1. Memorandum
To:
Cc:
From: Jerry Woods
Date: March 27, 2014
Re: Income Tax Underreporting Issue
Issues
1. Whether underreporting federal income tax rises to the level of misdemeanor without an underlying
felony.
2. Whether a misdemeanor conviction under 26 U.S.C. § 7203 is appropriate for our client.
Brief Answers
1. No. Underreporting federal income tax can be either a misdemeanor or a felony, depending on intent.
It is possible to be guilty of underreporting under § 7203 without being found guilty under § 7201 of
committing an affirmative act with the intent to evade or defeat paying income tax. Further, it is
possible to be guilty of underreporting under § 7203 without being found guilty of intentionally
making false statements, which raises an underreporting offense to the level of a felony under § 7206.
2. Yes. Our client thought that he was not supposed to report the income that he invested in real estate
properties until after he sold them. Therefore, he did not commit an affirmative act with the intent to
evade or defeat paying income tax. Additionally, he made no intentionally false representations as to a
material matter when filing his tax returns.
Rules
Whether a defendant’s records show any attempt to falsify or conceal information relating to income is
relevant to the question of intent. United States v. Salisbury, 365 Fed.Appx. 622, 626 (2010), (Not
selected for publication in the Federal Reporter).
When pleading nolo contendere to willful failure to pay income tax, Defendant admitted to willfulness
and could not subsequently attack evidence which proved willfulness. United States v. Freed, 688 F.2d
24, 25-26 (1982).

2. In Freed, the Government theorized that the defendant transferred assets to his wife’s name and
channeled income to his sons to avoid paying income tax. The Court determined that the defendant acted
willfully. Defendant was convicted of willful failure to pay income tax under § 7203. 688 F.2d 24, 25
(1982).
A willful failure to supply information, file an income tax return, or pay income tax rises only to the level
of misdemeanor, while an affirmative act, showing intent, is required to bring tax violation to the level of
felony. United States v. Mal, 942 F.2d 682, 684 (1991), (citing Sansone v. United States, 380 U.S. 343, 351,
85 S.Ct. 1004, 1010, 13 L.Ed.2d 882 (1965); Spies v. United States, 317 U.S. 492, 496, 63 S.Ct. 364, 366, 87
L.Ed. 418 (1943)).
Defendant provided no explanation of why he did not report certain sales transaction funds as income.
Therefore, proposed witness testimony employing a “pool of capital” theory for “non-recognition for tax
purposes” was properly barred from trial. United States v. Kokenis, 662 F.3d 919, 927 (2011).
A resident alien who willfully makes and subscribes a false income tax return in which the government
loss in revenue exceeds Ten-Thousand Dollars ($10,000.00) commits an “aggravated felony” that
involves “fraud or deceit.” Kawashima v. Holder, 132 S.Ct. 1166, 1169, 182 L.Ed.2d 1 (2012).
Because the INA provision broadly refers to crimes committed with an element of fraud or deceit, an alien
who willfully submits a tax return which is false as to a material matter is guilty of committing a felony
under 26 U.S.C.A. § 7206(1). Id.
If a defendant willfully aids and assists in preparing a tax return which is false as to a material matter,
defendant is guilty of committing a felony under 26 U.S.C.A. § 7206(2). Id.
A professional tax preparer who prepared returns for himself and his wife included details “he must have
known to be false, including misstating their marital status,” is relevant when determining intent under
§ 7206. United States v. Watson, 433 Fed.Appx. 284, 287 (2011), (Not selected for publication in the
Federal Reporter).
…
Courts define a willful failure to perform a known legal duty, such as tax payment, tax return filing, and
information disclosure, as an offense that rises to the level of a misdemeanor under 26 U.S.C. § 7203
because the willfulness lacks the additional element of an affirmative or deceitful act. United States v.
Salisbury, 365 Fed.Appx. 622, 626 (2010), (Not selected for publication in the Federal Reporter).

