Tax
Fraud
 
Part 4. Examining
Process
Chapter 23. Employment
Tax Handbook
Section 9. Employment
Tax Penalty and Fraud Procedures
4.23.9 Employment Tax Penalty and Fraud Procedures
4.23.9.1 (03-01-2003)
Overview
1.
This section explains the
employment tax penalty procedures.
2.
It is important that
taxpayers be treated equitably and that decisions
regarding liability for penalties be based on sound
analyses of the reasons advanced by the taxpayer for
failing to act.
3.
In 1989, the Omnibus Budget
Reconciliation Act (OBRA) consolidated and
restructured many penalty code sections to address
legislative inconsistencies.
4.
Penalty Policy Statement
P–1–18—ln accordance with this Policy
Statement, the
IRS
administers a penalty system that is designed to:
·
Ensure consistency.
·
Ensure accuracy of results
in light of the facts and the law.
·
Provide methods for the
taxpayer to have his or her interests heard and
considered.
·
Require impartiality and a
commitment to achieving the correct decision.
·
Allow for prompt reversal of
initial determinations when sufficient information
has been presented to indicate that the penalty is
not appropriate.
·
Ensure that penalties are
used for their proper purpose and not as bargaining
points in developing or processing cases.
5.
To ensure consistency, the
Service prescribes and uses a single set of
guidelines set out within the Penalty Handbook,
IRM
20.1, which will be followed by all operational and
processing functions
6.
Specific guidance on fraud
indicators and the development of fraud may be found
in
IRM
25.1.1 and 25.1.2.
4.23.9.2 (03-01-2003)
Introduction
1.
This section discusses the
penalties most frequently asserted in employment tax
examinations. The penalties covered in this section
should not be considered as all inclusive, and
research should be done on a case by case basis to
ensure correct penalty assessment. Examiners should
refer to the Penalty Handbook,
IRM
20.1, for complete information on penalties.
Specific guidance on fraud indicators and the
development of fraud may be found in
IRM
25.1.1 and 25.1.2. Exhibit 4.23.9.1 contains
instructions for determining civil penalty statute
of limitations.
2.
Penalties are asserted in
the same manner as the taxes to which they are
applied. Although income taxes are subject to the
deficiency procedure in IRC Subchapter B of Chapter
63, many penalties applying to income taxes have
been specifically exempted from the deficiency
procedure. For an example, see IRC section 6696(b).
3.
A Civil Penalties Master
file has been developed to accommodate most
penalties previously assessed on the Non-Master File
(NMF) and the W–4 penalty previously assessed as
MFT 30. These penalties are listed on Form 8278,
Computation and Assessment of Miscellaneous
Penalties which is used to forward the
assessment/abatement action for input.
4.
When using the Civil
Penalties Master File, the first assessment made on
an entity will establish the module since there is
no return filing to create the module prior to the
first assessment. These MFTs will be single entity
modules. No joint assessments can be made. Any joint
penalty liabilities, such as a jointly filed
frivolous return, must continue to be made on NMF
utilizing existing instructions.
4.23.9.3 (03-01-2003)
Reasonable Cause
1.
If it is determined that the
failure to act was due to reasonable cause, a
written statement setting forth the reason should be
obtained from the taxpayer. Form 4571, Explanation
for Filing Return Late or Paying Tax Late, is
available for this purpose with respect to failure
to file or pay.
4.23.9.4 (03-01-2003)
Managerial Approval
1.
IRC section 6751(b) requires
that penalty assessments be approved in writing by
the examiner's immediate supervisor. The examiner is
not required to provide a copy of the written
approval to the taxpayer.
2.
Penalties under IRC section
6651, failure to file tax return or to pay tax and
penalties automatically calculated through
electronic means are excepted from the approval
requirement. This means that the penalty must be
free of any independent determination by a Service
employee as to whether or not the penalty should be
imposed against a taxpayer. Despite the fact that
section 6651 penalties are exempted by statute from
the managerial approval requirement, examiners
should seek management approval of the fraudulent
failure to file penalty in section 6651(f) because
that penalty is not automatically calculated through
electronic means.
