“Tax Fraud” Defined and How the IRS Proves It
In continuing with the Tax Crimes series, we began by examining introducing you to the criminal tax investigation process and how referrals to the Internal Revenue Service’s (“IRS”) Criminal Investigation Division (“CID”) begin. Now, we will dive into the IRS’s definition of fraud, the “badges” of fraud, and what leads IRS compliance employees or CID Special Agents to the belief that indicators of fraud have become affirmative or over acts of fraud.
Definition of Fraud
Under Internal Revenue Manual (“IRM”) § 25.1.1.2, “fraud” is defined as the “deception by misrepresentation of material facts, or silence when good faith requires expression, which results in material damage to one who relies on it and has the right to rely on it.” Moreover, under IRM § 25.1.1.2, tax fraud is often defined as an intentional wrongdoing, on the part of a taxpayer, with the specific purpose of evading a tax known or believed to be owing. Therefore, tax fraud requires both:
1. A tax due and owing; and
2. Fraudulent intent.
Civil vs. Criminal Fraud
A key feature of tax fraud is that the offense may result in both civil and criminal penalties. Often, restitution will be ordered in criminal tax cases. Restitution will be ordered upon conviction, plea agreement, or as a condition of probation whereas in civil fraud cases, the IRS will assess the correct tax and impose civil penalties as an addition to tax. On the other hand, criminal fraud cases result in punitive action with penalties consisting of fines and/or imprisonment. IRM § 25.1.1.2.3 explains that criminal penalties are:
Enforced only by prosecution;
Intended to punish the taxpayer for wrongdoings; and
Serve as a deterrent to other taxpayers.
It is important to note that avoidance of tax is not a criminal offense. Taxpayers are free to legitimately minimize their taxes. Legitimate means of avoiding taxes includes preplanning events to reduce or eliminate tax liability within the confines of the law, while tax evasion involves some affirmative act to evade or defeat a tax or the payment of the tax. Tax evasion will be discussed in further detail below.
Internal Revenue Code (“IRC”) § 7201 – Attempt to Evade or Defeat Tax
Under IRC § 7201, any person who willfully attempts to evade or defeat any tax or the payment thereof shall be guilty of a felony and, upon conviction, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both.
Generally, IRC § 7201 creates two types of tax evasion offenses. First, there is the willful attempt to evade or defeat the assessment of a tax. Second, there is the willful attempt to evade or defeat the payment of a tax. Accordingly, the elements of tax evasion – often referred to as tax fraud – are as follows:
1. A tax due and owing;
2. Willfulness; and
3. Attempt.
Proof of a Tax Due and Owing:
Generally, the IRS must demonstrate the existence of a tax due and owing (i.e., a tax deficiency). See IRM § 25.1.1, Exhibit 25.1.1-1. It is important to verify that the income from which the tax deficiency resulted was in fact taxable income. See IRC §§ 61, 62, and 63. Some examples of types of income that are not often thought of or expressly specified in the Internal Revenue Code include:
Campaign contributions used for personal purposes;
Embezzlement;
Extortion proceeds;
Fraud income;
Gambling winnings;
Kickbacks; and
Loans received with no intent to repay.
Proof of Willfulness:
Under IRM § 25.1.1.1, the IRS defines “willfulness” as a voluntary and intentional violation of a known legal duty. This definition comes from a rich history of case law. Cheek v. United States, 498 U.S. 192, 200-01 (1991); United States v. Pomponio, 429 U.S. 10, 12 (1976); United States v. Bishop, 412 U.S. 346, 360 (1973). A good faith misunderstanding of the law or good faith belief that one is not violating the law will the negate the willfulness element required to convict a taxpayer of tax evasion under IRC § 7201.
Proof of Attempt:
Under IRC § 7201, the taxpayer must engage in an affirmative act for the purpose of attempting to evade or defeat the assessment of a tax. This elements requires more than a passive neglect of a statutory duty. A mere act of willful omission does not satisfy the affirmative act requirement. United States v. Masat, 896 F.2d 88, 97-99 (5th Cir. 1990).
As previously mentioned in Tax Crimes: Part I, indicators of fraud serve as a sign that actions may have been done for the purpose of deceit, concealment, or to make things seem other than what they are. As stated in IRM § 25.1.1.3, indicators of fraud (otherwise known as “badges of fraud”) do not, in and of themselves, establish that a particular action was done for the purpose of evading or defeating the assessment of a tax. What ultimately does establish the overt act or “attempt” is an affirmative action by the taxpayer. Under IRM § 25.1.1.3, affirmative actions establish that a particular action was in fact deliberately done for the purpose of deceit, subterfuge, camouflage, concealment, or some attempt to make things seem other than what they were.
By way of illustration, the Supreme Court set out examples of conduct which may constitute affirmative acts of evasion:
Keeping a double set of books;
Making false or altered entries;
Making false invoices;
Destruction of records;
Concealing sources of income;
Handling transactions to avoid usual records; and
Any other conduct likely to conceal or mislead.
See Spies v. United States, 317 U.S. 492, 498-99 (1943). Although the Supreme Court did not list this action in the “Spies Acts,” the most common affirmative act is signing and submitting a tax return under penalty of perjury.
Although this article is limited to a small subsection of criminal tax violations, the Tax Crimes series will continue to expand upon other criminal statutes within the 7200s section of Title 26. In the meantime, if you or someone you know is out of compliance with the IRS, contact the Wilson Firm today. We have helped plenty of taxpayers take advantage of criminal amnesty programs offered by the IRS.
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