31, 1955, as a guide in
determining defendant's net worth at the starting point." Additionally,
net worth statements submitted by the defendant either to the government or
to financial institutions can be particularly helpful in establishing an
opening net worth. See, e.g., Smith v. United States,
348 U.S. 147, 149 (1954); United States v. Honea, 556 F.2d 906, 908
(8th Cir. 1977); United States v. Balistrieri, 403 F.2d 472, 479 (7th
Cir. 1968), vacated on other grounds, 395 U.S. 710 (1969).
In United States v. Mastropieri, 685 F.2d 776, 785 (2d
Cir.1982), the court noted that less stringent standards with respect both
to establishing opening net worth and to negating non-taxable income sources
are justified in a case where the defendants were shown to have gone to
great lengths to conceal their unreported increases in wealth. While the
court observed that the investigation in that case should not be regarded as
a model, the case does furnish an example of a number of the steps that must
be taken to establish an opening net worth. Mastropieri, 685 F.2d at
779, 783. [FN2]
For additional cases holding that the government's evidence was
sufficient to establish the defendant's opening net worth with reasonable
certainty, see United States v. Greene, 698 F.2d 1364, 1372
(9th Cir. 1983) (jury could draw adverse inferences from the late stage at
which defense evidence was disclosed in spite of a motion for reciprocal
discovery); United States v. Goldstein, 685 F.2d 179, 181 (7th Cir.
1982) (evasion charged for three years, conviction on only one year,
sufficient if opening net worth established for year of conviction);
United States v. Dwoskin, 644 F.2d 418, 420 (5th Cir. 1981) (opening
net worth based on a financial statement signed by the defendant and
submitted to a bank); United States v. Schafer, 580 F.2d 774,
778 (5th Cir.1978); United States v. Giacalone, 574 F.2d 328, 331
(6th Cir. 1978); United States v. Honea, 556 F.2d 906, 908 (8th Cir.
1977); United States v. Mancuso, 378 F.2d 612 (4th Cir. 1967),
amended, 387 F.2d 376 (4th Cir. 1967); United States v.
Goichman, 407 F.Supp. 980, 986 (E.D. Pa. 1976), aff'd, 547 F.2d
778 (3d Cir. 1976).
31.05[4] Opening Net Worth Not Established
In a relatively small number of cases, the courts have found the
government's proof of the defendant's opening net worth insufficient to
support a conviction. For the most part, these are earlier cases, but they
furnish examples of pitfalls that must be avoided if the opening net worth
is to be established with reasonable certainty.
For an example of an erroneous opening net worth computation,
see United States v. Achilli, 234 F.2d 797, 804 (7th Cir.
1956), aff'd on other grounds, 353 U.S. 373 (1957). In
Achilli, one count of a three-count conviction was reversed because
the value of a residence sold by the defendant in the first prosecution year
(1946) was erroneously omitted from the opening net worth computation and
the error accounted for almost 80 percent of the deficit shown by the
government's computation. The error seems to have resulted from an
oversight by the government, because the sale of the residence omitted from
the defendant's opening net worth was reported in the capital gains schedule
of the defendant's 1946 return. Since the tax return was the only evidence
with respect to the time when the defendant acquired the property, the
government conceded that the property should have been included as an asset
in the computation of the defendant's net worth as of December 31, 1945.
Achilli, 234 F. 2d at 804. See also United States
v. Keller, 523 F.2d 1009, 1011 (9th Cir. 1975) (because the government
failed to pursue leads (regarding home improvements and furnishings) which
were reasonably susceptible of being checked, the opening net worth for 1967
was not reasonably certain and the evidence as to the 1967 count was
insufficient to go to the jury).
The importance of the testimony given by the agent who presents the
government net worth computation and the necessity for testifying fully is
illustrated in Merritt v. United States, 327 F.2d 820, 821 (5th Cir.
1964). The Merritt court reversed a tax evasion conviction because
the government failed in its burden of identifying which of the defendant's
assets had not been included in the opening net worth statement. The court
based its decision on the following testimony of the special agent who drew
up the net worth schedule:
Q. As a matter of fact don't you know that . . . this taxpayer
owned assets and had assets that you didn't even take into
account in this case? Don't you know that of your own personal
investigation?
A. He has some other assets, yes, sir.
Q. And this doesn't include all those assets does it?
A. No, sir.
. . . .
Q. Are you willing to swear under oath that these assets
represented in your net worth schedule are all and complete the
assets of this taxpayer and all and complete the liabilities of
this taxpayer?
A. I know there are other assets of the taxpayer.
. . . .
A. My investigation disclosed that the taxpayer would have other
assets. I know of no other liabilities.
Merritt, 327 F.2d at 821. The appellate court observed that
"[n]either counsel asked the Special Agent what these other assets were, and
his testimony does not reveal what he had in mind." Merritt, 327
F.2d at 821. Thus, the appellate court was unable to "determine whether
these assets were realty or personalty, or whether they were disposed of
during the years in question." Merritt, 327 F.2d at 822.
The Merritt case clearly demonstrates the requirement to review
the net worth computation in depth with the special agent and to establish
through testimony that the starting point includes, to a reasonable
certainty, all of the defendant's assets and liabilities. On occasion, the
agent will omit items from the net worth schedules for good reason. In
that event, the agent should questioned on direct examination regarding what
these items were and why he made the determination to omit those particular
items.
31.06 CASH ON HAND
31.06[1] Definition -- Need to Establish
As one court observed, "the most frequent challenge to the
government's computations in a net worth case is the opening cash balance."
United States v. Schafer, 580 F.2d 774, 779 (5th Cir. 1978). A
defendant's claim of cash on hand is commonly referred to as a cash hoard
defense. A typical cash hoard defense asserts that the defendant in earlier
years received money from such sources as gifts from family members or
friends, or an inheritance, which he then spent during the prosecution
period. The Supreme Court described the cash hoard defense as follows:
Among the defenses often asserted is the taxpayer's claim that the net
worth increase shown by the Government's statement is in reality not
an increase at all because of the existence of substantial cash on
hand at the starting point. This favorite defense asserts that the
cache is made up of many years' savings which for various reasons were
hidden and not expended until the prosecution period. Obviously, the
Government has great difficulty in refuting such a contention.
Holland v. United States, 348 U.S. 121, 127 (1954).
While it is often difficult to disprove the existence of a cash hoard,
the government must establish with reasonable certainty the amount of cash
that the defendant had in his possession at the beginning of the tax period.
United States v. Wilson, 647 F.2d 534, 536 n.1 (5th Cir. 1981). The
necessity for establishing cash on hand "with reasonable certainty" is well
summarized in United States v. Terrell, 754 F.2d 1139, 1146-47 (5th
Cir.1985):
The question of whether a defendant has a substantial amount of
cash-on-hand at the beginning of the indictment period must be
carefully investigated because the existence of a cash hoard could
greatly distort the net worth evaluation. Unaccounted for funds that
surface during the course of the net worth evaluation might be
explained by the fact that a defendant accumulated large sums of cash
which he kept on hand and began to spend during the indictment period.
See also United States v. Pinto, 838 F.2d 426, 431
(10th Cir. 1988).
A cash hoard defense often can be refuted by circumstantial evidence
establishing that the defendant either had no cash hoard or spent it before
the prosecution period. United States v. Ford, 237 F.2d 57 (2d Cir.
1956), vacated as moot, 355 U.S. 38 (1957). One way to defeat such a
claim is to show that the family member or friend alleged to be the source
of the cash did not have sufficient resources to give the defendant the
amount claimed. See United States v. Breger, 616 F.2d 634, 636
(2d Cir.1980); McGarry v. United States, 388 F.2d 862, 865 (1st Cir.
1967); United States v. Holovachka, 314 F.2d 345, 354-55 (7th
Cir.1963) (gifts and loan defense). See also
United States v. Calderon, 348 U.S. 160, 165 (1954); Friedberg v.
United States, 348 U.S. 142, 143 (1954).
While cash on hand does include the money that a defendant habitually
carries in his pocket, Calderon, 348 U.S. at 162, the concept of cash
on hand is more expansive. It includes all monies or cash readily available
to the defendant which are not deposited in a bank or other institution.
Thus, cash on hand can include: monies that the defendant had in his safe
or his business, Calderon, 348 U.S. at 162, and cash kept in a safe
deposit box and money buried in the defendant's backyard. United States
v. Bethea, 537 F.2d 1187, 1190 (4th Cir. 1976); United States v.
Carter, 462 F.2d 1252, 1255-56 (6th Cir.1972).
Whenever the defendant claims a cash hoard prior to indictment, the
prosecutor should attempt to learn the amount of this cash hoard, its
source, when it was received, where it was kept, and when and for what
purpose it was used. Sometimes, the transactions giving rise to the cash
hoard occurred long before the prosecution period. Holland, 348 U.S.
at 127. Although the government must eliminate the possibility of a cash
hoard when determining the defendant's cash on hand, not every far fetched
explanation offered by a defendant must be accepted at face value.
See United States v. Smith, 890 F.2d 711 (5th Cir. 1989)
(defendant never disclosed the existence and source of cash transactions to
the Special Agent during the investigation but at trial the defendant's
spouse claimed to have $23,000 in cash in a flower vase and to have saved
large cash gifts from her parents). For a cash hoard to have any bearing on
a net worth computation, the defendant must have spent all or part of it
during the prosecution years on assets or expenditures that appear in the
government's net worth statement. If the cash hoard remains the same
throughout the prosecution period, this money has no effect on the
defendant's net worth. United States v. Giacalone, 574 F.2d 328,
331-33 (6th Cir. 1978). The failure to use the cash hoard during the
prosecution years means that any assets acquired during those years were
acquired with other funds. See Section 31.08[2], infra.
As a practical matter, once the evidence establishes that the
defendant had cash available at the beginning of the prosecution period, the
government must produce evidence from which an inference can be drawn that
the cash was not utilized during the indictment period. Otherwise, any
available cash on hand must be subtracted from the computation reflecting
the net worth increase and nondeductible expenditures. If it cannot be
established that the cash hoard remained constant throughout the prosecution
period, then it must be assumed that any computed net worth increase and
nondeductible expenditures may be the result of the spending of the
pre-existing cash. See McGarry, 388 F.2d at 866.
31.06[2] Jury Question -- Burden of Proof
The existence of cash on hand at the beginning of the prosecution
period presents a factual issue for determination by the jury. Holland
v. United States, 348 U.S. 121, 134 (1954); United States v.
Calderon, 348 U.S. 160, 162-63 (1954); United States v. Breger,
616 F.2d 634, 635 (2d Cir. 1980); United States v. Carter, 462 F.2d
1252, 1256 (6th Cir. 1972); Hayes v. United States, 407 F.2d 189, 193
(5th Cir.1969); McGarry v. United States, 388 F.2d 862, 868 (1st Cir.
1967); United States v. Vardine, 305 F. 2d 60, 64-65 (2d Cir. 1962)
(conflicting testimony left to the jury and government properly based its
net worth summary on its version of the facts); Fowler v. United
States, 352 F.2d 100, 107 (8th Cir. 1965).