4.23.9.4.1 (03-01-2003)
Computation of Penalty Included in Notice
1.
In accordance with RRA 98,
sections 3306 and 3308 (notice requirements relating
to computation of Penalty and Imposed Interest,
respectively), IRC section 6751(a) requires that
each penalty notice include the name of the penalty,
the code section imposing the penalty, and a
computation of the penalty. The requirement became
effective
July 1, 2001
.
A.
The computation must
include:
I.
the formula for computing
the penalty,
II.
the amount of each of the
variables in that formula,
III.
the change in each of these
variables since the date of the of the last notice,
and
IV.
the bottom line amount of
the penalty imposed.
B.
The penalties shown on the
separate explanation sheet must agree with the
penalty amounts shown on any employment tax reports,
2504(WC), 466(x), etc., issued to the taxpayer.
C.
A notice of penalty for
purposes of IRC section 6751(a) is any notice on
which the Service asserts a penalty. Thus, a revenue
agents report, a thirty-day letter, a statutory
notice of deficiency, a notice and demand, or a
billing notice mailed subsequent to the notice and
demand are all notices of penalty.
D.
Notices issued after
June 30, 2001
and before
July 1, 2003
may satisfy the computational requirement if the
notice contains a telephone number at which the
taxpayer can request a copy of the taxpayer's
assessment and payment history with respect to such
penalty. After
June 30, 2003
, the computation of the penalty, described above,
must be included with the notice.
4.23.9.5 (03-01-2003)
Appeal Procedures
1.
The appeals procedures
provided with respect to employment taxes are
applicable to unagreed delinquency and other ad
valorem penalties proposed by an examiner, whether
such penalties are in connection with unagreed
adjustments to tax , or whether such penalties are
the only items in issue. The appropriate standard
preliminary 30-day letters, identified in
IRM
4.23.10.8 will also be used in all unagreed penalty
cases.
4.23.9.6 (03-01-2003)
Fraud Penalty
1.
In imposing fraud penalties,
it is necessary to differentiate between tax
avoidance and tax evasion. To successfully maintain
a charge of fraud in a tax case, it is necessary to
establish that a part of the deficiency is due to a
false material representation of facts by the
taxpayer and that the taxpayer had knowledge of its
falsity and intended that it be acted upon or
accepted as the truth.
2.
As stated in Policy
Statement P–9–5, the civil fraud penalty will be
recommended only where there is clear and convincing
evidence to prove that some part of the underpayment
of tax was due to fraud. Such evidence must show
intent to evade payment of tax, which the taxpayer
believed to be owing as distinguished from a
mistake, inadvertence, reliance on incorrect
technical advice, honest difference of opinion,
negligence, or carelessness.
3.
Among the factors to be
considered in recommending imposition of the civil
fraud penalty are whether:
A.
the circumstances are of a
flagrant nature; and
B.
the tax is diminutive.
4.
Recommendations for imposing
the civil fraud penalty must receive careful
scrutiny to make certain that such penalties are
asserted only in appropriate cases. The Service
bears the burden of proving civil fraud by clear and
convincing evidence in the Tax Court. See IRC
section 7454.
4.23.9.6.1 (03-01-2003)
First Indications of Fraud
1.
A first indication of fraud
can be described as a mere suspicion of fraud.
Examiners are legally permitted and should
endeavor to ask the taxpayer, the preparer, the
representative, or any other involved party for an
explanation of the "discrepancies" which
are the basis of the examiner's suspicion of fraud
and any other question(s) which will resolve the
uncertainty of the taxpayer’s intent.
2.
The examiner's judgement
will determine when certain techniques will be used,
how far each should be followed, and how far the
examination should be extended. At the first
indication of possible fraud, the examiner should
review the Fraud Handbook,
IRM
25.1. Guidelines concerning Employment Tax Fraud are
discussed in
IRM
25.1.2.6.
3.
To be effective, examination
techniques should be designed to disclose not only
errors in accounting and application of law, but
also irregularities such as backdated or forged
documents that indicate the possibility of fraud. It
is not suggested that an examiner deliberately set
out to make a fraud case out of every assigned
return or case file. However, indications of
possible fraud should be recognized where they
exist.
