IRS TAX FRAUD PENALTIES

Civil Tax Penalties

Many tax fraud cases do not result in IRS criminal prosecution. US Attorney’s office prosecutes only when it believes that conviction for criminal tax case is reasonably or sufficiently probable. A potential criminal case may be rejected during administrative review and returned for determination of civil liability. At the local tax audit level, IRS auditor may believe that the evidence supports only for a civil case and not pursue any criminal charges.

However, tax attorney should always remain on alert because a civil tax fraud investigation may at any time develop into a criminal tax prosecution without significant change of facts. The origin of any tax audit usually is the same for civil and criminal investigations. The IRS uses the same investigative tools including the administrative tax summons to gather facts to support any tax liability claims. Since penalties for civil tax fraud are percentage additions to the underlying tax, the tax deficiency must be determined before the IRS tax penalty can be assessed. Assessment of penalties is subject to the same administrative requirements as assessment of tax.

IRS recognizes that tax evasion or noncompliance by a taxpayer may be due to causes other than tax fraud. IRS tax code provides penalties not only for tax related fraud but also for negligence, late filing, and miscellaneous causes that result in any violation of the tax code.

Where IRS cannot prove fraud or pursue criminal charges, the negligence and miscellaneous penalties are often assessed.

• 1.Tax Fraud Penalty If any part of an underpayment of tax is due to fraud, a civil fraud penalty in the amount of 50 percent of the entire underpayment is imposed. Although it seems unfair, 50-percent penalty applies to the total taxes due even though some part of the underpayment may be due to innocent mistake or inaccurate interpretation of the tax law. Filing of amended tax returns after fraudulent returns have been filed does not cure the tax fraud or reduce the potential tax fraud penalty imposed by the IRS.
• 2. Negligence Tax Penalty If any part of the underpayment of any IRS income tax or gift tax is due to negligence or intentional disregard of rules and regulations but without evidence of intent to defraud, IRS will have the bases to assess an amount equal to five percent or up to twenty percent of the underpayment. Negligence penalty may not be assessed in situations where tax fraud penalty is assessed. The negligence penalty applies to the entire underpayment of taxes if negligence or intentional disregard of rules and regulations causes any part of the underpayment of IRS taxes.
• 3. Delinquency Tax Penalty Failure to file tax returns without reasonable cause triggers IRS authority to assess an amount equal to five percent of the net amount of tax due on the tax return for each month that the return is late is added to the tax that is owed. The net amount of tax due on the return includes both the tax due on the return, net of any timely payments, but also any deficiency subsequently assessed. The delinquency tax penalty is limited to 25 percent in the aggregate. Intent or willfulness is not required for assessment of the late filing penalty. It is assessed for late filing of tax returns unless the taxpayer can show reasonable cause for the failure to file. The delinquency tax penalty may not be assessed in situations where fraud penalty is assessed for the same act.
• 4. Additional Tax Penalties The Internal Revenue Code provides additional penalties for certain violations of the IRS Tax Code. The following are some common tax penalties: §6652 - Failure to file certain information returns like payroll 941 or 1120s forms; §6654 - Failure by individual to pay estimated income tax; §6655 - Failure by corporation to pay estimated tax; §6656 - Failure to make timely deposit of taxes; §6657 - NSF checks or non-negotiable instruments; §6658 - Violation of §6851; and §6672 - Failure to collect and pay over trust fund tax stemming from payroll.

Statute of Limitations for IRS Tax or Penalty Assessment
Assessment of tax must generally be made within three years after the return is due or filed, whichever is later. Statute of limitations period is extended to six years after the IRS tax return is filed or due, whichever is later, if a taxpayer omits from gross income or from the gross estate or total gifts an amount in excess of 25 percent of the gross income, gross estate, or total gifts stated in the tax return.

In the case of a filing a fraudulent tax return, a willful attempt to evade the tax, or a failure to timely file a tax return, the IRS Tax Code permits assessment or a proceeding in court for collection without assessment at any time. Statute of limitations does not apply when a fraudulent return or no return is filed allowing the IRS to assess taxes at any time. However, filing an accurate return to amend a fraudulent return, or filing any correct return at any time does not cure the fraud or delinquency but it does start the running of the three- or six-year period for statute of limitations.

