Wesley Snipes and the 861 Tax Avoidance Argument – White Collar Crime Speaker Chuck Gallagher Comments!

Just this morning I received this comment to one of my blogs:

“Don’t quit your day job and become an attorney because it looks like you really don’t know much about law.”

While I am not an attorney – never have been – the comment caused me to pause. I have been a CPA – Tax Partner in a CPA firm – and so I know a bit about tax law. However, I have focused on Wesley Snipes choices and the consequences that could have and did follow that I haven’t taken time to focus on his position, his prosecution and the outcome. So in the comments that follow I’ll try to break it down into manageable bits for those who want to know the thoughts behind Wesley’s actions.

First, let me say – so there is no miscommunication – I am not a CPA today. I lost my license years ago for making wrong choices. In fact, I was convicted for tax fraud and spent time in federal prison. Hence, not only was I trained formally (including a Masters with emphasis in tax), but I received a Ph.D. (s0 to speak) from the school of hard knocks – learning first hand the effect of choices and the consequences that can follow. So – I speak from training and experience.

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The Background: Wesley Snipes, for all I know, has been a law abiding citizen filing and paying his taxes like most normal folks for years. He has been successful and most would assume that he will continue to be – earning money from his services as an actor.

Somewhere back in the late ’90’s Snipes (unfortunately for him) came across two folks – Eddie Ray Kahn and Douglas Rosile – both of whom were promoters of an obscure position that a section of the tax code – Section 861 – somehow provided the ability for a US Citizen to avoid paying taxes on income earned within the US. Kahn has been described as a Veteran Tax Protester.

In August 2004 the following experts were part of a news release related to the tax protest activities of Eddie Ray Kahn and Douglas Rosile:

Eileen J. O’Connor, Assistant Attorney General for the Justice Department’s Tax Division, announced today that a federal court in Ocala, Florida has ordered four people and their businesses to stop preparing, selling, or marketing fraudulent tax schemes. The permanent injunction applies to Eddie and Kathleen (“Kookie”) Kahn of Sorrento, Florida; David Stephen Lokietz of Mt. Dora, Florida; Bryan Malatesta, a certified public accountant in Cleburne, Texas; and Eddie Kahn’s Mt. Dora, Florida businesses-American Rights Litigators (ARL), Guiding Light of God Ministries (GLGM), and Eddie Kahn and Associates.

“People who sell tax scams are cheating their customers as well as law abiding taxpayers,” said Assistant Attorney General O’Connor. “The IRS and Justice Department are working vigorously to protect the public and the U.S. Treasury from tax scams.”

The United States District Court for the Middle District of Florida entered the permanent injunction on August 12 after these defendants failed to respond to the Justice Department’s complaint. The court found that the defendants sold counterfeit checks, set up sham corporations (known as “corporations sole”) to help customers hide income and assets, and helped customers obstruct IRS investigations and collections by filing frivolous complaints against IRS employees. The order bars the defendants from selling these or any other fraudulent tax schemes and from representing customers before the IRS. The injunction also requires the defendants to send their customers a copy of the injunction and to refund to their customers all membership fees and other payments received for selling fraudulent tax schemes and services since 1996.

The court separately ordered that Eddie Kahn and Bryan Malatesta, who previously had been found in civil contempt of court for failing to obey the court’s preliminary injunction, be incarcerated until they turn over documents, including their customer list, to the Justice Department. To that end, the court directed the Clerk of the Court to issue bench warrants for the arrest and detention of Kahn and Malatesta until each complies with the previously entered injunction.

Now, let me first state – just because the government took this position does not mean that they were wrong. However, there is a clear difference between professionals (Tax Attorneys and CPA’s) who understand the law, the complexities of the law and the application of the law for tax avoidance purposes and those who can’t seem to find the legal boundary. The government’s position is that those named above have gone too far and crossed the legal line from tax avoidance into tax fraud.

Eddie Ray Kahn reminds me of Jim Jones – except that Kahn’s followers drink the “koolaid” of avoiding paying taxes or participating in the system. The “koolaid” in this case won’t kill them, but the consequences can be legally and financially devastating.

The 861 Argument: Tax avoidance promoters, like Eddie Ray Kahn, promote that tsections 861 through 865 of the Code permits an individual to take the position that either the individual or the individual’s U.S. based income is not subject to federal income tax. The arguments rely on sections 861 through 865 of the Code and the regulations (in particular, Treasury Regulation § 1.861-8) to argue that taxes are only imposed on income derived from certain foreign-based activities.