4.
When first indications of
fraud are uncovered, the examiner will discuss the
case with his/her manager. If the manager concurs
that there is a possibility of fraud, a conference
(either in person or over the phone) should be held
between the examiner, the manager and the Fraud
Referral Specialist (
FRS
). When all three agree that there is a potential
for fraud, then the case should be updated to Status
Code 17. Status Code 17 identifies the case as
having potential fraud issues and exempts it from
cycle time consideration on monthly
"aging" reports.
5.
At this time a plan of
action should be developed to establish and document
the affirmative acts or firm indications of fraud.
Refer to
IRM
25.1.2.1 for information on the minimum plan for
case development. The examiner should continue the
audit, being alert for other badges of fraud and
follow up on initial suspicions of fraud. See
IRM
20.1.5.12.1 for a list of common badges of fraud.
6.
The
FRS
serves as a resource person and liaison to
compliance employees to assist in fraud
investigations and offer advice on matters
concerning tax fraud in all the business
organizations. The
FRS
will be consulted in all cases involving potential
criminal fraud, as well as, those cases that have
potential for a civil penalty.
4.23.9.6.2 (03-01-2003)
Firm Indications of Fraud
1.
A firm indication of fraud
must be distinguished from a first indication of
fraud. A firm indication of fraud is a factual
determination that can only be made on a case by
case basis. An examiner who is in doubt should
consult with the manager and the
FRS
to determine if the indicators of fraud are
sufficiently developed. However, under no
circumstances shall examiners or managers obtain
advice and/or direction from Criminal Investigation
for a specific case that is under examination. In
addition, if a referral is being considered, an
examiner should not solicit an agreement or solicit
and receive delinquent returns prior to the
submission of a fraud referral.
2.
If an examiner discovers
firm indications of fraud, the examination should
immediately be suspended without disclosing to the
taxpayer the reason for such suspension. Examiners
are cautioned not to carry the investigation beyond
the point where a valid indication of fraud is
adequately supported by the workpapers.
3.
If the case does not meet
the guidelines for a criminal referral, then this
should be documented in the case file and the
examiner should then proceed with the civil
examination.
4.
If the case does warrant a
criminal referral, the examiner will prepare a
referral on Form 2797, Referral Report of Potential
Criminal Fraud Cases. See
IRM
4.23.6.5 for further instructions. The referral will
be forwarded through the manager, to the
FRS
, to CI's
Lead
Development
Center
and then to a Special Agent in Charge in CI.
4.23.9.6.3 (03-01-2003)
Cases Involving Possible Criminal Proceedings
1.
Information about the source
or details of evidence relating to a potential
criminal case must be safeguarded and withheld to
the extent necessary to avoid prejudice to a case.
This general rule is applicable not only during the
investigation of a case, but also in any action
taken with respect to the civil portions of a case
having open criminal aspects. When appropriate,
examiners are expected to coordinate proposed
disclosures of information through established
channels.
2.
Full cooperation among all
levels of operations in the Internal Revenue Service
must be maintained to ensure that there is no
duplication in investigations and unnecessary
inconvenience to the public is avoided. The examiner
should review IDRS to determine if any Z freeze (TC
914) conditions exist and if other functions are
assigned to the taxpayer case. Criminal
Investigation (CI) or the
FRS
should be contacted prior to beginning case action
whenever an un-reversed TC 914 is present in any
module.
3.
In employment tax cases
warranting assertion of the Trust Fund Recovery
Penalty (TFRP), there will be instances when any
appreciable delay in asserting and collecting the
tax or penalty would jeopardize the revenue. In all
such cases, the area director is authorized to
decide whether collection of the tax or penalty
might be jeopardized. If the revenue might be
jeopardized, the tax or penalty may be assessed and
collected by a quick assessment or a jeopardy
assessment, as the circumstances warrant. IRC
section 6672 does not bar assertion of the TFRP
against responsible officers whenever fraud is
asserted against the corporation on the underlying
employment tax liability.
4.