3. In Salisbury, the defendant thought that the antique firearms he purchased using income earned from
previous sales were not to be reported as income until he sold them. Id. at 629. He therefore understated
his income in the amount of approximately Nine-Hundred Twenty-One Thousand, One-Hundred
Twenty-One Dollars ($921,121.00). The court determined the tax loss to be in excess of One Million
Dollars ($1,000,000.00) once penalties and interest were factored. Id. at 625.
In its discussion of what determines willfulness, the court in Salisbury reasoned that the defendant had to
demonstrate through his actions that he voluntarily and intentionally violated a known duty. Id. at 628
(citing United States v. Pomponio, 429 U.S. 10, 12-13, 97 S.Ct. 22, 50 L.Ed.2d. 12 (1976)). To illustrate
this, the court pointed out that the defendant’s underreporting, combined with the fact that earnings
from many of his gun sales transactions were funneled to his girlfriend’s account instead of his own,
created “an inference of dishonesty,” therefore supporting willfulness. Id. at 629.
The defendant argued that “the government never proved that he willfully chose not to report his profits
in the years of the transactions as opposed to the years when he cleared out all of his gun inventory.” Id. at
628. However, the court noted that the defendant received a One-Hundred, Fifty-Thousand Dollar
($150,000.00) commission “for one transaction that never showed up in his taxes for the relevant year”
and that he received checks from an artist who sold artwork to the museum where the defendant was
employed, and these also went unreported. Id. at 629.
The court concluded that even the defendant’s amendment attempts did not “show that he made a full
and accurate report of all material facts” at the time when he filed, which was sufficient to support a
finding of willfulness. Id. at 628.
…
Courts have determined that by pleading nolo contendere to a willful failure to pay income tax, a
defendant is admitting to willfulness that cannot be subsequently attacked as insufficient for a finding of
willfulness. United States v. Freed, 688 F.2d 24, 25-26 (1982).
In Freed, the defendant, an attorney, claimed that he was at a Five-Hundred, Eighty-Seven Dollar and
Fifty-Cent ($587.50) deficiency after paying his mortgage, his son’s salary, and various living and
entertainment expenses, despite gross earnings of Fifty-Thousand Dollars ($50,000.00). Id. at 25. The
defendant believed that the evidence against him was insufficient for a conviction under § 7203 because of
a 1976 bankruptcy filing which discharged his 1972 tax liability. Id.
The court reasoned that the 1976 discharge had no real relevance to the charge of willfulness because the
tax years in question were 1973, 1974, and 1975 - not 1972. Id. at 25. Further, the court determined that by

4. pleading nolo contendere, the defendant was admitting his guilt and therefore could not challenge the
evidence against him at a later time. Id. at 26.
The court concluded that the defendant’s conviction to three counts of willful failure to pay income tax
under § 7203 was appropriate. Id. at 26.
...
Courts recognize that a willful failure to perform a known legal duty, such as tax payment, tax return
filing, and accurate information disclosure, is an action that does not automatically give rise to a felony
offense under 26 U.S.C. § 7201, which requires an additional affirmative act. United States v. Mal, 942
F.2d 682, 684 (1991), (citing Sansone v. United States, 380 U.S. 343, 351, 85 S.Ct. 1004, 1010, 13 L.Ed.2d
882 (1965); Spies v. United States, 317 U.S. 492, 496, 63 S.Ct. 364, 366, 87 L.Ed. 418 (1943)).
In Mal, the defendant filed W-4 forms with his employers stating that he was exempt from federal income
tax withholding. During this time, he did not file a return or pay income tax. The defendant believed that
he was not required to pay income tax because “his income was offset by moving expenses, interest
payments, and alimony and child support obligations.” Id. at 684.
In its discussion of what constituted a felony under § 7201, the court reasoned that the government has
the burden of proving that “the income tax was due and owing from the government, an affirmative act
in any manner to evade or defeat an income tax” had been committed, and “that the defendant’s attempt
to evade and defeat the tax was willful.” Id. at 685.
The defendant argued that jury instructions did not fully explain “that an affirmative act must be a
commission[,]” not merely “an omission.” Id. Additionally, he questioned the use of two different
definitions of the word “attempt” used throughout the trial, contending that these errors “‘left open the
possibility’ that the ‘jury may have convicted him solely on the basis of an omission rather than an
affirmative act.’” Id.
