Elements of New York Tax Fraud

 Introduction.  Preparers of New York State corporate, income, employment and sales tax returns should be aware of strict criminal penalties that await their clients, and should also be aware that in extreme cases, tax professionals themselves could theoretically be prosecuted under an accomplice theory for aiding or abetting dishonest taxpayers.  Tax legislation enacted in 2009 focused on tax evasion and tax fraud. Serious acts of tax evasion now attract far more severe criminal charges than prior to 2009. The Department of Taxation and the various Attorneys General are also vested with new resources to identify and prosecute persons engaging in tax evasion.

Under pre-2009 law, the failure to file a tax return constituted a felony only if the taxpayer willfully and with an intent to evade tax failed to file for three consecutive years. Tax Law §1801(a) created a new crime, that of “tax fraud,” which applies to all forms of tax evasion, whether accomplished by non-filing, false filing or other fraudulent scheme. The law now recognizes eight categories of tax fraud, starting with a class A misdemeanor, and rising to a class B felony. For purposes of comparison, homicide is also a class B felony.

Under prior law, taxpayers were generally required to have acted “willfully” in order to have committed a crime. However, most tax statutes did not define the term. Under present law, the term “willfully” is defined; and it creates a uniform minimum mental state required to commit a tax crime. Tax Law §1801(c), adopting the federal standard, defines the term “willfully” as “acting with an intent to defraud, intent to evade the payment of taxes or intent to avoid a requirement of [the tax law], a lawful requirement of the commissioner or a known legal duty.”

II.    Eight Categories of Tax Fraud

New York has eight “categories” of tax fraud, each contemplating varying degrees of punishment for the alleged tax offense, ranging from misdemeanors to serious felonies carrying with them the distinct possibility of long periods of incarceration. There is considerable overlap among the categories of tax fraud, so that in many cases, more than one statute could apply to one particular alleged offense. None of them is pleasant.

Tax Law §§ 1801(a)(1):  Willful Failure to File a Return or Other Required Document

Under former tax law, the failure to file income or corporate tax returns constituted a felony only if the taxpayer failed to file for three consecutive years. Under present law, felony liability attaches if the taxpayer (i) fails to file (even for a single year); (ii) intends to evade tax; and (iii) underpays in an amount that meets the monetary threshold. Accordingly, any willful non-filer who intends to evade tax and evades more than $3,000 in tax liability could face felony prosecution.

Tax Law §§ 1801(a)(2),(3): Willfully and Knowingly Making  or Filing a False Return or Report or Supplying False Information

Tax Law §1801(a)(2) provides that tax fraud occurs when a person willfully, while knowing that a return, report, statement or other document under that chapter contains any materially false or fraudulent information, or omits any material information, files or submits that return, report, statement or document with the state or any political subdivision of the state. Tax Law §1801(a)(3) addresses the submission of false information to The Department of Taxation. Thus, a person commits tax fraud if he willfully and knowingly supplies or submits materially false or fraudulent information in connection with any return, audit, investigation, or proceeding or fails to supply information within the time required by or under the provisions of the tax law or regulations.

The scope of the provision is as vast: Nearly every conceivable materially false tax filing or submission could theoretically fall within the ambit of §1801(a)(2) and (3). Section 1801(a)(3), which addresses submissions to the Department, includes oral submissions made in connection with an audit or investigation. Thus, the intentional submission of false documentation by the taxpayer or by his representative would constitute a false submission. So too would the false assertion by the taxpayer (or his representative) made to an auditor or investigator concerning the existence or non-existence of records. Tax Law §1832(b) makes clear that tax professionals who knowingly provide false documents or who make false assertions on behalf of taxpayers during audit face accomplice liability and will be subject to the same penalties as the taxpayer.

Under pre-2009 law, knowingly filing a false income or corporate tax return with intent to evade tax constituted a class E felony if the filing resulted in a “substantial understatement” of tax.” Under present law, the threshold for a substantial understatement was increased from $1,500 to $3,000. Felony liability now arises where a materially false submission has been made with an intent to evade a tax or to defraud where the false submission results in a tax evasion of more than $3,000.

Provisions of the Tax Law complement, but do not supersede, existing Penal Law provisions. Under the Penal Law, knowingly filing a false document with any public office or public servant constitutes a misdemeanor, which rises to felony status if the false filing is made with an intent to defraud the state or any political subdivision.  No minimum monetary threshold applies to the Penal Law statute. Thus, a taxpayer who files a false income tax return which defrauds New York of less than $3,000 would not be exposed felony liability under the Tax Law, but could be charged with a felony liability under the Penal Law.

