In a surprising victory, Wesley Snipes was acquitted of federal tax fraud and conspiracy counts, but was found guilty of failing to file tax returns. It was a particular vindication for his attorneys who did not put him on the stand or call defense witnesses – a very dangerous strategy that has backfired in many cases with a conviction. The acquittal was unexpected given the bizarre tax theory that he believed relieved him of paying taxes — his co-defendants were convicted on the basis of that scheme.

Snipes now could face up to three years in prison, and must pay back millions in taxes. Nevertheless, that is a big improvement over the 16 years in prison that he was facing.

His co-defendants did not do as well. Eddie Ray Kahn, the founder of a tax protest group, and Douglas P. Rosile, a delicensed accountant, were convicted by the same jury of tax fraud and conspiracy. They face up to 10 years in prison.

Snipes and two other men will focus on a little known movement based on Section 861 of the Internal Revenue Code. This group argues that citizens are only required to pay taxed on earnings made outside but not inside the country. Snipes could be looking at real jail time for his involvement with the group even after he signed a affidavit of incompetence in 2000 that he does not understand his basic tax obligations.

Snipes’ defense received a blow with the release of odd and mildly threatening letters that the actor wrote prosecutors after his indictment.

In the letters, Snipes reportedly accuses the IRS of trying to “terrorize, enslave, rape or pillage” taxpayers during his tax evasion trial in Florida. The letters were written in December 2006 after his indictment when most clients are on a short leash with counsel holding the other end.

According to the Ocala Star-Banner in this article, the letter includes the following statement that seems to come out of a character in “Blade”: “Warning – pursuit of such a high profile target will open the door for your increased collateral risk. I certainly don’t believe this is in your best interest.”

While his attorney Robert Barnes insisted that such statements are not threatening and “a lot of it was very gentle.” Of course, the real question is why a criminal defendant is writing irate letters to the IRS. It suggests that Barnes is not in control of his client — a basic requirement for effective representation.

The government has alleged that Snipes was fully aware that the 861 argument was a scam. He is accused of not filing any returns at all from 1999 to 2004 in addition to two false returns. If convicted, he could face up to five years in prison if the eight counts run concurrently — as they usually do. His co-defendants filed to income returns for Snipes and claimed refunds totaling almost $12 million.

At the center of the alleged criminal enterprise is Kahn who was the founder and leader of American Rights Litigators (ARL) and its successor, Guiding Light of God Ministries (GLGM).The government has long watched both organizations, which allegedly consulted with taxpayers in advancing fraudulent tax claims and schemes. The 861 argument has been described as a “cult belief” by experts, click here It is a widely cited and false claim.

One of the leading peddlers of this theory has been Larken Rose, who wrote a popular analysis of the provision. Larken described how regulations can be read to mean that if you do do foreign commerce or work in the Northern Mariana Islands, your income is not subject to taxation.

The government used this case to deter others from being drawn into the 861 crowd. Targeting a celebrity is a great way to getting that message out to taxpayers. On the government website, the IRS notes:

Sections 861 through 865 do not limit gross income subject to United Statestaxation to foreign-source income. In Notice 2001-40, 2001-1 C.B. 1355, the Serviceadvised taxpayers that it considers the Section 861 position to be a frivolous position.Courts repeatedly have rejected this and similar arguments as frivolous, and havepenalized taxpayers who make these types of arguments. See, e.g., Takaba v.Commissioner, 119 T.C. 285 (2002) (concluding that “[t]he 861 argument is frivolous”and sanctioning both the taxpayer and his attorney for making such frivolousarguments); Madge v. Commissioner, T.C. Memo. 2000-370 (concluding that the argument that only foreign income is taxable is frivolous).

For the latest on the trial, click here