Friday, January 02, 2009

The 861 Defense

This post is maybe only tangentially about cybercrime because it’s about an activity – what some would call a scam – that is primarily perpetrated via websites. The scam (which is what I’m going to call it) is an updated version of something that was going on when I clerked for a federal judge twenty years ago.

I’m going to use the facts in U.S. v. Marston, 517 F.3d 996 (U.S. Court of Appeals for the Eighth Circuit 2008) to illustrate what I’m talking about. In the 1990s, Clifford Marston was a Doctor of Podiatry in Springfield, Missouri. As the 1990s began to decline, so did his practice, which would up causing him what the opinion calls “considerable financial strain,” including a substantial amount of credit card and other debt. U.S. v. Marston, supra. In 1999, his daughter’s father-in-law showed Marston a website,
which taught that an individual had no legal duty to pay taxes on domestically earned income. After reviewing the website and conducting his own review of the tax code, Marston . . . came to the conviction that Congress had not authorized the collection of taxes on domestic income. On December 6, Marston acted upon this alleged belief and filed several amended employer's quarterly tax return forms 941 with the I.R.S., revising to zero all previously reported wages paid . . . for the 1996, 1997, and 1998 tax years, and requesting a refund of taxes previously paid in each corresponding year. Marston filed additional forms 941 on February 7, 2000 and March 23, 2000, revising to zero all of the employee wages paid . . . for the 1999 tax year. . . . For the 2000 tax year, Marston reported to the I.R.S., on forms 941, zero wages for the first two quarters and left blank all wage fields for the later two quarters. For the first quarter of 2001, he again filed a form 941 without any markings in any of the wage fields.
U.S. v. Marston, supra. He kept doing the same thing until he was indicted for tax evasion (26 U.S. Code § 7201) and for filing false documents (26 U.S. Code §7206(1)) with the IRS.

At trial (and again on appeal, because it didn’t work at trial), Marston relied on what is known as the “861 defense.” U.S. v. Marston, supra. At trial, Marston testified he had
formed the opinion that his income was non-taxable from several sources, including the statements of Thurston Bell and Larkin Rose, individuals who maintained separate websites advancing the so-called 861 defense, an argument that contends section 861 of the Internal Revenue Code permits taxation of only income derived from foreign sources.
U.S. v. Marston. Here’s how a federal court in Pennsylvania explained the 861 defense as advocated by Thurston Bell:
The Internal Revenue Code defines `gross income’ as `all income from whatever source derived. . . . ‘26 U.S.C. § 61(a). Bell claims the word `source’ in section 61 is defined in the `Source Rules and Other General Rules Relating to Foreign Income.’ 26 U.S.C. §§ 861-865. Section 861 states that certain `items of gross income shall be treated as income from sources within the United States....” 26 U.S.C. § 861(a). According to the [861 defense], domestically earned wages of U.S. citizens are not taxable because such wages are not specifically mentioned in the list of items of gross income that `shall be treated as income from sources within the United States.’ See 26 U.S.C. § 861(a). Bell concedes that section 861 itself does not exempt domestically earned wages of U.S. citizens. Nevertheless, he argues that such wages are not taxable because certain regulations promulgated under section 861 ( i.e. 26 C.F.R. §§ 1.861-8(a)(4), 1.861-8(f)(1), and 1.861-8T(d)(2)(ii)(A)) create an applicable exemption.
U.S. v. Bell, 238 F.Supp.2d 696 (U.S. District Court - Middle District of Pennsylvania 2003). (As the court noted, Bell had to concede that § 861 does not itself exempt domestically earned wages because § 861 specifically says that “[c]ompensation for labor or personal services performed in the” U.S. is to be treated as income from sources in the U.S..)

After Marston testified as to his belief that domestically-derived income is not taxable, the prosecutor cross-examined him. One of the things the cross-examination focused on was whether Marston knew “that Rose had been convicted of willful failure to file a tax return and that Bell had been enjoined from operating his website.” U.S. v. Marston, supra. The purpose, of course, was to cast doubt on Marston’s claim that he honestly believed the money he earned in the U.S. was not taxable and therefore did not have to be reported to the IRS. Marston admitted he had learned what had happened to Rose and Bell, but only after he had filed the forms with the IRS that provided the basis of the charges in the indictment. On further cross-examination, Marston admitted that he had continued to rely on Bell’s and Rose’s advocacy of the 861 defense even after he had learned one had been indicted and the other had been forced to shut down his website. U.S. v. Marston, supra.

