What Clients and Tax Advisors Can Learn From the Prosecution of John Castro of Castro & Company

On May 24, 2024, John Castro, the managing partner of Castro & Company was convicted of 33 counts of assisting in the preparation of fraudulent tax returns. According to a United States Attorney’s Office Press Release, John Castro marketed himself to clients around the world and claimed to be an “international tax expert” and “federal practitioner.” Between 2017 and 2019, John Castro filed more than 1,900 tax returns on behalf of individuals from all over the world.

John Castro allegedly promised his clients a significantly higher refund than they would receive from other preparers. During trial, John Castro admitted that the positions he took on tax returns were extreme, outlandish, and not supported by the law.

Sadly, John Castro is not the only professional that has taken extreme and outlandish positions on tax returns not supported by law. This is often referred to as the filing of a fraudulent or false tax return. Some tax professionals tax positions on tax returns not supported by law to increase revenue. Taking a position on a tax return not supported by law can result in criminal prosecution for both the client and the tax professional. Below, is a partial list of the offenses that client and tax professional could face by filing a false or fraudulent tax return with the Internal Revenue Service (“IRS”):

False or Fraudulent Returns or Statements

Under Internal Revenue Code Section 7206(1), any person who willfully signs and files any return, statement, or other document containing a declaration that is under penalties of perjury, and that he or she does not believe to be true and correct as to every matter, is guilty of a felony.

Aiding and Abetting the Preparation or Filing of False or Fraudulent Return

Internal Revenue Code Section 7206(2) is principally designed to reach tax preparers. It can and has been used against any attorney, CPA, tax preparer, and anyone else who “aids or assists in, or procures, counsels, or advises” in taking a fraudulent position on a tax return. If an individual is prosecuted and convicted under Section 7206(2), he or she will be guilty of a felony.

Below, please see Illustration 1, Illustration 2, and Illustration 3 which discusses an example of the potential consequences of filing a false or fraudulent tax return with the IRS.

Illustration 1.

Tom is a tax attorney in Los Angeles, California. Tom is great at marketing, but he is not a very good tax attorney. In order to fund his law practice, Tom aggressively markets his firm through a radio and online marketing campaign. In his marketing campaign, As a result of Tom’s advertisements, Sue is lured to Tom’s office for a “consultation.” During the consultation, Tom tells Sue that he is a very aggressive tax attorney when it comes time for preparing tax returns. Tom tells Sue that she is entitled to claim business deductions for her personal expenses. Tom knew that Sue is not entitled to claim business deductions for her personal expenses. Tom convinces Sue to retain his firm to prepare her tax return. The IRS audits the tax return prepared by Tom and refers the matter to the IRS Criminal Investigation Division. Can Tom and Sue be criminally prosecuted for the filing of a false or fraudulent tax return?

The Government could charge Tom with violating Internal Revenue Code Section 7206(2). The elements of Section 7206(2) are as follows:

1. The defendant aided and assisted in, or procured, counseled or advised the preparation or presentation of a return or document in connection with a matter arising under the internal revenue laws.
2. The return, statement or other document was false in respect to a material matter.
3. The defendant acted willfully.

Here, Tom knew that Sue did not qualify for business deductions for personal expenses. Yet, Tom prepared a false return to claim these deductions. Tom can be convicted of violating Section 7206(2). Tom may also be convicted of violating Section 7206(1). This Code section punishes individuals that file false tax returns. Because Tom signed and filed a false or fraudulent tax return with the IRS, Tom can also be convicted of filing a false tax return under Section 7206(1). Tom may also have to pay the Government restitution in the amount of the taxes it lost as a result of the fraudulent tax return he prepared.

Sue on the other hand will not be convicted of any tax crime because she did not “willfully” intend to file a false return with the IRS. In order for Sue to be convicted of a tax crime, the Government will have to prove that Sue willfully intended to file a false tax return with the IRS. Willfulness is an essential element of a tax crime. An act is done “willfully” if done purposely with the specific intent to disregard the law, or do that which the law forbids. The word “willfully” as used in connection with tax fraud means with a bad or evil purpose of defrauding the government. Sue’s acts in connection with wrongfully claiming deductions are not “willful” because of her good faith reliance on Tom, her tax attorney. Although Sue will not be criminally prosecuted, she may be subject to an IRS audit. The audit can subject Sue, victim-client to assessments of significant additional income tax, penalties, and interest which can cause significant financial hardship.