The foregoing cases demonstrate that as long as there is evidence from
which a jury can conclude that the government has established the amount of
cash on hand with reasonable certainty, the defendant is not entitled to a
judgment of acquittal on this issue. See, e.g., United
States v. Blandina, 895 F.2d 293, 302 (7th Cir. 1989); United States
v. Wilson, 647 F.2d 534, 536 n.1 (5th Cir. 1981); Breger, 616
F.2d at 635.
Once the government has established that a thorough investigation
failed to uncover evidence of cash on hand, the burden shifts to the
defendant to come forward with evidence of cash and he remains silent at his
peril. United States v. Mackey, 345 F.2d 499, 506 (7th Cir. 1965).
This burden arises because "[w]hether defendant had substantial sums of cash
at the starting point is a matter within defendant's knowledge."
Mackey, 345 F.2d at 506. See also Holland, 348
U.S. at 138-39; United States v. Mastropieri, 685 F.2d 776, 785 (2d
Cir. 1982); Fowler, 352 F.2d at 107; United States v.
Holovachka, 314 F.2d 345, 354 (7th Cir. 1963).
31.06[3] Amount of Cash on Hand
The net worth computation must reflect the amount of the defendant's
cash on hand for each year. However, once the government has established
the initial cash on hand, it becomes a matter of showing for a subsequent
year the amount of any prior cash that the defendant still had on hand plus
any cash on hand acquired during the year under consideration. Any cash on
hand acquired during a prosecution year, which is still on hand at the end
of the year, will increase the defendant's net worth unless the cash on hand
was derived from a nontaxable source, such as a gift or inheritance.
The amount of cash on hand reflected in the defendant's opening net
worth will depend on the evidence established by the investigation. In
United States v. Goldstein, 685 F.2d 179 (7th Cir. 1982), the
defendant was charged with evasion and was acquitted for the tax years 1974
and 1975, but convicted for the tax year 1976. The government established
the defendant's opening net worth as of 1973 and thereafter introduced
evidence of the defendant's net worth for each of the years 1974, 1975, and
1976. With regard to the defendant's argument that cash on hand was
underestimated by the government, the court pointed out that the government
could establish a 1976 opening net worth by establishing a net worth in an
earlier year and then calculating the effect of income and disbursements.
The court concluded that the government need not prove the cash on hand at
the beginning of each year with evidence independent of the other years.
Goldstein, 685 F.2d at 181. Accord United States v.
Pinto, 838 F.2d 426, 431-32 (10th Cir. 1988). Thus, the government's
calculations of income and disbursements based on a starting point were
adequate to prove the opening net worth for 1976.
In some instances, cash on hand may be appropriately reflected as
zero. See, e.g., United States v. Mastropieri, 685 F.2d
776, 779 (2d Cir.1982); United States v. Goichman, 407 F. Supp. 980,
986 (E.D. Pa.), aff'd, 547 F.2d 778 (3d Cir. 1976). In other
instances, the evidence may be such that cash on hand can be reflected as a
nominal amount. See, e.g., United States v. Carriger,
592 F.2d 312, 314 (6th Cir. 1979) ($500); Goldstein, 685 F.2d at 181
($100). In Carriger, cash on hand had no effect on the defendant's
net worth because the evidence established that the defendant had $500 in
cash on hand at the beginning of the prosecution period and $500 on hand at
the end of the prosecution period. Thus, there was no increase or decrease
in the defendant's net worth arising from cash on hand.
There are also instances where the government investigation indicates
a negative cash position, i.e., that an analysis of the defendant's
financial transactions in years prior to the prosecution period indicates
that the defendant spent more than was available on the basis of his prior
returns.
The facts of a case may be such that the evidence justifies an
assumption that any cash on hand that did exist remained constant, though
unknown, throughout the period covered. This situation arose in United
States v. Giacalone, 574 F.2d 328 (6th Cir. 1978). In Giacalone,
the defendant was a professional gambler, and the net worth statement
assumed the existence of a bank roll of cash which remained approximately
the same throughout the period covered. The government in its computation
used a dash rather than a dollar amount to represent the cash on hand. The
dashes symbolized an unknown, presumably constant, amount. The court
concluded that the use of dashes did not invalidate the net worth statement
and that "[t]he effect of using the dashes is no different from the use of
zeroes approved in United States v. Goichman, [407 F. Supp. 980 (E.D.
Pa. 1976), aff'd, 547 F.2d 778 (3d Cir. 1976)]." Giacalone,
574 F.2d at 331-33. Reflecting cash on hand with dashes was a practical
solution because it avoided "the untenable assumption that a professional
gambler could operate without any cash." Giacalone, 574 F.2d at 333.
Accord, United States v. Scrima, 819 F.2d 996 (11th Cir. 1987)
(floating cash or "dash" method approved in prosecution of a marijuana
smuggler).
31.07 EVIDENCE OF CASH ON HAND
31.07[1] Evidence of Financial Deprivation
In establishing cash on hand and disproving a claim of a cash hoard,
the government may use circumstantial evidence. In Holland v. United
States, 348 U.S. 121, 132 (1954), the defendants claimed opening cash on
hand of $113,000 and the government allowed $2,153.09. The government did
not introduce any direct evidence to dispute the defendant's claim.
Instead, the government relied on the inference that anyone who had the cash
the defendants claimed to have would not have "undergone the hardship and
privation endured by the Hollands all during the late 20's and throughout
the 30's." Holland, 348 U.S. at 133. The case provides an excellent
example of a thorough investigation, which traced the financial picture of
the Hollands as far back as 1913 (the first prosecution year was 1948), and
serves as a model for the type of circumstantial evidence that is admissible
to refute a cash hoard defense. Another example of the government defeating
a cash hoard defense by "painstakingly" tracing the defendant's finances
over a period of years can be found in Friedberg v. United States,
348 U.S. 142, 143 (1954) (decided the same day Holland). See
also United States v. Carter, 462 F.2d 1252 (6th Cir. 1972).
See also United States v. Ford, 237 F.2d 57, 59, 63 (2d
Cir. 1956), vacated as moot, 355 U.S. 38 (1957); Gariepy v. United
States, 189 F.2d 459, 461 (6th Cir. 1951).
On the other hand, the government must introduce evidence which
demonstrates more than the fact that the defendant was poor at an early
point in his life. The evidence must trace the defendant's financial
history up to the starting point. "Proof that the taxpayer was impoverished
by the depression, that he was working for his meals at $8 a week in 1935,
is too remote, absent proof of the taxpayer's financial circumstances in the
intervening years." United States v. Calderon, 348 U.S. 160, 164
(1954) (first prosecution year was 1946).
31.07[2] Admissions of Defendant
In establishing an opening net worth, the government will often rely
on statements made by the defendant to investigating agents, as well as to
third parties. See, e.g., Holland v. United States,
348 U.S. 121, 128 (1954) (statements made to agents); United States v.
Goldstein, 685 F.2d 179, 182 (7th Cir. 1982) (admissions in the form of
financial statements). Statements made by a defendant are admissible as
admissions. Fed. R. Evid. Rule 802(d)(2)(A).
Admissions are a fertile source of information, useful both in
establishing cash on hand and in refuting cash hoard defenses. A
distinction must be made, however, between admissions made by a defendant
prior to the crime (pre-offense admissions) and admissions made after the
crime (post-offense admissions).
31.07[2][a] Pre-Offense Admissions
Admissions made by a defendant prior to the crime do not have to be
corroborated. Warszower v. United States, 312 U.S. 342, 347 (1941);
United States v. Soulard, 730 F.2d 1292, 1298 (9th Cir. 1984);
United States v. Hallman, 594 F.2d 198, 200-01 (9th Cir. 1979)
(corroboration not required of admission in financial statement filed by the
defendant with a bank prior to the investigation conducted by the Internal
Revenue Service); Fowler v. United States, 352 F.2d 100 (8th Cir.
1965) (loan application was filed before crimes in controversy occurred, and
admissions made on application need not be corroborated).
31.07[2][b] Post-Offense Admissions
As a general rule, post-offense admissions must be corroborated.
United States v. Calderon, 348 U.S. 160 (1954); Smith v. United
States, 348 U.S. 147, 152-53 (1954). Generally speaking, in a criminal
tax case, a post-offense admission would be a statement made after the
filing of a false return or, if no return is filed, after the return was
due.
In Smith, 348 U.S. 147, the defendant's opening net worth was
based on a signed net worth statement given to the investigating agents by
the defendant, as well as other extrajudicial admissions made by the
defendant. Smith, 348 U.S. at 152. The Court found that the
government could corroborate the defendant's statement in one of two ways:
(1) either by substantiating the opening net worth directly; or (2) by
independent evidence as to the defendant's conduct during the prosecution
years, "which tends to establish the crime of tax evasion without resort to
the net worth computation." Smith, 348 U.S. at 157-58. The
government successfully relied on the second method to corroborate the
defendant's post-offense admissions in Calderon, by showing a
substantial increase in the defendant's assets that were sufficiently at
variance with his reported income to support an inference of tax evasion.
Calderon, 348 U.S. at 166- 67.
Corroborative evidence of post-offense statements by a defendant
regarding cash on hand is sufficient if it shows a substantial income
deficiency for the overall prosecution period. It is not necessary for the
corroborative evidence, as opposed to the evidence as a whole, to establish
that there was a deficiency for each of the years in issue.
Calderon, 348 U.S. at 168. Accord United States v.
Vardine, 305 F.2d 60, 65 (2d Cir. 1962) (evidence that defendant
periodically borrowed money to meet payrolls and other indebtedness, and
that there were frequently judgments outstanding against him tended to
corroborate figures defendant gave to agents). [FN3]
The Fifth Circuit, however, has held that it is not always necessary
to corroborate post-offense admissions as to cash on hand. In United
States v. Normile, 587 F.2d 784, 786 (5th Cir. 1979), proof of cash on
hand was based on the defendant's statement to the agent that "he kept no
more than $100 in cash because he did not feel safe having larger amounts
around." In response to the defendant's claim that the government failed to
corroborate this statement, the court stated that it "was not necessary for
the government to seek to corroborate the taxpayer's statement; indeed the
inherent secrecy of the cash hoard makes it impossible for any but the
keeper to know even of its existence, let alone the amount."
Normile, 587 F.2d at 786. Nevertheless, the court found that
independent evidence of substantial bank accounts did "tend to corroborate"
the defendant's admission, even though the government introduced no evidence
to corroborate the admission directly. Normile, 587 F.2d at 786-87.
See United States v. Terrell, 754 F.2d 1139, 1147 (5th Cir.
1985) (corroboration requirement does not necessarily extend to admissions
relating to cash-on-hand); United States v. Wilson, 647 F.2d 534, 536
n.1 (5th Cir. 1981). But see United States v.
Meriwether, 440 F.2d 753, 756-57 (5th Cir. 1971). See
also United States v. Scrima, 819 F.2d 996 (11th Cir. 1987) in
which a marijuana smuggler told agents during the investigation that he
maintained only $500 in cash on hand but claimed at trial that he had an
undisclosed cash hoard of $375,000 at the beginning of the indictment
period. The court found that "the government is not required to corroborate
the taxpayer's statement with respect to his cash on hand at the beginning
of the tax period. After everything possible is done to verify the opening
net worth, the issue of the amount of the defendant's cash hoard is properly
submitted to the jury." Scrima, 819 F.2d 996 n.3
31.07[3] Tax Returns As Admissions
"Statements made in an income tax return constitute admissions."
