Lead Opinion
Opinion by Judge IKUTA; Dissent by Judge KOZINSKI.
Michael Kayser appeals from his conviction for tax evasion in violation of 26 U.S.C. § 7201 for the year 2000. He alleges, among other things, that the district court erred in failing to instruct the jury in accordance with his theory of defense. We have jurisdiction under 28 U.S.C. § 1291 and we reverse and remand.
BACKGROUND
From November 1998 to May 2000, A2Z USA, Inc. (“A2Z”) employed Kayser first as a salesperson and later as a vice president for its Internet-based shopping mall. A2Z compensated Kayser as an independent contractor and paid him a commission by checks made out to his name. In July 1999, Kayser incorporated Aspen Ventures Inc. (“Aspen Ventures”) to receive A2Z income and take business deductions related to that income.
After failing to file timely tax returns for 1998 through 2000, Kayser ultimately filed his delinquent individual and corporate tax returns for those years in August 2001. Kayser was subsequently indicted on two counts of attempted income tax evasion (for 1999 and 2000) in violation of 26 U.S.C. § 7201.
However, Kayser did report $49,026 in deductible business expenses on Aspen Ventures’ 2000 return. These deductions were composed of automobile expenses, office expenses, utilities, travel and entertainment expenses, and rents. Kayser’s accountant testified that the deductions were calculated from receipts and records maintained by Kayser. As reported, the expenses generated a net operating loss of $49,026 on Aspen Ventures’ 2000 return, which Kayser then carried back to eliminate the corporate taxes owed by Aspen Ventures on the income it reported for 1999.
The government alleged that Kayser willfully structured his individual and corporate returns in the manner described above to evade taxes, and that as a result of this improper reporting, Kayser was able to declare virtually no tax due on the $145,000 or more he received from A2Z as income in 1999 and 2000.
At trial, Kayser’s primary theory of defense was that he had not willfully evaded paying taxes. During the course of the trial, Kayser raised a second theory, namely, that the A2Z income he failed to report on his individual return in 2000 should be offset by the $49,026 in business deductions he improperly reported on Aspen Ventures’ corporate returns in 2000 and carried back to 1999. This theory was supported by two principal pieces of evidence. First, Kayser testified that he incurred the entire $49,026 in business deductions in connection with the production of the individual A2Z income he received in 2000. In addition, Kayser’s accountant and the government’s expert both testified that an independent contractor’s legitimate and allowable business deductions could generally be used to reduce business income on an individual return.
On the last day of trial, Kayser asked the district court to approve the following jury instruction: “If the defendant had unclaimed deductions which would have offset his tax liability such that there was no tax due and owing, then there is no tax deficiency.” The government argued that this instruction was unwarranted because Kayser had introduced no evidence of previously “unclaimed” deductions. The government also argued that Kayser’s theory of defense was improper under United States v. Miller,
The district court agreed with the government and declined to give the request
Following trial, the jury found Kayser guilty of tax evasion for the year 2000, but failed to reach a unanimous verdict on the count concerning tax evasion in 1999. On appeal, Kayser argues that the district court erred by rejecting his proposed jury instruction.
DISCUSSION
Kayser contends he was entitled to a jury instruction on his theory that the government could not prove there was a tax deficiency in 2000 if Kayser had sufficient allowable business expenses to offset his unreported A2Z income for that year. Our cases hold that “[a] defendant is entitled to have the judge instruct the jury on his theory of defense, provided that it is supported by law and has some foundation in the evidence.” United States v. Fejes,
A.
