Federal Evidence Review

In failure to pay federal taxes trial, evidence of the defendant’s personal expenditures was probative on the issue of willfulness, and her failure to file individual and corporate tax returns and make tax deposits was admissible under FRE 404(b), in United States v. Ellis, 548 F.3d 539 (7th Cir. Nov. 20, 2008) (No. 07-2643)

In a recent tax case, the Seventh Circuit considered the admissibility of the defendant’s personal expenditures, and her uncharged failure to file individual and corporate tax returns and to make tax deposits. The circuit affirmed the admission of this evidence at trial.

In the case, defendant Ellis was the president and sole owner of a company which provided temporary pharmacists to medical facilities and retail businesses. She stopped making federal tax deposits during eight quarters, although records showed that she withheld more than $1.5 million in employment and federal income taxes and failed to contribute more than $400,000 in employment taxes. During this period, she transferred and used more than $3 million from company accounts for a personal residence, and house for her mother, numerous trips, a luxury car and home decorations. She was charged with failure to account for and pay federal taxes.

Before trial, she moved in limine to exclude evidence concerning her “use of money,” her failure to timely file tax returns during 1995 to 1999, until her accountant discovered the non-filings, and her failure to file and pay taxes after the period charged in the indictment. The trial court denied her motions. The trial court concluded the evidence of her personal expenditures was probative of her willfulness and to negate her “’principal defense’ that she was too busy to notice or remember her tax obligations.” Ellis, 548 F.3d at 542. The evidence “of the earlier failures to file the returns and to make deposits, even when accountants were doing all of the work [for Ellis] except the final submissions . . . [wa]s all relevant to show that defendant fully understood that [her company] PharmaSource was withholding the taxes and that the company and she were legally responsible for filing the returns and depositing the money with the IRS.” <Ellis, 548 F.3d at 543. Finally, her “failure to file individual and corporate tax returns was probative of the defendant’s state of mind on the charged violations because they tended to show that the violations were part of a larger disregard for federal tax obligations that a jury could find was willful.” Ellis, 548 F.3d at 543. After her conviction, she challenged the failure of the court to exclude the contested evidence.

The Seventh Circuit agreed that the evidence of the defendant’s personal expenditures was relevant on the issue of her willful violation of the tax laws. Ellis, 548 F.3d at 543 (citing Cheek v. United States, 498 U.S. 192, 200 (1991) (defining willful violation of the criminal tax laws as a “voluntary, intentional violation of a known legal duty”)). As the circuit explained:

“Because Ellis claimed that she had no time to remember her taxes, the ways she was spending her time -- traveling to Florida, buying cars, purchasing and overseeing the decoration of her two million dollar home -- were relevant. We also note that the amount of taxes Ellis failed to pay during the indictment period was around the same amount she spent on herself during the indictment period.”

Ellis, 548 F.3d at 543. The circuit also concluded the evidence was not unfairly prejudicial under FRE 403, and the trial court’s weighing of the evidence was not an abuse of discretion. The evidence of the defendant’s uncharged tax violations was relevant on the issue of willfulness and was admissible under FRE 404(b). As the circuit noted, this evidence was “relevant to negate Ellis’s defense of forgetfulness and show that she acted willfully; that is, that Ellis was aware of her duties to account for and pay over her taxes and disregarded those duties by failing to do so.” Ellis, 548 F.3d at 544; see also United States v. Kalita, 712 F.2d 1122, 1131 (7th Cir. 1983) (the failure to file uncharged tax returns was relevant to the issue of willfulness in a tax case). The uncharged tax violations satisfied the four-part test to admit other act evidence under FRE 404(b). United States v. Shields, 999 F.2d 1090, 1099 (7th Cir. 1993) (“(1) the evidence is directed toward establishing a matter in issue other than the defendant’s propensity to commit the crime charged, (2) the evidence shows that the other act is similar enough and close enough in time to be relevant to the matter in issue, (3) the evidence is sufficient to support a jury finding that the defendant committed the similar act, and (4) the probative value of the evidence is not substantially outweighed by the danger of unfair prejudice.”) (other citation omitted)

Under this standard, the circuit concluded that “the evidence was directed toward proving a matter at issue (Ellis’s disregard of a known duty), the prior acts were close in time and reliably substantiated, and the acts’ probative value was not outweighed by the danger of unfair prejudice…. While the evidence of past tax violations certainly makes Ellis look less than law abiding, the prejudice is not undue.” Ellis, 548 F.3d at 544; see also United States v. McCaffrey, 181 F.2d 854, 857 (7th Cir. 1999) (admitting evidence of the defendant’s uncharged failure to file income taxes and rejecting argument that the evidence was unfairly prejudicial; “The only prejudice McCaffrey has identified is that the evidence made him look guilty. Naturally, probative evidence is also prejudicial in a literal sense, but such prejudice is not ‘undue’ and is therefore not subject to exclusion under Rule 403.”).

The Ellis case demonstrates theories of admissibility in tax cases concerning the defendant’s expenditures during the period of the charged tax violations as well as uncharged tax conduct. This admissibility and relevance of this type of evidence will typically arise in tax cases.