United States v. Dinnell, 428 F. Supp. 205, 208 (D. Az. 1977),
aff'd without published opinion, 568 F.2d 779 (9th Cir. 1978). See
United States v. Hornstein, 176 F.2d 217, 220 (7th Cir. 1949) (cost
of goods sold). Items reported on returns that are the subject of the
prosecution, as well as earlier filed returns, are pre-offense admissions
which do not have to be corroborated. United States v. Burkhart, 501
F.2d 993, 995 (6th Cir. 1974) (citing cases). The government may take the
taxpayer's reported income as an admitted amount earned from designated
sources. As to the admissibility of a defendant's tax returns, see
also Fed. R. Evid. Rule 801(d)(2)(A).
The defendant's income tax returns are frequently used in a net worth
case as a guide in determining the defendant's net worth at the starting
point. See, e.g., United States v. Mackey, 345 F.2d
499, 504 (7th Cir. 1965). Admissions found in the defendant's tax returns
for earlier years can be particularly helpful in negating a cash hoard
defense when the returns show that reported income in previous years was
insufficient to enable the defendant to save any appreciable amount of
money. Friedberg v. United States, 348 U.S. 142, 143-44 (1954);
Holland v. United States, 348 U.S. 121, 134 (1954); United States
v. Terrell, 754 F.2d 1139, 1147 (5th Cir. 1985); United States v.
Hamilton, 620 F.2d 712, 715 (9th Cir. 1980) United States v.
Bush, 512 F.2d 771, 772 (5th Cir. 1975) (defendant's tax return
reflecting zero cash on hand supported government position); United
States v. Ross, 511 F.2d 757, 761 (5th Cir. 1975); United States v.
Carter, 462 F.2d 1252, 1255 (6th Cir. 1972); United States v.
Northern, 329 F.2d 794, 795 (6th Cir. 1964) (value of machines in
inventory taken from defendant's tax return); Leeby v. United States,
192 F.2d 331, 333 (8th Cir. 1951);.
31.07[4] Statements Given to Financial Institutions
Statements given to financial institutions are another fruitful source
of evidence regarding a taxpayer's cash on hand, as well as other assets and
liabilities. Friedberg v. United States, 348 U.S. 142, 144 (1954)
(loan application); United States v. Dwoskin, 644 F.2d 418, 420 (5th
Cir. 1981) (financial statement); United States v. Hallman, 594 F.2d
198, 200 (9th Cir. 1979) (financial statement); Fowler v. United
States, 352 F.2d 100, 107 (8th Cir. 1965) (loan applications); United
States v. Norris, 205 F.2d 828, 829 (2d Cir. 1953) (loan application).
In Dwoskin, 644 F.2d at 420, the defendant's opening net worth,
including cash on hand and cash unrestricted in banks, was based on a signed
financial statement the defendant had submitted to a bank. The government
did not include in its cash on hand figure $11,000 in an account on which
the defendant held as a trustee for his children because there was no
evidence that the defendant used the funds; indeed, the account had a higher
balance subsequent to the prosecution years.
Financial statements also can be used to impeach a defendant
testifying at trial. Thus, in Bateman v. United States, 212 F.2d 61,
67 (9th Cir. 1954), the defendant testified that he had $13,000 in cash and
the government introduced, "as competent impeaching evidence," a financial
statement that the defendant had given a bank showing cash of only $100.
31.07[5] Defendant's Books and Records
The defendant's business books and records are admissible, as records
of a regularly conducted business activity, Fed. R. Evid. Rule 803(6), and
as admissions. United States v. Hornstein, 176 F.2d 217, 220 (7th
Cir. 1949). See Paschen v. United States, 70 F.2d 491, 501
(7th Cir. 1934) (not necessary for government to prove the books and records
are correct). In some instances, the defendant's books and records can
establish the starting point. See, e.g., United States v.
Chapman, 168 F.2d 997, 1002 (7th Cir. 1948) (government entitled to
expect that books furnished for examination by taxpayer would be correct,
and a verification of their accuracy cannot be called an 'uncorroborated
admission').
The defendant's books and records also can be used to refute an attack
on the computation of cash on hand. In United States v. Mackey, 345
F.2d 499, 505 (7th Cir. 1965), an annual statement of the defendant's
corporation revealed that the corporation had less cash than the amount
claimed by the defendant.
Finally, it should be noted that entries in the books and records of
the defendant are valuable in establishing the financial history of the
defendant in early years, the defendant's business activities during the
prosecution years, and the defendant's assets and liabilities.
31.07[6] Statements of Accountants and Attorneys
When the defendant directs the investigating agents to his accountant
or bookkeeper for questions relating to taxes, any statements made by the
accountant or bookkeeper are admissions, and agents can testify as to these
statements. United States v. Diez, 515 F.2d 892, 896 n.4 (5th Cir.
1975); Hayes v. United States, 407 F.2d 189, 192 (5th Cir. 1969).
Rule 801(d)(2)(D), Fed. R. Evid., provides that a statement by the
defendant's agent (e.g., bookkeeper) "concerning a matter within the
scope of his agency or employment made during the existence of the
relationship" is an admission, whether the defendant has authorized the
making of the particular statement or not. See United States v.
Parks, 489 F.2d 89, 90 (5th Cir. 1974). Statements of the defendant's
bookkeeper or accountant concerning matters within the scope of their
activity or employment are admissible against the defendant as admissions.
Fed. R. Evid. Rule 801(d)(2)(C) or (D); United States v. Parks, 489
F.2d 89, 90 (5th Cir. 1974).
These cases relied upon the absence of an accountant-client privilege
because the defendant, knowing that mandatory disclosure of much of the
information therein is required on an income tax return, had no expectation
of privacy in documents and information provided to return preparers.
Couch v. United States, 409 U.S. 322 (1973). The Court in
Couch also noted that no confidential accountant-client privilege
exists under federal law, and no state-created privilege has been recognized
in federal cases. Couch, 409 U.S. at 335 (citations omitted).
Note that the cases discussed above were decided prior to the
Internal Revenue Service Restructuring and Reform Act of 1998 (the Act).
Section 7525 of the Internal Revenue Code provides:
Confidentiality privileges relating to taxpayer communications
(a) Uniform application to taxpayer communication with federally authorized
practitioners.
(1) General rule. With respect to tax advice, the same common law
protections of confidentiality which apply to a communication between a
taxpayer and an attorney shall also apply to a communication between a
taxpayer and any federally authorized tax practitioner to the extent the
communication would be considered a privileged communication if it were
between a taxpayer and an attorney.
(2) Limitations. Paragraph (1) may only be asserted in
(A) any noncriminal tax matter before the Internal Revenue Service; and
(B) any noncriminal tax proceeding in Federal court brought by or against
the United States.
(3) Definitions. For purposes of this subsection
(A) Federally authorized tax practitioner. The term "federally authorized
tax practitioner" means any individual who is authorized under Federal law
to practice before the Internal Revenue Service if such practice is subject
to Federal regulation under section 330 of title 31, United States Code.
(B) Tax Advice. The term "tax advice" means advice given by an individual
with respect to a matter which is within the scope of the individual's
authority to practice described in subparagraph (A).
Thus, by its own terms, the Act does not create an unlimited
accountant- client privilege. The Act provides that the privilege may only
be asserted in (A) any non-criminal tax matter before the Internal Revenue
Service; and (B) any noncriminal tax proceeding in Federal court brought by
or against the United States. Section 7525 (2)(A) and (B). Furthermore, it
only applies to communications between a taxpayer and a federally authorized
practitioner. Thus, the privilege is not available in a criminal
investigation or criminal court proceeding, but would apply in the context
of a civil audit.
Additionally, the Act specifically excludes from the privilege any
written communications regarding corporate tax shelters. 26 U.S.C. §
7572(b). That Section provides:
(b) Section not to apply to communications regarding corporate tax shelters.
The privilege under subsection (a) shall not apply to any written
communication between a federally authorized tax practitioner and a
director, shareholder, officer, or employee, agent, or representative of a
corporation in connection with the promotion of the direct or indirect
participation of such corporation in any tax shelter (as defined in section
6662(d)(2)(C)(iii)).
Thus, written communications with a representative of a corporation
in connection with efforts to persuade the corporation to participate in a
tax shelter are excluded from the privilege. Note that tax shelters are
defined as:
(iii) Tax shelter. For purposes of this subparagraph, the term "tax
shelter" means
(I) a partnership or other entity,
(II) any investment plan or arrangement, or
(III) any other plan or arrangement,
if a significant purpose of such partnership, entity, plan, or arrangement
is the avoidance or evasion of Federal income tax.
Additionally, in cases in which the accountant has been employed by
the defendant's attorney to assist the attorney in communicating with the
client and rendering legal advice, statements of the accountant may fall
within the attorney-client privilege. United States v. Gurtner, 474
F.2d 297 (9th Cir. 1973); United States v. Mierzwicki, 500 F. Supp.
1331, 1335 (D.Md. 1980). The most familiar situation occurs when the
attorney hires an accountant to assist the attorney's representation of the
taxpayer. See United States v. Kovel, 296 F.2d 918 (2d 1961).
A Kovel accountant is protected by an extension of the attorney-
client privilege.
In the case of attorneys, statements made by a taxpayer's attorney may
be admissible as admissions of a party-opponent pursuant to Fed. R. Evid.
801(d)(2) if it is shown that the statements are not barred by the
attorney-client privilege. A statement by a taxpayer's attorney attorney is
not privileged if it was authorized by the client and concerned the subject
authorized. United States v. Ojala, 544 F.2d 940, 945-46 (8th Cir.
1976). The court in Ojala admitted into evidence the attorney's
statement that the taxpayer's failure to file was not the result of his
political beliefs. The court found that the "statements were made in an
unequivocal manner by one who was acting as the appellant's attorney at the
time, and that they referred to a matter within the scope of the attorney's
authority." Ojala, 544 F.2d at 946. The court also noted that the
taxpayer was present when the statement was made and voiced no objection.
Id.
Another court admitted into evidence a statement by a taxpayer's
attorney which contradicted the taxpayer's assertion that he had filed his
tax returns. United States v. O'Connor, 433 F.2d 752, 755-56 (1st
Cir. 1970). The O'Connor court observed that the attorney's statement
did not exceed scope of attorney's actual authority. The court further
observed that it might rule otherwise if there had been evidence that the
taxpayer told his attorney not to make the statement or to "confine himself
to the position adoped by the defendant." Id. at 756. The court
found that it was "clearly within the power and duty of the attorney to do
what he could, in his own best judgment, [to aid the taxpayer]." Id.
Note, however, that courts have generally held that the preparation
of tax returns does not constitute legal advice within the scope of the
attorney-client privilege. In Re Grand Jury Investigation
(Schroeder), 842 F.2d 1223, 1224 (11th Cir. 1987); United States v.