We first consider whether Kay-ser’s proposed instruction was erroneous as a matter of law. The elements of attempted income tax evasion under 26 U.S.C. § 7201 are: (1) willfulness; (2) the existence of a tax deficiency; and (3) an affirmative act constituting an evasion or attempted evasion of the tax. Sansone v. United States,
A defendant may negate the element of tax deficiency in a tax evasion case with evidence of unreported deductions. See United States v. Marabelles,
Notwithstanding the greater sophistication of Kayser’s alleged tax evasion scheme, Marabelles and ElweH are controlling in Kayser’s case. Like the defendants in those cases, Kayser failed to report income on his individual return and was entitled to demonstrate at trial that he had deductions that could offset this previously unreported income. See Marabelles,
The government, however, argues that United States v. Miller prohibits a defendant who reports his income and deductions in one manner from arguing for an alternative characterization at trial. See Miller,
Contrary to the government’s argument, Miller does not preclude a defendant in a tax evasion case from asserting a defense that is inconsistent with information falsely reported on his challenged tax returns. Miller,
Miller tried to convince the district court to apply certain technical tax rules to transform a taxable diversion of funds into a non-taxable return of capital. Id. at 1210-14. Miller argued that a court must automatically treat funds diverted by a shareholder from a closely held corporation as a constructive corporate distribution, pursuant to a rule established in civil tax decisions. Id. Under the facts of his case, Miller contended that such a distribution would be a non-taxable return of capital. Id. at 1211 & n. 9. Therefore, the government could not prove a tax deficiency and Miller could not be convicted of tax evasion. Id. at 1211-12.
We rejected Miller’s theory, holding that the civil constructive distribution rules did not automatically apply in a criminal tax evasion case. Id. at 1214-15. Instead, we held that a criminal defendant wishing to raise a “return-of-capital” defense had to introduce evidence that the diverted funds were, in fact, a return of capital. Id. at 1215. For example, the defendant could demonstrate that the diverted funds were intended to be a return of capital by showing an adjustment in the corporate records indicating a reduction in his basis at the time of distribution. See id. at 1215.
Consistent with this ruling, Miller was allowed to present evidence to establish his return-of-capital defense at trial. See id. at 1215-16. However, the record did not support his defense: among other things, there was a substantial question whether Miller was even a shareholder of the corporation who could receive payments as a return of capital. Id. Based on the evidence, the district court concluded that the diverted funds constituted additional taxable salary, rather than a non-taxable return of capital. Id. at 1215. We held that the district court’s conclusion was not clearly erroneous. Id. at 1215-16.
Neither we nor the district court suggested that Miller was bound by the original characterization of the diverted funds, i.e., the corporation’s characterization of the diverted funds as “repayments of loans” or Miller’s failure to report the
The import of our holding in Miller is that a defendant remains free to present evidence that funds diverted from a corporation are a non-taxable return of capital, regardless of the manner in which he or the corporation originally reported the transaction. See id. at 1214-16; see also Boulware II,
Following Marabelles and Elwert, we hold that if Kayser had business expenses that were allowable offsets against his individual income, he had the right to show them and explain them as part of his defense for tax evasion. Marabelles,
B.
Having concluded that Kayser’s theory of defense represents a correct application of Marabelles and Elwert, we next turn to the question whether Kayser established an adequate foundation in the record to warrant an instruction on this theory. The legal standard is generous: “a defendant is entitled to an instruction concerning his theory of the case if the theory is legally sound and evidence in the case makes it applicable, even if the evidence is weak, insufficient, inconsistent, or of doubtful credibility.” United States v. Washington,
We review the district court’s conclusion that Kayser’s proposed instruction was not supported by sufficient evidence for an abuse of discretion. Fejes,
Kayser’s theory of defense was that the jury should apply the $49,026 in deductions he initially reported on his corporate tax return in 2000 to eliminate the deficiency on his personal return for that year. Under Marabelles and Elwert, this theory required Kayser to establish two elements: First, Kayser had to show that the $49,026 represented legitimate business expenses actually incurred by him in an individual capacity. Second, Kayser had to demonstrate that the $49,026 of business expenses represented “allowable” deductions on his individual return within the meaning of the Tax Code. Marabelles,
Through his own testimony, and the testimony of his accountant, Kayser presented evidence that he maintained records and receipts of his business expenses and that from those records, his accountant calculated the $49,026 of business expenses reported on Kayser’s corporate return. Kayser further testified that all of the $49,026 in business expenses was incurred in connection with his previously unreported individual A2Z income for 2000.
We also conclude that there was sufficient evidence from which a rational jury could find that the $49,026 represented allowable business expenses with respect to Kayser’s personal return. The record included Aspen Ventures’ 2000 tax return, which detailed that the business deductions in the amount of $49,026 were composed of automobile expenses, office expenses, utilities, travel and entertainment expenses, and rents. The government did not challenge either the character, amount, or validity of the expenses. At the same time, both the government’s expert and Kayser’s accountant testified that as a general matter, business expenses of the type reported on Aspen Ventures’ 2000 return could be used to reduce business income on an individual return. This evidence, though arguably weak, was sufficient to allow a rational jury to sustain Kayser’s defense. The district court therefore abused its discretion in failing to instruct the jury on this theory.
