Cross References
• Sestak, T.C. Memo. 2022-41, April 25, 2022

The taxpayer was employed by the U.S. Department of State at the U.S. Consulate in Ho Chi Minh City, Vietnam. While employed as a consular officer, he served as chief of the Consulate’s Nonimmigrant Visa Unit. He was responsible for reviewing U.S. visa applications, conducting interviews, and issuing U.S. visas to applicants.

In 2010, the taxpayer devised a scheme with a U.S. citizen and resident of Vietnam named Binh Vo. The taxpayer agreed to accept compensation (bribes) from applicants or their families in exchange for the taxpayer granting approval of nonimmigrant visas to the U.S.

This scheme required the taxpayer to use fake or code names, special email accounts, and cellphones for communication with Mr. Vo. Mr. Vo would inform the taxpayer in advance of the identity of each foreign national who agreed to pay money in exchange for a U.S. visa, and the taxpayer would then attempt to personally handle the applicant’s visa application, including conducting the applicant’s interview. In several instances, the taxpayer issued visas to applicants who had been previously denied visas. From February to September of 2012, the taxpayer approved 410 visa applications directed to him by Mr. Vo and others participating in the fraudulent scheme.

During this time period, the taxpayer received wire transfers totaling $3,227,501 to his bank account in Thailand.

In an attempt to hide his bribery proceeds from the U.S. government, the taxpayer acquired real property in Thailand, where he purchased nine real estate properties for a total of approximately $3.2 million. The taxpayer also arranged for his sister, who lived in the U.S., to receive $150,000 of his bribery proceeds, which she used to purchase a home in Yulee, Florida.

When the taxpayer filed his 2012 federal tax return, he reported his wage income of $122,029, but failed to report the $3,227,501 in bribery proceeds that he received.

Eventually the State Department uncovered the fraudulent scheme, and the taxpayer was arrested and extradited to the U.S. where he subsequently pleaded guilty to one count of conspiracy to commit offenses against the United States and to defraud the United States, one count of bribery of a public official, and one count of conspiracy to engage in a monetary transaction in property derived from a specified unlawful activity.

As part of the plea agreement, he executed a preliminary consent order of forfeiture imposing a forfeiture money judgment of $6,021,441 in favor of the United States, which included forfeiture of his real estate holdings in Thailand and other assets held by his co-defendants. Under his plea agreement, he agreed that his real estate holdings in Thailand represented bribery proceeds traceable to the fraudulent visa scheme, constituted property involved in the conspiracy to engage in a monetary transaction to which he pleaded guilty, and were subject to forfeiture. The taxpayer agreed to cooperate and voluntarily sell his real estate holdings in Thailand and to transfer the net proceeds to the United States to satisfy a portion of the money judgment entered against him.

Eventually, the real estate in Thailand was sold and in connection with the sales and other criminal forfeitures, the United States received $1,551,134.

The IRS first got involved with the case in 2015. After the audit of the taxpayer’s 2012 tax return, the IRS assessed tax and civil fraud penalties under IRC section 6663.

In tax court, the taxpayer argued that the liquidation of his real estate holdings in Thailand was not a forfeiture because the properties were located outside of the U.S. and therefore, outside the jurisdiction of the U.S. court system. The taxpayer claimed that because the proceeds from the sales of his real estate holdings were voluntarily transferred at a loss to the U.S. as part of his plea agreement, he is entitled to deduct the loss from his bribery proceeds. He also claimed that he purchased the property in Thailand for investment purposes, with the plan to rent the properties as an income-generating business. Therefore, the liquidation of his real estate holdings resulted in a substantial business loss.

The IRS argued that the taxpayer is not allowed to deduct losses against his bribery income because the losses as a result of the criminal forfeitures occurred in tax years other than the tax year in which he received the bribery proceeds. The IRS further argued, assuming arguendo that he incurred a loss in the tax year at issue, that the taxpayer is not entitled to deduct a loss from the criminal forfeitures of property because allowance of such a deduction would frustrate established U.S. and state policy.

The court stated it is undisputed that the taxpayer’s real estate holdings in Thailand were sold at a loss. The legal question before the court is whether the taxpayer is entitled to a tax deduction for the financial loss against his bribery proceeds for the tax year in question.

The proceeds derived from the taxpayer’s bribery scheme with Mr. Vo were subject to a court-ordered forfeiture. The court stated to allow the taxpayer a deduction for losses arising out of forfeited proceeds obtained through illegal activities would undermine public policy by permitting a portion of the forfeiture to be borne by the government, thus taking the sting out of the forfeiture. Federal courts have consistently disallowed loss deductions where the deduction would frustrate a sharply defined federal or state policy. In accordance with these controlling precedents, the court stated the taxpayer is not entitled to a loss deduction for the proceeds he forfeited pursuant to the forfeiture agreement with the United States.

The court next considered the civil fraud penalty under IRC section 6663, which imposes a penalty of 75% of the portion of the underpayment attributable to fraud. Circumstances that may indicate fraudulent intent include but are not limited to:
1) Understating income,
2) Keeping inadequate records,
3) Giving implausible or inconsistent explanations of behavior,
4) Concealing income or assets,
5) Failing to cooperate with tax authorities,
6) Engaging in illegal activities,
7) Supplying incomplete or misleading information to a tax return preparer,
8) Providing testimony that lacks credibility,
9) Filing false documents, including false tax returns,
10) Failing to file tax returns, and
11) Dealing in cash.

The taxpayer claimed he is not liable for the fraud penalty because while he was incarcerated (for the crimes he pleaded guilty to), he directed his tax preparer to file an amended return for 2012, reporting his bribery proceeds as income. The court noted the taxpayer is mistaken on this point. Fraud occurs upon the filing of a false return with the requisite fraudulent intent, and that conduct cannot be subsequently purged through the filing of an amended return.

The court stated the taxpayer’s activities with regard to the receipt of bribery proceeds and his attempt to hide the activities associated therewith are “badges of fraud” that clearly and convincingly indicate the civil fraud penalty under IRC section 6663 applies for the tax year at issue.