Fifth Amendment Tax Returns: How Al Capone Could Have Avoided Alcatraz

By Katelyn Brown, KLJ Staff Editor ^[1]

Infamous mobster Al “Scarface” Capone has inspired numerous films and countless literary characters since his criminal escapades during the Prohibition era.^[2] Despite the bootlegging, gambling, prostitution, and murder that occurred during his reign over the Chicago Outfit, he was never indicted for racketeering.^[3]  Instead, Capone failed to file a tax return from 1924 until 1929,^[4] and the IRS slammed him in 1931 for evading taxes on the millions in illegal income he earned during those years.^[5] He was sentenced to eleven years in prison, including a stint at Alcatraz.^[6]According to Section 61 of the Internal Revenue Code, a taxpayer’s gross income includes all income from whatever source derived.^[7] Illegal income must therefore be reported on a taxpayer’s annual tax return. It doesn’t come as a surprise, however, that criminals rarely report their unlawful earnings.^[8] A recent order from the United States Tax Court illustrates what happens when a taxpayer is brave enough to include income on his tax return that could potentially lead to criminal allegations.^[9]In Youssefzadeh v. Commissioner, the taxpayer included the requisite monetary amounts on his Schedule B form, which records interest and dividend income, but did not answer some of the questions regarding the source of that interest and dividend income.^[10] The taxpayer invoked his Fifth Amendment privilege against self-incrimination, stating incriminating evidence could arise if he answered all the questions on the Schedule B portion of the tax return.^[11] Although the total amount of income was clearly included on his tax return, the IRS responded by promising to levy a frivolous-return penalty against him if he did not completely fill out his return.^[12] The taxpayer insisted on using the Fifth Amendment as a defense to answering the questions regarding the source of his income and the IRS subsequently assessed the penalty.^[13]Section 6702 of the Internal Revenue Code governs the requirements for when a frivolous-return penalty can be charged.^[14] Three elements must be present in order to justify a frivolous-return penalty: (1) the document submitted must present itself to be a tax return, (2) the return must exclude enough information to preclude the IRS from judging “the substantial correctness of the self-assessment” or the information is substantially incorrect, and (3) “the taxpayer’s position must be frivolous or demonstrate a desire to impede the IRS’s administration of the Code.”^[15] The controversial element in this case was whether “the substantial correctness of the self-assessment may be judged” by looking at the face of the tax return.^[16] The IRS argued that all of the taxpayer’s information was needed to evaluate his return.^[17] The Tax Court interpreted this provision of the Internal Revenue Code according to the plain meaning of the text—the tax return must be “substantially correct” and does not have to be “completely correct.”^[18] Because the total amount of interest and dividends were included on Schedule B of the tax return, the failure to answer a few questions concerning the income source was held to be an insufficient justification for a frivolous-return penalty.^[19]Omitting all financial information, on the other hand, is in fact frivolous, according to the tax order resulting from Youssefzadeh v. Commissioner.^[20] The reason that criminals tend to leave illegal income off of their tax forms is that most criminals believe that reporting illegal income makes them a target for criminal prosecution.^[21] However, a provision in the Internal Revenue Code exists to ensure tax-return confidentiality.^[22] The IRS cannot tip off law-enforcement agencies if they believe a taxpayer is participating in illegal activities; interested law-enforcement authorities must initiate a process and get a court order that allows access to the taxpayer’s return.^[23]Al Capone seemed to be “above the law” until he was finally laid low by tax evasion charges.^[24] This recent order from the Tax Court suggests that if Capone had simply filed a Fifth Amendment tax return, he may not have gone to prison. Perhaps reporting and paying taxes on his illegal millions without revealing the source could have kept him out of Alcatraz.^[1] J.D. expected May 2018.^[2] Al Capone, History.com, http://www.history.com/topics/al-capone.^[3] Id.^[4] Douglas O. Linder, Al Capone Trial (1931): An Account, Famous Trials, http://law2.umkc.edu/faculty/projects/ftrials/capone/caponeaccount.html.^[5] Gabrielle Kratsas, 13 Infamous Tax Cheaters, USA Today (Mar. 1, 2014, 1:20 PM), http://www.usatoday.com/story/money/business/2014/02/28/famous-tax-cheats/5903143/.^[6] Id.^[7] I.R.C. § 61 (2016).^[8] Steve Hargreaves, The IRS Wants to Tax Your Illegal Income, CNN Money (Mar. 7, 2013, 12:47 PM), http://money.cnn.com/2013/02/28/news/economy/illegal-income-tax/.^[9] Timothy M. Todd, A Win for the Fifth Amendment at the Tax Court, Forbes (Nov. 16, 2015, 2:30 PM), http://www.forbes.com/sites/timtodd/2015/11/16/a-win-for-the-5th-amendment-at-the-tax-court/#633d8eeb3d60.^[10] Youssefzadeh v. Comm’r, Tax Court Docket No. 14868-14 L (Nov. 6, 2015) (available at https://perma.cc/JW9T-PUF6).^[11] Id.^[12] Id.^[13] Id.^[14] I.R.C. § 6702 (2016).^[15] Id.; Youssefzadeh, Tax Court Docket No. 14868-14 L.^[16] See Youssefzadeh, Tax Court Docket No. 14868-14 L.^[17] Id.^[18] Todd, supra note 9.^[19] See Youssefzadeh, Tax Court Docket No. 14868-14 L.^[20] Id.^[21] Hargreaves, supra note 8.^[22] I.R.C. § 6103 (2016).^[23] Hargreaves, supra note 8.^[24] Linder, supra note 4.*Featured Image by Ralph Dickey, licensed under Creative Commons BY-ND 2.0.