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Fraud penalty assessed against former IRS agent

A knowledge of the tax code developed over a career working for the IRS. Why was it used in assessing a fraud penalty in a recent tax court case?

The taxpayer who tried to challenge his assessment and fraud penalty had been an IRS revenue agent for 29 years. He had been trained to determine allowable business expenses and was a certified forensic examiner. But on his personal tax returns he had a pattern of inflating business expenses with personal expenditures for holiday decorations, parties, flowers and gifts.

The 75 percent fraud penalty

Ultimately, the taxpayer did not contest the deficiencies assessed from 2011 to 2013 ($113,194, $67,186 and $84,087). The case landed in tax court over the fraud penalty.

The IRS must show two things before assessing the fraud penalty:

  • An underpayment of tax
  • Due at least in part to some fraud

In this case, the only issue was whether the underpayment was fraudulent. Facts that helped the IRS included three prior cases against the same taxpayer related to the exact same issues. A case as far back as 1990 found that the taxpayer’s behavior suggested a “pattern or carelessness” in determining deductions that “had no basis in the law.”

Other case law relied on by the court stated, “a pattern of conduct that evidences an intent to mislead” is one of several “badges of fraud.” The tax court needed less than two pages to hold that the IRS had established enough evidence to support the fraud penalty.

Creativity can cause serious issues when applied to business deduction determinations. This is one category that the IRS watches closely.

Out-of-line deductions can easily be a red flag that triggers an audit. While there might be valid situations when flowers and holiday decorations qualify as business expenses, it is best to discuss your individual situation with an attorney before filing rather than having to justify them during an audit.

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