Unpublished Disposition, 917 F.2d 1307 (9th Cir. 1984)

MEMORANDUM^** 

Kevin J. Petri appeals from his conviction on the third count of a three-count indictment for income tax evasion. The sole issue is whether the district court properly instructed the jury so that the government was held to its burden of proving beyond a reasonable doubt all essential elements of the crime charged. Because we conclude that the district court did not hold the government to its burden, we reverse.

* A

The district court had proper jurisdiction under 18 U.S.C. § 3231 (1988); this court has proper jurisdiction under 28 U.S.C. §§ 1291, 2106 (1988); and Petri's appeal is timely. See Fed. R. App. P. 4(b).

In reviewing jury instructions,

" [w]e examine ' "whether or not the instructions taken as a whole were misleading or represented a statement inadequate to guide the jury's deliberations." ' "..." [W]e give the trial judge 'substantial latitude' so long as the instructions 'fairly and adequately cover the issues presented.' " ... " 'Jury instructions, even if imperfect, are not a basis for overturning a conviction absent a showing they constitute an abuse of the trial court's discretion.' "

United States v. Marsh, 894 F.2d 1035, 1040-41 (9th Cir. 1989), cert. denied, 110 S. Ct. 1143 (1990) (quoting numerous Supreme Court and Ninth Circuit precedents). Nonetheless, we must make certain that "the court gave adequate instructions on each element of the case to ensure that the jury fully understood the issues. We must consider whether the instruction was misleading or states the law incorrectly to the prejudice of the objecting party." Kisor v. Johns-Manville Corp., 783 F.2d 1337, 1340 (9th Cir. 1986) (citations omitted). "An instruction which assumes a fact which is in issue is prejudicially erroneous." Lyons v. United States, 325 F.2d 370, 375 (9th Cir. 1963).

B

In 1988, Kevin Petri was indicted on three counts of tax evasion in violation of 26 U.S.C. § 7201. The three counts corresponded to tax years 1981, 1982, and 1983 respectively. Section 7201 provides: "Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall ... be guilty of a felony." 26 U.S.C. § 7201 (1988) (as originally enacted Aug. 16, 1954).

With respect to tax year 1983, the government alleged more specifically that Petri had willfully violated section 280E. Section 280E, which became law in 1982 and which only affects subsequent tax years, states that:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

26 U.S.C. § 280E (1988) (as originally enacted Sept. 3, 1982).

At trial the government endeavored to prove that Petri had either instructed or allowed his accountant to deduct from his adjusted gross income certain costs that Petri had incurred as a result of his 1983 arrest for possession with intent to distribute marijuana in Arizona. In connection with that earlier criminal charge, Petri had incurred legal fees and had forfeited $6,000 in cash and possession of a four-year-old van, and the government charged that these items were illegally deducted.

At the conclusion of the evidentiary phase of the trial, the prosecution and defense counsel met with the court in camera to discuss proposed jury instructions. At that time, counsel for the defense objected to the language proposed by the court regarding Petri's alleged 280E violation. Counsel insisted that the language assumed as already proven that amounts deducted from Petri's 1983 gross income were drug-related. The court explained that the instruction in question was intended only to communicate to the jury the narrow point that section 280E became effective in 1983 and that it therefore had no bearing or applicability to the indictment's first two counts, which concerned tax years 1981 and 1982. Perhaps inferring from this explanation that the court intended to submit a different instruction dealing with the essential elements of the third charge, defense counsel withdrew his proposed alternative language, and the court simultaneously rejected the objection.

The parties thereupon returned to the courtroom where the judge proceeded to instruct the jury. Defense counsel then objected to the instructions as given, and the parties again retreated into chambers to discuss the objection. The court then revised the instructions; the parties returned to the courtroom; the jury was informed of the change; and the court was adjourned pending deliberations. Petri was subsequently convicted on all three counts.

On appeal, Petri raises two objections to the instructions. First, he alleges prejudicial error in the court's apparent assumption that he in fact took any deduction in 1983. Second, he alleges prejudicial error in the court's apparent assumption that any deduction that he may have taken included amounts incurred during alleged "trafficking in controlled substances." We conclude that the jury instructions were indeed prejudicial with respect to these essential elements of the alleged offense.

II

It is clear upon a reading of the provisions themselves that in order for an individual to be guilty of violating section 7201 through a willful violation of section 280E, that individual must underreport income and the income not reported must be an "amount paid or incurred during the taxable year in carrying on any trade or business ... [related to] trafficking in controlled substances." 26 U.S.C. § 280E. Review of both the in camera discussions and the actual jury instructions given reveals that the district court failed to hold the government to its burden of proving these two facts beyond a reasonable doubt. The court's handling of the jury instructions resulted in a fundamental misallocation of the burden of proof.

* This misallocation can be traced back to the time defense counsel first objected to the court's proposed instructions. During the initial instruction settlement conference, the following exchange took place:

MR. CUMMINGS [defense counsel]: The court's instruction seems to be in the nature of a tax court ruling that the defendant took a deduction for a ... loss ... in trade or business involving illegal drugs, that those losses weren't permitted after September 4th, '82, and he took it nevertheless.

Now, first of all, I do not believe that the evidence shows that the defendant deducted either an expense or a loss from the Arizona transaction.... All we know is that [Petri's accountant] reduced gross receipts by $31,000....

[Mr. Cummings then insisted that numerous theories could account for the apparent reduction in Petri's gross income, that under some circumstances the purchase of marijuana could constitute a legitimate deduction, and that the proposed instruction ought to be revised to account for these possibilities.]

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THE COURT: But the testimony that you are referring to contemplated that there was drug income.... I might feel a little differently about your position if you had established that there was a fund here that came from sale [sic] of marijuana. I don't think the predicate grounds are here for the Court to go into all this....

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MR. CUMMINGS: Well, just a second. The reason that we submitted an instruction, Your Honor, [is] because it became clear to us that the law involving tax treatment for expenditures involving or associated with illegal drugs was going to become involved in this case.... We've gone through the whole case. It's clear to us now that there are three possible tax consequences for expenditures involving illegal drugs.... We don't know what [Petri's accountant] did here. Whether he treated it as cost of goods sold increase [sic], an expense, or a loss.

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My point is that under some circumstances an expense would be appropriate, and under some circumstance [s] an addition to your cost of goods sold would be appropriate.

THE COURT: But if you wanted that kind of instruction, you should have proven that there was income from the sale of marijuana that we were dealing with here which these deductions might, and I say "might," because I'm not satisfied that they are, but might at least arguably be applicable in the light of 280 [E].

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MR. CUMMINGS: ....

What would be ironic here, Your Honor, is if when the IRS comes after Kevin Petri following this trial regardless of the results, and some tax court would rule that, yeah, we're going to give him a portion of these expenses in Arizona, because we think that some portion of them can be attributed to the attempts to purchase furniture down there.

Transcript of Jury Instruction Settlement Conference at 3-8, 10-11, 12-13 (emphasis added).

What this excerpt reveals is the apparent view of the court that Petri bore the burden of disproving elements of the crime. That notion contradicts the most fundamental tenet of Anglo-American criminal law: that the defendant is presumed innocent and that the government bears the burden of proving his guilt beyond a reasonable doubt. The fact that this excerpt may also reveal that the defense lacked a coherent theory of the case is irrelevant.¹  Whether there are fundamental errors in the defense's understanding of federal tax law and whether the evidence realistically supports an innocent explanation for the tax treatment accorded to Petri's 1983 income are also irrelevant. As a theoretical matter, it is possible that Petri claimed no deductions at all and that whatever deductions he did claim were unrelated to any illegal activities. The government bears the burden of proving that theory untenable to a jury of Petri's peers in a court of law.

B

What could have remained harmless error became prejudicial error when the court carried its misconception from the conference to the courtroom. After a lengthy address in which the court properly recited the general duties of jury service, the court instructed the jurors as follows:

You have heard considerable evidence and discussion about a particular provision in the tax laws that now prohibits any deduction for the amounts paid or incurred in conducting a trade or business involving the sale of illegal drugs. You are instructed that this law, Section 280 [E] of the Internal Revenue Code, became effective September 4, 1982. That is to say, no deductions were allowed for any amounts paid or incurred after September 4, 1982 [,] for any trade or business involving illegal drugs.

In this case, the Defendant has claimed a business loss on his 1983 tax return for the expenditure of attorney's fees and for the forfeiture of a 1979 van and $6,000 in cash in connection with criminal charges for possessing marijuana for sale in Arizona. The Defendant was arrested in 1983, and he subsequently claimed the loss on his 1983 tax returns which the Defendant filed with the Internal Revenue Service on August 2, 1984.

Transcript of Jury Instructions at 10-13 (emphasis added).

Upon defense counsel's objection to the underscored language, which clearly assumes both that the defendant did claim a deduction and that the deduction claimed was impermissibly drug-related, the court met with the attorneys at the side bar, and the following exchange took place:

MR. CUMMINGS: The defendant incorporates by reference the objections that he has previously made to these instructions in chambers. In particular, to the instruction dealing with, I think it's 280(c) [280E] of the Internal Revenue Code.... [Mr. Cummings offered several other objections.]

