A business owner runs the books himself. He codes some personal expenses as business costs so the other owners will not see how much the company pays for his lifestyle. He is not thinking about the IRS at all. He just does not want his partners asking questions. Years later, the IRS shows up and calls it fraud.
Can the IRS use a taxpayer’s dishonesty toward business partners to prove fraud against the government? The deception was aimed at other people, not the tax return. Does that distinction save the taxpayer from the 75% civil fraud penalty?
The Tax Court took up this exact question in Prezioso v. Commissioner, T.C. Memo. 2026-63. The case is a useful place to think through what really triggers the fraud penalty, and why “I was hiding it from my partners, not the IRS” is not the defense taxpayers think it is.
The Facts & Procedural History
The taxpayer helped run a family aerospace manufacturing company. He bought into the business, took over daily operations, and eventually became its chief executive.
Over time the company started paying his personal expenses. These were large expenses. Over the years at issue the company wrote more than 400 checks covering his personal costs, including credit cards, home renovations, landscaping, a pool contractor, boat and RV loans, and leased vehicles.
None of the expenses showed up on a Form W-2 or a Form 1099. So none of it was reported as income, and the taxpayer paid no tax on it. The company deducted the expenses anyway. You can start to see the issue here. The company was covering hundreds of thousands of dollars in personal spending, and none of it hit anyone’s return.
The way the taxpayer handled the bookkeeping is what turned an ordinary income reporting problem into a fraud case. He kept two sets of records. One set went to the outside accountant who prepared the returns. Another set, with different payee names and different expense codes, went to the other shareholders. For his personal charges he would swap in the name of a real company vendor and code the cost as a material purchase or equipment repair. Then he would switch the names back.
The company later went into receivership and bankruptcy after the other owners sued. The IRS eventually issued a notice of deficiency for tax years 2009 through 2013 with deficiencies and civil fraud penalties. The taxpayer conceded the deficiencies. He fought only the fraud penalties in the U.S. Tax Court.
What Is the Civil Fraud Penalty?
The tax code imposes a penalty of 75% of the underpayment that is due to fraud. See Section 6663(a). This is not the ordinary accuracy-related penalty of 20%. It is far larger, and it carries a stigma that the other penalties do not.
Because the stakes are high, the burden is high too. The IRS has to prove fraud, and it has to prove it by clear and convincing evidence. That is a higher standard than the usual rule, where the taxpayer has to prove the IRS wrong. For the civil fraud penalty, the government carries the load. It has to show an underpayment for each year and that at least part of that underpayment was due to fraud. And it has to do it year by year.
Here the underpayments were not in dispute. The taxpayer had conceded them. So the whole case came down to intent.
How Does the IRS Prove Intent?
Fraud is intentional wrongdoing meant to evade tax the person knows is owed. That is a state of mind, and people rarely admit it. So the courts allow the IRS to prove intent with circumstantial evidence. They look at what are called “badges of fraud.”
The badges are a familiar list. Understating income. Keeping poor records. Giving implausible explanations. Concealing income or assets. Giving a tax preparer incomplete or misleading information. Keeping two sets of books. No single badge decides the case. But several badges together become strong evidence of fraud.
The taxpayer here checked a lot of boxes. He substantially understated income for years. His explanations did not hold up. And he kept two sets of books. That last one is where the case gets interesting.
Does It Matter Who the Lie Was Aimed At?
Here is the argument the taxpayer made. Yes, he kept two sets of books. But the second set was not built to fool the IRS. It was built to fool the other shareholders, so they would not see how much the company was spending on him. The accountant who prepared the returns got the “real” records. So, he argued, the double bookkeeping was not evidence of an intent to evade tax.
It is a clever argument. And it failed.
The court has held that a taxpayer’s practice of double bookkeeping points to fraud even when the fraudulent set was kept for non-tax reasons. The court relied on a prior case where a taxpayer kept a false second set of books to mislead investors and creditors rather than the IRS. Keeping the false books was still strong evidence of fraudulent intent. The reasoning is simple. A person willing to falsify records to deceive one group of people has shown he is willing to falsify records, period. Dishonesty in business is a fair signal of a willingness to be dishonest with the government.
The court also did not fully buy the claim that the accountant got clean records. Some of the fake payee names carried over into the accountant’s set. And every personal expense, no matter whose name was on it, was given a business expense code. Nothing in the records the accountant received flagged a personal credit card charge as personal. The court basically said that a taxpayer cannot hide the ball from his own return preparer and then blame the preparer for the false return that results.
The Willful Blindness Backstop
The taxpayer had a fallback. He said he did not know at the time that the company’s payment of his personal expenses was taxable income to him. He thought it was all being reported correctly on the corporate return.
The court did not find that credible. The court went back to the jurat on the tax return. Even if you take the taxpayer at his word, he signed the corporate returns. He admitted he did not really review them or ask about their accuracy, despite running a bookkeeping system he knew was irregular. A person can be found to know about his own tax evasion through willful blindness to the facts.
The court concluded that closing your eyes on purpose is not the same as an honest mistake. There are situations where a genuine misunderstanding defeats fraud, but a signature on a return you chose not to read is a hard place to stand. And the line between a civil fraud finding and a criminal case is thinner than most people assume.
The result was a finding of fraud for every year at issue. The 75% penalty stuck.
The Takeaway
Fraud is about intent, and intent is proven by conduct. The lesson from this case is that the conduct does not have to be aimed at the IRS to count against you. If you are willing to keep false records to mislead a business partner, a lender, or an investor, a court can treat that as proof you would mislead the government too. The safer path is boring but effective. Report what the company pays on your behalf, give your preparer the full and accurate picture, and read the returns you sign. If the IRS is already asserting a fraud penalty, the standard of proof is high and there is real room to push back, but that fight starts with the records you kept long before the audit.
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