Lawless, 709 F.2d 485, 487-88 (7th Cir. 1983); United States v. El
Paso, 682 F.2d 530, 539 (5th Cir. 1982); United States v.
Gurtner, 474 F.2d 297, 298-99 (7th Cir. 1973). But see Colton
v. United States, 306 F.2d 633, 637 (2d Cir. 1962) ("There can, of
course be no question that the giving of tax advice and the preparation of
tax returns . . . are basically matters ssufficiently within the
professional competence of an attorney to make them prima facie subject to
the attorney-client privilege.").
31.07[7] Accountant's Workpapers
An accountant's workpapers can be useful in establishing opening net
worth figures, including cash on hand, as well as in establishing assets and
liabilities during the prosecution period. Prior to the Act, the workpapers
could be obtained, because there was no accountant-client privilege,
Couch v. United States, 409 U.S. 322, 335 (1973), nor a work-product
privilege with respect to workpapers. United States v. Arthur Young &
Co., 465 U.S. 805, 817 (1984). The Internal Revenue Service
Restructuring and Reform Act of 1998, discussed above, by its plain
language, applies only to communications between a taxpayer and his
accountant. It does not create a work- product privilege. Presumably, both
the communications and the workpapers can be acquired in criminal cases.
An accountant's workpapers are records which the accountant kept in the
ordinary course of business and may, with a proper foundation, be admissible
as exceptions to the hearsay rule pursuant to Fed. R. Evid. Rule 803(6).
Of course, it would be necessary to demonstrate that the information relied
upon by the accountant was provided by the taxpayer or an individual
authorized by the taxpayer to provide such information to the accountant.
31.07[8] Source and Application of Funds Analysis
Another method of establishing starting point cash on hand is to
analyze the defendant's available finances for the years leading up to the
starting point. This method is known as a source and application of funds.
Using this method, the government determines the amount of money available
to the defendant during the earlier years, and the amount that the defendant
spent.
For example, if the evidence demonstrates that the defendant had
$100,000 available from all sources, both taxable and nontaxable, and that
the defendant spent $90,000, this would leave only $10,000 as cash on hand.
This was the approach taken in United States v. Terrell, 754 F.2d
1139, 1143 (5th Cir. 1985), in which the defendant was not credited with any
cash on hand on the basis of a source and application of funds analysis
showing that the defendant's expenditures in prior years exceeded his
reported income plus nontaxable gifts by $229,000. As in the case of
establishing opening net worth, a thorough investigation is required to
support a source and application of funds analysis sufficient to establish
cash on hand with reasonable certainty. Terrell, 754 F.2d at 1146-47.
See also United States v. Goichman, 407 F. Supp. 980,
994-95 (E.D. Pa.), aff'd, 547 F.2d 778 (3d Cir. 1976).
31.08 NET WORTH ASSETS
31.08[1] Reflected at Cost -- Generally
As a general rule, when establishing the net worth of a taxpayer,
assets are reflected at cost and not at fair market value. Thus, if a
taxpayer buys a house for $50,000, the house is reflected as a net worth
asset at $50,000, even though the house may be worth $100,000 in the year
for which the taxpayer's net worth is being determined.
Assets are generally reflected in a net worth statement at cost
because the net worth method is concerned not with value (which may result
from appreciation rather than the receipt of taxable income) but only with
actual costs and expenditures. United States v. O'Connor, 237 F.2d
466, 473 n.6 (2d Cir. 1956). See United States v. Terrell,
754 F.2d 1139, 1145 (5th Cir. 1985) (using a cost basis to determine net
worth means that assets preexisting the indictment period are a source of
nontaxable funds only to the extent of basis); Hayes v. United
States, 407 F.2d 189 (5th Cir. 1969) (cost of partially constructed
apartments taken from defendant's income tax return, and cost of land based
on information furnished by the defendant's accountant).
As an exception to this general rule, cost is not used when the
Internal Revenue Code dictates that a basis other than cost be used in
determining tax consequences. For example, if services are paid for in
property, then the fair market value of the property is included as
compensation in gross income. Treas. Reg. § 1.61-2(d) (26 C.F.R.). In
this situation, property received in exchange for services would be
reflected at its fair market value in the net worth computation. For other
examples of situations where an asset would be reflected at a figure other
than cost, see 26 U.S.C. § 1014(a) (basis of property acquired
from a decedent is the fair market value of the property at the date of the
decedent's death); 26 U.S.C. § 1015 (basis of property acquired by
gifts and transfers in trust).
31.08[2] Across the Board Assets
An across the board asset is an asset which the taxpayer owned in the
opening year and continued to own throughout the prosecution years, with no
increase or decrease in the cost of the asset. Since a net worth
computation measures changes, an across the board asset does not affect a
taxpayer's net worth. For example, assume that the prosecution years are
1995 through 1998, and the defendant purchased stock for $10,000.00 in 1994
and still owned the same stock at the end of 1998. There would be no change
in the basis of the stock, and the effect on the defendant's net worth would
be zero. Because an across the board asset does not affect the net worth
computation, it has been held that it is not error to leave such an asset
out of the net worth computation. United States v. Mackey, 345 F.2d
499, 505 (7th Cir. 1965).
It is not necessary for the government to establish the basis for
every asset the taxpayer owns. United States v. Schafer, 580 F.2d
774, 778 (5th Cir. 1978). It is sufficient for the government to identify
with reasonable specificity the basis in every asset, including cash, in
which a purchase or sales transaction occurred in the tax years in question.
Schafer, 580 F.2d at 778. Note, however, that in Schafer, the
court assumed that possible omitted assets were across the board assets.
In United States v. Tolbert, 406 F.2d 81, 84 (7th Cir. 1969),
the government's net worth computation reflected the defendant's accounts
receivable as an across the board asset for all of the years in question.
The government figure was based on a statement the defendant had given the
agents. There was testimony at the trial that the accounts receivable had
increased during the prosecution years. The court rejected the defendant's
argument that it was reversible error not to reflect the alleged increase,
observing that if the accounts receivable did increase during the
prosecution years, the error in failing to reflect the increase was in the
defendant's favor and did not prejudice him. The court found that there
would be prejudice only if the evidence showed that the accounts receivable
had decreased during the prosecution years. Tolbert, 406 F.2d at 84.
See also United States v. Scrima, 819 F.2d 996, 999
(11th Cir. 1987) ("government employed the floating cash or dash formula
where cash is an unknown but constant factor throughout the net worth
period"); United States v. Terrell, 754 F.2d 1139, 1145 (5th Cir.
1985); United States v. Dwoskin, 644 F.2d 418, 421 (5th Cir. 1981).
31.08[3] Bank Accounts and Nominee Accounts
Money in the bank represents an asset in a net worth computation. In
the usual situation, it is a relatively simple matter to determine how much
money the defendant had in the bank at the end of each year, with the
balance being reflected in the net worth statement. However, all
outstanding checks should be subtracted from the end of the year bank
statement balance otherwise the balance would be inflated. United
States v. Vardine, 305 F.2d 60, 65 (2d Cir. 1962). Similarly, deposits
in transit are added to the end of the year statement balance.
In a number of instances, the taxpayer will have maintained bank
accounts in the names of family members or in the names of third-party
nominees. It must then be determined whether the money in the account was
supplied by the defendant. If so, the bank balances are included in the
defendant's net worth. This was the case in United States v.
Balistrieri, 403 F.2d 472, 479 (7th Cir. 1968), vacated and remanded
on other grounds, 395 U.S. 710 (1969), aff'd after remand, 436
F.2d 1212 (7th Cir. 1971). There, the defendant attacked the propriety of
including cash that had been deposited in the bank in his name and the name
of his nineteen-year old son in the defendant's net worth computation.
Rejecting the defendant's argument, the court found that the jury had ample
grounds to believe that the money was in fact the defendant's, since the
government proved that the defendant controlled the account and withdrew a
substantial amount from it. Balistrieri, 403 F.2d at 479.
See also Talik v. United States, 340 F.2d 138, 141 (9th
Cir. 1965) (attributing entire balance in account to defendant was justified
because either the account belonged to defendant or any money belonging to
the daughter was a gift from her parents).
31.08[4] Assets and Liabilities of Husband and Wife or Children
In determining a defendant's opening net worth, consideration must be
given to assets and liabilities of a non-defendant spouse and children.
Such assets and liabilities need not be included in the government's
computation where the net effect of inclusion would be de minimis. The
government, however, must have investigated a spouse's and/or child's
assets and liabilities before deciding not to include them in the
computation. United States v. Goichman, 407 F. Supp. 980, 995-96
(E.D. Pa.), aff'd, 547 F.2d 778 (3d Cir. 1976).
A failure to conduct such an investigation of the defendant's spouse
resulted in a reversal in United States v. Meriwether, 440 F.2d 753
(5th Cir. 1971). The court held that the government failed to establish
with reasonable certainty a definite opening net worth of the joint income
of Meriwether and his wife, saying that the government "came near ignoring
Mrs. Meriwether." Meriwether, 440 F.2d at 755.
The Ninth Circuit appears to disagree with the Fifth Circuit, however,
holding that the government is not required to establish the net worth of
the defendant's spouse as part of its prima facie case. United States v.
Hallman, 594 F.2d 198, 200 (9th Cir. 1979). Instead, the government's
duty to investigate spousal assets only arises under its obligation to
negate reasonable explanations or leads furnished by the defendant.
Hallman, 594 F.2d at 200. However, unless merited by the particular
circumstances of a given case, consideration always should be given to the
assets and liabilities of a spouse.
A somewhat different issue is whether the government can use a joint
net worth statement for both husband and wife. The Fifth and Sixth Circuits
have answered in the affirmative. In United States v. Brown, 667
F.2d 566 (6th Cir. 1982), both husband and wife were tried and convicted of
income tax evasion. The court concluded that the government's use of a
joint net worth statement was "justified," even though the wife was the
nominal owner of the business that was the source of the unreported income,
because "the financial affairs of the two defendants were so intertwined as
to justify a joint reconstruction of their income." Brown, 667 F.2d
at 568.
In a non-defendant spouse case, United States v. Giacalone, 574
F.2d 328 (6th Cir.1978), the government's evidence showed that the
defendant's wife earned no income prior to and during the prosecution years,
that she made some nondeductible expenditures with funds furnished by her
husband, and that she and her husband filed joint returns. Because the
defendant was charged with attempting to evade taxes owed by both him and
his wife, and "her financial transactions were intertwined with those of her
husband," the court approved the government's use of a joint net worth
statement. Giacalone, 574 F.2d at 333.
In United States v. Smith, 890 F.2d 711, 714 (5th Cir. 1989),
the Fifth Circuit relied on Brown and Giacalone in rejecting a
defendant's claim that the government was required to exclude assets of the
defendant's spouse and child to ensure the accuracy of the net worth
analysis. In Smith, the government excluded both the income of the
defendant's daughter and gifts to the defendant's wife and daughter before
arriving at a final net worth determination of the defendant and his spouse.
The court stated that the "fabric of the financial blanket is so closely
woven that a computation of net worth on the joint income of the spouses is
clearly permissible." Smith, 890 F.2d at 714.
