February 2003
By ALEXANDER A. MIUCCIO, CIC Legal Counsel
While this space is regularly devoted to issues arising from construction litigation, there are at times compelling cases that fall outside what is generally considered "construction law" that bears reporting. Particularly so when a contractor is involved. This month's column presents a cautionary tale about the two principals of a contracting company who were convicted of tax fraud in federal court, based, in part, upon their methods of paying overtime to employees and failing to provide proper 1099 forms to subcontractors. The convictions in the United States District Court for the Eastern District of Pennsylvania were recently affirmed by United States Court of Appeals for the Third Circuit in the case of United States of America v. Gambone.
Background
John A. Gambone, Sr., and Anthony Gambone are brothers who owned and operated a construction business, known as Gambone Brothers Organization, Inc. The indictment accused them of engaging in a three-part conspiracy over the course of a 20-year period to file false personal income tax returns and to aid and assist certain of their employees and subcontractors in doing the same. The three prongs of the scheme, each of which led to a conviction, were described as: cash-skimming; overtime/expense reimbursement/off-payroll fraud and unreported subcontractor payments.
Cash-Skimming
The Gambones built homes that they sold to purchasers. They systematically received payments in cash from the purchasers for "extras." Rather than report the cash in the corporate books, they took it home and placed it in their safes or nightstands. They also used the cash payments to purchase United States savings bonds, the income from which does not have to be reported to the IRS until the bonds are cashed. In this manner, the Gambones attempted to hide additional income from the IRS.
Overtime/Expense Reimbursement/Off-Payroll Fraud
The most serious part of the tax fraud conspiracy involved the Gambones aiding and assisting their employees in preparing false individual income tax returns. The Gambones used three methods to avoid reporting significant wages paid to employees, with the intention that the employees not report the additional income.
First, the Gambones made it clear to all incoming employees that they did not pay overtime. Rather, they paid straight time for all work over the 40-hour work week, but paid it off the books. They issued a payroll check for the 40-hour work week and a separate, non-payroll check for the overtime hours, with no taxes withheld. This was intended by the Gambones to avoid the overtime pay requirement of the Fair Labor Standards Act and to avoid paying Social Security and Medicare taxes on the overtime. The employees, although receiving straight time instead of overtime pay, were encouraged not to report the income, and thus avoid paying taxes on it. They understood that they need not report the income, since there was no withholding. At the trial, one witness testified that the non-payroll "overtime" checks had been described by one of the Gambones as "mad money" so the employees could "take one check home and the old lady don't have to know about the other one." Other employees testified to being told that the overtime was paid "off the books" or "under the table."
Second, the Gambones attempted to avoid reporting wages by disguising certain employees' raises as expense reimbursements, which are not reported as income. The third method involved paying some employees partially or completely "off-payroll," that is, paying them from non-payroll, operating accounts, rather than from payroll accounts, regardless of whether it was overtime or straight time pay. In furtherance of the scheme, the Gambones had their finance department issue false W-2 forms that reported the regular wages but failed to report the overtime wages, expense reimbursements and off-payroll wages.
Unreported Subcontractor Payments
The last prong of the tax fraud conspiracy involved the failure to file IRS forms 1099 to report payments to certain subcontractors and encouraging the subcontractors not to report the income to the IRS. The Gambones negotiated lower rates with some of their subcontractors on the basis that they would not report the payments. Approximately half of the subcontractors, all of whom should have received 1099 forms from the Gambones for the millions of dollars worth of services rendered by the subcontractors, did not receive the 1099 forms.
Conviction
After a jury trial, the Gambones were convicted on numerous counts with respect to all three prongs of the conspiracy. They sought to have the convictions set aside by the trial court. The court did, in fact, set aside two counts, but sustained the remaining convictions. The court sentenced the Gambones to 37 months in prison, imposed terms of supervised release upon completion of the prison term, and ordered them to pay fines of $75,000, to pay the IRS $3 million and to pay certain costs of the prosecution.
On appeal, the convictions were affirmed.
Conclusion
It has been said that nothing is certain except death and taxes. This case represents a good illustration of that maxim. It does not pay for a contractor to attempt to defraud the IRS, particularly where payroll taxes and subcontractor payments are involved. The Gambones may have evaded the IRS for 20 years, but they are now paying the price. Sooner or later, the IRS will collect those inevitable taxes.
About the author: Mr. Miuccio is a partner in the New York City- based law firm Altieri, Kushner & Miuccio, P.C. and legal counsel to the Construction Industry Council of Westchester and Hudson Valley, Inc. Robert Mark Wasko, senior associate with the firm, assisted in the preparation of this article.