Tax & Business Insights

Civil Tax Fraud Penalty

Volume 23 Issue 2 --  March/April 2011

The civil fraud tax penalty has been described by some as a double headache because it is usually preceded by a criminal tax proceeding and then a separate civil fraud penalty action. The purpose of this newsletter is to discuss the civil fraud penalty in general terms and provide a few pointers concerning it. There are lengthy treatises on the civil fraud penalty, and  this newsletter is not designed to handle such a massive subject in great detail.

The policy of the U.S. Department of Justice is to refer any criminal tax case involving, usually, jail time or monetary penalties to the IRS after the Department of Justice has concluded its case, particularly if the taxpayer is found guilty. As often happens, it is frequently advantageous to plead guilty to a lesser criminal offense than to risk going to trial and being found guilty of tax evasion and sentenced to five or six years in jail.

The civil fraud penalty is 75% of the tax liability, plus interest. Often, the civil fraud penalty plus the interest will exceed the original tax liability. This is typically true because it takes so long for the criminal case to get through the court system. By the time the taxpayer serves his or her jail time, many years can elapse before the civil fraud case comes to trial.

While criminal tax cases have to be conducted in the U.S. District Court, civil tax fraud is always tried in the U.S. Tax Court. Assuming the criminal matter did not result in plea or conviction of tax evasion, but rather some lesser criminal offense, then it is possible to contest the civil fraud penalty in the Tax Court.  Often, the only issue in the Tax Court is the question of fraudulent intent.

Unusual for the IRS attorneys, they have the burden of proving fraudulent intent, not just negligence or carelessness. Typically, the IRS will have the Criminal Investigation Report, and the same agents that assisted in the criminal matter work in conjunction with the IRS trial attorneys to prepare the civil fraud case.

If an individual pleads guilty to tax evasion under Internal Revenue Code  § 7201, there is no defense to the civil fraud penalty in the Tax Court. There are, however, various criminal tax violations which do not automatically render the civil fraud penalty uncontestable. For example, pleading guilty to filing a false return does not automatically prevent the taxpayer from defending his or herself against the civil fraud penalty, although the only ground for defense may be lack of fraudulent intent.

Some government personnel believe that if any criminal plea was entered the civil fraud penalty is an automatic entry, but this is not true unless one pleads guilty to tax evasion. Nonetheless, negotiating a settlement of the civil fraud penalty can be difficult.

 Having to make a choice between pleading guilty to a lesser tax crime versus going to trial and risking a conviction for tax evasion and the resulting civil fraud penalty is daunting. Going to trial and losing almost always results in more jail time than the jail time flowing from a plea. The fact that a taxpayer who has pled guilty to or been found guilty of a tax crime then has to defend him or herself against the civil fraud penalty is a terrific burden.

While not much discussed, there is an informal yardstick by which the Justice Department decides which cases to prosecute.  It appears  that, regardless of culpability, the Criminal Investigation Division will not audit criminal tax activity unless there is a least $70,000 to $80,000 in potential tax liability at stake.  Stated differently “small fish” are often not prosecuted even though many of the badges of fraud are present.

If your client is being investigated by the Criminal Investigation Division of the IRS, it is essential that an attorney knowledgeable about criminal tax cases be retained early. In appropriate circumstances, it may be possible to negotiate a plea deal rather than go before a jury.

For the government, one benefit of a criminal tax prosecution is the inevitable news release following the sentencing touting the government’s successful prosecution. Civil tax fraud litigation does not result in such news releases even though the Tax Court decision is a public document.

If the IRS decides to impose the Civil Fraud Penalty, it must first issue a Notice of Deficiency asserting the penalty. The taxpayer then has a choice of conceding the penalty or contesting it by filing a timely Tax Court petition.  For those still in jail, it is common to default on the Notice of Deficiency. Many are so despondent or impoverished that they ignore the Notice, default, and then face a large tax bill when released.

While Tax & Business Professionals does not handle criminal cases directly, if your client is involved in a criminal or potential criminal matter, you may want to contact us for advice. 

Copyright 2011
By Tax and Business Professionals, Inc.
9837 Business Way
Manassas, VA 20110
(800) 553-6613

While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.

Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.