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.