Tax Law § 1801(a)(4): Willfully Engaging in a Scheme  to Defraud the State in Connection With Any Matter Under the Tax Law

Tax Law §1801(a)(4) supplements §§1801(a)(2) and (a)(3) by ascribing tax fraud status to acts which do not involve filing a false document or making a false submission to the Department but nevertheless involve elements of fraud and scienter. Thus,  §1801(a)(4) provides that a person (not necessarily a taxpayer) commits tax fraud when he “willfully engages in any scheme to defraud the state or a political subdivision . . . by false or fraudulent pretenses, representations or promises as to any material matter, in connection with any tax imposed. . .” Although employing language similar to that found in the Penal Law, the Tax Law is more severe in that it does not require a “systemic ongoing course of conduct,” as does the Penal Law. However, at the same time the Tax Law is more lenient than the Penal Law in that false representations must be with respect to a “material” matter.  This statute is apparently intended to reach persons engaging in schemes such as cigarette tax evasion that do not necessarily involve the filing of returns or the remission of taxes. Tax Law §1801(a)(4) is also apparently intended to act synergistically with new classes of tax felonies, described below.

Tax Law §§ 1801(a)(5): Willfully Failing to Remit Taxes Collected on Behalf of the State

Withholding taxes collected from employees and sales taxes collected from customers constitute trust fund taxes. While fiduciaries who misappropriate these funds have always been subject to prosecution under the Penal Law for larceny, prosecution under the Tax Law had been problematic, since prosecution of employers who failed to remit employment taxes was limited to a misdemeanor charge, regardless of the amount of payroll taxes collected and not remitted; and the failure of a tax vendor to remit collected sales tax was not a criminal act under the Tax Law.  However, Tax Law §1801(a)(5) now provides that tax fraud occurs when a person willfully “fails to remit any tax collected in the name of the state or on behalf of the state . . . when such collection is required under this chapter.”  Therefore, resort to the Penal Law is no longer necessary to seek felony prosecution for crimes involving failure to remit sales or withholding taxes.

Tax Law §§ 1801(a)(6): Willfully Failing to Collect a  Sales, Excise or Withholding Tax That is Required to Be Collected

Under former tax law, the failure of employers to collect employment tax, and the failure of vendors to collect sales tax, constituted a misdemeanor. The failure to collect $10,000 in sales tax, or the failure to collect $100 in sales tax on ten or more occasions, constituted a class E felony. Tax Law §1801(a)(6) now provides that the willful failure to collect tax when required constitutes tax fraud per se. If taxes not collected exceed $3,000 in one year, felony liability attaches; otherwise, misdemeanor liability attaches.

Tax Law §§ 1801(a)(7): Willfully and With an Intent to Evade Any Tax, Failing to Pay a Tax Due

Tax Law §1801(a)(7) provides that a taxpayer who willfully and with intent to evade tax fails to pay such tax commits tax fraud. The present law imposes a stricter standard for prosecution than the pre-2009 law in that the failure to pay must be both willful and possess an intent to evade tax. This protects taxpayers who file but cannot pay the tax from potential criminal liability. However, for those taxpayers whose failure to file does meet the more exacting standard, felony liability may attach if the amount of the underpayment exceeds specified thresholds. Apparently, this provision is intended to provide prosecutors with an avenue of recourse to punish those taxpayers who actually file accurate sales or income tax returns but who fails to pay those reported tax liabilities, if there was an underlying intent to evade tax, even if the taxpayer was unable to pay the tax. This provision is eerily reminiscent of debtor’s prison, a draconian concept abolished in New York in 1832. One wonders if this violates the U.S. Constitution.

Tax Law §§ 1801(a)(8): Issuing  False Exemption Certificates

Tax Law §1801(a)(8) provides that a tax fraud act includes one where a party willfully issues an exemption certificate, an inter-distributor sales certificate, a resale certificate, or any other document capable of evidencing a claim that taxes do not apply to a transaction, which he or she does not believe to be true and correct as to any material matter, which omits any material information, or which is false, fraudulent, or counterfeit.
Under present law, (i) a willful omission in an exemption certificate constitutes a violation of law and (ii) felony liability can attach (previously only misdemeanor liability arose) if the taxpayer possesses the intent to evade tax and as a result of the fraudulent act underpays an amount which meets the monetary thresholds specified in the felony tax fraud sections.

III.  Felony Tax Fraud Classes

For the aforementioned provisions of the Tax Law to result in a consummated act of tax fraud, and to constitute a felony under the Tax Law, three separate requirements must be met:

First, the taxpayer must act willfully; that is, the taxpayer must intend to commit the prohibited act.