31.08[5] Real Property
Real property is reflected in the net worth computation at cost,
unless the realty falls within one of the exceptions, such as realty
received as an inheritance. Where cost cannot be established by direct
evidence, a determination should be made whether the realty was purchased or
sold at a time when revenue stamps were affixed to deeds pursuant to a
federal statute which imposed a tax on deeds. 26 U.S.C. § 4361,
repealed. If the realty was purchased or sold at a time when the tax on
deeds was in effect, the revenue stamps can be used to compute the sales
price of the realty. United States v. 18.46 Acres Of Land, Etc., 312
F.2d 287, 289 (2d Cir. 1963); Dickinson v. United States, 154 F.2d
642, 643 (4th Cir. 1946); Ramming Real Estate Co. v. United States,
122 F.2d 892, 895 (8th Cir. 1941). On occasion, state stamps can also be
used to compute the sales price.
Jointly owned property is especially common in the case of a husband
and wife. For an example of a jointly owned asset properly included in full
in the defendant's net worth, see O'Connor v. United States,
203 F.2d 301, 303 (4th Cir. 1953). See also United States
v. Costello, 221 F.2d 668, 672 (2d Cir. 1955), aff'd, 350 U.S.
359 (1956); United States v. Johnson, 319 U.S. 503, 516 (1943) (jury
could find that a string of gambling houses ostensibly conducted as separate
enterprises by co-defendants was in fact a single, unified gambling
enterprise owned by one defendant).
Finally, note that records of documents affecting an interest in
property and statements in documents affecting an interest in property may
be admissible as exceptions to the hearsay rule. Fed. R. Evid. Rules
803(14) and (15).
31.08[6] Partnership Interest
When the taxpayer has invested money in a partnership, the taxpayer's
share of the partnership capital is reflected as an asset. United States
v. Mancuso, 378 F.2d 612, 614-15 (4th Cir.), amended, 387 F.2d
376 (4th Cir. 1967). In Mancuso, the government had little direct
evidence to establish the percentage interest the defendant had in the
partnership. Therefore, the government allocated an equal share of the
partnership capital to all the partners, including the defendant, which
corresponded to the distribution of profits as reported on the partnership
tax returns. The government agent testified that this "conformed to the
ordinary legal presumption that in absence of evidence of an agreement to
the contrary the partners' interests are equal." Mancuso, 378 F.2d
at 616.
31.08[7] Errors in Net Worth Computation
If there is an error in the net worth computation for one of the
prosecution years, the error will not necessarily affect other prosecution
years. United States v. Keller, 523 F.2d 1009, 1012 (9th Cir. 1975)
(error did not carry over to a subsequent year since the asset was disposed
of in the prior prosecution year). Moreover, even if an error does affect
all of the prosecution years, the government is not required to prove its
case to a mathematical certainty. If a substantial understatement remains
after accounting for the error, then a guilty verdict will be upheld.
Keller, 523 F.2d at 1012.
31.09 LIABILITIES
The government must present evidence of a defendant's liabilities.
These liabilities are subtracted from assets in arriving at a taxpayer's net
worth. As with assets, the defendant's liabilities must be established with
reasonable certainty.
For examples of evidence establishing liabilities, see
United States v. Schafer, 580 F.2d 774, 780 (5th Cir. 1978); Beard
v. United States, 222 F.2d 84, 89 (4th Cir. 1955).. Testimony by the
investigating agent as to the amount of a liability, without independent
documentation or third-party testimony, is inadmissible hearsay. See
United States v. Morse, 491 F.2d 149, 153-55 (1st Cir. 1974) (a bank
deposits case, but the principle is applicable to a net worth case).
On the other hand, when the agent's investigation reveals that there
were no liabilities, the agent can testify to the negative finding. It is
not hearsay. United States v. Dwoskin, 644 F.2d 418, 423 (5th Cir.
1981); Morse, 491 F.2d at 154 n.8;. Otherwise stated, a witness may
testify as to his or her failure to find records after a search. United
States v. Lanier, 578 F.2d 1246, 1255 (8th Cir. 1978); United States
v. Robinson, 544 F.2d 110, 114-15 (2d Cir. 1976); United States v.
Jewett, 438 F.2d 495, 497-98 (8th Cir. 1971); United States v.
DeGeorgia, 420 F.2d 889, 891-92 (9th Cir. 1969); Charron v. United
States, 412 F.2d 657, 660 (9th Cir. 1969); McClanahan v. United
States, 292 F.2d 630, 637 (5th Cir. 1961) ("[t]his, in fact, is
frequently the only way in which a negative fact can be proved").See
also Fed. R. Evid. Rules 803(7) and 803 (10).
As a general rule, when the defendant is a cash basis taxpayer, the
net worth computation does not include accrued liabilities. United
States v. Balistrieri, 403 F.2d 472, 479 (7th Cir. 1968), vacated and
remanded, 395 U.S. 710 (1969), aff'd after remand, 436 F.2d 1212
(7th Cir. 1971). On the other hand, if the defendant has received cash or
property in exchange for a liability, then the asset and liability are both
included in the net worth computation whether the defendant is on a cash or
accrual basis. For example, if the defendant buys a house in exchange for a
mortgage, the house would be shown as an asset and the mortgage as a
liability.
31.10 NONDEDUCTIBLE EXPENDITURES
31.10[1] Added to Net Worth Increase
After subtracting the ending net worth from the starting point, the
resulting net worth increase is further adjusted by adding to the increase
the taxpayer's nondeductible expenditures during the year, including living
expenses, for items which are not reflected as assets on the net worth
statement. Holland v. United States, 348 U.S. 121, 125 (1954);
United States v. Terrell, 754 F.2d 1139, 1144 (5th Cir.1985);
United States v. Hamilton, 620 F.2d 712, 714 n.1 (9th Cir.
1980);United States v. Skalicky, 615 F.2d 1117, 1119 (5th Cir. 1980);
United States v. Hiett, 581 F.2d 1199, 1200 n.1 (5th Cir. 1978);
United States v. O'Connor, 237 F.2d 466, 473 n.7 (2d Cir. 1956). "The
taxpayer's nondeductible expenditures are added to the adjusted net values
of the defendant's assets at the end of the subject year and, consequently,
increase the figure to be compared with the opening net worth."
Hamilton, 620 F.2d at 716. See also, United States
v. Scrima, 819 F.2d 996, 999 (11th Cir. 1987).
31.10[2] Burden on Government
The government has the burden of establishing that the expenditures
added to the net worth increase are nondeductible expenditures, as opposed
to deductible expenses such as business expenses. Any addition to the net
worth increase must be limited to nondeductible expenditures. Fowler v.
United States, 352 F.2d 100, 103 (8th Cir. 1965). The government must
establish the nature of an expenditure by independent documentary or
testimonial evidence. Greenberg v. United States, 280 F.2d 472 (1st
Cir. 1960) (agent's testimony regarding expenses insufficient to establish
nature of expenditure).
It is improper to designate an expenditure as personal based solely on
a review of the taxpayer's checks by the investigating agent and the agent's
testimony that a check is either for a personal or business purpose. The
agent's testimony is hearsay. See Siravo v. United States,
377 F.2d 469, 474 (1st Cir. 1967) (third parties testified and the court
"was careful to exclude testimony by the special agent as to conversations
with others"); Johnson v. United States, 325 F.2d 709, 711 (1st Cir.
1963).
Admissions by the defendant may establish whether expenditures are
personal or business. Checks with a notation of "personal" written on them
constitute a pre-offense admission. Fowler, 352 F.2d at 103.
See also United States v. Altruda, 224 F.2d 935, 939
(2d Cir. 1955) (admitted personal living expenses were added to the net
worth increases).
Finally, a nondeductible expenditure made by or on behalf of a spouse,
children, or any third party can be added to the defendant's net worth
increase where it can be shown that the defendant furnished the funds for
the expenditure. United States v. Giacalone, 574 F.2d 328, 333 (6th
Cir. 1978) (government proof traced a number of nondeductible expenditures
by the wife to funds furnished by the defendant); Ford v. United
States, 210 F.2d 313, 317 (5th Cir. 1954); . Cf. United
States v. Lawhon, 499 F.2d 352, 355-56 (5th Cir. 1974) (citrus groves
and certificates of deposit in the names of children); United States v.
Balistrieri, 403 F.2d 472, 479 (7th Cir. 1968), vacated and remanded
on other grounds, 395 U.S. 710 (1969), aff'd after remand, 436
F.2d 1212 (7th Cir. 1971) (bank account in name of defendant and his minor
son).
31.10[3] Nondeductible Expenditures -- Examples
Proof of non-deductible expenditures -- such as food, clothing,
shelter and gifts -- is one factor in the net worth and expenditures
method of proof. . . . Government tax experts routinely add living
expenses to their net worth schedules.
United States v. Scott, 660 F.2d 1145, 1173 (7th Cir. 1981).
See United States v. Hamilton, 620 F.2d 712, 716 (9th Cir.
1980).
In Scott, the only daily living expense the government included
in its net worth calculation was food. As Attorney General of the State of
Illinois, Scott traveled on state business and his travel vouchers were used
as a basis for arriving at his unreimbursed food expenditures. Scott,
660 F.2d at 1151. In addition to food expenses, the government's net worth
computation included cash travel expenses for personal trips that the
government was able to document and the purchase of a stamp collection and a
diamond ring. Scott, 660 F.2d at 1150-51.
Living expenses can be based on estimates provided by the taxpayer.
In United States v. Burdick, 214 F.2d 768, 770 n.6 (3d Cir. 1954),
vacated, 348 U.S. 905 (1955), aff'd on remand, 221 F.2d 932
(3d Cir. 1955), the government estimated the defendant's living expenses at
$2,000 a year on the basis of the defendant's admission that he spent $20 to
$25 a week for household expenses alone. See also United
States v. Doyle, 234 F.2d 788, 794 (7th Cir. 1956) (expenditures for
living expenses arrived at largely from defendant's own statements).
Another method of establishing living expenses is to rely on
"independent estimates from the Bureau of Labor on what a person with (the
taxpayer's) reported income and family and financial obligations would be
expected to spend on non-deductible items." Hamilton, 620 F.2d at
716. Caution must be exercised, however, in using Bureau of Labor
statistics estimates. The estimates are broken down into categories, such
as food, clothing, household operations, alcohol, tobacco, gifts, and
contributions, etc. The items selected for net worth purposes should be
limited to necessities such as food, household operations, and clothing.
Estimates of expenditures subject to greater variation, such as for
recreation, transportation, and similar items, should not be used. Personal
insurance premiums and federal income taxes paid by a taxpayer may also be
added to the net worth increase. Dawley v. United States, 186 F.2d
978, 980 (4th Cir. 1951). In Armstrong v. United States, 327 F.2d
189, 192 (9th Cir. 1964), nondeductible expenditures included living
expenses, payment of insurance premiums, fees paid to an attorney, bond
premiums, and other nondeductible expenditures. Automobiles, antiques, and
travel were added to the net worth increase as nondeductible expenditures in
United States v. Sorrentino, 726 F.2d 876, 880 (1st Cir. 1984).
