IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA UNITED STATES OF AMERICA : v. : CRIMINAL NO. 08-592-01 JOHN P. KAROLY JR. : GOVERNMENT'S GUILTY PLEA MEMORANDUM I. INTRODUCTION Defendant John P. Karoly Jr. is charged in superseding indictment no. 08-592-01, filed on March 12, 2009, with three counts of wilfully filing false federal income tax returns, in violation of 26 U.S.C. 7206(1)(Counts 1, 2 and 3), one count of conspiracy to commit wire fraud, in violation of 18 U.S.C. 371 (Count 4), two counts of wire fraud, in violation of 18 U.S.C. 1343(Counts 5 and 6), three counts of mail fraud, in violation of 18 U.S.C. 1341 (Counts 7, 8 and 9), and three counts of money laundering, in violation of 18 U.S.C. 1956(a)(1)(B)(I) and 2 (Counts 10, 11 and 12), and three counts of money laundering, in violation of 18 U.S.C. 1957 and 2 (Counts 13, 14 and 15). Specifically for purposes of this guilty plea, the false federal income tax return counts (Counts 1, 2 and 3) result from defendant John P. Karoly Jr. willfully filing false federal income tax returns for calendar years 2002, 2004 and 2005, by knowingly failing to report additional taxable income of approximately $5,201,095.00. II. PLEA AGREEMENT SUMMARY The government and the defendant have entered into a written guilty plea agreement, attached as Exhibit A. The defendant will enter a guilty plea to counts 1, 2 and 3 of
the superseding indictment, and waive all rights to appeal. The parties agree to a non-jury trial of counts seven through fifteen on a stipulated set of facts. If the defendant is found guilty of any of these counts, he will waive all post-trial motions and appeal rights, both direct and collateral. At the time of sentencing, the government will move to dismiss counts four, five and six against all defendants. As to counts one through three, the government s position is that the base offense level for the offenses of conviction is 22 under 2T1.1(a)(1) and 2T4.1(I) of the advisory Sentencing Guidelines, based upon a total tax loss in the amount of approximately $1,955,395.00. The defendant agrees with this amount for purposes of the guilty plea. The defendant reserves the right to present evidence at the time of sentencing to prove a lower amount of unreported income and resulting tax loss. In addition, the government s position is that a two level upward adjustment is warranted for defendant s obstruction of justice under U.S.S.G. 3C1.1. The defendant reserves the right to argue against the obstruction of justice enhancement at the time of sentencing. The government s position is that the defendant is not entitled to any acceptance of responsibility departure under 3E1.1. The defendant reserves the right to argue to the court at sentencing that he should be entitled to a 2-level departure for acceptance of responsibility under 3E1.1(a). In addition, the government s position is that the total amount of tax loss is as follows: a) for calendar year 2002, the defendant failed to report taxable income in the approximate amount of $834,267.00, resulting in additional income tax due and owing in the amount of $316,988.00, plus interest and penalties; b) for calendar year 2004, the defendant failed to report taxable income in the approximate amount of $3,304,258.00, resulting in 2
additional income tax due and owing in the amount of $1,242,073.00, plus interest and penalties; and c) for calendar year 2005, the defendant failed to report taxable income in the approximate amount of $1,062,570.00, resulting in additional income tax due and owing in the amount of $396,334.00, plus interest and penalties. Thus, there is a total amount of unreported income of approximately $5,201,095.00 with a resulting total tax loss due and owing by the defendant in the amount of approximately $1,955,395.00, plus interest and penalties to be calculated by the Internal Revenue Service. The government has the right to make whatever recommendation it deems appropriate at the time of sentencing. III. ELEMENTS OF THE OFFENSE Counts 1-3 (wilfully filing false federal income tax returns) In order to prove the offense of filing false income tax returns in violation of 26 U.S.C. 7206(1), the government must prove beyond a reasonable doubt that: 1. the defendant made or subscribed an income tax return, in this case, federal income tax returns Form 1040 for calendar years 2002, 2004 and 2005; 2. the tax return contained a written declaration that it was made under the penalties of perjury; 3. the defendant did not believe that the return was true and correct as to every material matter, in this case, defendant failed to report a substantial amount of taxable income which should have been reported; and 4. the defendant acted willfully. 3