Second, the taxpayer must possess an intent to defraud New York. (Thus, merely intending to commit the prohibited act is not enough. The taxpayer must intend to commit the prohibited act and that act must be in furtherance of an intent to defraud New York. Thus, for example, a taxpayer who mistakenly believes that he was not required to file a tax return and had no intent to defraud New York would appear not meet the required threshold.)

Third, the tax liability must meet certain monetary thresholds.
The chart below summarizes the monetary thresholds required for various classes of tax felonies. A comparison is made with felony classification of other nontax crimes. For example, tax evasion in am amount exceeding $50,000 and armed robbery are now Class C felonies. Another departure from previous tax law is that a taxpayer engaged in income or corporate tax evasion in amounts exceeding $10,000 will now be exposed to serious felony liability.

Those committing sales or withholding tax evasion crimes have long been subject to felony prosecution for larceny under the Penal Law. Taxpayers filing a false return, but who fail to reach the $3,000 monetary threshold for being charged with a Class E felony, could still be prosecuted under the Penal Law for “Offering a False Instrument for Filing,” which is a class E felony.

Tax Fraud Amt.        Nontax Equivalent

E   4th      > $3,000                  DWI
D   3rd     > $10,000                Burglary
C   2nd     > $50,000                Robbery
B   1st      > $1,000,000           Homicide

IV.    Other Considerations

In determining a particular class of tax felony, tax liabilities evaded within a single-year period may be aggregated, but not those occurring over more than one year. However, this limitation applies only with respect to aggregation under the Tax Law. Aggregation of sales tax or withholding tax liabilities over multiple years may occur where larceny prosecution is commenced under the Penal Law. Tax Law §1800(c) imposes monetary penalties for tax felonies in amounts which are the greater of (i) double the amount of the underpaid tax liability or (ii) $50,000 for individuals or $250,000 for corporations. Fines for misdemeanors relating to tax fraud are $10,000 for individuals and $20,000 for corporations.

Under subsection (m) of Criminal Procedure Law §20.40(4), the taxpayer may be prosecuted in the county where the economic activity to prosecute the tax crime arose. This statutory change from pre-2009 law results from the assumption that taxpayers may be involved in economic activity in one county that results in the filing of a tax return in a different county. Tax Law §1831 makes the willful failure to comply with a subpoena issued by the Department of Taxation a misdemeanor. Previously, misdemeanor liability attached to the willful failure to comply with some, but not all, administrative subpoenas issued by the Department.

Tax Law §32 now requires tax preparers who are not licensed attorneys or CPAs to register with the Department as tax preparers and to sign every return which they prepare. Under Tax Law §1833, failure to register or to sign a return constitutes a misdemeanor.

V.   Conclusion

The Tax Law provides New York tax authorities with a vast arsenal of weapons to counter tax fraud. The Department of Taxation has in effect become a “new IRS” at the state level. Accordingly, tax professionals should be prepared to defend taxpayers not liable for tax fraud against possible acts of overreaching under the new law by the Department, the Attorney General, or by local prosecutors. The New York legislature, a democratically elected body, has made a decision to impose severe criminal sanctions on dishonest taxpayers. The criminal sanctions imposed under the tax law prosecute and impose punishment for crimes which are undeniably malum in se. Yet, one can legitimately question whether the amalgam of tax statutes which operate to impose the same criminal sanction against one guilty of tax fraud involving $51,000 and a person who has committed armed robbery is fair. The felony characterization of the current tax law might violate both the Due Process Clause of the Fourteenth Amendment and the prohibition against cruel and unusual punishment of the Eighth Amendment.

Just as the Rockefeller drug laws of the 1970’s were repudiated in later years for imposing inappropriately severe sanctions for certain drug-related crimes, the possibility that a taxpayer convicted of tax fraud could now face incarceration for a lengthy number of years for a white collar crime not involving violence or theft is, at least to some, disturbing. It seems incongruous that a person who defrauds New York even by $1 million has committed a crime of the same moral turpitude as a person who commits premeditated murder.

In fairness to the Legislature, it should be noted that federal sentencing guidelines have also mandated longer prison terms for those guilty of tax fraud. Until 1987, most taxpayers convicted of criminal tax violations against the United States received probationary sentences. Under Federal Sentencing Guidelines, effective for tax crimes after November 1, 1993, taxpayers found guilty of federal tax crimes also stand an increased likelihood of being incarcerated for some period of time.