Gifts, vacation trips, payments for a maid, and gifts for a spouse and third
parties are further examples of nondeductible expenditures. United States
v. Goichman, 407 F. Supp. 980, 989 (E.D. Pa.), aff'd, 547 F.2d
778 (3d Cir. 1976).
Where the government is unable to trace expenditures for household
goods or services, personal entertainment, or personal care items, the jury
can properly conclude that the defendant must have incurred some expenses
for these items and that these expenses would have added to the defendant's
net worth increase and expenditures, beyond what the government proved.
Scott, 660 F.2d at 1151. Omitting personal expenditures for food and
clothing does not permit the jury to improperly speculate as to the
defendant's personal expenses. United States v. Notch, 939 F.2d 895,
900 (10th Cir. 1991). In Notch, the Tenth Circuit recognized that
"[t]his conservative approach to the net worth computation made the analysis
appear more credible" and can be viewed "as showing that the jury need not
consider personal expenses in order to conclude that defendant understated
his income." Notch, 939 F.2d at 900.
Note that there is a difference in the net worth treatment when living
expenses are to be used in determining cash on hand in the opening net worth
as opposed to expenditures for living expenses made in a prosecution year.
When the purpose is to determine the opening cash on hand of the taxpayer,
living expenses and other expenditures are subtracted from the available
resources of the taxpayer in determining whether the taxpayer expended all
or part of what might otherwise constitute cash on hand. When the purpose
is to reflect the increase in wealth of the taxpayer, living expenses and
other nondeductible expenditures in a prosecution year are added to the net
worth increase,.
31.11 REDUCTIONS IN NET WORTH
The purpose of the net worth computation is to arrive at taxable
income, and the computation therefore must reflect taxable consequences.
Therefore, nontaxable items received by the taxpayer during the prosecution
period must be eliminated or accounted for in the net worth computation.
The following types of nontaxable items must be subtracted from the total
reflecting the net worth increase and nondeductible expenditures: gifts
received, inheritances, nontaxable pensions, the nontaxable portion of
capital gains, veterans benefits, dividend exclusions, tax-exempt interest,
proceeds from life insurance, and any other nontaxable items.
An example of the treatment of such an item is found in United
States v. Holovachka, 314 F.2d 345, 355 (7th Cir. 1963). In that case,
the defendant had purchased bonds for investment purposes and received
monies during the prosecution year representing the repayment of principal
and nontaxable interest:
Government treated the principal repayments as a tax free return of
capital which correspondingly decreased defendant's investments in
such bonds for those years. The yearly interest payments received on
these bonds were considered to be tax free and were accordingly
deducted from defendant's net worth. The trial court properly
instructed the jury that the repayments of principal and the earned
interest constituted non-taxable income.
Holovachka, 314 F.2d at 355.
Technical items and items that are clearly not fraudulent are also
deducted from the taxpayer's computed net worth. Thus, the underreporting
of an income item as the result of an inadvertent error of the defendant or
his accountant should not be charged to the defendant. Any such item is
subtracted, or otherwise accounted for, in arriving at taxable income.
In United States v. Altruda, 224 F.2d 935, 940 (2d Cir. 1955),
the defendant's accountant explained to the examining agent prior to trial
that the defendant had made "errors" in underreporting income from realty
holdings, and the defendant was given credit for these amounts in the
government's net worth computation. In United States v. Allen, 522
F.2d 1229, 1231 (6th Cir. 1976), a technical adjustment was made, reducing
the net worth computation to allow for an error discovered in one of the
adding machine tapes used in preparing the defendant's return. The net
effect was that the adjustment allowed the entire deduction claimed by the
defendant on his return, and the defendant was not charged with the error in
the net worth computation.
31.12 ATTRIBUTING NET WORTH INCREASES TO TAXABLE INCOME
31.12[1] Generally
The net worth method of proof requires evidence supporting "the
inference that the defendant's net worth increases are attributable to
currently taxable income." Holland v. United States, 348 U.S. 121,
137 (1954); United States v. Dwoskin, 644 F.2d 418, 422 (5th Cir.
1981); United States v. Hom Ming Dong, 436 F.2d 1237, 1241 (9th Cir.
1971); United States v. Mackey, 345 F.2d 499, 506 (7th Cir.
1965); . Increases in net worth, standing alone, cannot be assumed to be
attributable to currently taxable income.
There are two ways of supporting an inference that net worth
increases are attributable to currently taxable income:
1. Proof of a likely source of taxable income. Holland, 348
U.S. at 137-38.
2. Negating non-taxable sources of income. United States
v. Massei, 355 U.S. 595 (1958).
Either method is sufficient. See also United States v.
Sorrentino, 726 F.2d 876, 879-80 (1st Cir. 1984); United States v.
Scott, 660 F.2d 1145, 1151 (7th Cir. 1981); Dwoskin, 644 F.2d at
422; United States v. Grasso, 629 F.2d 805, 807-08 (2d Cir. 1980);
United States v. Hiett, 581 F.2d 1199, 1201 (5th Cir. 1978).
31.12[2] Proof of Likely Source of Taxable Income
The government can establish a likely source of taxable income through
direct or circumstantial evidence. The applicable rule requires "proof of a
likely source, from which the jury could reasonably find that the net worth
increases sprang." Holland v. United States, 348 U.S. 121, 138
(1954). It is not necessary for the government to prove by direct evidence
that the unreported income reflected by the net worth computation, in fact,
came from the likely source established. United States v. Mackey,
345 F.2d 499, 506-07 (7th Cir. 1965). See also United
States v. Smith, 890 F.2d 711, 714 (5th Cir. 1989) (likely source of
income could be indicated by business operations, mineral interests, real
estate, stocks, bonds, commodities, and gambling); United States v.
Greene, 698 F.2d 1364, 1373 (9th Cir. 1983) (the government need not
prove a specific source, but only a likely source, and evidence established
real estate sales, interest income on loans, and unreported securities
transactions as likely sources of taxable income); United States v. Hom
Ming Dong, 436 F.2d 1237, 1241-42 (9th Cir. 1971) (grocery store
ownership provided likely source); United States v. Costello, 221
F.2d 668, 671-72 (2d Cir.), aff'd, 350 U.S. 359 (1956) (the evidence
established that the defendant was a gambler and "gambling is an occupation
with indeterminate possibilities").
Likewise, the government does not have to show that the likely source
was capable of generating the entire amount of unreported income charged in
the indictment. United States v. Costanzo, 581 F.2d 28, 33 (2d Cir.
1978). The court found that extensive proof supported the inference that
the defendant's bakery was a likely source of unreported taxable income
because the bakery was large enough to generate substantial amounts of
unreported cash receipts. Costanzo, 581 F.2d at 33. Evidence of
specific items of unreported income is admissible to show a likely source
from which the net worth increases may have come. Holland, 348 U.S.
at 138; United States v. Schafer, 580 F.2d 774, 777 n.5 (5th Cir.
1978). See also United States v. Hagen, 470 F.2d 110, 111
(10th Cir. 1972), in which the defendant claimed surprise and argued that
the government introduced evidence as to specific items of unreported income
to an extent that the specific items proof "changed the theory of the case
or in any event overshadowed the net worth proof." The court noted that the
specific items evidence assumed such a large role at the trial that "at the
end it became difficult to say whether it still was a net worth case."
Hagen, 470 F.2d at 112. But the court continued:
In any event the Government followed and met the requirements of
Holland v. United States. The evidence of specific items was
proper as indicated to show wilfulness, but it was also proper to show
a likely source under Smith v. United States, 348 U.S. 147, 75
S.Ct. 194, 99 L.Ed. 192 and United States v. Calderon, 348 U.S.
160, 75 S.Ct. 186, 99 L.Ed. 202.
470 F.2d at 113.
In a situation such as that in Hagen, problems as to the
government's method of proof can be avoided by clearly designating in a
response to a motion for a bill of particulars the method of proof to be
relied upon by the government, such as, net worth method and specific items
method, or net worth method corroborated by specific items of unreported
income.
Once the government has introduced evidence of a likely source of
taxable income, the government has no burden to negate all possible
nontaxable sources of the unreported income. While the government does have
a duty to check out reasonable leads, when the defendant furnishes no leads,
"the Government is not required to negate every possible source of
nontaxable income, a matter peculiarly within the knowledge of the
defendant." Holland v. United States, 348 U.S. 121, 138 (1954).
Caution must be exercised in following this principle, however, because the
government has an obligation in net worth cases to conduct a thorough
investigation, which would include searching for nontaxable sources of
income.
Once a likely source is established, the government does not have to
show that it has investigated "the many possible nontaxable sources of
income, each of which is as unlikely as it is difficult to disprove."
Holland, 348 U.S. at 138. The government is not limited to showing a
single likely source of taxable income but can introduce evidence of as many
possible sources of taxable income as the investigation has developed.
See, e.g., Feichtmeir v. United States, 389 F.2d 498,
502 (9th Cir. 1968) (evidence showed the defendant had interests in eight
operating businesses, investments in real estate, a trust deed, a joint
venture, stocks and bonds, and an undisclosed Mexican source of income).
31.12[3] Illegal Sources of Income
There is no requirement that the likely source of income be a legal
source. James v. United States, 366 U.S. 213 (1961). "[G]ross income
means all income from whatever source derived . . . ." 26 U.S.C. § 61.
Due to the possibility of undue prejudice, courts closely examine
evidence of an illegal source of income. See, e.g., United
States v. Tunnell, 481 F.2d 149, 151 (5th Cir. 1973) (likely source of
the defendant's net worth increases could have been income from prostitution
activities at a motel the defendant operated). When the likely source of
income is illegal, the evidence must present more than suspicion and
innuendo. See Ford v. United States, 210 F.2d 313, 317 (5th
Cir. 1954) (reversing a police chief's tax evasion conviction because
testimony as to payoffs by prostitutes was not connected to the defendant).
But see United States v. Windham, 489 F.2d 1389, 1391
(5th Cir. 1974) (stating that Ford conviction was reversed because of
the speculative, hearsay nature of the testimony, not because of its
content).
Likewise, it must be clear that the purpose of introducing evidence of
illegal activities is to establish a likely source of income, and the
evidence must not be introduced or alluded to in a manner calculated to
inflame the jury. In United States v. Abodeely, 801 F.2d 1020 (8th
Cir. 1986), the government presented evidence that the defendant derived his
unreported income from illegal prostitution and from legal gambling
activities. After a lengthy discussion of the Rule 403 probative/prejudice
balancing test, the court concluded that it had:
[N]o conceptual difficulty with the evidence concerning prostitution.
While it is certainly prejudicial, it is highly probative of
unreported taxable income. The gambling evidence, while having less
direct probative value, is much less prejudicial, and indeed if its
admission was error (which this court does not conclude), the error
was harmless beyond a reasonable doubt. After all, having been shown
that Abodeely ran a bar and a brothel, even the most straitlaced Iowa
jury would hardly have been adversely affected by a showing of his
participation in the legal, though perhaps sinful and worldly in the
eyes of a midwestern jury, activity of gambling in Nevada.
