The IRS Civil Fraud Penalty: Penalties for Tax Evasion
The IRS is authorized to impose a penalty for fraud. This is one of the many civil tax penalties that the IRS has in its toolbox.
This civil fraud penalty applies if there is an underpayment of tax required to be shown on a tax return that is attributable to fraud, such as reporting a fictitious business on your tax returns.
This penalty is not all that common. Absent a criminal conviction, the IRS has exercised considerable restraint in imposing this civil penalty.
If the IRS has assessed a civil fraud penalty against you or if you are wondering whether your conduct could trigger this penalty, this page is for you. We’ll try to answer these questions.
As explained below, tax fraud is synonymous with tax evasion. We’ll use the terms fraud and tax evasion interchangeably in this article.
About the Civil Tax Fraud Penalty
The fraud penalty is an amount equal to 75 percent of the underpayment which is attributable to fraud. This is the maximum civil penalty for tax evasion.
This percentage is applied only to the portion of the underpayment attributable to fraud. It does not necessarily apply to the whole understatement. For example, consider the situation where you include on your tax return a large tax deduction that you knew you were not entitled to. You also included a deduction that you thought you were entitled to. If the IRS disallows both tax deductions, the fraud penalty should only apply to the first tax deduction.
The IRS fraud penalty only applies if you file a tax return. No tax return, no fraud penalty.
The IRS fraud penalty also only applies if there is an understatement of tax. No understatement, no fraud penalty.
The IRS fraud penalty also cannot apply to the portion of an understatement that an accuracy-related penalty is imposed for. You cannot be held liable for both penalties.
What is Tax Fraud?
The civil fraud penalty is found in I.R.C. § 6663. Section 6663 does not provide a definition of the term “fraud.”
The courts usually describe tax fraud as the intentional commission of an act or acts for the specific purpose of evading tax believed to be due and owing. They say that fraud requires that you intended to evade taxes known to be due and owing by “conduct intended to conceal, mislead or otherwise prevent the collection of taxes and that is an underpayment.”
There has to be an intent to evade tax. An honest mistake is not fraud.
The courts consider so-called “badges of fraud” to determine whether there was an intent to evade tax. These badges are just factors that are considered. They include factors such as unreported income, the failure to keep adequate books and records or concealing books and records, failure to cooperate with the IRS investigation, misleading statements, dealing in cash, etc. This is akin to the “affirmative acts” required for criminal tax fraud.
The more of these badges of fraud, the more likely a civil fraud penalty will be upheld.
The Government Has the Burden
The IRS has the burden to prove that there is an understatement attributable to fraud. It has to make this showing by clear and convincing evidence. This is a high burden. However, the IRS can meet this burden with circumstantial evidence.
If the IRS meets this burden, then the entire understatement is presumed to be attributable to fraud. It is up to you then to prove what portion of the understatement is not attributable to fraud. Luckily, you only have to meet the preponderance of the evidence standard. This is much less than the IRS’s clear and convincing standard.
Is a Spouse Equally Liable for Fraud?
Section 6663 makes it clear that a spouse is not liable for the civil fraud penalty unless some portion of the understatement is due to their fraud.
Thus, a spouse that files a joint tax return may be jointly liable for the understatement, but one of the spouses may be able to escape liability for the civil fraud penalty.
When Does the IRS Impose the Civil Fraud Penalty?
The IRS often imposes this penalty after a criminal prosecution for tax evasion. The conviction for criminal tax evasion in a case involving a tax return that was filed can prove fraud for purposes of the civil fraud penalty. If the criminal case results in a plea agreement, the agreement may be sufficient to prove fraud for purposes of the civil fraud penalty.
Absent a criminal prosecution, it has been our experience that the IRS only imposes this penalty in situations where it can make an example out of the taxpayer. This includes taxpayers who are tax return preparers, attorneys, accountants, politicians, and celebrities.
We address several court cases that explain how this process works. You can read about our civil fraud penalty articles here.
Civil Tax Fraud Penalty Attorney
We are tax attorneys in Houston, Texas and we help with cases involving penalties, including the civil fraud penalty.
If the IRS has assessed a civil fraud penalty or you have questions about the fraud penalty, we want to hear from you. Call us at (713) 909-4906.