The IRS is staffing up, the states are in need of money, and every day there is another story of someone who thought they could game the system. Unfortunately, the taxing authorities are not in the mood to play a game. The IRS has added the newly-created Office of Fraud Enforcement and is now training their field auditors to look for and refer instances of fraud to the Criminal Investigation Division.
A taxpayer under audit needs to self assess the facts and understand the potential risks that an audit can bring. The IRS has a number of tools in its toolbox and a criminal referral is just one. There is also the potential for a Civil Fraud penalty assessment as well.
The IRS cannot impose a fraud penalty simply based on suspicion. Fraud needs to be proven based on all of the facts and circumstances of the particular case. However, it generally begins with acts of deception, misrepresentations, and omissions that go beyond simple carelessness. A common defense is reliance on a professional, and this depends on whether the professional fully informed, the taxpayer followed their advice, and the level of the taxpayer’s knowledge in matters of taxation.
Tax fraud can be loosely defined as a knowing material misrepresentation or omission of facts with the purpose of evading tax. To be assessed as a fraud penalty, there needs to be both a balance due as well as fraudulent intent.
Tax avoidance and tax evasion are cousins. The former refers to legal means of reducing a tax liability while the latter refers to illegal means to reduce a taxpayer’s liabilities. No one is required to pay more in tax than is due and everyone is free to organize their financial affairs to minimize the tax bill.
The IRS can proceed in a civil manner and assess a penalty, or it can proceed in a criminal context. To obtain a criminal conviction, the IRS needs to prove willfulness, meaning the act or acts must be beyond simple omissions or misunderstanding of the byzantine tax code.
The IRS may assess a civil fraud penalty if it believes that the tax understatement is based on fraud. The penalty is 75% of the understatement attributable to fraud. To get there, there must be evidence to support the taxpayers intent to evade tax.
There is no statute of limitations on assertions of the Civil Fraud penalty.