Richard A. Dollinger
Richard A. Dollinger ()

During the course of discovery or a support trial, a judge learns that a witness or a party has unreported “under-the-table” income. Instinctively, a trial judge may recoil: The federal1 and state2 taxing authorities should be informed.

But the judicial decision to report tax evasion or other illegal conduct to “appropriate authorities” is more complicated, with an overlay of ethical rules and practical complications that caution judicial restraint.

Judicial Discretion

Every state requires judges to maintain the integrity and independence of the judiciary and avoid impropriety or its appearance.3 Judges in New York have a clear duty to “take appropriate action” if there is “a substantial likelihood of any attorney violations of the Rules of Professional Conduct.”4 Judges may assume that the same duty extends to witnesses and parties that appear before them but, in New York, the duty to report illegal conduct is not mandatory and rests instead within the judge’s discretion. In a 1988 opinion, the New York Advisory Committee on Judicial Ethics held:

in the absence of any statutory requirement, the trial judges are not obligated to report the apparent misconduct; they may exercise their discretion in determining whether to report the actions.5

The committee described “mandatory reporting” as “undesirable” because it would dissuade witnesses from truth-telling and encourage the use of a threat of criminal prosecution in settlement discussions.6

A chorus of later ethical opinions provide some guidance for judicial discretion, leaving it up to trial judges on whether to report a litigant’s alien status,7 allegations that a lawyer-husband misused his Interest of Lawyer’s Account (IOLA),8 a positive drug test by a doctor in a divorce matter;9 the receipt of unreported income to a divorce party who received Social Security disability benefits,10 the filing of a false instrument,11 statutory rape12 or even an open bench warrant.13

Even after issuance of these opinions, some trial judges have nonetheless assumed that the judge has an “obligation” to report potential tax evasion by a divorcing spouse to appropriate authorities. In Hashimoto v. La Rosa, the Supreme Court, New York County, after reading an affidavit from the husband in which he admitted tax evasion, held that it was “obligated to report admissions of tax evasion or fraud to the authorities.”14

Similarly, in Beth M. v. Joseph M., the spouse testified at trial that she failed to pay taxes on certain unreported rental income and the Supreme Court, Nassau County, held it was “obligated to report admissions of possible tax evasions or fraud.”15 Finally, in PP v. KP, the Supreme Court, Nassau County, sent its decision and order to the IRS when a witness testified that she received income and paid no taxes on it, commenting that in the face of “candid admission,” the court “believes it appropriate to forward the decision and order to the IRS.”16

New Jersey Case

Most state judicial ethics codes follow the “discretion to report” maxim.17 But in exercising that discretion, New York courts should carefully consider the experience in New Jersey. A seminal 1991 decision holds that New Jersey judges are bound by ethical considerations to report “illegal conduct” when “it comes to the attention of the court.”

In Sheridan v. Sheridan, the New Jersey Supreme Court concluded that the failure to file an income tax return—while “not uncommon in matrimonial litigation and occurs occasionally in civil litigation”—should be reported.18 In that case, the couple had more than $110,000 in unreported income stashed in shoe boxes and a dog biscuit box. The court noted that attorneys are ethically required to report wrongdoing and judges should not sit mute in the face of acknowledged, demonstrated or potential wrongdoing, and hence, a judge’s obligation to report is even more expansive [than an attorney's obligation] and the judge should report “all evil heard and seen.”19

The rule in Sheridan still guides New Jersey’s judges and it surfaces most often in matrimonial matters, when a couple’s finances are under adversarial scrutiny. Trial judges have reported materially false income tax filings,20 excessive deductions or “intentional under reporting of income,”21 and erroneous child care deductions.22 One court suggested it may be required to report tax evasion even if a litigant filed an amended return.23

New Jersey’s experience demonstrates that if a judge decides to report “wrongdoing,”‘—either under a mandate to do so or at their discretion—the courts can end up engulfed in deciding, at least on a threshold basis, countless taxing questions, such as reporting bartering transactions and erroneous use of child-care deductions, even though these may be complex federal taxing questions outside the usual ken of state trial judges.

Policy Considerations

When, as in New York, the judicial reporting of illegal conduct shifts from mandatory to discretionary, a variety of compelling public policy considerations, articulated by the courts in New Jersey under a mandatory requirement, still confront a trial judge in New York. A courtroom is not a “duty-free zone” where a crime may be admitted with impunity, and a blanket judicial attitude of “hear no evil, see no evil, report no evil” does not inspire public confidence in the judicial system.24 But, conversely, a discretionary decision to report instances of “under-the-table” employment or “under-reported income” during matrimonial or support matters raises substantial practical concerns.

