When does a failure to file a tax return become fraudulent?

It is not uncommon for taxpayers to get a little behind on the filing of their tax returns. But consistent late filing under some circumstances can lead to fraudulent failure to file civil penalties.

If failure to file a return is fraudulent, a civil penalty known as the “fraudulent failure to file penalty” may apply under IRC 6651(f). This penalty amount is 75% of the tax due on the return.

Two prong test

The burden of proof is on the IRS to establish fraud by clear and convincing evidence.

Specifically, the IRS must show that:

1. the taxpayer underpaid his income tax for each year in issue and

2. at least some portion of each such underpayment was due to fraud.

Indicators of fraudulent failure to file

The second prong of the fraud test requires the IRS to prove that, for each year, the taxpayer’s failure to file an income tax return was due to fraud.

Fraud for that purpose is defined as “intentional wrongdoing designed to evade tax believed to be owing.”

In other words, the IRS must prove that “the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes by not filing his return when due.”

A fraudulent state of mind may be proved by circumstantial evidence because direct proof of the taxpayer’s intent is rarely available.

Indicators of fraud have been developed over the years by the courts. Those badges of fraud include: (1) understatement of income, (2) maintenance of inadequate records, (3) failure to file tax returns, (4) implausible or inconsistent explanations of behavior, (5) concealment of income or assets, (6) failure to cooperate  with tax authorities, (7) engaging in illegal activities, (8) an intent to mislead which may be inferred from a pattern of conduct, (9) lack of credibility of the taxpayer’s testimony, (10) filing false documents, and (11) dealing in cash.

Although no single factor is necessarily sufficient to establish fraud, a combination of factors is more likely to constitute persuasive evidence. Acts committed subsequent to the due date of a return may be relevant evidence of a taxpayer’s intent in failing to file that return.

What to do if you haven’t filed your tax returns

It’s rare for the IRS to assess fraudulent failure to file penalties and even more rare to refer the case to the DOJ for criminal charges.

If you haven’t been contacted by the IRS about your missing returns, you should file your returns as soon as possible, preferably after discussing with a professional if there are any indicators of fraud present.

If you have been contacted for a non-filer audit or investigation, you should take the notice very seriously and seek professional counsel.

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