IV. MAXIMUM SENTENCE/SENTENCING GUIDELINES A. Maximum statutory sentence Counts 1-3, Filing False Federal Income Tax Returns, 26 U.S.C. 7206(1) 3 years imprisonment, a $250,000 fine, 1 year supervised release, and a $100 special victim/witness assessment, as to each count. TOTAL MAXIMUM SENTENCE: 9 years imprisonment, a $750,000 fine, 1 year supervised release, and a $300 special victims/witness assessment, in addition to the payment of all back taxes due, together with penalties and interest. B. Sentencing guidelines As to counts 1, 2 and 3 only Base Offense Level 22 ( 2T1.1(a)(1) and 2T4.1, based upon a total tax loss of approximately $1,955,395.00)) Upward adjustment for obstruction +2 of justice ( 3C1.1) Total Offense Level 24 Criminal History Category I Advisory Sentencing Guidelines Range 51 to 63 months imprisonment V. FACTUAL BASIS FOR THE GUILTY PLEA The government would prove the following facts beyond a reasonable doubt if this case were to proceed to trial: Defendant John P. Karoly Jr. willfully filed false federal income tax returns for calendar years 2002, 2004, and 2005, by knowingly failing to report additional taxable income in 4
the amount of approximately $5,201,095.00. The government s position is that the total amount of tax loss is as follows: a) for calendar year 2002, the defendant failed to report taxable income in the approximate amount of $834,267.00, resulting in additional income tax due and owing in the amount of $316,988.00, plus interest and penalties; b) for calendar year 2004, the defendant failed to report taxable income in the approximate amount of $3,304,258.00, resulting in additional income tax due and owing in the amount of $1,242,073.00, plus interest and penalties; and c) for calendar year 2005, the defendant failed to report taxable income in the approximate amount of $1,062,570.00, resulting in additional income tax due and owing in the amount of $396,334.00, plus interest and penalties. Thus, there is a total amount of unreported income of approximately $5,201,095.00 with a resulting total tax loss due and owing by the defendant in the amount of approximately $1,955,395.00, plus interest and penalties to be calculated by the Internal Revenue Service. The government would present the following evidence in support of each count: 2002 Defendant John P. Karoly Jr. filed a federal income tax return reporting $0 in taxable income. He failed to report $834,267 in taxable income resulting from a single civil settlement in which Karoly earned a fee of $938,135. The unreported taxable income results from Karoly failing to advise his accountant of two checks which Karoly wrote as follows: check dated 1/23/02, check no. 1396 for $ 658,775 (this was repayment of a personal loan from Bruce Rothrock Sr. which had previously been made to John Karoly and his wife), and another check dated 1/23/02, check no. 1408, for $175,498.18, payable to John P. Karoly Jr.. Karoly did not 5
file his 2002 federal income tax return until 2004. The evidence will show that Karoly maintained an IOLTA account in 2002 at Summit Bank. We will show a wire transfer on 1/22/02 from St. Paul Fire and Marine Insurance Co. into the Karoly IOLTA account at Summit Bank, in the amount of $1,275,000. This was a total civil settlement for his client Kimberly Rankin. After the settlement funds are wired into Karoly s IOLTA account we will be able to prove the following disbursements, several of which were for personal uses: 1/23/02 - Check #1405, $333,732.82, payable to Kimberly Rankin 1/23/02 - Check #1396, $658, 775, payable to Bruce Rothrock (this was repayment of a personal loan previously made by Rothrock to Karoly and his wife) 1/23/02 - Check # 1401, $3,000, payable to Heather J. Kovacs (secretary/employee of Karoly Law Office) 1/23/02 - Check # 1408, $175,492.18, payable to John Karoly (partial fee) A fee to Karoly of $938,125 was earned by Karoly Law Office, and recorded on the law office settlement sheets. Only approximately $92,000 of this fee was reported as income on Karoly s 2002 tax return. The government has obtained the law office settlement documents to prove the settlement distributions. Karoly wrote the checks out of his IOLTA account directly and did not make deposits into his law office operating account when the fees were earned. Therefore, there is no record of income being made to him from the law office operating account, even though the $938,125 was earned as of 1/22/02. By leaving the funds in his IOLTA account, it appeared that withdrawals were made from client funds and not his own, thus hiding his true income. 6
The government would present the testimony of Kimberly Rankin who confirms the $333,732.82 amount she received in settlement. Further, Bruce Rothrock Sr. would testify that the $658, 775 was for the repayment of a personal loan previously made to Karoly and his wife. 2004 Defendant Karoly reported $881,353 in taxable income on his federal income tax return. He failed to report $3,304,258. Again, all of this unreported income is documented by checks and does not include any unreported cash fees from criminal cases. Karoly s 2004 tax return was not filed until April 19, 2006. The civil Hirko Case settlement The majority of the unreported income in calendar year 2004 is derived from a civil settlement in a case known as Hirko. Hirko involved a civil lawsuit against the City of Bethlehem and its Police and Fire Departments. The case was settled after the liability portion of trial. Karoly signed a civil settlement agreement in which the total amount of the settlement was documented at $7,890,000, and his fees were documented at $4,150,000. This figure is also contained on the Karoly Law Office settlement worksheet, which Karoly provided to the PA Disciplinary Board in response to a subpoena in late 2006, and which was provided to the government in this case. Unreported $1,000,000 of alleged reimbursable expenses Karoly reported to his accountant tax preparer for 2004 that his fees were only $3,150,000. Karoly failed to report an additional $1,000,000 which the settlement agreement noted as reimbursable or advanced client expenses. In fact, the government would prove that 7
