25.1.7 Failure to File22.214.171.124 Overview126.96.36.199 Pre-screening Non-filers188.8.131.52 Audit Information Management System (AIMS) - Examination Function only184.108.40.206 Development of Fraud220.127.116.11 Criminal Referral18.104.22.168 Secured Delinquent Return (DEL RET)22.214.171.124 Civil Closure 126.96.36.199.1 Assessment Procedure for the Fraudulent Failure to File (FFTF) Penalty Part 25. Special TopicsChapter 1. Fraud HandbookSection 7. Failure to File 25.1.7 Failure to File Manual Transmittal November 23, 2015 Purpose (1) This transmits revised 25.1.7, Fraud Handbook, Failure to File. Material Changes (1) 188.8.131.52(1) - Added indicators of fraud and cautionary statement for certain cash-intensive businesses. (2) 184.108.40.206(1) - Added reference to IRM 220.127.116.11 to include over-arching guidance to all compliance employees. (3) 18.104.22.168(3) - Revised to reference IRM 22.214.171.124.6. (4) 126.96.36.199(2) - Corrected title of Form 2797. (5) 188.8.131.52(2) - Corrected link to Examination PSP office in the note. (6) 184.108.40.206(1) - Moved existing IRM 220.127.116.11, Civil Closure, to IRM 18.104.22.168. (7) 22.214.171.124(5) - Clarified guidance for convictions under IRC 7201. (8) 126.96.36.199(6) c) - Added cautionary statement for certain types of businesses. (9) 188.8.131.52.1 - Moved existing IRM 184.108.40.206, Assessment Procedure for the Fraudulent Failure to File (FFTF) Penalty, to a sub section of IRM 25.1.7, Civil Closure. (10) 220.127.116.11.1(1) - Clarified guidance as to when the fraudulent failure to file penalty should be assessed. (11) 18.104.22.168.1(2) - Immediate supervisory pre-assessment approval of the fraudulent failure to file penalty is required in writing. (12) 22.214.171.124.1(3) - The fraudulent failure to file penalty based on tax reported on a delinquent return is not subject to Notice of Deficiency procedures; however, Area Counsel review and approval is required to ensure that case facts support fraud. Effect on Other DocumentsThis IRM supersedes IRM 25.1.7 dated August 22, 2014. AudienceCriminal 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(11-23-2015)Charles Pillitteri, Acting Director, Servicewide Operations, SB/SE 126.96.36.199 (11-23-2015) Overview This section discusses procedures that apply Service-wide concerning fraud in failure to file cases. Willful failure to file a tax return is a misdemeanor pursuant to IRC 7203. In cases where an overt act of evasion occurred, willful failure to file may be elevated to a felony under IRC 7201. If failure to file a return is fraudulent, a civil penalty known as the "fraudulent failure to file (FFTF) penalty" may apply under IRC 6651(f). This penalty may apply to all returns due after 12/31/1989 (without regard to extensions). Note: The civil fraud penalty under IRC 6663 may apply to all returns required to be filed after 12/31/1989. Specific guidance on fraud indicators and the development of fraud can be found in IRM 25.1.1, Overview/Definitions, and 25.1.2, Recognizing and Developing Fraud. IRM 188.8.131.52.7.5, Fraudulent Failure to File - IRC 6651(f), provides specific procedures for assertion of the FFTF penalty. 184.108.40.206 (11-23-2015) Pre-screening Non-filers On the initial screening of a non-filer case, the compliance employee must determine if the facts indicate potential fraud. Indicators of fraud for consideration, in addition to those previously identified in IRM 220.127.116.11, Indicators of Fraud, are as follows: History of non-filing or late filing, and an apparent ability to pay; Note: This indicator of fraud alone is insufficient support for assertion of the FFTF penalty and should be cited in combination with other fraud indicators such as: Repeated contacts by the Service; Knowledge of the filing requirements (i.e., advanced education, business (especially tax) experience, record of previous filing etc.); Experience of the taxpayer in tax matters such as a law professor, CPA or tax attorney; Failure to reveal or attempts to conceal income or assets; Understating income; Failing to cooperate with IRS agents or employees; Providing incomplete or misleading information to the taxpayer’s tax return preparer; Failing to maintain adequate records; Filing false documents, including filing false income or other tax returns; Offering implausible or inconsistent explanations; Age, health, and occupation of the taxpayer; Substantial tax liability after withholding credits and estimated tax payments; Large number of cash transactions (i.e., purchases by cash and large cash deposits evidenced by documented cash transactions (printout from the Financial Crimes Enforcement Network (FinCEN) Query system research), payment of personal and business expenses in cash when cash payment is unusual and/or the cashing (as opposed to the deposit) of business receipts; Caution: Consider whether business is a cash-intensive business and if cash must be used for paying expenses: for example, in the marijuana industry, where banks have been reluctant to provide bank accounts for these businesses. Indications of significant income per Information Return Processing (IRP) documents (i.e., substantial interest and dividends earned, investments in IRA accounts, stock and bond transactions, high mortgage interest paid); Note: Consideration should be given to any allowable expenses the taxpayer may have to offset self-employment income. Refusal or inability to explain the failure to file; and Prior history of criminal tax prosecutions for Title 26 violations. If indications of fraud exist, the compliance employee will discuss the case with the group manager. If the group manager concurs that the possibility of fraud exists, the fraud technical advisor (FTA) will be contacted. Whenever feasible, a face-to-face meeting will be held between the compliance employee, group manager and FTA to discuss the need for fraud development. If the possibility of fraud exists: DO NOT SOLICIT tax returns. If returns are submitted, they should be accepted but not processed, and clearly documented in the case history. See IRM 18.104.22.168.3, Delinquent Return Secured by Examination After SFR TC 150 Posted - Accepted as Filed Procedures, IRM 22.214.171.124.4, Delinquent Return Secured by Examination After TC 150 SFR Posted, With Audit Potential - Process Partial Assessment Procedures, and IRM 126.96.36.199 for proper handling. DO NOT VOLUNTEER ADVICE to the taxpayer concerning any potential course of action to follow. DO NOT DISCUSS tax liabilities, penalties, fraud, or criminal referral possibilities with the taxpayer. 