Thursday, June 28, 2012

Tax Court Finds IRS Compliance Officer Liable for Civil Fraud Penalty (6/28/12)

Readers interested in the risks of being audited with respect to income tax noncompliance arising from foreign assets (particularly financial accounts) often ask what it takes for the IRS to prove fraud.  I am aware of no standard litmus test of civil tax fraud that will identify, particularly for laymen, when a court might find civil fraud.  However, decided cases can help set parameters from which, with enough cases, one might be able to make an educated guess as to when a court might find civil tax fraud.

We have one such case yesterday from the Tax Court.  Quinn v. Commissioner, T.C. Memo. 2012-178, here.

Ms. Quinn was an IRS tax compliance officer.  She claimed what appear to be such large charitable contributions ($48,000+ for 2 years) and medical deductions ($47,000+ for 2 years), that the IRS scoring techniques probably flagged her for audit.  She also claimed certain dependents that she was not entitled to claim.

The Court held that she was not able to substantiate her claims.  Not only that, her evidence in attempts to substantiate was bogus in some cases and highly suspicious in others.  For example, here is the Court's key discussion of the charitable contribution claims:
Petitioner proffered "receipts" purportedly confirming charitable contributions. They were inconsistent and unreliable. Representatives from seven different charitable organizations credibly testified that the receipts were altered or fabricated. For example, petitioner offered a receipt purportedly substantiating $12,500 of charitable contributions to a religious organization. The purported receipt, however, identified individuals other than the couple as the donors. The organization's records did not reflect any contributions made by the couple and confirmed that the other identified individuals had contributed $12,500. Other purported receipts also appeared to have been tampered with and were suspect. None of the organizations' records verified any charitable contributions the couple claimed for the years at issue. Nor did the couple's bank statements corroborate the amounts the couple claimed they contributed. Further, Mr. Quinn did not recall making any of the purported contributions. In each instance, petitioner failed to offer reliable substantiation. We therefore conclude that petitioner is not entitled to any deduction for claimed charitable contributions of $48,116 for the years at issue except the nominal amounts respondent conceded, which consisted of $175 for 2006 and $10 for 2007.
A similar pattern existed for the medical deductions.  And, the dependency exemptions were also bogus.

Not surprisingly, the Court sustained the 75% civil fraud penalty in Section 6663.  In getting to that holding, the Court went through the following steps.

1.  The IRS has the burden of proving civil fraud by clear and convincing evidence.

2.  "Once the Commissioner has established by clear and convincing evidence that any portion of an underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud, except with respect to any portion of the underpayment that the taxpayer establishes (by a preponderance of the evidence) is not attributable to fraud."

3.  Fraud requires that "the taxpayer [have] acted with specific intent to evade tax that the taxpayer knew or believed he or she owed by conduct intended to conceal, mislead or otherwise prevent the collection of the tax."

4.  Fraud is usually proved by circumstantial evidence.

5.  The badges of fraud are considered in determining whether the IRS met the burden of proof.

After these general propositions, the Tax Court then moved to the specific:
Our analysis starts with a fact that permeates the entire record. Namely, petitioner is an experienced tax compliance officer that remains employed by the IRS. Petitioner should have a complete understanding of substantiation requirements. Despite her background, petitioner has presented altered or fabricated documentation in an attempt to deceive respondent and the Court.
As to contributions, the Court said:
She understated her income by claiming deductions she was not entitled to claim for each year at issue. Even if we accepted her purported records (which we do not), she still claimed significantly more contributions and expenses than her questionable records supported. It is incredible that a tax compliance officer would be able to substantiate only $185 of charitable contributions yet claim charitable contributions of $48,116 for the years at issue. The charitable organizations confirmed that petitioner claimed contributions that she had not made. It is equally troubling that she was able to substantiate only $30 of the $47,542 of medical and dental expenses claimed. 
* * * * 
While we cannot be certain of the source, we find that some (if not most) of petitioner's records for each year at issue were altered. Unexplained inaccuracies in other documents imply that petitioner fabricated receipts for both years at issue. Even documents that appeared genuine did not substantiate that the couple actually incurred those costs or expenses.
Her testimony and assertions in the post-trial brief were also inconsistent and implausible. Petitioner maintained she was unaware of the requirements for accurately stating and substantiating income. We find this incredible. In contrast, the credible testimony of her supervisor, her husband and representatives of the charitable organizations contradicted petitioner's records, testimony and assertions.
She lost the deductions and the court imposed the civil fraud penalty.


  1. Compared to her, we (who are in ovdi) are all role model taxpayers.  Surprisingly she was not criminally prosecuted. 

  2.  I agree. Compared to her, minnows in ovdi should be compensated by the govt for  being so good and forthcoming (or naive).