C.
We thus conclude that the requested jury instruction was supported by law and had sufficient foundation in the evidence. Because the district court erred in declining to instruct the jury on Kayser’s theory of defense, we reverse Kayser’s conviction.
REVERSED and REMANDED.
Notes
. Section 7201 provides:
Any person who willfully attempts in anymanner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.
. Testimony at trial indicated that Kayser received either $41,765 or $53,445 in income from A2Z in 2000 and that this income should have been reported on Kayser’s individual return for 2000.
. Boulware II does not hold otherwise. In Boulware II, the government moved in limine to preclude the defendant from introducing expert testimony that the diverted funds could be deemed a constructive dividend constituting a return of capital.
. Kayser did not argue that the $49,026 in business deductions he reported on Aspen Ventures' 2000 return "flowed through” Aspen Ventures to his individual return. The government’s argument that Aspen Ventures is not a flow-through entity is therefore irrelevant.
. The dissent contends that "Kayser made only very broad statements that the deductions relate to his personal income, and even then he hedged quite a bit.” Dissent at 1081. However, as the dissent acknowledges, on direct examination, Kayser specifically and unambiguously testified that "every deduction” reported on Aspen Ventures’ 2000 corporate return related directly to Kayser’s A2Z income. The prosecution made effective use of its cross-examination to raise doubts about the assertions Kayser made on direct examination. While Kayser's stumbling answers on cross-examination may further weaken the evidence supporting his defense, under our case law, Kayser is entitled to his proposed instruction even if the evidence supporting his theory of defense "is weak, insufficient, inconsistent, or of doubtful credibility.” Washington,
. In discussing the weakness of Kayser’s evidence, the dissent merges the two separate counts of Kayser’s indictment by noting that "[t]o escape conviction, ... Kayser had to show that he had enough deductions to shelter both his 1999 and 2000 income.” Dissent at 1080 (emphasis in original). There is no dispute that Kayser did not have sufficient deductions to offset both his 1999 and 2000 income. However, Kayser may still raise a deficiency defense with respect to the second count of his indictment (relating to the 2000 tax year) when a rational jury could conclude that Kayser had sufficient allowable deductions to negate the government’s proof of deficiency with respect to that year.
. Kayser argues that any instructional error by the district court cannot be harmless. See United States v. Escobar de Bright,
Kayser also argues that he was wrongfully prevented from introducing evidence to support his theory of defense and that the district court misapplied the Sentencing Guidelines in determining the total tax loss by refusing to reduce Kayser’s 2000 unreported income by the deductions he reported on Aspen Ventures’ 2000 return and carried back to 1999. Given our reversal and remand for a new trial, we do not reach these issues.
Finally, Kayser asserts that his indictment should be dismissed because the grand jury was improperly instructed. However, as Kay-ser acknowledges, our precedent has squarely rejected his position and we therefore affirm the district court’s denial of Kayser's motion to dismiss the indictment. See United States v. Navarro-Vargas,
Dissenting Opinion
dissenting.
The majority begins its analysis by dutifully reciting a well-established rule: “A defendant may negate the element of tax deficiency in a tax evasion case with evidence of unreported deductions.” Maj. op. at 1073 (citing United States v. Marabelles,
1. Kayser was charged with tax evasion for failing to report income on his 2000 individual return. His proposed instruction would have allowed the jury to apply the $49,026 in deductions, which he had reported on his corporate tax return, to his personal income. As the government argued at trial, this defense is foreclosed by Miller. In Miller, we dealt with a highly analogous situation, where the taxpayer wished to re-characterize a distribution from his corporation as a return of capital, rather than as a dividend. Miller’s argument, like Kayser’s, was that what mattered was the reality of the transaction, not the way he initially papered it. We rejected this contention. Our rationale for reaching this conclusion is highly instructive:
In civil tax cases the purpose is tax collection and the key issue is the establishment of the amount of tax owed by the taxpayer. In a criminal tax proceeding the concern is not over the type or the specific amount of the tax which the defendant has evaded, but whether he has willfully attempted to evade the payment or assessment of a tax. Goldberg, supra,330 F.2d at 40 ; Simon, supra,248 F.2d at 876 .
