The IRS Civil Tax Fraud Penalty: What You Need to Know
The civil tax fraud penalty is one of the most draconian penalties the IRS can assess. Like all things tax, there are rules that apply. This article addresses the rules the basic rules in the Code and the rules the courts have developed with respect to the civil tax fraud penalty.
Civil Tax Fraud Penalty, GenerallyThe civil tax fraud penalty applies to any underpayment of tax due to fraud. We*ll address what counts as fraud later. For now, suffice it to note that there must be an understatement for the penalty to apply. This means that taxes must be due and owing to the government.
The amount of the civil tax fraud penalty is computed based on this understatement. The amount of the penalty is equal to a staggering 75 percent of the underpayment. When interest is factored in, the amount of the penalty and interest accrued on the penalty can exceed the amount of tax that would have otherwise due and payable.
The IRS Has to Prove FraudThe burden of proof falls on the IRS to prove that (1) an underpayment of tax exists and (2) some portion of the underpayment is attributable to fraud. That the IRS has this burden makes sense given the punitive nature of the civil tax fraud penalty.
The IRS*s buren is that of clear and convincing evidence. This is generally defined as the degree of proof which will produce in the mind of the trier of facts a firm belief or conviction as to the allegations sought to be established.
The courts have explained that it is an intermediate standard, being more than a mere preponderance, but not to the extent of such certainty as is required beyond a reasonable double required in criminal cases.
This sets a high hurdle for the IRS to overcome for the civil tax fraud penalty.
What is Civil Tax Fraud?As noted above, the IRS has to prove that some portion of the underpayment is attributable to fraud. And it has to do so by clear and convincing evidence.
To meet this standard, the IRS must find the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead or otherwise prevent the collection of taxes.
The intent element means that the taxpayer took some affirmative act. The intent element also excludes negligence, carelessness, misunderstanding or unintentional understatement of income.
Proof of Fraud: Direct or CircumstantialThe IRS can establish fraud by proof of the taxpayer*s intentions or by circumstantial evidence.
Intent can only be inferred from any conduct likely to mislead or conceal. This generally requires direct evidence.
In most cases, the IRS relies on circumstantial evidence. A nonexclusive list has been established as circumstantial evidence including:
1. an understatement of income,
2. inadequate records,
3. concealing assets,
4. failure to file tax returns,
5. the taxpayer*s experience and knowledge, especially concerning tax laws,
6. whether or not the taxpayer has provided implausible or inconsistent explanations,
7. the taxpayer*s involvement in illegal activities, and
8. failure to cooperate with tax authorities.
These factors are often referred to as *badges of fraud.*
Amount Attributable to FraudIf the government establishes that any portion of the understatement is due to fraud, the entire underpayment is treated as attributable to fraud.
This means that even items of income that were omitted or deductions and credits that were taken incorrectly, but through an honest mistake, can be included in computing the civil tax fraud penalty.
This general rule does not apply if the taxpayer can establish that a portion of the underpayment is not attributable to fraud. This puts the burden back on the taxpayer.
Like the IRS*s burden, this presents a high hurdle for taxpayers to overcome once the IRS has proven that the taxpayer committed fraud.