Tax Law FAQ
What is tax fraud?
WHAT IS TAX FRAUD?
Tax fraud is often defined as an intentional wrongdoing on the part of a taxpayer, with the specific purpose of evading a tax known or believed to be owing. Tax fraud requires both an underpayment of tax due and fraudulent intent
KEY TAKE AWAYS
- Fraud requires willfulness – a willful violation is one committed knowingly.
- Every Revenue Agent has a checklist on his or her desk with a list of badges of fraud; the more boxes checked, the more likely the agent will can prove fraud.
- Look for a pattern of unreported income, inadequate books and records, and hidden bank accounts (agents do not like false statements).
- Government must prove fraud by clear and convincing evidence.
- A good-faith belief that one is not violating the law negates willfulness; in other words, a mistake or reliance on an accountant is not fraud.
Internal Revenue Manual
The Internal Revenue Service has a Fraud Handbook that is contained in Part 25.1 of the Internal Revenue Manual. Fraud is defined in the Manual as follows:
- Fraud is deception by misrepresentation of material facts, or silence when good faith requires expression, which results in material damage to one who relies on it and has the right to rely on it. Simply stated, it is obtaining something of value from someone else through deceit.
See IRM 188.8.131.52 (01-23-2014). The Fraud Handbook provides an overview and definitions of fraud, and instructs IRS employees such as an IRS Revenue Agent how to recognize and develop fraud. The primary objective of the fraud program is to foster voluntary compliance through the recommendation of criminal prosecutions and/or civil penalties against taxpayers who evade the assessment and/or payment of taxes known to be due and owing. See IRM 184.108.40.206 (01-23-2014). Generally, for fraud to be considered, an IRS Revenue Agent must show:
- An additional tax due and owing as the result of a deliberate intent to evade tax; or
- The willful and material submission of false statements or false documents in connection with an application and/or return.
Id. The Government has the burden of proof in establishing fraud, and the major difference between civil and criminal fraud is the degree of proof required. See IRM 220.127.116.11.2 (01-23-2014). In criminal cases, the Government must present sufficient evidence to prove guilt beyond a reasonable doubt. Id. In civil fraud cases, the Government must prove fraud by clear and convincing evidence. Id.
If any part of any underpayment of tax required to be shown on a return is attributable to fraud, section 6663(a) imposes a penalty equal to 75% of the portion of the underpayment which is attributable to fraud. Section 6663(b) provides that once the Commissioner establishes that any portion of the underpayment is due to fraud, the entire underpayment is to be treated as attributable to fraud except with respect to any portion that the taxpayer establishes, by a preponderance of the evidence, is not attributable to fraud. The entire taxable year remains open under section 6501(c)(1) even if only a part of the underpayment for a year is attributable to fraud. Lowy v. Commissioner, 288 F.2d 517, 520 (2d Cir. 1961), aff’g, T.C. Memo. 1960-32. “Thus, where fraud is alleged and proven, respondent is free to determine a deficiency with respect to all items for the particular taxable year without regard to the period of limitations.” Colestock v. Commissioner, 102 T.C. 380, 385 (1994).
Once an underpayment has been proven, the second prong of the fraud test requires the Commissioner to prove that, for each year at issue, at least some portion of the underpayment is due to fraud, defined as an intentional wrongdoing designed to evade tax believed to be owing. DiLeo v. Commissioner, 96 T.C. at 874. The Court may examine the taxpayer’s whole course of conduct to determine whether fraud exists. Stone v. Commissioner, 56 T.C. 213, 224 (1971). The existence of fraud is a question of fact to be resolved from the entire record. Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), aff’d without published opinion, 578 F.2d 1383 (8th Cir. 1978). Fraud is never imputed or presumed, and therefore the Commissioner must meet his burden through affirmative evidence. See Niedringhaus v. Commissioner, 99 T.C. 202, 210 (1992); Petzoldt v. Commissioner, 92 T.C. 661, 699 (1989); Beaver v. Commissioner, 55 T.C. 85, 92 (1970). Fraud may be proved by circumstantial evidence and reasonable inferences drawn from the facts because direct proof of a taxpayer’s intent is rarely available. Toushin v. Commissioner, 223 F.3d 642, 647 (7th Cir. 2000), aff’g, T.C. Memo. 1999-171; Petzoldt v. Commissioner, 92 T.C. at 699. Fraud is not imputed from one spouse to another. Stone v. Commissioner, 56 T.C. at 227-228. In the case of a joint return, the section 6663 penalty does not apply with respect to a spouse unless some part of the underpayment is due to the fraud of such spouse. Section 6663(c).
Determination of Fraudulent Intent
Over the years, courts have developed a nonexclusive list of factors that demonstrate fraudulent intent. These badges of fraud include
- Understatement of income,
- Inadequate maintenance of records,
- Implausible or inconsistent explanations of behavior,
- Concealment of assets or income,
- Failure to cooperate with tax authorities,
- Engaging in illegal activities,
- An intent to mislead which may be inferred from a pattern of conduct,
- Lack of credibility of the taxpayer’s testimony,
- Failure to file tax returns,
- Filing false documents,
- Failure to make estimated tax payments, and
- Dealing in cash.
See Spies v. United States, 317 U.S. 492, 499 (1943); Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), aff’g, T.C. Memo. 1984-601; Niedringhaus v. Commissioner, 99 T.C. at 211. A taxpayer’s intelligence, education, and tax expertise are relevant for purposes of determining fraudulent intent. See Stephenson v. Commissioner, 79 T.C. 995, 1006 (1982), aff’d, 748 F.2d 331 (6th Cir. 1984); Iley v. Commissioner, 19 T.C. 631, 635 (1952).
Courts discuss the factors in turn in deciding whether a taxpayer is liable for a civil fraud penalty. See O’Neal v. Commissioner, T.C. Memo 2016-49, where the Tax Court applied the factors to determine that married individuals were liable for the civil fraud penalty. In a fraud case, it can be helpful to prepare a fraud evidence chart. A sample chart is here Fraud Evidence Chart
A good-faith misunderstanding of the law or a good-faith belief that one is not violating the law negates willfulness, whether or not the claimed belief or misunderstanding is objectively reasonable. Cheek v. United States, 498 U.S. 192 (1991).
Joint Tax Return
Fraud is not inputted to from one spouse to another, in the case of a joint return. The IRS must establish that some part of the underpayment is due to the fraud of such spouse. A possible defense is showing that there was no fraud by the other spouse under section 6663(c) because the other spouse was uninvolved in the business. Another possible defense is establishing that the other spouse is entitled to innocent spouse relief under section 6015(c) or 6015(f). There, they key issues are establishing that the other spouse did not know or have reason to know, and no benefit.
How Can We Help?
Individuals who are concerned about possible tax fraud should contact competent tax counsel, who can evaluate the case, explain the options, and develop a defensible strategy. See the following fraud evidence chart.