On May 23, 2016, the U.S. Court of Appeals for the Second Circuit reversed a jury’s finding of civil fraud against Countrywide Home Loans and other lenders, finding that the government had failed to prove fraud in Countrywide’s sale of mortgages to Fannie Mae and Freddie Mac. Peter J. Henning wrote an excellent piece in the New York Times’ White Collar Watch pointing out just how difficult it can be to prove fraud. The Countrywide case, brought under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), showed that one person’s “brazen fraud,” as presiding District Court Judge Jed Rakoff called it, is another person’s merely distasteful intentional breach of contract. The Second Circuit took the latter viewpoint.
How does this relate to tax enforcement? If the burden of proving garden-variety fraud is high, the burden of proving tax fraud is higher still. To prove tax fraud, the government must prove not only that a taxpayer made a false statement but that the taxpayer understood the tax law well enough to know that he or she was violating it. In other words, there can be no conviction in the absence of an intentional violation of a known legal duty. This has been the law at least since the Supreme Court’s decision in the 1991 case of Cheek v. United States. Unlike what we learned in our high school civics classes, ignorance of the law is an excuse in the world of tax fraud.