Ninth Circuit Tax Court Appeal of Fraud Penalty Denied in Chico

Ninth Circuit Tax Court Appeal of Fraud Penalty Denied in Chico

Ninth Circuit Tax Court Appeal of Fraud Penalty Denied in Chico

When it comes to Civil Tax Fraud penalties, it is important for Taxpayers to understand the concept of badges of fraud. In Chico, the Ninth Circuit Court of Appeals affirmed the Tax Court ruling which found a civil penalty against Taxpayer for Fraud was valid. The fraud stemmed from alleged civil violations involving significant underpayment of tax — and Taxpayers’ failure to provide substantial evidence rebuking the badges of fraud. In order to understand how the Tax Court came to its finding – and why the Appellate Court affirmed the Tax Court’s ruling, let’s explore the Chico v Commission of Internal Revenue:

What are Badges of Fraud?

Badges of Fraud are factors used to determine whether or not a person’s actions (or lack thereof) are sufficient for the IRS to pursue a claim for Fraud. As provided by the IRS:

      • Signs of fraud are referred to as indicators or badges of fraud. Fraud indicators are an action, omission, or both. An action is defined as an activity deliberately undertaken in order to accomplish some objective. An omission is a failure to take action in a particular matter.

      • Taxpayers who knowingly take actions that result in the understatement of a tax liability often leave evidence in the form of identifying earmarks (or indicators). These indicators serve as a sign or symptom, or signify that actions may have been done for the purpose of deceit, concealment or to make things seem other than what they are.

      • Indicators may only suggest that actions may have occurred for the purpose of evading tax, however, indicators alone do not establish fraud.

Common Badges of Fraud

Badges or “Indicators” of Fraud can be broken down into further categories, but here are some of the common “Conduct of Taxpayer” Badgers of Fraud

      • False statement about a material fact pertaining to the examination.

      • Attempt to hinder or obstruct the examination. For example, failure to answer questions; repeated cancelled or rescheduled appointments; refusal to provide records; threatening potential witnesses, including the examiner; or assaulting the examiner.

      • Failure to follow the advice of accountant, attorney or return preparer.

      • Failure to make full disclosure of relevant facts to the accountant, attorney or return preparer.

      • The taxpayer’s knowledge of taxes and business practices where numerous questionable items appear on the tax returns.

      • Testimony of employees concerning irregular business practices by the taxpayer.

      • Destruction of books and records, especially if just after examination was started.

      • Transfer of assets for purposes of concealment, or diversion of funds and/or assets by officials or trustees.

      • Pattern of consistent failure over several years to report income fully.

      • Proof that the tax return was incorrect to such an extent and in respect to items of such magnitude and character as to compel the conclusion that the falsity was known and deliberate.

      • Payment of improper expenses by or for officials or trustees.

      • Willful and intentional failure to execute pension plan amendments.

      • Backdated applications and related documents.

      • False statements on Tax Exempt/Government Entity (TE/GE) determination letter applications.

      • Use of false social security numbers.

      • Submission of false Form W-4.

      • Submission of a false affidavit.

What Happened in Chico?

The Court of Appeals sums of the case and Fraud as follows:

      • The record supports the Tax Court’s findings that the Chicos:

        • (1) understated their income by more than $275,000 over three years;

        • (2) produced no “adequate records” to substantiate the figures reported on their tax returns;

        • (3) failed to file tax returns for Lakewood Patient Resource Center even after being asked to do so by the Revenue Agent with the IRS in 2016;

        • (4) implausibly attributed their underreported income to nontaxable investments from an inheritance when the Revenue Agent accurately 2 characterized the majority of these transfers as nontaxable;

        • (5) concealed income from Lakewood by failing to report constructive dividends received in 2011 and reporting only some of the income they received in 2010; and

        • (6) failed to cooperate with the Revenue Agent’s investigation by ignoring his early requests for interviews and blaming their attorney for failing to produce adequate records. See Bradford, 796 F.2d at 307–08 (listing badges of fraud).

      • The Tax Court also considered these badges of fraud in the context of Mr. Chico’s specialized knowledge and experience on “corporate and business taxation” as a tax preparer himself to find even stronger circumstantial evidence of fraud. There is no clear error in the Tax Court’s finding that the total weight of these badges provided clear and convincing evidence of the Chicos’ “‘specific intent to avoid a tax known to be owing.’” Maciel v. Comm’r, 489 F.3d 1018, 1026 (9th Cir. 2007) (quoting Estate of Trompeter v. Comm’r, 279 F.3d 767, 773 (9th Cir. 2002)). Therefore, we affirm the judgment of the Tax Court.

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