Post-Return Conduct Can Be Insufficient for Finding of Civil Fraud Penalty

On December 3, 2014, the United States Tax Court issued an opinion in Brown v. Commissioner, T.C. Memo. 2013-275, in which the Court found that the taxpayers were not liable for the fraud penalty under Internal Revenue Code (I.R.C.) section 6663(a) despite the fact that the taxpayer-husband submitted questionable documents to the IRS during the income tax examination. There has been some interesting commentary in the past weeks about this case (here and also here) concerning the submission of false documents to the IRS during the course of a civil examination or a criminal investigation.

Courts have repeatedly held that a final criminal judgment for tax evasion under I.R.C. section 7201 collaterally estops relitigation of the issue of fraudulent intent in a subsequent proceeding over the civil fraud penalty under I.R.C. section 6663(a). DiLeo v. Commissioner, 96 T.C. 858, 885 (1991), affd. 959 F.2d 16 (2d Cir. 1992). For example, see our previous post on the Senyszyn case, where the taxpayer was estopped from relitigating fraudulent intent, but not the amount of the deficiency. The Brown case, however, shows that the particulars of the fraudulent intent required for civil and criminal purposes can potentially diverge when it comes to post-filing conduct.

While the Court in Brown found that the documents submitted during examination were not adequate to establish fraudulent intent at the time the taxpayers filed the return, providing false statements and misleading documents to the IRS during an audit can be a factor that weighs in favor of a finding of civil fraud. Ruark v. Commissioner, 449 F.2d 311, 313 (9th Cir. 1971). Post-filing conduct can be a "badge of fraud" for purposes of the civil fraud penalty to the extent that such conduct suggests a taxpayer's state of mind at the time the return is filed. E.g., Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), aff'g T.C. Memo. 1984-601. However, as the Court in Brown noted, for purposes of the civil fraud penalty, the "fraudulent intent must exist at the time the taxpayer files the return," rather than an intent that is formed at some later time.

However, the criminal tax evasion penalty under I.R.C. section 7201 is broader than the civil fraud penalty under I.R.C. section 6663(a) in that the evasion penalty encompasses both intent to evade assessment of tax and intent to evade collection. See IRS Tax Crimes Handbook at 4-18. In the context of criminal tax evasion, courts have found that any conduct having the likely effect of misleading IRS representatives is sufficient to constitute a willful attempt to evade tax. U.S. v. Goodyear, 649 F.2d 226, 228 (4th Cir. 1981) (false statements to IRS agents to conceal unreported income to evade tax assessment).

So while the submission of a false document might not be relevant in a case concerning the civil fraud penalty to the extent it does not establish fraudulent intent at the time the return is filed, it is possible that the submission of the same document could constitute an affirmative act intended to evade assessment for criminal fraud purposes.

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