If an examiner learns that
an assigned case involves a taxpayer who is the
subject of a criminal investigation, all activity on
the case will be immediately suspended. The
examiner’s manager will consult with the
Supervisory Special Agent in Criminal Investigation
relative to the continuance of employment tax
activity on the case. If agreement to either
continue the suspension or to resume the employment
tax activity on the case cannot be reached at the
group or territory level, the issue will be decided
at the area level. Where more than one area is
involved, the Director of Field Operations having
jurisdiction over the criminal investigation will
resolve the question.
5.
In income, estate, and gift
tax cases in which criminal prosecution has been
recommended (except potential jeopardy cases), the
Service does not authorize assessment of additional
taxes and penalties during the time the
recommendation for criminal prosecution is under
consideration or during the period such cases may be
awaiting trial or pending an appeal. The same
procedure will be followed with respect to
employment tax cases in which criminal prosecution
has been recommended.
6.
Threat of criminal
prosecution shall not be made in any case. If a
question concerning civil action arises in a case
with open criminal aspects, it will be resolved on
the basis of whether the criminal case will be
prejudiced by the proposed civil action. Policy
Statement P–4–84 provides that the consequences
of civil enforcement actions on criminal
investigations for the same taxable periods and same
types of taxes must be carefully weighed. Any
discussion or negotiation regarding settlement of
civil enforcement actions must be guided by this
policy, and input from the
FRS
.
4.23.9.6.4 (03-01-2003)
Common Fraudulent Devices
1.
Fraud may exist where a
taxpayer willfully attempts to illegally underreport
taxes, or does not pay taxes. For a taxpayer to be
guilty of a crime in which willfulness is an
element, that individual must have acted
deliberately, knowingly, and with the specific
intent to violate the law.
2.
The majority of criminal
fraud situations employment tax examiners will
encounter result from:
A.
Willful failure to account
for, collect, or pay over taxes (IRC section 7202).
B.
Willful failure to file a
return (IRC section 7203).
C.
Willful failure to pay taxes
owed (IRC section 7203).
D.
Willful submission of a
false statement under perjury (IRC section 7206(i)).
E.
Failure to collect and
deposit in a special trust fund account (IRC
sections 7215 and 7512(b)).
F.
Attempts to obstruct or
impede tax administration (IRC section 7212(a)).
3.
The Penalty Handbook notes
several elements that may be indicative of fraud.
Examiners should remain continually alert for these
and other "badges of fraud."
4.23.9.6.5 (03-01-2003)
Referrals to Criminal Investigation Division
1.
Cases are referred to
Criminal Investigation Division by using Form 2797
(Referral Report of Potential Criminal Fraud Cases).
Form 2797 is not required for Civil Fraud Referrals.
Contact the Fraud Referral Specialist (
FRS
) for assistance. (See
IRM
25.1.1, Fraud Handbook—Criminal Referrals, for
additional instructions).
2.
The referral should be a
detailed, factual presentation of those factors that
were used to establish firm indications of fraud.
The report should include, but not be limited to:
affirmative act(s) of fraud, the taxpayer’s
explanation of the affirmative act(s) when it will
assist in determining intent, and the estimated
criminal tax liability, financial statements, public
records checks, account transcripts, and a copy of
the last filed return. No workpapers or attachments
are required with the referral.
3.
There may be instances where
at the time the examiner discovers indications of
fraud, the information available is insufficient to
complete Form 2797 in all respects. Even so, the
examiner will not delay preparing the report but
will complete it to the extent possible.
4.
A separate Form 2797 should
be prepared for each individual, entity and type of
tax involved in the suspected fraud. After
concurrence and signature by the manager, the
referral will be immediately transmitted to the
FRS
. Supporting documents and a copy of each referral
will be retained in the examiner's case file and
will not be transmitted with the Form 2797 referral.
See
IRM
25.1 for further instructions.
5.
When the taxpayer is the
only party involved in the fraud, the form is
prepared in triplicate and must be approved by the
manager. One copy is retained with the case file.
The original and one copy are forwarded to the
FRS
for review and concurrence. The
FRS
will review the Form 2797 and immediately forward it
to their manager for approval.