First, the court would still seemingly need to be satisfied that the claims, as a threshold matter, are worthy of belief and sufficiently proven—even at a preliminary stage. There is little case law or ethical guidance on what proof would support such an evaluation at the preliminary stages of a divorce or support action.

Second, unreported income or tax evasion may surface in pretrial conferences, well before any witness testifies. Judges may then face a difficult choice: whether to disclose an intention to report tax evasion before completion of the matter. This author can find no authority on whether a trial judge, who concludes that discretion requires a report to authorities, must inform the parties that it is contemplating reporting the violation and whether the party to be reported has a right to a hearing before the report occurs. But, other statutes and cases provide some insight.

The Penal Law prohibits the threat of criminal prosecution as a means of extracting money in a civil suit.25 Lawyers are barred from presenting or threatening to present criminal charges solely to obtain an advantage in a civil matter.26 These rules would suggest that a judge should carefully consider whether to warn any party in the midst of a family support matter that they will report tax-related crimes.

The dangers posed by advising litigants about reporting illegal activity is manifest in All Modes Transport v. Hecksteden,27 in which the New Jersey trial judge interrupted cross-examination of a litigant regarding potential tax evasion, recessed the trial and advised the attorneys at an in-chambers conference that while the current testimony was not sufficient to justify reporting the witness to a prosecuting authority, if the examination continued and showed additional instances of unwarranted deductions, the court would report the witness. In the alternative, the judge suggested that the witness settle. After the litigant settled, he challenged the settlement as coerced, claiming that his right to proceed was compromised by the judge’s statement that further testimony would trigger his obligation to report.

The appellate court vacated the settlement, holding that the trial judge has no obligation to warn the testifying party about the possible reporting of his conduct and the judge’s suggestion that no report would be filed if settlement occurred gave the witness’ opponent an “improper advantage” because such “a threat may be even more coercive when the court is the source.”28 If a trial judge warns any party about exercising discretion to report and a settlement—advantageous to the non-threatened party—emerges, it may be difficult later to filter out the coercive impact of the judge’s warning if the settlement is later attacked.

Third, the court should also consider whether to place its exercise of discretion on the record in the case. There is no ethical determination, based on this author’s research, that suggests a trial judge in New York is obligated to disclose on the record that he or she intends to report a litigant’s conduct to authorities or any requirement that a litigant be heard before the report is filed. There is also no guidance in the manner of how and to whom to make such a report.

Fourth, the court may confront another quandary: If the couple filed a joint tax return, signed by both spouses, there may be liability to both the husband and wife and the potential tax debts would be a marital debt, subject to equitable distribution. An impending tax investigation will, no doubt, pinch family finances and a resulting tax warrant or other financial penalty could easily impair a parent’s ability to support a child. In contemplating a decision to report, the court should consider whether a tax penalty—and its impact on family finances—would be in the best interests of the children and their support needs.

Fifth, any court considering reporting may also need to fashion an equitable basis for reporting and apply the same reporting rules to lower income litigants—who may be desperate to generate “under-the-table cash”—as will be applied to higher income litigants, like the parties in Sheridan, who stashed away hundreds of thousands of dollars. Often, in divorce cases, the amount of “under-reported income,” is relatively small, especially in modest-income families.

While a court may be less likely to report small cases of tax evasion, the federal penalties for failing to file or misreporting income do not differentiate between higher income and lower income payors. As another consideration, if a court reports a scofflaw in one case, it would seemingly need, as a part of its discretion, to be consistent and report all similar scofflaws in future cases. Overzealous reporting could easily compromise a court’s future exercise of discretion as much as ignoring illegality.

Any court considering reporting must also avoid a potential sideshow at trial, in which it may seek to make a finding of under-reported income over the objection of a litigant. The court might also face another difficult choice if a litigant seeks to condition any settlement on the court withholding any report to the state or federal taxing authorities. The court would not be bound by such an agreement but, as a practical matter, its decision may adversely impact any possible settlements or a restoration of post-divorce relationships between the litigants.