The court concluded that the jury instructions provided “did not constitute plain error” and that the jury
was given very clear and proper instruction on the requirements for a § 7201 violation in order for the
government to prove guilt beyond any reasonable doubt. Id. at 686 (citing Fournier, 861 F.2d at 149).
…
Courts define good faith as “a claim that [the defendant] did not act willfully.” Courts go on to define
willfulness as a “voluntary and intentional violation of a known legal duty or the purposeful omission to

5. do what the law requires.” United States v. Kokenis, 662 F.3d 919, 930 (2011) (quoting United States v.
Brimberry, 961 F.2d 1286, 1291 (7th Cir. 1992)).
In Kokenis, the defendant, president of Delta Oil and Delta Energy, instructed his accountant to prepare
tax returns showing transactions as liabilities instead of the sales they truly were for tax years 1997-2000.
These transactions were in excess of $6.3 Million ($6,300,000.00). Id. at 923. Orlando Mondero, Delta
Oil and Delta Energy’s controller and accountant, contacted the IRS in 1998 concerning fraudulent
transactions. Id. at 922.
In its discussion of what constitutes good faith, the court reasoned that the government had the burden
of proving that the defendant acted willfully and that he did not “believe that the tax return was true,
correct, and complete as to every material matter.” Id. at 930.
The defendant challenged Mondero’s honesty and argued that the government did not prove willfulness.
Further, he argued that testimony by five witnesses which would have supported his good faith argument
was barred. Id. at 926. The court reasoned that the evidence the defendant wanted to introduce was
irrelevant and otherwise misleading or confusing. Id. at 928. Additionally, the court stated that the
evidence provided did not support a showing of good faith. Id. 929-930.
The court held that the defendant was not entitled to a good faith instruction because the evidence
presented showed that he acted willfully. Id.
…
Courts acknowledge the definition of deceit is “‘the act or process of deceiving (as by falsification,
concealment, or cheating).’ Webster’s Third New International Dictionary 584 (1993).” Id. at 1172.
In Kawashima, the defendant’s were resident aliens who intentionally and knowingly made and assisted
in making false statements on their income tax returns. Because the loss to the government exceeded
Ten-Thousand Dollars ($10,000.00), the court concluded that the defendants committed an “aggravated
felony” that involved “fraud or deceit,” characterized in the Immigration and Nationality Act §
101(a)(43)(M)(i), 8 U.S.C.A. § 1101(a)(43)(M)(i), which classifies removable offenses. Id. at 1169.
The defendants argued that they should not be found guilty under 26 U.S.C. § 7206, but instead under §
7201. The defendants then argued that, because of ambiguities that existed in the language of §
1101(a)(43)(M)(i) and (ii), the court should rule in favor of the defendants. Id. at 1176.
However, the court reasoned that because Clause (i) addressed felonies more broadly, Clause (ii) was
developed to ensure that income tax evasion was a deportable offense under § 7201. Id. at 1175.

6. The court held that the convictions under § 7206 were appropriate because they constituted aggravated
felonies under Clause (i) involving fraud and deceit. Id. at 1176.
Application
Similarly to our client’s scenario, the defendant in Salisbury underreported his income from the sale of
antique firearms with the intent to report his profits once these weapons were sold. Id. at 625. The court
found defendant was aware of his duty to pay income tax based on other income reported. Id. at 629. The
tax loss to the government, after interest and penalties were calculated, exceeded One Million Dollars
($1,000,000.00) Id. at 625. Our client mistakenly underreported his income believing that he was
supposed to report his income once the properties were sold.
The defendant in Salisbury made substantial profits from the transactions but failed to pay all of the tax
due. “He reported no relevant income in the first year, and $247,888 in ‘seller premiums’ (listed under
capital gains) in the second.” Defendant later “filed amended tax returns to account for some, though not
all, of the additional income from his gun sales.” Defendant’s explanation was that he “thought items
were not to be reported as income until sold.” Id. at 625.
