25.1.6  Civil Fraud

25.1.6.1  (10-30-2009)
Overview

  1. This section discusses the procedures to follow in a civil fraud case.

  2. A civil fraud penalty case may be developed based on facts and circumstances of a civil examination or result from a criminal investigation (CI) initiated case.

  3. 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, honest difference of opinion, negligence or carelessness. In the case of a joint return, intent must be established for each spouse separately 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 on one spouse only.

  4. Specific guidance on fraud indicators and the development of fraud may be found in IRM 25.1.1 and 25.1.2.

  5. IRM 20.1 provides specific procedures for assertion of the civil fraud penalty.

  6. Form 6809, Civil Fraud Penalty Monitoring Formis no longer used to monitor penalties. The form has been removed from the Forms Repository.

25.1.6.2  (10-30-2009)
Procedures

  1. Civil fraud no longer requires a referral to CI. Determination of this penalty is the shared responsibility of the examiner, his/her group manager and the Fraud Technical Advisor (FTA). If agreement cannot be reached regarding assertion of the civil fraud penalty, the decision will rest with the group manager.

    Note:

    The campuses follow the Campus Fraud Procedures prescribed in IRM 4.19.10.9. The SB/SE Campuses are now in a position to develop and assert the civil fraud penalty and impose a 10-year ban on earned income tax credit (EITC). The FTA assigned to each Campus will assist with the development , write-up and review of the civil fraud penalty issues. Also, Counsel has been assigned to each Campus to assist with review and approval of the penalty issues for Statutory Notice of Deficiency (SNOD) purposes. See IRM 4.19.10.1.9 for additional procedures relating to this issue.

  2. Upon concurrence of the group manager and FTA, cases being developed for civil fraud, including write-up and review of the civil fraud penalty and/or the fraudulent failure to file penalty, will be updated on AIMS to status code 17 (Fraud Development), via Form 11661 ,Fraud Development Recommendation - Examination.

  3. For civil settlement of a prosecution case, the examiner should contact Cl to ascertain which criminal statutes the taxpayer was convicted of before attempting to resolve the related civil fraud penalty. The examiner should obtain a copy of the plea agreement or judgment notating the applicable criminal statutes and years. See 25.1.5 for procedures in securing information that can be used in the civil settlement of cases investigated through grand jury procedures.

  4. In cases where fraud was considered and the civil fraud penalty is not being recommended, the examiner must explain in the work papers why the penalty was not asserted.

  5. If criminal prosecution of a taxpayer has been recommended by CI to the Department of Justice, the civil fraud penalty and/or the fraudulent failure to file penalty may be removed only upon written recommendation or concurrence by Area Counsel. This rule applies also in the case of any related taxpayer involved in the same transaction and to any other year or period of the same taxpayer which is related to or affects the year or period for which criminal prosecution is recommended. Cases returned for civil settlement should be updated upon receipt to AIMS Status Code 17, unless a determination has been made that the civil fraud penalty is not being developed and/or asserted. The case will be returned to AIMS Status Code 12, if the civil fraud penalty is not applicable or is subsequently determined to be non-applicable.

  6. Area Counsel must approve the civil fraud penalty prior to issuance of a SNOD.

25.1.6.3  (10-30-2009)
Evidence of Fraud

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

    • Deception,

    • Misrepresentation of material facts,

    • False or altered documents,

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

  2. The courts focus on key badges of fraud in determining whether there was an"intent to evade" tax. Some of the common "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);

    • Acts of the taxpayer evidencing an intent to evade tax (e.g., false statements, destruction of records, transfer of assets),

    • A consistent pattern over several years of underreporting taxable income,

    • Implausible or inconsistent explanations of behavior,

    • Failure to cooperate with the examiner,

    • Concealment of assets

    • 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

  3. The Facts section of the penalty write-up should include a detailed description of all applicable badges of fraud. Additionally the examiner should include other items of deception or instances where the taxpayer may have misled or misrepresented fact to the government.

25.1.6.4  (10-30-2009)
Collateral Estoppel

  1. Examiners and managers should be aware of collateral estoppel and the important distinction it can have in civil fraud penalty cases.

  2. Collateral estoppel is a legal doctrine that prevents a taxpayer, who has been previously convicted of criminal tax evasion under IRC §7201, from asserting a defense to the civil fraud penalty. "Collateral estoppel, like the related doctrine of res judicata, has the dual purpose of protecting litigants from the burden of relitigating an identical issue with the same party or his privy and of promoting judicial economy by preventing needless litigation." Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326 (1979). The courts routinely look to the presence of several factors in applying collateral estoppel. The issue for which estoppel is being sought must have been necessary in reaching the original decision (see Parklane case cited above), the party to be estopped had a "full and fair opportunity to litigate" the issue in the original suit - Montana v. United States, 440 U.S. 147, 154 (1979), and the issue must have been part of a valid and final judgment.'' Ashe v. Swenson, 397 U.S. 436, 443 (1970). The doctrine of collateral estoppel applies only to the years for which the taxpayer has been convicted. Intent must be established for non-conviction years.

  3. A conviction under IRC § 7206(1), filing a false return, does not collaterally estop the taxpayer from asserting a defense to the civil fraud penalty since conviction under IRC § 7206(1) does not require proof of fraudulent intent to evade federal income taxes. In these cases, additional development will be needed to establish the taxpayer’s intent to evade assessment of a tax to be due and owing.

25.1.6.5  (10-30-2009)
Case Closing

  1. Monitoring of fraud on AIMS

    1. Form 5344, Examination Closing Record,is used to capture the following information in item 38:

      • Enter "F" if criminal prosecution has been successfully concluded,

      • Enter "C" if the 75% fraud penalty was asserted under IRC section 6663 or

      • Enter "B" if both apply.

    2. Form 5599, TE/GE Examined Closing Record, is used by TE/GE to capture the same information in item 38.

  2. Form 3198, Special Handling Notice, must be used for routing of civil fraud penalty cases.


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