the Karoly firm had substantially less than $1,000,000 in advance or reimbursable client expenses for the Hirko case. Checks can be traced from the $1,000,000 which Karoly failed to report to pay fees and bonuses to expert witness (co-defendant) John Shane, bonuses to Karoly employees James Heidecker, Heather Kovacs (secretary), and other employees. In addition, Karoly used this money for personal expenses unrelated to the case such as purchase of stock from Bill Talbert and Talbert Fuel, and personal home kitchen remodeling and pool repairs, all expenses he falsely claimed on his tax returns as business expenses. The amount of Hirko expenses claimed and provided to the accountant for tax purposes was $259,294.82. As such, the $1,000,000 not disclosed to his accountant received in calendar year 2004, is unreported income to Karoly. 50% deferral of income ($1,578,000) In addition to failing to report the $1,000,000, Karoly told his accountant that the case was on appeal and that the accountant should not claim the full remaining $3,150,000 as income until the appeal gets resolved. Accountant Al France would testify about a discussion with Karoly on or about April 13, 2005, and actually made a note on the accountant worksheet that 50% of the $3,150,000 should be deferred income per JK. Truth is, there was no appeal of the case and the civil settlement agreement provided a release of all claims and appeals (actually, the only appeal pending was a finding of contempt against Karoly for some of his conduct during the trial, but this had no effect on the amount of the settlement, only a fine which was imposed on Karoly personally). On May 27, 2004, Karoly deposited the sum of $7,390,000 into his IOLTA account. On July 26, 2004, Karoly deposited the remaining $500,000 of this settlement into his 8
IOLTA account. On June 3, 2004, Karoly wrote check #10787 from his IOLTA account payable to John P. Karoly, Esq. for $3,156,000 which was deposited into his personal Pershing securities account. Karoly had unrestricted access to all of these funds. As such, the deferral of approximately $1,578,000 (50% of the $3,150,000) was unlawful since Karoly had access to the full amount and spent it. When Karoly told his accountant to defer 50% of this income, this resulted in an additional $1,578,000 of unreported income for 2004. Indeed, the remaining 50% of the deferred income was never reported in 2005 or 2006. Karoly has not yet filed his 2006 or 2007 tax returns, so this $1,578,000 still remains unreported as of this date. False Personal Expenses Deducted as Business Expenses ($226,258) The IRS determined that there were several claimed business expenses deducted on the return which were in fact personal, and not business related. $21,258 was deducted as depreciation for Morris Black. This is a kitchen remodeling company. There was no work performed at the Karoly law office, but rather, Karoly had the work performed at his residence he shares with his wife. On July 23, 2004, Karoly wrote a check for $37,200 to Morris Black from his IOLTA account. The government has obtained the Morris Black receipt showing the address of defendant Karoly s personal residence where the work was performed, and the testimony of defendant Karoly s bookkeeper who paid the expense at Karoly s direction, that no work was performed at the law office. We also have testimony of Karoly s accountant/tax preparer Alan France, who had a discussion with Karoly about who Morris Black was, and Karoly told him it was for cabinets in his law office. 9
$205,000 deducted for Talbert Fuels stocks and loans. Alan France, Karoly s accountant, would testify that Karoly had a discussion with France and told him that Talbert Fuels was a client and that these were deductible expenses to the law office. Karoly also failed to disclose that he was paid compensation for being on the Talbert Fuel Board of Directors. William Talbert of Talbert Fuels would testify that Karoly has lent Talbert money and was repaid with Talbert Fuels stock. Thus, the $205,000 client expense deducted on Karoly s 2004 tax return as Cost of Sales, was actually a false deduction and constituted unreported taxable income to Karoly. Fraudulent $500,000 charitable deduction for Lehigh Valley Community Foundation Defendant Karoly made a $500,000 charitable donation to the Lehigh Valley Community Foundation which was never intended by Karoly to be used for charitable non-profit purposes. In fact, after taking the $500,000 charitable deduction, Karoly then attempted to have the whole $500,000 donated to his private foundation (Urban Wilderness Foundation) which Karoly set up on December 30, 2005; this request was refused by Lehigh Valley Community Foundation. Karoly eventually had the funds distributed to his church, the UCC Dubbs Memorial Church in Allentown, Pennsylvania, and then had the church distribute funds back to Karoly in the name of the Urban Wilderness Foundation, the private foundation which Karoly had set up, and to which the Lehigh Valley Community Foundation had refused to donate the funds. All of the money was used for Karoly personal expenses. Not one penny went to charity, other than some donations to the church which they were allowed to keep. As such, this $500,000 charitable deduction is a false deduction. 10
Alan France, Karoly s CPA, would testify that Karoly came to him in December 2004 and wanted to set up a private foundation to help inner city kids. France told him that since the foundation was not set up in 2004 that he could not make a charitable contribution to his private foundation to deduct. Therefore, France recommended a charitable deduction to the Lehigh Valley Community Foundation, a legitimate 501(c)(3) foundation which allows donors to establish donor funds to be distributed to various charitable organizations. Karoly agreed and wrote a personal check on December 30, 2004 for $500,000 to the Lehigh Valley Community Foundation. Karoly did not designate a specific charity to distribute the funds to by the Lehigh Valley Community Foundation and the money sat in a money market fund at the Foundation until 2007. In the meantime, Karoly refused to complete the required donor fund agreements or designate who the funds should be distributed to, despite several requests to him from Lehigh Valley Community Foundation. On December 30, 2005, Karoly set up the Urban Wilderness Foundation, a private foundation. Karoly is the President and sole signatory on the checking account. No employees or charitable activities performed by Urban Wilderness Foundation. It was not established to be a non-profit organization under IRS Section 501(c)(3). On December 6, 2006, Karoly told Lehigh Valley Community Foundation that he wanted to donate all $500,000 to the Urban Wilderness Foundation. The Lehigh Valley Foundation did its due diligence and could find no information about the Urban Wilderness Foundation but learned that it was not a non-profit tax-exempt organization under 501(c)(3), and therefore would not distribute the funds to them. In September 2007, they sent an information form to Karoly to get info about Urban Wilderness Foundation, but Karoly never completed nor 11
sent back the form. After learning that he could not get his $500,000 back as a distribution to the Urban Wilderness Foundation, Karoly then made arrangements with his church, the Dubbs Memorial United Church of Christ (Dubbs UCC) to make donations to them, as Karoly directed. They agreed. They assumed Karoly could make donations and since he had donated the money to Lehigh Valley Community Foundation, where the money would actually come from in the form of a check, that he could direct how the money would be spent. Karoly knew that once a person donates to Lehigh Valley Community Foundation, the money belongs to the Foundation and is not the donor s anymore. The donor can make recommendations as to how it is distributed, but the Foundation has the sole and final decision. In February 2007, Karoly directed Lehigh Valley Community Foundation to distribute $90,000 to Dubbs UCC. Since Dubbs UCC was a religious, tax-exempt organization under IRS section 501(c)(3), Lehigh Valley issued a check to Dubbs and mailed a copy of the grant letter to Karoly. Karoly directed the church to use $33,864 of the $90,000 to pay for personal expenses of Karoly, i.e. funeral and catering expenses for Karoly s brother s memorial service. The government has obtained the receipts from the church and the Lehigh Valley Community Foundation. In September 2007, Karoly directed Lehigh Valley Community Foundation to donate the balance of his account to Dubbs UCC. On September 18, 2007, Lehigh Valley issued a check for $433,569 to Dubbs UCC which was mailed, and copy of the grant letter mailed to Karoly. On September 21, 2007, Karoly directed the Dubbs UCC to pay $90,000 of that money to Urban Wilderness Foundation, which it did, and which Karoly deposited in the checking 12