188.8.131.52 (11-23-2015) Audit Information Management System (AIMS) - Examination Function only In non-filer cases where a criminal referral is probable and where it is determined that a substitute for return (SFR) should not be posted to the Master File, use push code 037, potential criminal investigation referral/non-filer. For most examiners, the Audit Information Management System (AIMS) will remain a skeletal base until a transaction code (TC) 150 posts. Otherwise, use push code 036, non-filer, and an SFR will be generated. The request for push code input is made using Form 5345-D, Examination Request-ERCS (Examination Returns Control System) Users, or Form 5345-B, Examination Request Non-ERCS Users. The request is routed by the compliance employee to his/her group manager for review and approval. Upon group manager approval, the form is routed to the group secretary or other designated person for input. The AIMS project code should be changed to 0149, non-filer referral for fraud, if a criminal referral is probable. 184.108.40.206 (11-23-2015) Development of Fraud If there are indicators of fraud that warrant fraud development, see IRM 220.127.116.11, Fraud Development Procedures, for specific guidance to compliance employees on the procedures required in such cases. The following actions assist the employee in establishing affirmative acts (firm indications) of fraud: Interview the taxpayer to determine the reason or the intent of the taxpayer's noncompliance. Ask sufficient questions to determine the extent of the delinquency, including the periods and tax due. Document verbatim, if possible, the questions asked and the taxpayer's response or lack of response. Identify any personal reasons that could affect the taxpayer's ability to comply. If the information is not provided by the taxpayer, attempt to secure the information from third party sources. Attempt to get a definitive statement from the taxpayer regarding additional expenses not listed in the books and records. These expenses could include, but are not limited to, expenses paid in cash or "under-the-table" payments to employees. Attempt to establish year-end cash on hand for each year under investigation. Verify income from all available sources. Methods of income verification include, but are not limited to: Reviewing FinCEN Query data; Securing IRP data if not already available or reviewing Information Data Retrieval System (IDRS) via command codes: INOLE, IROLE, SUPOL, IRPTR, IRPOL; Securing copies of Forms W–2 from employers and Forms 1099 from customers; Securing copies of checks issued to the taxpayer from Form 1099 issuer(s); Examining the taxpayer's books and records of income and expenses; Reviewing the last return filed. This assists in identifying income sources as well as deductions and exemptions used in tax computations; and Securing current financial information including a check of public records for assets, and a physical observation of the taxpayer's residence, place of business and/or other identified properties. When checking public records, in addition to identifying the assets, information may be available as to when the assets were acquired and the amount paid for such assets. This information will determine whether the taxpayer had the ability to pay the taxes owed when due. Access to a full credit report is governed by the Fair Credit Reporting Act. See IRM 18.104.22.168.6, Statutory limitations on Acquiring Credit Reports From a Consumer Reporting Agency-Summons Required, for guidance. If subsequent to receipt of a full credit report for a Balance (BAL) DUE investigation, fraud is discovered on a delinquent return (DEL RET) or a previously filed return, or unreported income is discovered, a summons must be issued under IRC 7609 for another credit report. However, the Service may not obtain a full credit report of a sole proprietor, partner or fiduciary without a summons where there is no lien against the individual taxpayer. Finally, use of a full credit report as a basis for a referral to Criminal Investigation (CI), a summons must be issued in accordance with IRC 7609, because of the third party record keeper notice requirement. 22.214.171.124 (11-23-2015) Criminal Referral Contact the FTA for the criminal criteria when considering submission of a criminal fraud referral of a non-filer. When the group manager and the FTA concur that firm indications of fraud exist and criminal criteria are met, the compliance employee will prepare Form 2797, Referral Report of Potential Criminal Fraud Cases. The Form 2797 should be prepared as described in IRM 126.96.36.199, Preparation of Form 2797 - Referral Report of Potential Criminal Fraud Cases. 