Kahn and others rely on this as a foundation for their positions that one does not have to pay taxes on US earned income. Likewise, there are other similar arguments that the IRS is not properly sanctioned and that there is no constitutional authority to tax citizens, etc. (the list goes on and on). Most of the folks sucked in by Kahn have elected not to pay taxes and not to file – claiming that there is not authority to compel such activity.

Snipes Actions: First, Snipes is just a well known figure who is a pawn at play here. Kahn sucked him in and in order to get Kahn (which the government did) they used the notoriety of Snipes to draw attention the the consequences than can follow choices like what Snipes made.

Snipes (now well documented) did the following:

  • After being indicted in 2006, actor Wesley Snipes sent a document to the Internal Revenue Service declaring he was a “nonresident alien” of the United States, refuting his Social Security number and warning that continued prosecution could lead to professional consequences for federal employees. Now honestly how dumb was that? It was clear that Snipes had, by this time, been drinking a lot of Kahn’s “koolaid.”
  • IRS Frivolous Return Program senior technical advisor Shauna Henline read excerpts of the document at his trial of the 600-page declaration signed by Snipes and sent Dec. 4, 2006, Snipes said he had “no ill intent or malice” and didn’t want to evade any lawful requirement to pay taxes. But he went on to say the government had “no lawful authority to impose any kind of criminal sanctions.” Snipes claimed (and that’s what saved his butt) that he just wanted the IRS to prove to him that he did have to file and pay taxes. Kahn, and others, promoted that one should not file or pay until the IRS satisfied their questions. They used that as a defense. In other words, don’t file or pay, rather push their issues or agenda with the IRS assuming that they would not get an answer and hence avoid the requirement to pay.
  • Snipes declared he had no taxable U.S. income, making the IRS Form 1040 “absolutely the wrong form for me to file.” He also claimed taxes withheld were “stolen funds.” Here’s where the 861 argument comes into play. Their position is that income earned in the US is not taxable therefore, since his income from acting was earned in the US – he obviously didn’t need to file a tax return.

Governments Position: As one can imagine, the IRS takes a different position. Treasury Regulations (some 29 pages) have been issued that define the meaning of Section 861. Click on the link if you want to mire up in the details. An excerpt defining income is shown below:

(a) Categories of Income.— Part I (section 861 and following), Subchapter N, Chapter 1 of the
Code, and the regulations thereunder determine the sources of income for purposes of the income
tax. These sections explicitly allocate certain important sources of income to the United States or to
areas outside the United States, as the case may be; and, with respect to the remaining income
(particularly that derived partly from sources within and partly from sources without the United
States), authorize the Secretary or his delegate to determine the income derived from sources within
the United States, either by rules of separate allocation or by processes or formulas of general
apportionment. The statute provides for the following three categories of income:

(1) Within the United States. The gross income from sources within the United States,
consisting of the items of gross income specified in section 861(a) plus the items of gross income
allocated or apportioned to such sources in accordance with section 863(a). See §§ 1.861-2 to
1.861-7, inclusive, and § 1.863-1. The taxable income from sources within the United States, in the
case of such income, shall be determined by deducting therefrom, in accordance with sections
861(b) and 863(a), the expenses, losses, and other deductions properly apportioned or allocated
thereto and a ratable part of any other expenses, losses, or deductions which cannot definitely be
allocated to some item or class of gross income. See §§ 1.861-8 and 1.863-1.

Likewise, not only has the government issued Treasury Regulations but Revenue Ruling 2004-30 was issued on March 22, 2004 related to frivolous tax returns and attempting to avoid taxes under section 861. The introduction of the Ruling states:

This ruling emphasizes to taxpayers, and to promoters and return preparers who assist taxpayers with tax schemes, that there is no authority in sections 861 through 865 of the Code that permits an individual to take the position that either the individual or the individual’s U.S. based income is not subject to federal income tax. The ruling also describes many of the possible civil and criminal penalties that apply to people who make frivolous section 861 arguments to evade tax.

Notice: If there is a Treasury Regulation that defines income and a Revenue Ruling that says don’t use this as a position to avoid taxes – one might assume that you would want COMPETENT tax advice – not advice from the likes of Eddie Ray Kahn and his “koolaid” crowd.

