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May 1992

Prosecution of taxpayer's mistresses for failure to pay income tax reversed. (Estates & Trusts)

by Saslaw, Joseph S.

    Abstract- The Court of Appeals overturned the decision of the District Court to hold two women liable for failing to report monies received from their lover as income. In the US v. Harris case, twin sisters Leigh Ann Conley and Lynette Harris received more than $500,000 from their lover, David Kritzik, for which they failed to file tax returns. The District Court convicted Conley and Harris with willful failure to file tax returns and willful tax evasion. However, the Court of Appeals dismissed these charges because it found that the evidence presented by the government failed to show whether Kritzik's payments to his mistresses were given as income or as gifts.

Under Commissioner v. Duberstein, 363 U.S. 278 (1960), the donor's intent is the "critical consideration" in distinguishing between gift, which give rise to gift tax liability on the part of the donor and income, which is taxable to the recipient.

With respect to Conley, the only direct evidence that the government presented regarding Kritzik's intent was Kritzik's gift tax returns. On those returns, Kritzik identified gifts to Conley of $24,000, $30,000, and $36,000 for the years 1984-86, respectively, substantially less than the total amount of monev that Kritzik transferred to Conley. The government's remaining evidence consisted of a bank card that Conley signed listing Kritzik in a space marked "employer" and testimony that Conley picked up a check at Kritzik's office every week to ten days, a practice that the government associated with being an employee.

At trial, Harris, who was charged with failure to file tax returns and tax evasion, tried to introduce as evidence three letters that Kritzik wrote. In the first letter, Kritzik wrote that he loved and trusted Harris and that, "so far as the things I give you are concerned--let me sav that I get as great if not even greater pleasure in giving than .vou get in receiving .... I love giving things to you and to see vou happy and enjoying them." In the second letter, Kritzik wrote, "I... love you very much and will do all that I can to make you happy/' adding the he would arrange for Harris's financial securit).,. The third letter was written by Kritzik to his insurance company, and it concerned jewelry that he had "given to Ms. Lvnette Harris as a gift." Kritzik gave a copy of the letter to Harris. The district court excluded the letters from the evidence on the ground that they constituted hearsay. Both ConIey and Harris were found guilty. They appealed. The Appeals Court reversed the conviction and remanded the case with instructions to dismiss the indictment against the women.

Insufficiency of Evidence As to Conley

Conley was convicted on each of four counts for violating 26 U.S.C. paragraph 7203, which provides, "Any person ... required.. to make a (tax) return ... who willfully fails to... make such return... shall, in addition to other penalties provided by law, be guilty.' of a misdemeanor... ConIe.v was "required ... to make a return" only if the money that she received from Kritzik was income to her rather than a gift. Assuming that the money was income, she acted "willfully/* and so is subject to criminal prosecution, only if she knew of her duty to pay taxes and "voluntarily and intentionally violated that duB'." The government's evidence was insufficient to show either that the money Conley received was income or that she acted in knowing disregard of her obligations. "Gross income" for tax purposes does not include gifts, which are taxable to the donor rather than the recipient. In Commissioner v. Duberstein, 363 U.S. 278, 285 (1960), the Supreme Court stated that in distinguishing between income and gifts the "critical consideration"... is the transferor's intention." Regarding the, "critical consideration" of the donor's intent, the only direct evidence that the government presented was Kritzik's gift tax returns. This leaves the question whether Kritzik's other payments were taxable income to Conley or whether Kritzik underreported his gifts. The gift tax returns raised the question; they did not resolve it.

This failure to show Kritzik's intent was fatal to the government's case. Without establishing Kritzik's intent, the government could not establish that Conley had any obligation to pay income taxes. Even if Kritzik's gift tax returns proved anything, the government presented no evidence that Conley knew the amounts that Kritzik had listed on his returns. Absent proof of Kritzik's intent, and Conley's knowledge of that intent, the government had no case.

The government's remaining evidence consisted of a bank card that Conley signed listing Kritzik in a space marked "employer," and testimony regarding the form of the payments Conley received. The bank card was not evidence of Kritzik's intent and was open to conflicting interpretations. Conley contended that she listed Kritzik as a reference and no more. As to the form of the payments, the government showed that Conley would pick up a regular check every week to ten days, either from Kritzik personally or, when he was not in, from his secretary. According to the government, this form of payment was that of an employee picking up regular wages, but it could have just as easily been that of a dependent picking up regular support checks. (The case was silent as to whether or not payroll taxes had been deducted from the payments, a factor germane to the question of intent).

The Court said, "We will not permit a verdict based solely upon the piling of inference upon inference" U.S. v. Balzano, 916 F.2d 1273, 1284 (Tth Cir. 1990). The Court reversed because, "Where the evidence as to an element of crime is equally consistent with a theory of innocence as a theory of guilt, that evidence necessarily fails to establish guilt beyond a reasonable doubt." In the present case, the bare facts of Kritzik's gift tax returns, the bank card, and the form of payments were as consistent with an inference of innocence as one of guilt. The evidence did not support a finding of guilt beyond a reasonable doubt. The admissibility of Kritzik's letters to Harris.

Kritzik's Letters to Harris

Harris was convicted of two counts of willfully failing to file Federal income tax returns under 26 U.S.C, paragraph 7203 (the same offense for which Conley was convicted) and two counts of willful tax evasion under 26 U.S.C. paragraph 7201. At trial, Harris tried to introduce as evidence the three letters that Kritzik wrote; but the District Court excluded the letters as hearsay. The District Court also suggested that the letters would be inadmissible under Fed. R. Evid. 403 because the possible prejudice from the letters exceeded their probative value.

The Court held that the letters were not hearsay because they were offered to prove Harris' lack of wilfulness, not for the truth of the matters asserted. They further held that the critical nature of the letters to Harris' defense precluded their exclusion under Rule 403. The letters were hearsay if offered for the truth of the matters asserted that Kritzik did in fact love Harris, enjoyed giving her things, wanted to take care of her financial security, and gave her the jewelry at issue as a gift. But the letters were not hearsay for the purpose of showing what Harris believed, because her belief does not depend on the actual truth of the matters asserted in the letters. Even if Kritzik were lying, the letters could have caused Harris to believe, in good faith, that the things he gave her were intended as gifts. The good faith belief, in turn, would preclude any finding of wilfulness on her part. The Court held that the District Court abused its discretion in excluding the letters and so also reversed Harris' conviction.

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