The difficulty in automatically applying the constructive distribution rules to this case is that it completely ignores one essential element of the crime charged: the willful intent to evade taxes, and concentrates solely on the issue of the nature of the funds diverted. That latter aspect is not the important element. Where the taxpayer has sought to conceal income by filing a false return, he has violated the tax evasion statutes. It does not matter that that amount could have somehow been made non-taxable if the taxpayer had proceeded on a different course.12 To apply the constructive distribution rules to this situation would nullify all of the taxpayer’s prior unlawful acts.
Miller,
Under this rule, a defendant in a criminal tax case is bound by the way he papered the transaction at the time he earned the income in question. In Miller, the taxpayer was bound by the fact that his corporate books did not reflect the distribution as a return of capital. That he could later, as a matter of economic reality, claim that the distribution was a return of capital was of no consequence, because contemporaneously maintained records did not support that re-characterization. Miller went on to explain:
In holding that the constructive distribution rules should not automatically be applied, it is not herein asserted that diverted funds could never be a return of capital. However, to constitute thelatter, there must be some demonstration on the part of the taxpayer and/or the corporation that such distributions were intended to be such a return. To hold otherwise would be to permit the taxpayer to divert such funds and if not caught, to later pay out another return of capital; or if caught, to avoid conviction by raising the defense that the sums were a return of capital and hence nontaxable.
Although this rule creates some tension with Marabelles and Elwert,
The IRS, however, did audit Kayser and found that he had underreported his personal income in 2000. If the deductions are shifted from his corporate to his individual return, this would affect his 1999 corporate tax liability. The same deductions cannot be used twice: He can either use them to wipe out his 2000 personal income or he can carry them back to wipe out his 1999 corporate income. Having chosen to do the latter when he filed his returns, the deductions are used up and are not available to offset his 2000 personal income. Contrary to the majority’s holding, Marabelles and Elwert are thus not on point because Kayser does not have allowable deductions that were not reported on his return. Even if the deductions in question could have been treated as personal deductions, had Kayser claimed them as such on his individual return, the district court properly concluded that Kay-ser is stuck with the way he reported them at the time — which was as corporate deductions. To let him now go back and treat the deductions as applicable to his personal income allows for precisely the kind of heads-I-win, tails-the-government-loses scenario that Miller sought to foreclose.
2. Even under the majority’s new rule, the district court did not abuse its discretion in refusing to give the proposed instruction because Kayser did not present sufficient evidence to warrant the instruction. Kayser needed to establish that he had enough allowable deductions to elimi
Kayser reported $49,026 in business expenses on his 2000 corporate return and carried back these expenses to eliminate his corporate tax liability for 1999. He was able to carry back these losses because he failed to report $41,765 of personal income from A2Z in 2000 and thus had no 2000 reported income against which to claim deductions.
But the 1999 tax year was not beyond the government’s reach. In fact, Kayser was being tried for tax evasion for both 1999 and 2000. To escape conviction, therefore, Kayser had to show that he had enough deductions to shelter both his 1999 and 2000 income. There just weren’t enough deductions to do this. On his 1999 corporate return, Kayser reported $104,532 in income; he paid taxes on none of it because he claimed $111,061 in deductions to wipe out his 1999 corporate income — including $49,026 in carryback losses from 2000. If he shifted $41,765 of these deductions to cover his unreported income for 2000, that would have left him only $69,296 in deductions for 1999 to offset the $104,532 in income reported on his corporate return. Thus, even assuming Kayser were allowed to reassign some or all of his deductions from 1999 to 2000, he would have some unsheltered income in one or both years; the majority admits as much. See maj. op. at 1077 n. 6.