We can’t know what was in the jury’s mind when they decided the case, but Marston’s testimony on cross-examination presumably convinced them that his alleged belief in the 861 defense did not prevent his having “willfully” evaded taxes and filed false documents with the IRS. To show Marston acted willfully, the prosecutor had to prove he committed a “voluntary, intentional violation of a known legal duty.” Cheek v. U.S. 498 U.S. 192 (1992). When I was in practice, prosecutors usually did this, in part, by showing that the defendant had paid taxes before he or she subscribed to a version of the 861 defense. That would no doubt have been true here, since Marston had apparently paid taxes up until 1999. And I assume the prosecutor argued to the jury that Marston’s knowledge that his two tax mentors had gotten into trouble with the government for this activity must have, and should have, eroded his belief in the 861 defense they advocated.

What I find interesting here is not what happened to Mr. Marston (whose conviction and sentence of 26 months in prison were upheld on appeal) but the fact that people who argue that we for some reason do not have to pay income tax are using websites to spread their theories without facing any real consequences. One of Marston’s mentors was apparently convicted of tax evasion, but as far as I’m concerned, that’s a subsidiary issue. I don’t know where all of this is now, but when I clerked for a federal judge and later encountered one of these cases in practice, what I saw was what I considered to be gullible people who had drunk a particular kind of Kool-Aid and wound up facing what were often really harsh consequences. I don’t know about Marston, but I saw people who not only faced criminal penalties, they also lost their homes, their jobs, their cars, everything because of the back taxes, penalties and other fees they owed the IRS.

And yes, I know, people shouldn’t be gullible, and we can’t protect people from their own stupidity. I quite agree with all that. What I’m saying, though, is that I don’t see why the people who provide the tax Kool-Aid don’t face criminal consequences themselves, by which I mean criminal consequences for spreading the 861 and other tax avoidance messages.

What the Department of Justice has been doing is obtaining injunctions that bar people like Bell from using websites or other media to spread information about the 861 defense “or any other abusive tax shelter, plan or arrangement that incites taxpayers to attempt to violate the internal revenue laws”. U.S. v. Bell, supra. In the Bell case, the Justice Department got such an injunction against Marston’s mentor, Thurston Bell, and the DOJ seems to have done the same with a number of others who had operated such sties. I think that approach is fine, as long as it actually works, i.e., as long as they don’t find some way of evading the injunction by, say, operating alias sites (or taking the sites outside the U.S., where they would functionally be beyond the reach of the DOJ and U.S. courts).

I’ve always wondered why the Department of Justice doesn’t prosecute people who operate 861 defense websites for aiding and abetting tax evasion and the filing of false tax documents. I realize there are First Amendment issues here, because people have a right to express their opinions about many things, including the tax laws. But some, at least, of these sites go beyond simply expressing an opinion about what is, and is not, “income.” Here’s how one court described what such a site – operated by the Save-a-Patriot-Fellowship (SAPF) – provided:
[T]hrough its website,, and other publications, SAPF informs its members of various products and services it offers for sale. SAPF represents that these products and services, if used as SAPF instructs, will enable members to legally stop paying income tax on their `U.S.-source income.’ For example, SAPF sells a document called an `Affidavit of Revocation and Rescission’ which [it] claims can be used to revoke the members' original applications for Social Security numbers. As a result of this `revocation,’ according to [SAPF], the individual is no longer obligated to file income tax returns or have taxes or Social Security contributions withheld from his or her earnings. SAPF also provides upon payment of an established fee a `Statement of Citizenship’ which members are instructed to give their employers to persuade those employers to stop withholding taxes from the SAPF member's wages.
U.S. v. Kotmair, 2006 WL 4846388 (U.S. District Court – District of Maryland 2006). It seems to me that selling documents the sole utility of which lies in facilitating tax evasion should qualify as aiding and abetting tax evasion. Those documents are, after all, tools the only use of which is for the commission of a crime.

(In the Kotmair case, btw, the court entered an injunction permanently barring the SAPF folks from using their website to continue their activities).

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