Finally, a court should consider the impact of reporting on the scofflaw’s counsel. Matrimonial attorneys certify their clients’ financial representations and, if under-reported income surfaces, the court may be required to investigate whether and when counsel knew of “under-the-table” income—and the falsehood of the sworn financial representations in the statement of net worth—before evaluating whether to report counsel to appropriate disciplinary authorities.29

Conclusion

In short, New York’s matrimonial trial judges face a complicated balance in exercising discretion to report litigants’ tax evasion to authorities. Spouses who have lived together, benefitting from under-reported income, will never mention their family’s tax evasion until a divorce intervenes. Trial judges, often greeted at pretrial conferences with allegations of under-reported income, will face difficult choices in exercising their discretion while seeking to equitably resolve disputed matrimonial and support matters.

Richard A. Dollinger is a member of the New York Court of Claims and an acting Supreme Court justice in Rochester. Jason Zirbel, a law school student, assisted in the preparation of this article.

Endnotes:

1. A conviction under the Internal revenue Code can lead to imprisonment for five years and a $100,000 fine. 26 U.S.C. §7201.

2. New York punishes “tax fraud acts,” including a failure to file an annual return, which is a Class A misdemeanor. N.Y. Tax Law §1801. If the taxpayer evades more than $3,000 in taxes, the crime is a Class E felony, with penalties up to four years. N.Y. Penal Law §70(2)(e). N.Y. Tax Law §1803.

3. See e.g., 22 NYCRR §100.2(A).

4. NYCRR §100.3(D)(2); Adv. Comm. On Jud,. Ethics 10-85 (the trial judge must personally determine whether an attorney’s conduct “constitutes a substantial violation”).

5. Advisory Comm on Jud. Ethics Opin. 03-110 (2004); Adv. Comm. On Jud,. Ethics Opin 88-85 (1988)

6. Id.

7. Adv. Comm. On Jud,. Ethics Opin 05-30.

8. Adv. Comm. On Jud,. Ethics Opin. 13-127

9. Adv. Comm. On Jud,. Ethics Opin. 06-13

10. Adv. Comm. On Jud,. Ethics Opin. 08-155.

11. Adv. Comm. On Jud,. Ethics Opin. 9-71

12. Adv. Comm. On Jud. Ethics Opin. 05-84

13. Adv. Comm. On Jud,. Ethics 1 Opin. 03-35

14. 4 Misc.3d 1037(A)(Sup. Ct. New York Cty 2004).

15. 12 Misc.3d 1188(A)(Sup. Ct. Nassau Cty 2006).

16. 30 Misc.3d 1223(A)(Sup. Ct. Nassau Cty 2011).

17. See e.g., Oregon Judicial Conduct Comm., Op. 86-1 (1986) (no duty to report violation of the Internal Revenue Code to the IRS); Louisiana Supreme Court Comm. on Judicial Ethics, Op. 73 (1987) (no ethical duty to report civil and criminal tax fraud or matters relating to tax fraud).

18. 247 N.J. Sup. 552 (Sup. Ct. 1990).

19. 247 N.J. Sup. at 567.

20. Fitgerald v. Fitzgerald, 2012 N.J. Super. Unpub LEXIS 1376, p. 14 n. 7 (Super. Ct. App. Div. 2013).

21. Challow v. Challow, 2011 N.J. Super. Unpub. LEXIS 1068 (Super. Ct. App,. Div. 2011).

22. Onyiuke v. Onyiuke, 2011 N.J. Super. Unpub. LEXIS 1541 (Super. Ct. App. Div. 2011).

23. MacFarland v. MacFarland, 2008 N..J. Super. Unpub. LEXIS 2654 (Super. Ct. App. Div. 2008).

24. Arizona Supreme Court, Judicial Ethics Advisory Committee, Ad. Op. 92-15, Discussion, p. 1.

25. People v. Harper, 75 N.Y.2d 313, 317 (1990); N.Y. Penal Law §155.05 [2] [e] [iv].

26. 22 NYCRR §1200.0(3)(4).

27. 389 N.J. Super. 462 (Super. Ct. App. Div. 2006).

28. 380 N.J. Supr. at 472.

29. Hunt v. Hunt, 273 A.D.2d 875,876 (4th Dept. 2000) (discussing the certification requirements in matrimonial actions and 22 NYCRR 202.16 (e) and 130-1.1a); Rosen v. Rosen, 161 Misc.2d 795,799 (Sup. Ct. Queens Cty 1994) (reason for the imposition of the certification requirement clearly is to impress upon the matrimonial bar the necessity for compliance with minimal standards of candor and honesty).