25.1.6  Civil Fraud

Manual Transmittal

November 05, 2014

Purpose

(1) This transmits revised IRM 25.1.6, Fraud Handbook - Civil Fraud.

Material Changes

(1) Audience - Replaced "Large & Mid-size Business (LMSB)" with "Large Business & International (LB&I)" .

(2) 25.1.6.1 - Deleted reference to Form 6809, Civil Fraud Penalty Monitoring Form.

(3) 25.1.6.1(3) - Added note regarding consideration of civil fraud penalty in non-filer cases.

(4) 25.1.6.2(1) - Deleted reference to Criminal Investigation (CI) involvement in civil fraud determinations. Clarified that the compliance group manager may update a case to AIMS status code 17 and pursue the civil fraud penalty in scenarios where the Fraud Technical Advisor (FTA) does not agree.

(5) 25.1.6.2(2) - Clarified that assertion of the civil fraud penalty is the shared responsibility of the compliance employee, compliance group manager, and FTA. Added specific guidance for SB/SE and W&I Campuses.

(6) 25.1.6.2(3) - Clarified civil fraud penalty narrative guidance.

(7) 25.1.6.2(4) - Clarified guidance as to when the FTA will approve assertion of the civil fraud penalty via Form 11661, Fraud Development Recommendation - Examination.

(8) 25.1.6.2(5) - Provided procedures for enhancing case development.

(9) 25.1.6.2(6) - Added guidance for cases where collateral estoppel applies.

(10) 25.1.6.2(8) - Updated guidance as to when Area Counsel approval is required for non-assertion of the civil fraud and/or fraudulent failure to file penalty in Title 26 cases.

(11) 25.1.6.2(9) - Added guidance for successfully prosecuted Title 18 cases.

(12) 25.1.6.2(10) - Added guidance for SB/SE cases with criminal restitution.

(13) 25.1.6.2(11) - Added guidance for LB&I cases with criminal restitution.

(14) 25.1.6.2(12) - Added guidance for cases returned to the field from suspense for civil disposition.

(15) 25.1.6.3(2) - Added clarification for indicators of fraud.

(16) 25.1.6.4(2) - Added Note to clarify that a taxpayer may argue the amount of tax due to fraud even in cases where the civil fraud penalty may be automatically asserted.

(17) 25.1.6.5(2) - Expanded guidance on completion of Form 3198, Special Handling Notice for Examination Case Processing.

(18) Exhibit 25.1.6-1 - Added procedural decision guide Exhibit.

Effect on Other Documents

This material supersedes IRM 25.1.6, dated October 30, 2009.

Audience

Criminal Investigation (CI), Large Business & International (LB&I), Small Business/Self-Employed (SB/SE), Tax Exempt/Government Entities (TE/GE), and Wage & Investment (W&I)

Effective Date

(11-05-2014)

William P. Marshall, Director, Fraud/BSA, Small Business/Self-Employed

25.1.6.1  (11-05-2014)
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 case initiated by Criminal Investigation (CI).

  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, 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.

    Note:

    When considering the civil fraud penalty, the fact that a taxpayer has not filed and has tax due is not sufficient to assert the civil penalty. An affirmative act of fraud, as stated in IRM 25.1.1.3(2), Affirmative Acts (Firm Indications) of Fraud, must also be present.

  4. Specific guidance on fraud indicators and the development of fraud may be found in IRM 25.1.1, Overview/Definitions, and 25.1.2, Recognizing and Developing Fraud.

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

25.1.6.2  (11-05-2014)
Procedures

  1. Upon concurrence of the Examination group manager and Fraud Technical Advisor (FTA), civil fraud development cases will be updated on AIMS to status code 17 (Fraud Development), via Form 11661, Fraud Development Recommendation - Examination.

