A taxpayer will not be assessed a tax penalty if they had reasonable cause for the understatement on a tax return and acted in good faith. (IRC Section 6664(c)(1). Likewise, the civil fraud penalty requires clear and convincing evidence that the taxpayer intended to evade tax. If the IRS can produce clear and convincing evidence to meet its burden, it is unlikely that the taxpayer can show reasonable cause and good faith. So, how else can a taxpayer negate the element of fraudulent intent to avoid the IRS’ civil fraud penalty?
Taxpayer’s Personal Attributes
The taxpayer’s personal attributes, such as education, familiarity with bookkeeping, and business experience, are all considered in the determination of intent. As the Tax Court has held in a line of cases, the trier of fact must take into account the training and experience of the party charged in determining the presence or absence of fraud. Hence, a taxpayer’s lack of education or skills may negate fraudulent intent.
Personal attributes are usually accompanied by other evidence, like cooperation during the examination, reliance on a tax return preparer, or similar evidence inconsistent with intentional concealment or deliberate misrepresentation.
Mental Disease or Emotional Disorders
Evidence of the taxpayer’s mental disease or emotional disorders that do not amount to insanity may also negate fraudulent intent. In one case, the conflict between the psychiatric testimony and the taxpayer’s astuteness prevented the finding of fraud (Hollman v. Commissioner, 38 TC 251 (1962). However, in another case, the Trial Court held that the taxpayer’s heavy drinking and potential alcoholism does not necessarily result in incompetency; although, it may preclude the finding of fraudulent intent (Chaffin v. Commissioner, TC Memo. 1983-394 (1983).
No Expertise in Tax Law
A taxpayer who is not an expert in tax law might not be held liable for fraudulent intent, especially when complicated facts and issues exist in the return. Even a taxpayer who is highly educated, but with no expertise or knowledge of United States tax law, may lack the intent to commit fraud when filing their tax return.
Shifting the Responsibility
The filing of a correct return is a non-delegable duty. A taxpayer is liable for any breach of the duty to file a correct tax return, even if the incorrect information was another person’s doing. A taxpayer cannot escape his responsibility for a correct return by committing its preparation to an accountant, tax lawyer, or others.
However, if a taxpayer supplies his accountant with books and records that are, in the taxpayer’s belief, accurate and correct, such an act lacks the intent to commit fraud. To succeed in shifting the responsibility of underpayment in tax resulting from sloppy bookkeeping or preparation of returns, the taxpayer will have to prove the steps taken to ensure the correctness of the supplied records.