Note that Kayser made only very broad statements that the deductions relate to his personal income, and even then he hedged quite a bit: He claimed he would have attempted to declare some of those deductions on his individual return. He didn’t say what portion of the $49,026 he would have claimed; it could have been $41,765 or more, or it could have been less. It’s even less clear when we consider his backtracking on cross-examination: He admitted that some of the expenses “could have been” attributable to Aspen Ventures, and that the expenses “were primarily due to the consulting business as well as Image Network.” Again, we don’t know which portion. As the majority notes, it is defendant’s burden to show that the claimed expenses would have reduced his income to zero for the relevant tax year (here 2000). Maj. op. at 1073-74 (citing Marabelles,
Even assuming Kayser had testified that he would have claimed all the deductions on his individual return, this wouldn’t have been enough. To wipe out his 2000 unreported income, Kayser also had to show that the deductions would have been allowable. See maj. op. at 1076 (citing Marabelles,
This brings us down to the accountant’s testimony. Kayser’s accountant (who was the government’s witness) testified on direct that “[i]f the deductions were attributable to Mr. Kayser and had he paid those personally, he could have deducted those personally ... and the tax return for the corporation would have been nonexistent; it just would have been a zero return.” (Emphasis added.) On cross-examination, the accountant testified that “if
The majority seems to think it’s sufficient that “both the government’s expert and Kayser’s accountant testified that as a general matter, business expenses of the type reported on Aspen Ventures’ 2000 return could be used to reduce business income on an individual return.” Maj. op. at 1077. But the majority does not examine what the witnesses actually said. Significantly, the majority points to no statement by either witness that supports its watery characterization. In fact, neither witness testified that the actual business expenses reported by Aspen Ventures were allowable on Kayser’s individual return. Kayser’s accountant, like the government’s expert, assumed hypothetically that the deductions were allowable and then opined what effect this would have had on Kayser’s 2000 individual return. Even then, the accountant hedged, suggesting that other parts of the return would have to be amended. Nowhere did he say that the deductions were actually allowable under the tax code; nor did he claim that Kayser’s hypothetical individual return, when adjusted properly, would have resulted in zero tax liability.
In short, Kayser did not provide sufficient proof to enable a rational jury to find that he had enough allowable deductions to reduce his 2000 personal tax liability to zero. Nor could he, given that he needed these same deductions to shelter his 1999 income. Under these circumstances, the district court did not abuse its discretion in refusing to give the instruction. See Streit,
* * *
In reversing defendant’s conviction, the majority creates a defense against criminal tax liability that conflicts with established circuit precedent. And it does so unnecessarily, as defendant has fallen far short of meeting his burden to warrant the erroneous instruction. The majority thus eviscerates the evidentiary standard for proposed jury instructions by forcing a district court to give an instruction that’s only supported by generalities and hypothetical possibilities. I must part company with my colleagues in both of these precarious endeavors.
. At the time the funds are initially diverted, it might well be argued that they could constitute either income or a return of capital. However, once the taxpayer has assumed control of the funds and then fails to report such funds as income or to make any adjustments in the corporate books to reflect a return of capital, he has already violated the tax evasion statutes. Accord, Spies v. United States,
. This tension was pointed out by Judge Thomas's concurring opinion in Boulware II. Judge Thomas criticized Miller because it holds that "a defendant may be criminally sanctioned for tax evasion without owing a penny in taxes to the government. Not only does this result indicate a logical fallacy, but is in flat contradiction with the tax evasion statute's requirement of 'the existence of a tax deficiency.’ ”
. Nor did the district court prevent defendant from presenting evidence to support the proposed instruction. The majority does not reach this issue, see maj. op. at 1077-78 n. 7, but it’s worth noting that the district court gave defendant ample opportunity to introduce such evidence. When defendant first raised the issue on the penultimate day of trial, the court noted that "you may have a problem given the state of the evidence if you argue that, but you may not. It just depends on how everything comes in and what the arguments are, what the objections are. And I can't rule hypothetically on every permutation of argument that we might hear in the case. We'll just have to defer that until the time of argument.” When defendant presented his proposed instruction the next day, the court similarly noted, "Well, I’m going to decline to give this instruction at this point; the evidence doesn't support it.” Defendant thus cannot blame the district court for his failure to present the requisite evidence.
. At trial, the IRS case agent testified that Kayser underreported his 2000 personal income by $53,445, but the government's expert calculated the figure more conservatively at $41,765. See maj. op. at 1072 n. 2. The district court relied on the more conservative calculation at sentencing, and the government relies on the same figure on appeal. While we also must rely on the conservative calculation here, it's worth noting that Kayser concedes that he’d have no defense if the jury bought the higher calculation because he wouldn’t have had sufficient deductions to eliminate all tax liability.