Conclusion: I have taken a keen interest in this trial, as I spent time in prison with others who were there for just the same reasons that Snipes took – taxes aren’t legal, income in the US isn’t subject to tax, etc. After prison, they decided that their minds were once again clear and they became law abiding citizens – avoiding the wrath of the IRS.

In Snipes case he had three things going for him: (1) he actually, to the jury, came across as a victim of Kahn’s ill advice – asking for information (albeit in a bizarre way), and acting not as a conspirator but just a misguided tax payer; (2) the race card was played early so it put the “all white jury” on notice that justice should be served. Had Snipes been convicted on all charges – it would have had racial overtones hence coloring the verdict (no pun is intended); and (3) Snipes had the benefit of star power. Notice that rarely do “stars” get the same treatment that plain folks seem to experience.

What’s next? The acquittal on the felony charge doesn’t relieve Snipes from his responsibility to pay taxes. The Internal Revenue Service can still sue him in civil court for back taxes for the years in which he didn’t file returns, from 1999 through at least 2004. The government says Snipes earned almost $38 million during that time.

Snipes is prepared to pay the taxes he owes for the years he didn’t file, Bernhoft, his attorney said.

“Mr. Snipes has always been committed to doing the right thing, and after this trial is over, he’ll make whatever amends are required. But this is a man of integrity.”

Prison for Snipes? Some how I doubt it – although I would be that the IRS would love to see some time served for Snipes convictions – even if it’s a short time like Martha Stewart. The message then would be clear.

The judge ordered a pre-sentencing investigation, which could take up to 75 days, but set no date for sentencing. He also reduced Snipes’ bond from $1 million to $250,000. Pending the sentencing hearing, Kahn will remain in custody, and Rosile will remain free on bond, the judge said.

Both Kahn and Rosile were convicted of tax fraud and will, no doubt, spend many years in federal prison.

The IRS will continue to aggressively pursue tax protesters, O’Neill said.

“We’re going to continue to go after those people, and I think you will see more indictments of tax protesters,” he said. “The IRS will go after all of those taxes.”

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As a professional speaker talking about business ethics and white collar crime (www.chuckgallagher.com) it is clear that this case will be talked about for years to come. One thing is for sure – a clear message was sent and when the smoke clears, I would bet that Snipes once again comes to his senses and files and pays his taxes. Hopefully, he won’t continue his protest – cause after this experience, he can’t claim that he just didn’t know.

NOW SNIPES KNOWS!

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One Response to Wesley Snipes and the 861 Tax Avoidance Argument – White Collar Crime Speaker Chuck Gallagher Comments!

  1. Instead of posting a comment I received this one by e-mail. It is shown here…

    Chucky Chucky,

    I would have preferred you had just paid us instead of fighting us and our strong arm the IRS. You know people like you never learn. We bought you lock stock and barrel in 1933. You know, the U.S. was bankrupt, HJR 192 and you poor little people could only turn to us for help. We, the International Bankers, took your american economy over in 1913 with the establishment of the Federal Reserve. Then 20 years later in ’33 not long after we collasped the market in ’29 we bankrupted your stupid little ass’s. You have to admit back then, most americans had just fallen of the hay stack. Really illiterate and dumb. So in ’33 we issued our notes of debt. You know, the FEDERAL RESERVE NOTES you twits call money. Have you morons ever read your dollar bills? Look stupid, read the word NOTES on the bill. In other words, NOTES of debt to us. Your president and congress in ’33 were paid handsomely for passing the legislation giving us the rightful ownership of all the land and territories of the United States, it’s possessions and most importantly it’s slaves (you and your fellow americans, dumb wit) and all the taxes we can collect from your labor to pay us back. But of course, you know you will NEVER pay us back cause you keep borrowing more than you pay back. We’re fat dumb and happy here forever.

    Now chucky, keep up the good work and tell those little peons we own them and their kids as a good sheperd owns his sheep. Well, we’re not exactly a GOOD sheperd. But yes, you keep telling those inconsequential little minded people in your country to pay those taxes or we will sick our IRS on them. As for you, don’t even think about fighting us ever again or your ass might end up in jail and you’ll never get out this time. Keep up the good work!!!!!

    Ciao ciao,
    chucky

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