When does a taxpayer’s negligence, inadvertence, mistake, or good-faith misunderstanding of the law rise to the level of a civil fraud penalty or criminal offense, such as tax evasion? Stated differently, when does the government view failing to report income, claiming false deductions, or filing an incorrect tax return trigger a criminal investigation and possibly a referral to the Department of Justice for prosecution?
Many taxpayers understandably want to know whether their cases will be investigated by CI. The answer is never clear cut. However, the Internal Revenue Manual provides some insight into the selection process, stating that the following should be considered in determining whether an investigation meets the definition of CI’s mission:
- high profile;
- egregious allegations;
- deterrent effect; and
- conformity with CI’s annual business plan.
See IRM section 184.108.40.206. The IRM makes a point of distinguishing tax avoidance from tax evasion, noting that the distinction is ‘‘fine, yet definite’’:
Avoidance of taxes is not a criminal offense. Any attempt to reduce, avoid, minimize, or alleviate taxes by legitimate means is permissible. The distinction between avoidance and evasion is fine, yet definite. One who avoids tax does not conceal or misrepresent. He/she shapes events to reduce or eliminate tax liability and, upon the happening of the events, makes a complete disclosure. Evasion, on the other hand, involves deceit, subterfuge, camouflage, concealment, some attempt to color or obscure events or to make things seem other than they are. For example, the creation of a bona fide partnership to reduce the tax liability of a business by dividing the income among several individual partners is tax avoidance. However, the facts of a particular investigation may show that an alleged partnership was not, in fact, established and that one or more of the alleged partners secretly returned his/her share of the profits to the real owner of the business, who, in turn, did not report this income. This would be an instance of attempted evasion.
See IRM section 220.127.116.11.2.1.
Often what can make or break a case from going criminal is whether the amount of the tax loss is sufficient to meet the Justice Department’s guidelines — information that is not publicly available. Other key factors are whether the case involves a pattern of unreported income (multiple years of non-compliance) and who is the taxpayer (age, health, level of sophistication, and education).
Critical to the government’s case in both a charge of tax evasion under section 7201 and a civil fraud penalty under section 6663 is the ability to show that the taxpayer’s conduct was willful. This is in sharp contrast to conduct attributable to negligence, inadvertence, mistake, or conduct that results from a good-faith misunderstanding of the requirements of the law. Specific intent to violate the law is an element of some federal criminal tax offenses such as tax evasion.
Individuals or businesses facing an IRS criminal investigation should contact competent counsel who can formulate a defensible strategy and plan.