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THE COURT: ....

The other objections are overruled. But I'm concerned here, Mr. Cummings, if in this case it is your contention and you're changing your position and now saying that the Defendant does not claim a business loss on the '83 tax return for the expenditure of attorney's fees. I don't want to instruct the jury that he does if you're denying it. And I think, then, that the instruction should perhaps be phrased to the jurors so that it states, "... from all the evidence, if you find ..." and so forth.

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All right. And I think I understand your position. The difficulty is we started the trial with the Defendant admitting that this was the case. And then after I drafted the instruction, the Defendant withdrew one of his instructions, the one relating to the 280 [E], and then said that isn't the fact of the matter. And so now, I think the problem could be solved by simply putting an "if" in there.

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The whole purpose of this instruction was simply to put the 280s [sic] into focus on the dates, and in the process of doing it, we relied on the Defendant admitting certain things which the Defendant later has now retracted, and so the instruction has got to be revised so that we are not telling the jury that the--that the Defendant has claimed-- [h]e's saying he doesn't know what that is. I want to say to the jury that if from that examination they find that, then this is the way it fits into the date picture here.

Id. at 23, 25, 26-27, 29 (emphasis added). Again, the court's language betrays a fundamental misunderstanding of where the burden lies. Whether the defense presented a coherent explanation for the evidence and whether it adhered consistently to that theory is of no consequence. Even in the late stages of jury instruction, the defense is entitled to change its view of the evidence. The burden still rests with the government to prove all elements of the crime charged beyond a reasonable doubt, and the instructions must reflect that burden. Even if implicitly admitted at trial, an essential element of the offense must be assumed unproven by the court and must appear as unproven in the instructions. Finding the essential facts remains the exclusive province of the jury.² 

After revising the challenged instruction in chambers, the court returned to the courtroom and reinstructed the jury as follows:

THE COURT: ....

Now, I also instructed you concerning section 280 [E] of the Internal Revenue Code which became effective on September 4 of 1982. As a part of those instructions, I stated to you that the Defendant claimed a particular loss or reduction. And what I want to say to you, rather, is that if you find from an examination of all of the evidence that the Defendant did claim a reduction on his tax return in connection with expenditure of attorney's fees and for the forfeiture of a 1979 van and $6,000 in cash in connection with the criminal charges for possessing marijuana for sale in Arizona, that that occurred on his 1983 tax return. That the Defendant was arrested in April of 1983, and that he later claimed that loss, if in fact he did, on the 1983 return. And so the question is for you folks to determine whether that is what occurred. In other words, whether or not the defendant did in fact do that, but it occurred if at all, on the 1983 return.

Id. at 31-32.

The law of this circuit clearly establishes that a court can cure or render harmless ambiguities and errors in its initial instructions by reinstructing the jury. See United States v. Lee, 864 F.2d 531, 535 (9th Cir. 1988). Nonetheless, when the original instruction betrays prejudgment on the part of the court in a criminal trial, the harm inflicted can rarely be undone. Having heard the court's initial instructions, a reasonable jury could fairly have discounted the sincerity of the revised version. They may very well have concluded that the new instruction was a last-minute concession to the defense in what was to the court's mind quite clearly an already hopeless case.

There is implicitly an acute danger of impermissibly inferring guilt by association when the defendant in a tax prosecution is an identified drug offender. That danger increases when the criminal charge in question is the third of three counts, and the jury is justifiably predisposed to convict on the prior two. In such circumstances, especial care is required. There is no doubt that the court's original instruction impermissibly assumed as proven elements of the third crime charged. The court's attempt to correct that prejudicial error was incomplete and inadequate to guide the jury's deliberations on that issue. See Hall, 650 F.2d at 997-98.

III

For the foregoing reasons, appellant's conviction on the third count of the indictment must be reversed and the cause remanded for retrial. Because the district court did not apportion the sentence it imposed among appellant's three convictions, we must therefore vacate the sentence and remand for resentencing on the two convictions untouched by this appeal.

REVERSED and REMANDED.

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Recognizing the inherent danger to the defendant's fair trial due to the complex underpinnings of the net worth method, the Supreme Court in Holland established the requirement of detailed, comprehensive jury instructions on the net worth method of proof:

Charges should be especially clear, including, in addition to the formal instructions, a summary of the nature of the net worth method, the assumptions on which it rests, and the inferences available both for and against the accused.

We interpret and adopt this as a clear requirement for explanatory jury instructions in net worth cases.

650 F.2d at 997 (citation omitted), 998 (quoting Holland v. United States, 348 U.S. 121, 129 (1954), reh'g denied, 348 U.S. 932 (1955)).