Tax Fraud Examinations & the IRS

Tax Fraud Examination and How Violations Lead to Fines & Penalties

How Tax Fraud Violations Leads to Penalties

Tax Fraud Examinations: In general, not all Tax Examinations by the IRS are bad. Some are paper correspondence audits, and other are simply CP2000 letters. But, the Tax Fraud Examination and eggshell audits are tough.

Tax Fraud is essentially, when a person willfully attempts to avoid paying taxes by either:

• Underreporting income
• Intentionally not filing tax returns; and/or
• Falsifying deductions

There are factors or considerations, which are called “Badges of Fraud,” but at its core, if you knowingly fail to file a tax return, reporting income, or falsify deductions it is tax fraud.

We will summarize Tax Fraud Examination

Understanding Tax Fraud Examinations

Civil tax fraud is a comprehensive subject. In order to make it palpable to you (while keeping you awake), will break it down into various topics as provided in the IRS IRM (Internal Revenue Manual)

When Does the IRS Issue Civil Tax Fraud Penalties?

As provided by the IRS:  

“Civil fraud penalties will be asserted when there is clear and convincing evidence to prove that some part of the underpayment of tax was due to fraud.

Such evidence must show the taxpayer’s intent to evade the assessment of tax, which the taxpayer believed to be owing. Intent is distinguished from inadvertence, reliance on incorrect technical advice, sincerely-held difference of opinion, negligence or carelessness.

In the case of a joint return, intent must be established separately for each spouse as required by IRC 6663(c) . The fraud of one spouse cannot be used to impute fraud by the other spouse.

Thus, the civil fraud penalty may be asserted only on one spouse, unless there is sufficient evidence that both spouses participated in the fraudulent act(s) resulting in the underpayment reported in their joint return.”

Breaking Down the Elements of Civil Tax Fraud

It is important to understand the words being used to establish civil tax fraud. These are called “elements,” and the elements to civil tax fraud are as follows:

– Underpayment of Tax

– Due to Fraud (aka the IRS must show the taxpayer’s intent to evade the assessment of tax, which the taxpayer believed to be owing)

– Intent is distinguished from inadvertence, reliance on incorrect technical advice, sincerely-held difference of opinion, negligence or carelessness

– In the case of a joint return, intent must be established separately for each spouse as required by IRC 6663(c).

– The fraud of one spouse cannot be used to impute fraud by the other spouse.

– Thus, the civil fraud penalty may be asserted only on one spouse, unless there is sufficient evidence that both spouses participated in the fraudulent act(s) resulting in the underpayment reported in their joint return.”

More than Negligence

The IRS has a heavy burden when it comes to proving fraud, which is why Tax Fraud Examinations are tough.

If the IRS can merely prove mistake or inadvertence, that alone is insufficient to find you liable for IRS Civil Tax Fraud.

Evidence of Fraud

As provided by the IRS:

Since direct proof of fraudulent intent is rarely available, fraud must be proven by circumstantial evidence and reasonable inferences. Fraud generally involves one or more of the following elements:

– Deception

– Misrepresentation of material facts

– False or altered documents

– Evasion (i.e., diversion or omission)

Badges of Fraud

As provided by the IRS:

The courts focus on key badges of fraud in determining whether there was an “intent to evade” tax.

A determination of fraud is based on the taxpayer’s entire course of conduct, with each badge of fraud given the weight appropriate to a particular case. An evaluation of fraud is based on the weight of the evidence rather than the quantity of the factors. Some of the common “first indicators (or badges) of fraud” include:

– Understatement of income (e.g., omissions of specific items or entire sources of income, failure to report substantial amounts of income received)

– Fictitious or improper deductions (e.g., overstatement of deductions, personal items deducted as business expenses)

– Accounting irregularities (e.g., two sets of books, false entries on documents)

– Obstructive actions of the taxpayer (e.g., false statements, destruction of records, transfer of assets, failure to cooperate with the examiner, concealment of assets)

– A consistent pattern over several years of underreporting taxable income

– Implausible or inconsistent explanations of behavior

– Engaging in illegal activities (e.g., drug dealing), or attempting to conceal illegal activities

– Inadequate records

– Dealing in cash

– Failure to file returns, and

– Education and experience

Civil Code Section 6663 – Imposition of Fraud Penalty

Internal Revenue Code Section 6663 can be broken down as follows:

(a) Imposition of penalty

If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

(b) Determination of portion attributable to fraud

If the Secretary establishes that any portion of an underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud, except with respect to any portion of the underpayment which the taxpayer establishes (by a preponderance of the evidence) is not attributable to fraud.

(c) Special rule for joint returns

In the case of a joint return, this section shall not apply with respect to a spouse unless some part of the underpayment is due to the fraud of such spouse.

Clear and Convincing Evidence

The IRS has summarized its take on Clear and Convincing Evidence as follows: “ evidence showing that the assertion made is highly probable or reasonably certain. This is a greater burden of proof than preponderance of the evidence but less than beyond a reasonable doubt.”

Criminal Tax

When it comes to criminal tax fraud, it can come in many different categories, for example:

• Tax Fraud
• Tax Evasion
• Money Laundering
• Making False Statements
• Smurfing
• Structuring

Some common examples of Tax Crimes may include:

26 U.S.C. 7201 (Attempt to Evade or Defeat Tax)

Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.

26 U.S.C. 7203 (Willful Failure to File a Return)

Any person required under this title to pay any estimated tax or tax, or required by this title or by regulations made under authority thereof to make a return, keep any records, or supply any information, who willfully fails to pay such estimated tax or tax, make such return, keep such records, or supply such information, at the time or times required by law or regulations, shall, in addition to other penalties provided by law, be guilty of a misdemeanor and, upon conviction thereof, shall be fined not more than $25,000 ($100,000 in the case of a corporation), or imprisoned not more than 1 year, or both, together with the costs of prosecution.

In the case of any person with respect to whom there is a failure to pay any estimated tax, this section shall not apply to such person with respect to such failure if there is no addition to tax under section 6654 or 6655 with respect to such failure. In the case of a willful violation of any provision of section 6050I, the first sentence of this section shall be applied by substituting “felony” for “misdemeanor” and “5 years” for “1 year”.

26 U.S.C. 7206 (Fraud and False Statements)

Any person who—

How To Avoid Tax Fraud Examination Penalties