Court Rules in Favor of Taxpayer, Prevents IRS from Imposing Civil Fraud Penalty Based on Statute of Limitations

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Court Rules in Favor of Taxpayer, Prevents IRS from Imposing Civil Fraud Penalty Based on Statute of Limitations

Recently, the Federal Tax Crimes blog drew attention to an interesting case in which a taxpayer successfully prevailed over the IRS in U.S. Tax Court – despite having a known history of lying to the IRS and engaging in tax crimes, for which he had previously been sentenced to 27 months in prison. The issue in dispute? Whether the IRS was justified in assessing civil fraud penalties, which the plaintiff, Richard C. Mathews, contested. The outcome of the case? Ultimately, the court ruled in favor of the taxpayer, barring the IRS “from assessing deficiencies and alternative… accuracy-related penalties” under 26 U.S. Code § 6662(a), citing, in defense of its decision, the IRS’ failure “to establish by clear and convincing evidence that [Mathews] filed false and fraudulent returns with the intent to evade tax” for the years in dispute, namely 2007 and 2008. Our tax litigation attorneys take a closer look at this dispute.

Court: IRS Fails to Provide Clear and Convincing Evidence of Intent to Evade Tax, No Civil Fraud Penalty to Be Imposed

During 2013, Mathews was sentenced to more than two years in prison after being convicted on “five counts of filing false income tax returns and one count of obstructing the IRS laws,” according to Department of Justice (DOJ) records. At the time, prosecutors explained, Mathews was found guilty of having engaged in a scheme to underreport gross receipts on his federal income tax returns, reporting to the IRS approximately $22,200 over the period from 2004 to 2008, when the actual figure that should have been reported was closer to $245,300. He also engaged in tax obstruction by hindering the probe into his activities, “making false statements to and regarding actions taken by IRS agents, creating a trust to avoid payment of taxes, and filing false returns” throughout the course of an IRS criminal investigation.

Five years later in 2018, Mathews and the IRS again crossed paths when the former filed a petition contesting a fraud determination that would have enabled the IRS to assert the civil fraud penalty. Without actually denying or disputing IRS assertions that he previously failed to report income, Mathews argued that nonetheless, because the relevant statute of limitations had expired (i.e. run out of time), the penalties being sought were improper.

The IRS unsuccessfully attempted to counter that an exception should apply under 26 U.S. Code § 6501(c)(1), which eliminates the normal three-year time limits that apply under 26 U.S. Code § 6501(a) where false returns are concerned, stating, “In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.” Because the IRS could not provide “clear and convincing evidence” that Mathews acted, as mentioned, “with the intent to evade tax,” the court took Mathews’ side against the IRS, expressing “doubt that the petitioner filed false and fraudulent returns with the intent to evade tax for the years in issue…” In short, the court held that the three-year time limit to assess tax should apply due to lack of adequate evidence proving Mathews’ intent, effectively preventing the IRS from assessing deficiencies.

According to court records, the deficiency for 2007 ($6,556) would have, under 26 U.S. Code § 6663, resulted in a civil fraud penalty of $4,917, while the deficiency for 2008 ($16,405) would have generated a civil fraud penalty of approximately $12,303. These figures are derived from a simple calculation: “75% of the portion of the underpayment which is attributable to fraud,” which is the civil fraud penalty provided by 26 U.S. Code § 6663(a).

IRS Appeals and Tax Litigation Attorneys for Tax Dispute Resolution

The IRS normally has three years to assess taxes, penalties, and interest, though in some cases, a longer 6-year time limit applies, or where fraud has been proven to occur – no statute of limitations exists. This can fuel or result in disputes when the IRS claims that taxpayers are liable for payments in connection with older tax returns. Appeals or, if necessary, tax litigation can resolve these disputes for the taxpayer. However, because these procedures are complex, it is strongly recommended that taxpayers seek competent, experienced tax counsel. If you believe that the IRS has billed you in error for a tax debt you do not owe, speak to the IRS appeals attorneys at the Tax Law Office of David W. Klasing about your options for proceeding. To set up a reduced-rate consultation, contact us online, or call (800) 681-1295 today.

Also, we’ve expanded our offices! In addition to our offices in Irvine and Los Angeles, the Tax Law Offices of David W. Klasing now have offices San BernardinoSanta BarbaraPanorama CityOxnardSan DiegoBakersfieldSan Jose, San FranciscoOakland and Sacramento.

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