6.
After the Form 2797 is
approved by the
FRS
's manager, one copy is forwarded to a Lead
Development Center for research. Another copy is
transmitted to a Special Agent for evaluation. The
Special Agent will contact the examiner to set up an
initial meeting. The
FRS
may also be contacted if feasible.
7.
If a case involving a
collateral examination results in a fraud referral,
the affected territories will coordinate the
referrals.
8.
If the referral is accepted
by Criminal Investigation (CI), they will finish
completing the original Form 2797 and return it to
the
FRS
who will retain a copy and forward the original to
the referring examiner. In most cases, the referring
examiner will become the cooperating agent on the
case. See
IRM
25.1.4.3.1 for the duties of a cooperating agent.
Once accepted, the examiner will update the case to
Status Code 18 and Project Code 095.
9.
If CI does not accept the
referral, Form 2797 and a memorandum of declination
will be returned to the examiner. This memorandum
should remain in the case file.
10.
After notification that the
referral was not accepted, the examination may be
resumed. The examiner will continue to be alert for
new indications of fraud in declined referral cases.
If they develop, the case will again be referred to
the
FRS
in accordance with referral procedures.
4.23.9.6.6 (03-01-2003)
Civil Fraud Penalty Rates
1.
IRC section 6663(a) provides
that if any part of the underpayment of tax required
to be shown on the return is due to fraud, a penalty
equal to 75% of the portion of the underpayment
which is attributable to fraud will be added.
2.
IRC section 6663(b) further
provides that if the
IRS
established that any portion of the underpayment is
attributable to fraud, the entire underpayment shall
be treated as attributable to fraud. However, if the
taxpayer establishes by a preponderance of evidence
that any portion of the underpayment is not
attributable to fraud, such portion will be excepted
from the fraud penalty.
3.
IRC section 6664(b) provides
that the penalty applies only when a return has been
filed. See
IRM
4.23.9.9(3) of this section for the fraudulent
failure to file penalty.
4.
IRM
20.1.5.12, IRC Section 6663:Civil Fraud Penalty, of the Penalty Handbook
provides current rates and specific procedures for
assertion of the civil fraud penalty.
IRM
20.1.5.2 further describes coordination between the
fraud penalties and other penalties.
4.23.9.6.7 (03-01-2003)
Civil Fraud Procedures
1.
A Civil fraud penalty case
may be developed on the facts and circumstances of a
civil examination or result from the completion of a
criminal prosecution.
2.
Civil fraud no longer
requires a referral to Criminal Investigation (CI).
Determination of this penalty is a shared
responsibility of both the examiner and manager. The
Fraud Referral Specialist (
FRS
) is also available for assistance.
3.
When a case is being closed
in which the civil fraud penalty is being assessed,
the examiner should prepare the Form 6809, Civil
Fraud Penalty Monitoring Form. The orginal Form 6809
should be placed in the case file and a copy of this
form should be sent to the
FRS
.
4.
Upon concurrence of the
manager and
FRS
, cases being developed for potential fraud should
be updated to Status Code 17.
5.
For civil settlement of a
prosecution case, the examiner should contact CI to
ascertain which criminal statutes the taxpayer was
convicted of before attempting to resolve the
related civil fraud penalty. The examiner should
obtain a copy of the plea agreement or judgement
notating the applicable criminal statutes and years.
6.
In cases where fraud was
considered and the civil fraud penalty is not being
recommended, the examiner will explain in the
workpapers why the penalty was not asserted.
7.
On successful criminal
prosecution cases returned for civil tax settlement,
Area Counsel must provide written approval for
non-assertion of the civil fraud penalty.
8.
In statutory notice cases,
Area Counsel must approve civil fraud penalties
prior to issuance.
9.
Examiners and managers
should be aware of collateral estoppel and the
important distinction it can have in civil tax fraud
penalty cases. Refer to the
IRM
25.1.6, Civil Fraud for a more complete explanation.
10.
When closing a fraud case,
enter "C" or "F" on the
appropriate line of Form 5344 | 