Originally, the defendant was charged by the government with wire fraud and conspiracy to commit tax
evasion. The jury acquitted the defendant of these charges but found him guilty of two misdemeanor
counts of willful failure to pay tax under § 7203. Id. at 625.
Unlike our client’s scenario, the government theorized that the defendant in Freed actually transferred
funds to his wife and his sons in order to avoid paying income tax. The defendant was an attorney whose
gross income was approximately Fifty-Thousand Dollars ($50,000.00) for at least one of the years in
question. But after making mortgage payments on a house that he transferred to his wife’s name, paying
his son’s salary, and paying other expenses, the defendant claimed that he was actually Five-Hundred,
Eighty-Seven Dollars and Fifty-Cents ($587.50) in debt and could not pay his taxes. Id. at 25.
The defendant in Freed argued that the evidence that the government presented was insufficient for a
conviction because the record demonstrated that he was unable to pay tax. Further, since he filed for
bankruptcy in 1976, he was released from his 1972 tax liability. It was his opinion that because of this, the
government could not find the defendant guilty of willfulness. However, the court pointed out that the
indictment had nothing to do with his taxes owed for that year. Instead, the government’s argument
relied on the defendant’s willfulness for tax years 1973, 1974, and 1975. Id. at 25.
Because of the defendant’s plea of nolo contendere, the court reasoned that the defendant was admitting
his guilt to the offenses detailed in the indictment. Therefore, he could not challenge the evidence against

7. him at a later time. The court found the defendant guilty of three counts of willful failure to pay income
tax under 26 U.S.C. § 7203. Id. at 26.
Mal differs greatly from our client’s scenario because, during his time as a steamfitter, the defendant did
not file a return or pay income tax. The court reasoned that to be found guilty of a felony under § 7201,
the government has the burden of proving that the defendant owed the income tax in question by the
government, that the defendant committed an affirmative act to evade or defeat the tax in question, and
“that the defendant’s attempts to evade and defeat the tax was willful.” Id. at 685. Our client did file his
return and he paid income tax.
Although the defendant in Mal argued that he thought his tax commitment was justifiably offset by
moving expenses, child support, and alimony, the court determined that the defendant “violated § 7201
by (1) failing to file tax returns; (2) failing to pay a tax; and (3) filing a false W-4 form.” The defendant
intentionally filed a false W-4 form, which ultimately “constitute[d] a sufficient affirmative act to
support a felony tax evasion prosecution” for which he was ultimately convicted. Id. at 685.
Also distinguished from our client’s issue, the defendant in Kokenis, president of Delta Oil and Delta
Energy, told his accountant to reverse sales transactions and reapply these as liabilities so that he would
appear to owe the government no income tax. These transactions exceeded $6.3 Million ($6,300,000.00).
Id. at 923. Orlando Mondero, Delta Oil and Delta Energy’s controller and accountant, contacted the IRS
concerning fraudulent transactions. Id. at 922.
The defendant challenged Mondero’s honesty and argued that the government did not prove willfulness.
The defendant wanted to present a “pool of capital theory,” arguing that doing so “would [ ] provide[ ] a
layer of credibility to [his] argument that he did not act willfully when he proposed to [his controller and
accountant] that the sales transactions not be reported as income[.]” Id. 929-930.
The defendant also argued that testimony by five witnesses would have shown good faith and proven
that the defendant was entitled to a good faith instruction. This testimony was barred because it was
deemed irrelevant, misleading, and confusing. Id. at 927. Additionally, the court stated that the evidence
provided did not support a showing of good faith because the defendant’s pool of capital theory could
not be applied to any of the transactions and there was no proof that the funds received would ever be
used specifically for future development. Id. at 929.
When determining what constitutes good faith, the court reasoned that the government had the burden
of proving that the defendant acted willfully and that he knew that the tax return was not “true, correct,
and complete as to every material matter.” Id. at 930.

8. Although the court noted that good faith could be demonstrated if willfulness could not be proven, the
court in Kokenis concluded that the evidence provided did not support a showing of good faith.