account. One week later, September 26, 2007, Karoly directed that the balance of the $433,569 be distributed to Urban Wilderness Foundation by Dubbs UCC. On that date, $293,569 was delivered to Karoly by the church treasurer. The check was payable by a brokerage firm to Dubbs UCC but the treasurer, at Karoly s direction, delivered it with an open endorsement in the back. It was deposited into Urban Wilderness checking account. All of the money was used for Karoly personal and law office expenses; not a penny was spent on charitable purposes. In total, of the $500,000 donated to Lehigh Valley Community Foundation and for which Karoly took a $500,000 charitable deduction in 2004 (although the return was not filed until 2006), the sum of $383,569 went back to Karoly and was used for personal expenses. Thus, the IRS determined that the $500,000 charitable deduction for 2004 was in fact taxable income to Karoly since it was a false charitable deduction which was not intended, nor ultimately used, for charitable purposes. Thus, total amount of false deductions and taxable income for 2004 is $3,304,258. 2005 Karoly reported $565,963 in taxable income on his federal income tax return. He failed to report $1,062,570. Again, all of this unreported income is documented by checks and does not include any unreported cash fees from criminal cases. Urban Wilderness Foundation $250,000 deduction On December 30, 2005 Karoly set up the Urban Wilderness Foundation, a private foundation. He is the President and sole signatory on the checking account. No employees or charitable activities performed by Urban Wilderness Foundation. It was not established to be a 13
non-profit organization under IRS Section 501(c)(3). On December 30, 2005, Karoly opened a checking account for Urban Wilderness Foundation and made a $250,000 deposit, which Karoly deducted as a charitable deduction. This deduction was not allowable since the Urban Wilderness Foundation was not a tax-exempt 501(c)(3) organization. Thus, there is an additional $250,000 of income for 2005. $50,000 deduction for donation to Dubbs UCC church On January 1, 2006, Karoly wrote a $50,000 check from Urban Wilderness Foundation to Dubbs UCC. Karoly, however, used the $50,000 deduction for 2005 although he did not make any such donation during calendar year 2005. It was made on January 1, 2006. In fact, the church giving statement for the Karolys during 2005 showed a total donation to the church of only $870, and not $50,000 as Karoly claimed. $26,713 alleged business expense deduction to purchase property On June 3, 2005, Karoly and his wife purchased a 110 acre lot in White Haven, PA. He used $400,000 of funds earned from fees in the Hirko case. The remaining $26,713 was paid to seller Steve Wasko from Karoly law office account. Karoly deducted this amount as a client cost. This amount was not business related and related solely to the personal purchase of the property. As such, it was unlawfully deducted as a business expense and was taxable income to Karoly in 2005. $4,555 and $2,960 deducted as depreciable asset In 2005, Karoly deducted $4,555 relating to Morris Black, depreciable asset. As noted earlier, Morris Black was not a client, but rather installed kitchen remodeling in Karoly s residence and was unrelated to his business. He should not have taken the deduction as a 14
depreciable asset. This $4,555 was taxable income to Karoly. Karoly bought a 2005 Lincoln Navigator for his secretary Heather J. Kovacs for $68,900, using law office funds. It was titled in the name of Heather J. Kovacs. It was solely used by Heather Kovacs. Karoly was not entitled to depreciate this asset since it did not belong to Karoly or the firm. Thus, the $2,960 deduction was also taxable income to Karoly. $70,000 loans and stock in Talbert Fuels and $12,500 compensation Karoly obtained $70,000 worth of Talbert stock in 2005 which he misrepresented to CPA Alan France as being a client expense. This $70,00 was taxable income and should not have been deducted. In addition, Karoly received additional stock worth $12,500 from Talbert Fuels for Karoly agreeing to perform services as a member of the Board of Directors. This amount was never reported to CPA Alan France and was taxable income to Karoly. $100,000 loan to Eric Dalius On April 13, 2005, Karoly made a loan to client Eric Dalius of $100,000 from Karoly s IOLTA account. Dalius confirmed to agents that Karoly had made him the loan of $100,000 unrelated to any case. Karoly acknowledged this loan to the PA Disciplinary Board. Thus, the $100,000 deduction as cost of sales was actually taxable income to Karoly. Dalius paid back the loan. $544,022 in client deposits not reported The defendant s law office provided client posting sheets to the government in response to a subpoena. Karoly s bookkeeper, Joanne Brantley, explained that whenever a client makes a payment, it is posted in the client posting sheets. The total amount of income in the client posting sheets for 2005 is $544,042. 15
This amount, however, was never reported to CPA Alan France. This amount is client income to Karoly although not from any civil settlements. The only amount reported to CPA Alan France by Karoly was the amount of client civil settlements. Karoly failed to disclose, and thus failed to report additional income of $544,042. Thus, total amount of false deductions and taxable income for 2005 is $1,062,570. Respectfully submitted, MICHAEL L. LEVY United States Attorney SETH WEBER KEVIN R. BRENNER Assistant United States Attorneys 16
CERTIFICATE OF SERVICE I hereby certify that a true and correct copy of the Government's Guilty Plea Memorandum in this case was served upon defense counsel by hand-delivery, as follows: Robert E. Goldman, Esquire P.O. Box 239 Fountainville, PA 18923 Date: July 6, 2009 SETH WEBER KEVIN R. BRENNER Assistant United States Attorneys 17