Abodeely, 801 F.2d at 1026. See also United States
v. Smith, 890 F.2d 771, 716 (5th Cir. 1989) (defendant not prejudiced by
introduction of evidence concerning his gambling activities); United
States v. Tafoya, 757 F.2d 1522, 1526-28 (5th Cir. 1985) (income from
payments for attempted assassinations; bank deposits case); United States
v. Vannelli, 595 F.2d 402, 405-06 (8th Cir. 1979) (evidence of
defendant's prior misdemeanor convictions of misappropriation of funds held
admissible to show intent, opportunity, scheme, or plan from which
unreported income could be derived and to show potential source of
unreported income; bank deposits case); Windham, 489 F.2d at 1391;.
The illegal sources for generating income are virtually limitless.
See United States v. Dall, 918 F.2d 52 (8th Cir. 1990)
(illegal importation of veterinary drugs); Clinkscale v. United
States, 729 F.2d 940, 942 (8th Cir. 1984) (prostitutes turned over
income to defendant, which he failed to report); United States v.
Chapman, 168 F.2d 997, 1000-01 (7th Cir. 1948) (black market sales of
meat likely source of income).
Skimming is another example of a likely source of taxable income which
a jury could conclude accounts for the defendant's increase in net worth.
See United States v. Koskerides, 877 F.2d 1129, 1138 (2d
Cir. 1989) (two diners operated as cash businesses may be likely source of
unreported income where previous owner had much higher revenue than
defendant and testimony indicated the possibility of skimming); United
States v. Sorrentino, 726 F.2d 876, 880 (1st Cir. 1984); United
States v. Hamilton, 620 F.2d 712, 715 (9th Cir. 1980) (jury could have
found that the likely source of taxable funds was the illegal diversion of
money from slot machine revenues); [FN4] .
Drug sales frequently provide a possible source of income. See
United States v. Scrima, 819 F.2d 996, 999 (11th Cir. 1987);
United States v. Palmer, 809 F.2d 1504, 1505 (11th Cir. 1987); United
States v. Lewis, 759 F.2d 1316, 1328, 1336 (8th Cir. 1985); United
States v. Horvath, 731 F.2d 557, 563 (8th Cir. 1984); United States
v. Heyward, 729 F.2d 297 (4th Cir. 1984); [FN5] United States v.
Enstam, 622 F.2d 857, 860 (5th Cir. 1980); United States v.
Browning, 723 F.2d 1544, 1547 (11th Cir. 1984).
The government should make sure that the jury instructions make it
clear that the defendant is on trial for tax evasion and for no other
crimes. See Windham, 489 F.2d at 1389 (commenting that this
was done in United States v. Tunnell, 481 F.2d 149 (5th Cir. 1973)).
Limiting instructions are also advisable. Palmer, 809 F.2d at 1505
(11th Cir. 1987) (trial court properly maintained jury's focus on tax issues
and properly minimized any possible prejudice by giving clear limiting and
final instructions).
31.12[4] Negating Nontaxable Sources of Income
It is well established that "[s]hould all possible sources of
nontaxable income be negated, there would be no necessity for proof of a
likely source." United States v. Massei, 355 U.S. 595 (1958). The
Fifth Circuit summarized the government's burden where the defendant has
failed to provide any leads as to nontaxable sources of income:
We therefore hold that in an income tax evasion case based on the net
worth method of proof, when the taxpayer gives no leads as to
nontaxable sources, the government satisfies its burden of negating
all possible nontaxable sources within the meaning of Massei by
showing that it conducted a thorough investigation that failed to
reveal any nontaxable source.
United States v. Hiett, 581 F.2d 1199, 1202 (5th Cir. 1978). In
response to the defendant's argument that the government must negate every
possible source of nontaxable income, the court in Hiett noted that
this would be an impossible task because:
[It] would require the government to exhaust the inexhaustible -- to
conduct an absolutely limitless investigation. It would cast the
government in the role of a conjurer, forcing it to pull nontaxable
sources out of a hat. Appellant would require the government to
embark on a Magellan-like expedition in order to prove that the
unreported income was taxable. Not only would the Government have to
circle the globe in its search, it would also have extraorbital
responsibility, since appellant's position requires it to prove a
cosmic negative. To state appellant's position is to establish its
absurdity. If Massei and Holland are to have viability
in our jurisprudence, they cannot be read to sanction such a result.
Hiett, 581 F.2d at 1201. Accord United States v.
Notch, 939 F.2d 895 (10th Cir. 1991); United States v. Schipani,
362 F.2d 825, 830 (2d Cir.), vacated and remanded on other grounds,
385 U.S. 372 (1966) (government can meet its burden under United States
v. Massei, by negating all reasonably possible sources of
nontaxable income). The investigating agent may testify that his
investigation failed to uncover any sources of nontaxable income. United
States v. Dwoskin, 644 F.2d 418, 423 (5th Cir. 1981); United States
v. Penosi, 452 F.2d 217, 219 (5th Cir. 1971).
In short, it is sufficient if the government's evidence establishes
that there was a thorough investigation, "which removes any reasonable doubt
that the defendant's unreported income came from non-taxable sources."
United States v. Hiett, 581 F.2d 1199, 1202 (5th Cir. 1978).
See also United States v. Smith, 890 F.2d 711, 714 (5th
Cir. 1989). [FN6]
31.13 REASONABLE LEADS DOCTRINE
31.13[1] Duty to Investigate Reasonable Leads
Taxpayers frequently give the government's agents leads indicating the
specific sources from which claimed cash on hand was derived, such as prior
earnings, stock transactions, real estate profits, inheritances, gifts, etc.
Holland v. United States, 348 U.S. 121, 127 (1954). The
Holland reasonable leads doctrine places on the government the duty
of "effective negation of reasonable explanations by the taxpayer
inconsistent with guilt" -- a duty limited to the investigation of "leads
reasonably susceptible of being checked, which, if true, would establish the
taxpayer's innocence." Holland, 348 U.S. at 135-36.
Thus, the government's duty to investigate leads provided by the
taxpayer hinges on the presence of two factors: (1) the taxpayer's
explanation must be relevant and reasonable; and (2) the explanation must be
reasonably susceptible of being checked. Holland, 348 U.S. at
135-36; United States v. Anderson, 642 F.2d 281, 285 (9th Cir. 1981)
(loan from acquaintance in Nigeria not a reasonable lead and not reasonably
susceptible of being checked).
The government meets its burden when it "investigates reasonably
possible sources of non-taxable income, and explores whatever leads the
taxpayers or others may proffer." United States v. Mastropieri, 685
F.2d 776, 785 (2d Cir. 1982). The government is not required to do the
impossible. United States v. Greene, 698 F.2d 1364, 1371 (9th Cir.
1983). Once the government establishes a prima facie case, the taxpayer
"remains quiet at his peril." Mastropieri, 685 F.2d at 785.
Accord United States v. Goldstein, 685 F.2d 179, 182 (7th
Cir.1982) (information on nontaxable income should be supplied by the
taxpayer). Although the burden of proof never shifts from the government,
the defendant has the burden of production regarding any reasonable
leads. United States v. Vardine, 305 F.2d 60, 63 (2d Cir. 1962). It
is up to the taxpayer to furnish the reasonable leads. United States v.
Notch, 939 F.2d 895, 899 (10th Cir. 1991); United States v.
Caswell, 825 F.2d 1228, 1234 (8th Cir. 1987);. The government is not
required to pursue "phantom clues as to some mysterious sources and assets."
United States v. Hamilton, 620 F.2d 712, 715 (9th Cir. 1980).
For cases in which the court found that the defendant's explanations
were not reasonable or reasonably capable of being checked, see
United States v. Londe, 587 F.2d 18, 20 (8th Cir. 1978) (lead found
to be completely lacking in credibility and did not warrant follow-up beyond
the production of the individual as a government witness, which did
occur); United States v. Potts, 459 F.2d 412, 414 (7th Cir. 1972)
(the government's failure to investigate leads from witnesses whose
credibility was tenuous did not require a reversal); United States v. Hom
Ming Dong, 436 F.2d 1237, 1242-43 (9th Cir. 1971) (when leads are
"sketchy" and the defendant furnishes little useful information, there is
less of a burden on the government); United States v. Ford, 237 F.2d
57, 64 (2d Cir. 1956), vacated as moot, 355 U.S. 38 (1957) (claims of
gifts so vague that they were not susceptible of further investigation);
Smith v. United States, 236 F.2d 260, 267 (8th Cir. 1956)
(explanation that his funds came from old mailbags and old iron pots not
reasonably susceptible of being checked).
Moreover, there is "at least a minimal burden upon the taxpayer, once
he chooses to furnish leads to the government, to aid in the investigation
of the purported nontaxable source." Hom Ming Dong, 436 F.2d at
1242-43. See United States v. Terrell, 754 F.2d 1139, 1146
(5th Cir. 1985) (taxpayer has a burden to furnish leads, and the government
cannot be faulted for failure to identify any possible basis in cattle where
the government was diligent in following up on all leads relating to the
cattle, despite the fact that defendant was uncooperative in providing
leads); United States v. Blandina, 895 F.2d 293, 302-03 (7th Cir.
1989) (scope of government's investigation of reasonable leads does not
require government to subpoena records which defendant refused to turn
over).
For examples of adequate government investigation of taxpayer leads
which were susceptible to investigation, see United States v.
Smith, 890 F.2d 711, 714-15 (5th Cir. 1989) (court rejected a
"reasonable leads" challenge regarding gifts to the defendant); United
States v. Koskerides, 877 F.2d 1129 (2d. Cir. 1989) (government negated
defendant's claim that he had received non-taxable funds from family and
friends in Greece).
In situations where a taxpayer furnishes leads which might reasonably
explain his net worth bulge in a manner inconsistent with guilt and the
government fails to investigate these leads, the trial judge should consider
the taxpayer's explanations as true. Vardine, 305 F.2d at 63.
However, when the defendant advances a specific explanation of the source of
funds expended and that explanation is proved false, the government need not
pursue possible nontaxable sources. Feichtmeier v. United States,
389 F.2d 498, 503 (9th Cir. 1968); United States v. Holovachka, 314
F.2d 345, 357 (7th Cir. 1963).
Failure of the government to investigate reasonable leads provided by
the defendant can result in a severe remedy. The trial judge can consider
such leads as true and find the case insufficient to go to the jury.
Holland, 348 U.S. at 135. The court can direct a verdict on any
count where there would not be a substantial tax deficiency if the lead is
assumed to be true. United States v. Keller, 523 F.2d 1009, 1011 (9th
Cir. 1975) (because the government failed to pursue leads which were
reasonably susceptible of being checked, the opening net worth for 1967 was
not reasonably certain and the evidence as to the 1967 count was
insufficient to go to the jury).
The failure to track down reasonable leads, however, is not always
fatal to the government's case. If the uninvestigated lead is assumed to be
true and there remains a substantial, unexplained tax deficiency, then
reversal of a conviction (or a directed verdict) is not warranted.
See Scanlon v. United States, 223 F.2d 382, 388-89 (1st Cir.