  3. Greedy as I am -:).  Back a few months ago, RRSP off penalty would make me very happy and willing to pay 12.5% penalty.  Now, I am thinking of opting out hoping for much less penalty.   Should I feel guilty for being greedy ?

  4. So have you made a decision about what you're going to do, now that the RRSP is off?

  5. yes you should :)
    you were initially happy, paying whatever was asked but stay out of jail. Then you were happy to get RRSP off. now you want to opt out and pay less penalty :)
    after opting out if you get what you ask, you may want to see if there is a way to sue for mental anguish and collect more than what you paid :) :) :)

    just kidding. i am happy that they took RRSP out of the penalty calculation for you

  6. Not yet, and I am still waiting from my examiner.  Based on new FAQ, I should wait for they rule RRSP late election first. I am 50%vs50% on opting out.  I have paid the penalty already in my first package, this is like to ask them to give me money back.  Based on my understanding on non-willful FBAR penalty,  I should get a bit better than 12.5% on the peak.  The risk is almost none as my facts are simple/not bad at all. No hiding no secret to IRS.  I should be in between reasonable cause (no penalty) and negligence (small penalty).       

  7. You probably should check what the IRS did with the penalty you sent in. If it is being held as a deposit against the penalty when assessed (either in lieu of or FBAR), then obtaining a refund should be no problem. If it has been applied to an in lieu of penalty in advance of the Form 906, you may be subject to the 2 year refund statute of limitations. Have someone check that for you.

    Jack Townsend

  8. Jack, Thanks.. since I have not signed 906, and I sent this in lieu penalty by mistake, I should be able to ask IRS to send it back to me ? Am I right ?  I will check my examiner.

  9. Need to ask your examiner. However, if your case is going to be processed soon and you think you are going to accept the IRS's calculations, then you might make a strategic call not to ask that it be returned.

    This just emphasizes that one benefit from all of these programs, as structured, is that the in lieu or penalty (or the FBAR penalty on opt out) is not due until the end. Since the in lieu of and the FBAR penalties do not draw interest until assessed, the taxpayer does get some benefit of delayed processing -- at least if the taxpayer does not send the in lieu of penalty in early.

    Jack Townsend

  10. Jack, Thanks!  I think I may ask where they put my $9000  in lieu penalty, and if it is subjected to 2 years SOL for refund.  If not, I can just give IRS the free loan for being patriotic -:).  Also I don't give them the impression that I am about opt-out.   My examiner is a nice guy, maybe just for him, I should have it closed to reward him for his time on my PFIC.

  11. ij,
    I'm intrigued by your comment. Did the IRS remove your RRSP'S from the penalty base calculation? If so, have they decided to do that for all who hold RRSP's?

  12. Hi Titus,  Not yet, but I did not include RRSP into base of in lieu penalty when I did my calculation.  RRSP will be (and should be) removed from the penalty base and IRS has recently issued new FAQ  with RRSP policy.

  13.  ij, I like to think I am a nice guy too, but I don't think you would like to spend 9K just to please me :)

    If your examiner wasted several hours on PFICs that likely netted the IRS only a few hundred dollars, then that just shows the IRS is not using its resources wisely.

  14. Layperson, not only to please a nice agent, I do have some concern on my RRSP.  Once I opt-out, RRSP FBAR violation may be back to the table, that will add more to my total balance.  Even with Level 2 non-willful penalty @ 2% rate, that will be more than I can get inside OVDI.  So this is something I have to consider too

  15.  Jack

    I don't think the 2 year refund SOL should apply however the IRS has applied the money internally. Especially if it was sent in a separate check, clearly designated for the in-lieu penalty. This money has nothing to do with taxes.

    After all, the IRS has not asked for this payment. Even if the IRS HAD asked for this payment to join the program, someone who opts out without signing the 906 should have it returned since they are not in the program any more. There is no FBAR penalty assessed. If the IRS were to assess a FBAR penalty against (say) ij or someone else asking for a return of this deposit, it would have to go through the full process of making an FBAR assessment, including getting clearance with IRS Chief Counsel's office, going through Appeals. DoJ Tax may even need to get a judgement in Federal Court before the penalty is actually due (there is some uncertainty over whether the judgement is actually needed -- I think it is.

     The IRS cannot just legally hold on to a check sent  as a prepayment of the in-lieu penalty from someone who opts out. I don't think they have ANY statutory or administrative authority to do that. I think someone who opts out should request the IRS to refund this deposit as soon as possible. If nothing else, that would push the IRS to complete opt out faster. Otherwise, if it came to that, one could contact the TAS for just this issue or file suit in the Court of Federal Claims.

  16. Researcher, I sent it in one single check (in lieu penalty plus tax due, penalty and interests).  I think I should ask them to clarify where to put this money.  The OVDI FAQ in early 2011 was not very clear what should be included in the package, and I am not a professional tax evader and could not have known what to do and   


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