Illustration 2.

The facts are the same as Illustration 1, but Tom assigns the preparation of Sue’s return claiming to Kent, as associate of Tom’s law firm. Kent knows that Tom has exaggerated who can qualify for the credit in the past, but he did nothing about it. Kent is also aware that Sue is not entitled to claim the deductions sold to her by Tom. However, Kent is eager to please Tom, so he prepares and signs the return claiming the false deductions.

Can Tom and Kent be criminally prosecuted?

Just because Tom did not prepare and sign the return claiming the false deductions does not mean he cannot be criminally prosecuted. Prosecutions under Section 7206(2) can be brought against anyone who “aids, abets, counsels, induces, or procures” the commission of an offense by another may be charged as a principal. In this example, Tom induced Sue to file a tax return claiming fraudulent deductions. Even if Tom did not sign the return claiming the false deductions, Tom convinced Sue to file a false tax return. Then Tom assigned the preparation of the fraudulent return to his associate. As a result, Tom can still be prosecuted under Section 7206(1). Kent violated Section 7206(1) and Section 7206(2) by filing fraudulent tax return with the IRS for the same reasons as discussed in Illustration 1..

Tom and Kent can also be charged under 18 U.S.C. Section 371. The statute punishes individuals for conspiring to defraud the United States.

Section 371 provides in relevant part:

If two or more persons conspire either to commit any offense against the United States, or to defraud the United States, or any agency thereof in any manner or for any purpose, and one or more of such persons do any act to effect the object of the conspiracy, each shall be fined under this title or imprisoned not more than five years, or both.

The elements of Section 371 are as follows:

1. The existence of an agreement to accomplish an illegal or unlawful objective or to defraud the United States.
2. The defendants knew of the agreement and with such knowledge voluntarily participated in the conspiracy.
3. The commission of an overt act by conspirators in furtherance of the objective of conspiracy.

Since Tom and Kent conspired together to file a return fraudulently claiming a credit that defrauded the Government, both Tom and Kent can be prosecuted under Section 371.

Tom and Kent could also be liable for restitution for the loss to the IRS as a result of the tax return they prepared.

Illustration 3.

Let’s assume that Tom tells Kent that he wishes to form a “unified front” as a defense to the charges alleged by the IRS. As part of the unified defense, Tom and Kent will have their own defense counsel. But the attorneys will work together. Tom has also told Kent that his firm will pay for Kent’s legal defense.

Can Tom and Kent enter into such an agreement?

Once the criminal prosecution commences, Tom and Kent will likely begin to point the preverbal finger at each other. Thus, agreeing to a unified front is problematic. In addition, Tom’s payment of Kent’s legal fees may make the situation worse for Kent. The value of payment of Kent’s legal fees from Tom’s business may be taxable to Kent. The failure to report the value of the legal services on Kent’s tax return could make the situation even worse for him.

The criminal prosecution of John Castro and the above examples should provide a clear and equivocal warning to tax professionals contemplating preparing a fraudulent tax return. There is no fee worth risking a criminal prosecution. The criminal prosecution of John Castro should also serve as a warning. If your tax return seems too good to be true- your tax return was probably prepared incorrectly. If your tax return gets audited by the IRS, you will be liable for the taxes, interest, and penalties. Always review the tax return prepared by your tax professional and if the tax return seems “too good to be true,” question your tax professional before your return is filed with the IRS.

If John Castro prepared your tax returns, you should have a tax professional review the returns reviewed by a qualified international tax attorney. This is particularly the case if you had a foreign retirement plan and a treaty position was taken, large deductions were taken for meals and entertainment, or home office deductions were claimed. Having a qualified international tax attorney review the tax returns prepared by Castro & Company could reduce your risk of an IRS audit and IRS assessments. We have assisted a number of former clients of Castro & Company get things right with the IRS.

Anthony Diosdi is an international tax attorney at Diosdi & Liu, LLP. Anthony Diosdi frequently represents taxpayers nationally in controversies before the Internal Revenue Service, United States Tax Court, United States Court of Federal Claims, Federal District Courts, and the Circuit Courts of Appeal. In addition, Anthony Diosdi has written numerous articles on international tax planning and frequently provides continuing educational programs to tax professionals. Anthony Diosdi is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.