    Note:

    Where the FTA and Examination group manager do not agree on whether a case should be developed for civil fraud, the Examination group manager may update the case to AIMS status code 17 without the FTA's concurrence. However, the compliance group manager should contact the FTA group manager to discuss the situation prior to updating the status code. Regardless, preparation of Form 11661 is required to document the decision for fraud development and to ensure consistent treatment of all fraud cases. Where consensus with the FTA was not reached, Form 11661 should clearly document that pursuing the civil fraud penalty is the compliance group manager's decision. Ultimately, the final decision on an examination case rests with the Examination group manager.

  2. Determination of the civil fraud penalty is the shared responsibility of the examiner, his/her group manager and the FTA.

    Note:

    Campus Fraud Procedures are prescribed in IRM 4.19.10.4, Fraud Referrals. The SB/SE Campuses are positioned to develop and assert the civil fraud penalty, and to impose a 10-year ban on earned income tax credit (EITC) cases. Before determining the civil fraud penalty based on a disallowed EITC, consult Chief Counsel Notice 2014-007 http://intranet.prod.irscounsel.treas.gov/irsccdm/ccdm/CC-2014-007.pdf and, if necessary, local counsel. The notice describes the application of the accuracy-related or civil fraud penalties to disallowed EITC claims, based on an "underpayment" , per IRC 6664. The civil fraud or accuracy-related penalty may not apply, depending on the amount of income tax the taxpayer shows on his return and the amount of the EITC he claims. (Rand v. Commissioner). Each campus' assigned FTA will assist with the development, write-up and review of the civil fraud penalty issues. Each campus also has dedicated Counsel to assist with review and approval of the penalty issues for Statutory Notice of Deficiency (SNOD) purposes. See IRM 4.19.10.4.10.3, 90-Day Procedures, for additional guidance.

    Note:

    Campus Fraud Procedures prescribed in IRM 4.19.10.4, Fraud Referrals, also apply to the five W&I Campuses. The civil fraud program is centralized at the Austin Campus, and receives transfers of potential fraud cases from all W&I campuses, with the FTA's approval for case development. The FTA assigned to the Austin Campus assists the Austin Examination Fraud Coordinator (EFC) with case development, write-up, and review as necessary. The EFC works closely with Austin Counsel on preparing and obtaining approval for the 90-day letter language; imposing the 10-year ban on EITC claims and/or asserting the civil fraud penalty.

  3. The FTA works with the examiner to ensure the fraud penalty narrative does, in fact, substantiate the assertion of the civil fraud or fraudulent failure to file penalties. The FTA will recommend enhancements to the fraud narrative, as needed, to clearly explain the indicators of fraud. The affirmative acts in each case should be described in such detail as to leave no doubt as to why assertion of the civil fraud penalty or fraudulent failure to file penalty is justified.

  4. If the FTA concurs with the examiner's fraud narrative and no additional information is required, the FTA will indicate his/her concurrence with the assertion of the civil fraud penalty or fraudulent failure to file penalty on Form 11661. A copy of the Form 11661 will be forwarded to the FTA group manager and the original will be returned to the examiner for inclusion in the administrative case file.

  5. If the FTA recommends that the examiner further case development, the FTA will document the reason(s) why and note the required additional steps in the Plan of Action. If the FTA does not agree that the civil fraud penalty should be asserted, this should also be documented and discussed with the examiner and his/her group manager. If the Examination group manager disagrees with the FTA recommendation that the civil fraud penalty should not be asserted, the case will remain in AIMS status code 17. Ultimately, the final decision on such a case rests with the Examination group manager.

  6. For civil disposition of a prosecution case, the examiner should contact Cl to ascertain the criminal statutes under which the taxpayer was convicted before attempting to resolve the related civil fraud penalty. If a taxpayer is criminally convicted under IRC 7201, the conviction precludes the taxpayer from objecting to the civil fraud penalty for the year at issue under the doctrine of collateral estoppel. See IRM 25.1.6.4 for additional information. However, the amount of the liability and the "underpayment" upon which the civil fraud penalty is based must be fully developed. Further, collateral estoppel would only apply to the year or years for which a conviction under section 7201 was obtained. For years where the conviction was obtained under a statute other than section 7201, or for years for which the taxpayer was not criminally convicted, the examiner must develop the civil fraud penalty prior to recommending its assertion. The examiner should consult the local FTA and Area Counsel for assistance in developing the case. The examiner should obtain a copy of the plea agreement or judgment notating the applicable criminal statutes and years. See 25.1.5, Grand Jury Investigations, for procedures in securing information for use in the civil settlement of cases investigated through grand jury procedures.