Joint Tax Returns and Effect on Spouse
When a couple files a joint return, both spouses are jointly and severally liable for the entire tax due, even if one spouse was unaware of inaccuracies or fraudulent activities on the return. This means an innocent spouse can be held responsible for the full amount of tax and any deficiencies, regardless of their involvement or knowledge.
Civil Penalties: Normally, an innocent spouse is also liable for civil fraud penalties and other civil penalties associated with the joint return. However, exceptions exist where the innocent spouse might not be liable for civil fraud penalties if they were acting under duress or if the fraudulent activity occurred before the return was filed but the return itself was accurate.

Statutory Period for Tax Assessment:

Six-Year Limitation: If the joint return omits more than 25% of gross income, the IRS has six years to assess the tax, not the usual three. This extended period applies regardless of the innocent spouse's awareness or involvement in the omission. False or Fraudulent Returns: If the return is false or fraudulent, there is no statute of limitations for the IRS to assess taxes, potentially affecting the innocent spouse with assessments made long after the typical three-year period if fraud was committed by the other spouse.

Choice of Forum for Civil Litigation
As in all civil federal tax matters, the taxpayer has the choice of three forums in which to litigate his tax case: the US Tax Court, the federal district court, and the US Court of Claims. Tax and penalties must first be paid before suit can be brought for tax refund in the federal district court or the Court of Claims. The burden of proof is substantially the same in each forum. Taxpayer has the burden of proof on the tax deficiency and the IRS must show evidence of fraud.
A jury trial is available only in the federal district court. This may benefit in situations where there are soft factors and empathy factors that favor a taxpayer that may be given less consideration in Tax Court and Court of Claims proceedings. However, keep in mind that in federal court the taxpayer, as a plaintiff, carries the burden to convince twelve jurors and the often-skeptical federal district judge.

Burden of Proof and Barred Years:
In the Tax Court, taxpayers generally bear the burden of proving the Commissioner’s tax assessments wrong, except in cases where new matters are introduced by the government or where fraud is alleged. In fraud cases, the government must prove intent to evade tax. If the government cannot prove fraud but the taxpayer also fails to disprove the deficiency, and the statute of limitations hasn’t expired, the deficiency can still be assessed, but without the fraud penalty.
Fraud investigations often extend beyond the normal three-year statute of limitations. If the Commissioner proves fraud, assessment can occur at any time, shifting the burden back to the taxpayer to challenge the deficiency.

Effect of Criminal Case on Civil or Tax Court Litigation:
Jeopardy Assessment: Usually, civil cases are paused during criminal proceedings. Jeopardy assessments might be made if it's believed the taxpayer is dissipating assets, but these are rare when criminal action is pending due to potential negative impacts on the criminal case.

Simultaneous Civil and Criminal Cases:

The government might be reluctant to discuss or disclose information in civil cases if a criminal case is ongoing, potentially leading to strategic advantages for the taxpayer in court.

Guilty Verdict or Plea: A guilty plea or verdict in a criminal tax evasion case can be used in civil proceedings to support fraud penalties for the same years, but not necessarily for different years unless directly related.

Nolo Contendere Plea: This plea doesn't admit guilt but can be used for credibility assessment, though its admissibility varies by jurisdiction.

Acquittal: Even if acquitted criminally, civil fraud penalties can still be imposed due to the different standards of proof.

IRS Offer in Compromise and Tax Settlement:
While Criminal Case Pending: The IRS typically won’t discuss compromises or settlements until the criminal case concludes.

Post-Criminal Proceedings: After criminal resolution, cases revert to standard civil processing, where settlement might involve fraud penalties unless waived by the IRS Criminal Division.

IRS Appeals Division: If unresolved at the District level, cases might go to the IRS Appeals Office, which can settle fraud penalties with or without additional approval, depending on whether criminal prosecution was recommended.