Therefore, the defendant was not entitled to a good faith instruction because the evidence presented
showed that he acted willfully. Id. 929-930.
Our case differs from Kawashima because the court in that case found Mr. Kawashima guilty of
knowingly and willfully submitting a tax return which was false as to a material matter under § 7206(1).
Id. at 1172-1173. The court found Mrs. Kawashima guilty of willfully aiding and assisting in preparing or
presenting a tax return which is false as to a material matter under § 7206(2). Id. at 1173.
The defendants argued that, instead of being charged under § 7206, they should be charged under § 7201
and that because of ambiguities in the language used in 8 U.S.C. § 1101(a)(43)(M)(i) and §
1101(a)(43)(M)(ii) pursuant to § 7201, the court should rule in favor of defendants. Id. at 1176 (2012).
The court in Kawashima noted that “[w]hen subparagraph (M) was enacted, the term ‘deceit’ meant ‘the
act or process of deceiving (as by falsification, concealment, or cheating).’ Webster’s Third New
International Dictionary 584 (1993).” Id. at 1172. Further, the court reasoned that while “it is still true that
the elements of tax evasion pursuant to 26 U.S.C. § 7201 do not necessarily involve fraud or deceit,”
(Emphasis in original), § 1101(a)(43)(M)(ii) was not intended to remove “all other tax offenses from the
scope of Clause (i)’s plain language. Rather, it was intended to “ensure that tax evasion pursuant to § 7201
was a deportable offense.” Id. at 1175.
The court in Kawashima held that the convictions under § 7206 were appropriate because the defendants
committed felonies which involved fraud and deceit. Id at 1176.
The Internal Revenue Expedited Plea Program
The goal of the Expedited Plea Program is to provide a speedy but appropriate resolution to investigation
and prosecution, serving the interests of the taxpayer and the government. Therefore, investigations
under this program do not require the same level of preparation as normal tax investigations. However,
they do require procurement of sufficient evidence to meet Federal Rules of Criminal Procedure 11 (b)(3)
(Fed. R. Crim. P. 11(b)(3)) requirements to establish a referable matter. Also, the investigation charges
must appropriately address the taxpayer’s crimes. I.R.M., 9.6.2.2.1.1. (2004).
Of particular importance to our case, for the plea agreement to be acceptable under the program, it must:
1. involve legal source income
2. establish culpability for the violations charged
3. include the most significant violation

9. 4. consider the totality of the fraud committed by the taxpayer
5. not reduce tax return felony counts to misdemeanors
Taxpayers who wish to use the Expedited Plea Program are expected to cooperate fully with the IRS in
determining and satisfying tax liability. Criminal aspects must also be addressed. The appropriate IRS
division will complete any unresolved civil investigation should the criminal investigation be completed
through the use of these procedures without establishing proper civil liability. Id.
Conclusion
Under current tax law, the above cited cases suggest that if an individual willfully failed to pay his income
tax, willfully failed to file his income tax, or willfully failed to supply information, pursuant to 26 U.S.C.
§ 7203, underreporting federal income tax rises to the level of misdemeanor but is not so serious as to rise
to the level of a felony. The above cited cases also suggest that if an individual commits an affirmative act
with the intent to evade or defeat paying income tax pursuant to § 7201, the offense rises to the level of a
felony. If an individual intentionally and knowingly makes a false statement on a tax return or
intentionally and knowingly assists in making a false statement on a tax return, the offense rises to the
level of a felony under § 7206.
In our scenario, our client failed to supply necessary information to the IRS based on his belief that he was
not supposed to report this income until after properties he invested in were sold. Therefore, our client
did not knowingly submit a tax return which was false as to a material matter.
I strongly recommend that all concerned parties carefully consider the circumstances noted in the above
cases when weighing our client’s options. Further, after a very careful review of the facts in our client’s
case, when compared to the above cases, the only reasonable conclusion that I can draw is that he is guilty
of a misdemeanor under 26 U.S.C. § 7203 and not guilty of a felony under § 7201 or § 7206.