1955) (government's failure to investigate this lead would require acquittal
of the defendant if the government's case turned on that evidence but even
assuming this lead to be true, the government's evidence was sufficient to
convict); Anderson, 642 F.2d at 285 (9th Cir. 1981) (even if the
defendant's explanation were true, there would be more than $100,000 of
unexplained income, and this difference would be sufficient to support the
conviction).
At least one circuit has held that, if there is a challenge to the
sufficiency of the government's investigation, it becomes a jury question
whether or not the government was unreasonable in its failure to investigate
alleged leads. Greene, 698 F.2d at 1371.
The government's failure to investigate leads by the defendant has
also been challenged unsuccessfully in the grand jury context. One court
refused to dismiss an indictment, finding the defendant's contention that
the government failed to exhaust leads during the grand jury investigation
insufficient to warrant dismissal of the indictment. United States v.
Todaro, 610 F. Supp. 923, 925 (W.D.N.Y. 1985). In Todaro, the
court held that the pre-trial motion to dismiss was premature because this
was a matter for trial, citing Holland, 348 U.S. 121, and United
States v. Scott, 660 F.2d 1145, 1167 n.42 (7th Cir. 1981).
31.13[2] Leads Must Be Reasonable and Timely
In addition to furnishing leads that are reasonable and reasonably
susceptible of being checked, the taxpayer must furnish any leads in a
timely manner. Therefore, leads must be provided to the government a
sufficient amount of time before trial to permit investigation. United
States v. Sorrentino, 726 F.2d 876, 881 n.2 (1st Cir. 1984). Where
there is no evidence that the defendant gave leads to the government before
trial and the defendant testifies at trial that the net worth increase was
due to the receipt of nontaxable income, the issue is one for the jury.
United States v. Vardine, 305 F.2d 60, 65 (2d Cir. 1962).
The underlying principle is that "the taxpayer has a burden to furnish
'leads'. . . so that the government can investigate and perhaps clear the
taxpayer prior to trial." United States v. Schafer, 580 F.2d 774,
779 (5th Cir. 1978). See United States v. Terrell, 754 F.2d
1139, 1146 (5th Cir. 1985). See United States v. Dwoskin, 644
F.2d 418, 423 n.4 (5th Cir. 1981) (had leads been provided during the
investigative process, the government would have had an obligation to pursue
them to the extent that they were relevant and reasonably susceptible of
being checked).
In short, leads must be furnished well in advance of trial. Smith
v. United States, 236 F.2d 260, 263-64 (8th Cir. 1956). A lead
furnished "on the eve of indictment" is too late. United States v.
Procario, 356 F.2d 614, 617 (2d Cir. 1966) (a bank deposits case, but
the same principle applies in a net worth case).
31.14 NET WORTH SCHEDULES
At the close of its case, the government typically calls a summary
expert witness who summarizes the evidence and introduces schedules
reflecting the government's net worth computation. It is well established
that a government agent can summarize the evidence and introduce into
evidence computations and schedules reflecting the defendant's net worth.
Costello v. United States, 350 U.S. 359 (1956); United States v.
Johnson, 319 U.S. 503, 519 (1943); United States v. Lewis, 759
F.2d 1316, 1329 n.6 (8th Cir. 1985) (summary exhibit used to verify the net
worth theory); United States v. Sorrentino, 726 F.2d 876, 884 (1st
Cir. 1984); United States v. Skalicky, 615 F.2d 1117, 1120 (5th Cir.
1980); United States v. Gardner, 611 F.2d 770, 776 (9th Cir. 1980);
United States v. Allen, 522 F.2d 1229, 1234 (6th Cir. 1975);
United States v. O'Connor, 237 F.2d 466, 475 (2d Cir. 1956); Fed. R.
Evid. Rule 1006.
The net worth schedules must be based upon evidence in the record;
otherwise, the schedules are not admissible. See, e.g.,
Sorrentino, 726 F.2d at 884; Allen, 522 F.2d at 1234;
United States v. Diez, 515 F.2d 892, 905 (5th Cir. 1975);
O'Connor, 237 F.2d at 475; see also United States v.
Citron, 783 F.2d 307, 316 (2d Cir. 1986) (cash expenditures method).
The government's net worth computation is not required to give effect
to contentions of the defendant. Rather, the government's summary or net
worth computation is based on a selection of that evidence which supports
the government's contentions. It is a summary of evidence tending to prove
guilt, and it reflects the government's version of the facts. United
States v. Diez, 515 F.2d at 905; United States v. Lawhon, 499
F.2d 352, 357 (5th Cir. 1974) (jury was instructed that the summary chart
presented only the government's view of the case); Holland v. United
States, 209 F.2d 516, 523-24 (10th Cir.), aff'd, 348 U.S. 121
(1954) (charts purporting to graphically show the government's case based
upon the government's version of the evidence used in closing argument to
the jury).
Essentially, the government's net worth computation is not intended to
be a summary of all of the evidence introduced by the government. Nor does
the summary purport to include theories of the defense brought out either on
the direct or cross-examination of a government witness. As a matter of
tactics, however, there are situations where the evidence is in conflict and
the government computation will reflect the view that is more favorable to
the defendant, i.e., not all evidence favorable to the defendant
should necessarily be disregarded.
Note the distinction made in Flemister v. United States, 260
F.2d 513, 517 (5th Cir. 1958), in which the court observed that a government
summary need not give effect to the contentions of the accused, but if the
summary purports to be a statement of all of the evidence then it must be a
summary of all of the evidence. The summary must be what it purports to be.
In Flemister, the court found that the government summaries failed to
show that they represented only the testimony of government witnesses and
were not a summary of all of the relevant testimony. Flemister, 260
F.2d at 517. To avoid this problem, the agent should testify clearly that
the government's net worth computation is a summary only of government
contentions and not a summary of all of the evidence in the record.
31.15 JURY INSTRUCTIONS
In a net worth case, detailed, comprehensive jury instructions on the
method of proof are essential. "Charges should be especially clear,
including, in addition to the formal instructions, a summary of the nature
of the net worth method, the assumptions on which it rests, and the
inferences available both for and against the accused." Holland v.
United States, 348 U.S. 121, 129 (1954); United States v. Carter,
721 F.2d 1514, 1538 (11th Cir. 1984); United States v. Wirsing, 719
F.2d 859, 861-62 n.4 (6th Cir. 1983).
Convictions have been reversed when the trial judge failed to give
full explanatory instructions on the net worth method. United States v.
Hall, 650 F.2d 994, 999 (9th Cir. 1981); United States v.
Tolbert, 367 F.2d 778, 781 (7th Cir. 1966); United States v.
O'Connor, 237 F.2d 466, 472 (2d Cir. 1956). "[T]he complete lack of any
instruction on the nature of the [net worth] method and its concomitant
assumptions and inferences affects a substantial right of the accused and
constitutes plain error. . . and requires a reversal despite the lack of an
objection by the defendant to such omission." Tolbert, 367 F.2d at
781.
For a sample net worth jury instruction, see the section on
jury instructions, infra.
31.16 SAMPLE NET WORTH SCHEDULE
On the next page is a reproduction of the net worth computation
admitted into evidence in United States v. Carter, 462 F.2d 1252,
1253 (6th Cir. 1972).
RUSSELL L. CARTER
Computation of Unreported Taxable Income Based On
Net Worth and Personal Living Expenses
12-31 12-31 12-31 12-31
ASSETS 1962 1963 1964 1965
Cash on Hand $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00
Cash in Banks
Checking Accounts 2,556.79 167.56 356.06 264.57
Bonds -- Series E 90,897.58 121,770.04 122,001.00 131,601.17
Stocks and
Notes Receivable 2,983.72 1,983.72 983.72 13,487.50
Real Estate 9,386.92 9,386.92 9,386.92 51,886.92
Business Equipment 5,700.00 5,700.00 5,700.00 5,700.00
Automobiles 9,428.49 4,950.00 6,854.70 8,554.70
TOTAL ASSETS $136,953.50 $159,958.24 $176,282.40 $242,494.86
LIABILITIES
Mortgages and
Loans Payable $ 402.88 $ 49.93 $ -0- $ 22,260.00
Allowance for
Depreciation 7,059.11 5,105.90 4,089.00 6,040.85
TOTAL LIABILITIES $ 7,461.99 $ 5,155.83 $ 4,089.00 $ 28,300.85
NET WORTH $129,491.51 $154,802.41 $172,193.40 $214,194.01
Beginning Net Worth (129,491.51) (154,802.41) (172,193.40)
Increase in
Net Worth $ 25,310.90 $ 17,390.99 $ 42,000.61
Personal Living
Expenses 12,646.61 22,303.34 16,283.63
Adjustments to
Net Worth (1,144.97) (861.14) (1,039.21)
Adjusted Gross
Income $ 36,182.54 $ 38,833.19 $ 57,245.03
Deductions (2,394.66) (2,461.99) (3,738.75)
Exemptions (2,400.00) (2,400.00) (2,400.00)
Taxable Income
Corrected $ 32,017.88 $ 33,971.20 $ 51,106.28
Taxable Income
Reported (7,527.33) (18,765.49) (9,610.33)
Unreported Taxable
Income $ 24,490.55 $ 15,205.71 $ 41,495.95
FN 1. The defendant contended that the use of the net worth method was not
proper because the government did not make the necessary preliminary proof
that (1) the taxpayer had no books; or (2) refused to produce them; or (3)
the books did not clearly reflect his income; and (4) the circumstances were
such that the net worth method did reflect his income with reasonable
accuracy and certainty. McGrew v. United States, 222 F.2d 458, 459
(5th Cir. 1955).
FN 2. As an evidentiary matter, the Mastropieri court criticized the
fact that the record did not contain the "form of letter or letters" which
the special agent sent to the banks, brokerage firms, and lending
institutions that he canvassed as a part of the investigation.
Mastropieri, 685 F.2d at 779 n.3. This concern suggests that care
should be taken in drafting such letters, because they may be used later to
demonstrate the effort made to locate the defendant's assets and
liabilities.
FN 3. Where corroboration is required, the jury should be instructed on that
requirement. See United States v. Marshall, 863 F.2d 1285,
1288 (6th Cir. 1988) (reversing a jury verdict because the jury was not
instructed that a defendant's extrajudicial statements must be corroborated
with independent evidence).
FN 4. It is interesting to note that in Hamilton, 620 F.2d 712 (9th
Cir. 1980), the court upheld as admissible, and found most convincing, the
testimony of a statistical expert who had examined the slot machines,
reviewed their reported performance, compared their performance with similar
machines at other casinos and with the manufacturer's built-in
specifications, and concluded that the odds against the machine performing
as poorly as the records indicated were greater than two billion to one.
Hamilton, 620 F.2d at 715.
FN 5. This case is of particular interest because the court admitted
evidence that the defendant's plane was found in Georgia in 1980 loaded with
over 4,000 pounds of marijuana and the prosecution years were 1978 and 1979.
FN 6. The Second Circuit suggested that in rare situations less stringent
standards might apply with respect to both establishing opening net worth
and to negating nontaxable income sources. These standards "are justified in
a case like this where defendants were shown to have gone to such lengths to
conceal their unreported increases in wealth." United States v.
Mastropieri, 685 F.2d 776, 785 (2d Cir. 1982).