188.8.131.52 (11-23-2015) Secured Delinquent Return (DEL RET) Compliance employees should consider referring the secured DEL RET to CI for consideration if it has been determined that the DEL RET has a substantial understatement of income and/or a substantial overstatement of deductions that are fraudulent, and criminal criteria is met. The group manager and the FTA should become involved as discussed in IRM 184.108.40.206. If failure to file and the DEL RET are fraudulent, assertion of both the FFTF penalty (based on the FFTF net amount due) and the civil fraud penalty (based on the DEL RET deficiency) should be considered. Again, the group manager and the FTA should become involved as discussed in IRM 220.127.116.11. Note: Collection function employees only should consider a referral to Examination Planning and Special Programs office (PSP), http://mysbse.web.irs.gov/examination/examorg/ppa/fieldexamwpa/10487.aspx, for FFTF penalty and civil fraud penalty consideration, if the DEL RET(s) is fraudulent and criminal criteria are not met. The referral information (including identifying taxpayer information) should be placed on a memorandum and forwarded to the Area PSP for assignment consideration. 18.104.22.168 (11-23-2015) Civil Closure If the criminal criteria are not met, the compliance employee will complete the examination or SFR action whether or not the taxpayer files a DEL RET. Compliance employees should contact the FTA, if necessary, for assistance in developing the FFTF penalty. Further direction on assertion of the penalty is contained in IRM 20.1, Penalties Handbook. The addition to tax under IRC 6651(f) (fraudulent failure to file) should be proposed when evidence clearly indicates the taxpayer fraudulently failed to file a return, or filed the return late. The civil fraud penalty under IRC 6663 applies only if the Service possesses clear evidence that the taxpayer reported an underpayment on his or her return attributable to fraud. Penalties should not be used as a bargaining tool. In non-filer cases, a criminal conviction for willful failure to file a Federal return under IRC 7203 collaterally estops a taxpayer from denying liability under IRC 6651(a), the delinquency addition to tax, in a civil case. The addition to tax for FFTF is not automatic. Although a conviction under IRC 7203 does not collaterally estop a taxpayer from challenging the FFTF addition, the conviction further supports indications of fraud. If the non-filer is convicted under IRC 7201, the taxpayer is collaterally estopped from denying fraudulent intent in relation to the civil fraud penalty or the FFTF penalty. The taxpayer may, however, contest the amount of the underpayment supporting the civil fraud penalty determined by the IRS or the amount of the tax required to be shown on the return in connection with the determined FFTF penalty. Collateral estoppel for a conviction under IRC 7201 only applies to the year(s) of the conviction and the civil fraud penalty or FFTF penalty, not the tax liability. The mere fact of failing to file a return does not constitute sufficient evidence to sustain fraud. Overt acts of evasion must be identified to impose the FFTF penalty. In addition to the previously listed firm indications of fraud, the following examples can apply to failure to file cases: Attempts by the taxpayer to conceal or transfer assets to evade collection of tax subsequently assessed; Taxpayer furnishes a false W–4 to his employer; and/or Taxpayer’s use of dummy business entities, bank accounts opened under assumed names and use of false taxpayer identification numbers in an attempt to conceal the source of income or identity of the owner. Caution: For example, some marijuana businesses have created dummy business entities in an attempt to get a bank account, thereby hiding the true nature of their business. Area Counsel must provide written approval for non-assertion of the FFTF penalty under IRC 6651(f) if a taxpayer has been successfully prosecuted by the Department of Justice under any criminal statute for failing to file. If successful prosecution has not been obtained, non-assertion of the FFTF penalty will be at the discretion of the compliance group manager. Compliance group managers are encouraged to consult with their local FTA for assistance. 22.214.171.124.1 (11-23-2015) Assessment Procedure for the Fraudulent Failure to File (FFTF) Penalty Once it is determined that the DEL RET is fraudulent and either criminal criteria is not met or a criminal investigation is concluded, the FFTF penalty, based on the tax reported on the DEL RET should then be assessed. Note: When the taxpayer files a DEL RET, the limitation period for assessment begins. The FFTF penalty, based on the tax reported on the DEL RET, must be assessed within 3 years of receipt of the DEL RET. The FFTF penalty does not keep the statute period for assessment open beyond the 3 year period in this scenario. Written pre-assessment approval by the immediate supervisor is required. See IRM 126.96.36.199.7.5.1(8), FFTF Penalty Assessment - Procedural Requirements. The portion of the FFTF penalty, based on the tax reported on the DEL RET, is not subject to deficiency procedures and should not be included in a Notice of Deficiency. However, if the delinquent filing results in a deficiency, only that portion of the FFTF penalty attributable to the deficiency should be included in the Notice of Deficiency. Note: To ensure case facts support fraud and because the assessment of a FFTF penalty attributable to the amount originally shown on a return is not reviewable by the tax court, all 30-day letters proposing a FFTF penalty on the tax reported on the DEL RET must be reviewed and approved by Area Counsel prior to issuance. See IRM 188.8.131.52.1(11), 30-Day Letters and IRM 184.108.40.206.7.5.1(3), FFTF Penalty Assessment-Procedural Requirements. Letter 2777, Pre-Assessment appeals letter for the fraudulent failure to file penalty, may be used in lieu of the regular 30-day letter when appropriate.