  7. In cases where fraud was considered and the civil fraud penalty is not recommended, the examiner must explain fully in the work papers consideration of the penalty and why it was not asserted.

  8. The civil fraud penalty and/or the fraudulent failure to file penalty must be asserted if a taxpayer was successfully prosecuted by the Department of Justice under Title 26 (i.e. Sections 7201, 7203, 7206(1)) and the prosecution involved additional tax assessment(s) as opposed to payment of existing assessment(s). Any exceptions to this rule must be approved by Area Counsel. In unsuccessful prosecution cases, non-assertion of the civil fraud penalty and/or the fraudulent failure to file penalty is the discretion of the Examination group manager. Examination group managers are encouraged to consult with their local FTA for assistance. This rule also applies 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 was successful.

    Note:

    Refer to IRM 25.1.6.4, Collateral Estoppel.

  9. Assertion of the civil fraud penalty or fraudulent failure to file penalty should be considered when a taxpayer is successfully prosecuted by the Department of Justice under Title 18 and the facts underlying the criminal case directly relate to additional assessments. The nature and scope of the civil action in such cases is at the discretion of the Examination group manager. Examination group managers are encouraged to consult with their local FTA for assistance and Area Counsel should be consulted as appropriate.

  10. For SB/SE, cases where criminal restitution can be assessed as a tax under IRC 6201(a)(4), contact SB/SE Area Counsel for further guidance.

  11. For LB&I, cases with criminal restitution, contact the Pre-Filing & Technical Guidance (PFTG) Senior Program Fraud Analyst upon receipt for guidance.

  12. Cases returned to the field from Fraud or Grand Jury suspense for civil disposition are returned in AIMS status code 17. Based on the facts and circumstances of the case, if and when a joint determination by the examiner, his/her manager and the FTA is made to not develop and/or assert the civil fraud penalty, the case will be updated to AIMS status code 12. The case must clearly document the reason(s) for such determination.

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

25.1.6.3  (11-05-2014)
Evidence of Fraud

  1. 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)

  2. 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

  3. The Facts section of the penalty narrative 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 facts to the government.

25.1.6.4  (11-05-2014)
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.

    Note:

    Although a taxpayer is collaterally estopped from asserting a defense to the civil fraud penalty, he may still argue the actual tax amount and amount of the underpayment reported in the return due to fraud.

  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 is required to establish the taxpayer’s intent to evade assessment of a tax to be due and owing.

25.1.6.5  (11-05-2014)
Case Closing

  1. Monitoring fraud-related activities 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. The examiner must identify the applicable penalty code section and computed penalty amount for each tax period on this form and provide any special closing instructions for Centralized Case Processing (CCP).

Exhibit 25.1.6-1 
Procedural Decision Guide

If Then Next steps
The FTA concurs with the examiner's fraud narrative and no additional information is required The FTA will indicate his/her concurrence with the assertion of the civil fraud penalty or fraudulent failure to file penalty on Form 11661. A copy of the Form 11661 will be forwarded to the FTA group manager and the original will be returned to the examiner for inclusion in the administrative case file.
The FTA recommends futher development The FTA documents the reason(s) why and notes the required additional steps in the Plan of Action. Case is returned to examiner.
The FTA does not agree that the civil fraud penalty should be asserted The FTA documents the reason(s) why and discusses it with the examiner and examiner's group manager.  
The Examination group manager disagrees with the FTA's recommendation that the penalty should not be asserted The case will remain in AIMS status code 17. Ultimately, the final decision on such a case rests with the Examination group manager.

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