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The method of operating a business (i.e., lack of internal controls, dealing in cash, etc.) may be indicative of improperly filed tax returns. The initial contact by the IRS examiner provides the opportunity to obtain valuable information, which may not be readily available later. If fraud is discovered, it is important for the IRS to determine who is responsible for the fraudulent act(s) – the taxpayer, the tax return preparer or both.
When these occur, there is a greater potential for material misstatement of taxable income than in cases involving individuals earning salaries and wages.
However, fraud may be present in any type of tax return.
In cases where a return has not been filed and fraud is suspected, the IRS representative is instructed not to demand a return from the taxpayer.
Thus, the civil fraud penalty may be asserted on one spouse only. To prove fraudulent intent, the IRS must demonstrate that the taxpayer intended to evade tax he believed to be due, by showing proof of conduct intended to conceal, mislead, or otherwise prevent the collection of such tax.[ii] Fraud can not be imputed or presumed – the government must prove by affirmative evidence that an understatement of tax set forth on the return is attributable to fraud.[iii] Intent is distinguished from inadvertence, reliance on incorrect technical advice, honest difference of opinion, negligence or carelessness.[iv] RELIANCE AS A DEFENSE.
The existence of fraud is a question of fact to be resolved from the entire record.[v] Because direct proof of a taxpayer’s intent is rarely available, fraud may be proven by circumstantial evidence, and reasonable inferences may be drawn from the relevant facts.[vi] Mere suspicion, however, does not prove fraud.[vii] Reliance on a tax professional is a proper defense to the imposition of penalties, as the Supreme Court has observed: When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice.