When Can a Taxpayer Face Civil Fraud Penalties?

Crimes like tax evasion often capture most of the public’s attention, however, it is essential to realize that while tax evasion penalties are harsh and typically include a prison sentence, tax consequences become serious even before criminal charges are justified. Depending on the facts and circumstances present, the IRS auditor or agent may decide to seek the civil fraud penalty. As its name suggests, the civil fraud penalty is civil rather than criminal in nature. However, a prison sentence is still a distinct possibility as the evidence needed to assert the civil fraud penalty is the same evidence necessary for a criminal conviction.

The civil fraud penalty can allow the IRS and prosecutors to seek enormous penalties that can leave a taxpayer in a seemingly unsurmountable financial hole. For taxpayers who may implement aggressive tax positions or questionable tactics, the civil fraud penalty can easily erase the benefit of the aggressive strategy and much more.

What Is the Civil Fraud Penalty Rate?

The Civil Fraud penalty is set forth in IRC 6663. Section 6663(a) provides that when any part of an understatement of tax can be attributed to fraud, then a penalty equaling 75 percent of the underpayment of tax can be imposed. Subject to the exception, Section 6663(b) holds that when any portion of a tax underpayment can be attributed to fraud, then the entire underpayment is attributed to fraud. Essentially, taxpayers who are found liable for the civil fraud penalty will owe back taxes on the original underpayment, interest on the unpaid taxes, and the civil fraud penalty. Taking actions that can justify the imposition of a civil fraud penalty can significantly increase an individual’s tax liability.

What Can I Expect when the IRS Seeks the Civil Fraud Penalty?

When taxpayers begin to fear that he or she may have made an error or staked out too aggressive of a tax position, they often begin to worry about the audit and enforcement process they will face. Such considerations and damage control planning are wise. Taxpayers who reach out and engage with a tax lawyer in the earlier stages of a tax controversy can often strategically plan to avoid a worst-case tax enforcement scenario from both a civil and criminal tax perspective.

Unfortunately, there is no single path to a tax proceeding that seeks to impose the civil fraud penalty. The IRS Internal Revenue Manual specifically instructs agents that, “A civil fraud penalty case may be developed on the facts and circumstances of a civil examination or on the result from the completion of a criminal tax prosecution.” Thus, the civil fraud penalty can arise as a civil revenue agent, or agent out of the criminal investigation division, works a case. The civil fraud penalty can also be sought after the civil side of the IRS makes a referral to the IRS Criminal Investigation division and subsequently pursued civilly after IRS-CI declines to bring criminal tax charges.

If the IRS agent and the agent’s manager determine that the penalty is appropriate, he or she will complete either Form 5344 or Form 5599. Furthermore, IRS Form 3198 will also be completed to set forth the actual penalty amount.

For What Types of Tax Violations Can I Face the Civil Fraud Penalty?

First the good news: If you fail to file a tax return in any form, then you cannot face the civil fraud penalty. This is because Section 6664(b) of the Internal Revenue Code holds that the penalty applies only when a return has been filed by the taxpayer. However, this is not a recommendation to avoid filing one’s taxes. The failure to file taxes can carry an array of penalties. Furthermore, when the failure to file tax returns appears to be part of a scheme to willfully conceal income or evade taxes, serious tax charges can be advanced including tax evasion especially if Spies factors are present.

Generally, the civil fraud tax penalty is applicable to any and all civil tax enforcement actions when certain elements are present. These elements include a material misrepresentation and knowledge of the fact that what was being purported as true was, in fact, false. Thus, acts like intentionally misrepresenting the character or nature of income, concealing income, or engaging in an array of other fraudulent tax acts can justify the imposition of a civil fraud penalty.

Concerned About Facing Civil or Criminal Tax Penalties Due to an Audit or Returns you have Filed in the Past?

If you are concerned that overly aggressive tax positions will haunt you or your business when it comes time for an audit, or worse yet criminal tax investigation, the tax lawyers and tax professions of the Tax Law Office of David W. Klasing may be able to help. David Klasing is a dually certified tax attorney and CPA, with a master’s degree in taxation, who can put his vast experience as a public auditor to work for you. The tax lawyers of the Tax Law Office of David W. Klasing can develop a customized legal strategy that is responsive to your concerns and preferences. To schedule a confidential, reduced cost initial consultation, please call our tax law office or see our YouTube video on what to do if you cheated on your taxes and face an audit.