25.1.6. Civil Fraud

(1) Mission. The mission of the Office of Fraud Enforcement (OFE) is to promote compliance by strengthening theIRS’ response to fraud and mitigating emerging threats. This includes:

• Improving fraud detection and development to address areas of high fraud/risk noncompliance.

• Cultivating internal and external partnerships to identify new treatment streams to enhance enforcement.

• Pursuing civil fraud penalties and recommending criminal cases that will lead to prosecutions, where appropriate.

(2) OFE builds strong internal and external partnerships and serves as the primary civil liaison to IRS-Criminal Investigation. By supporting cases throughout the life cycle and through full consideration of available treatments, OFE facilitates optimal disposition of cases with civil or criminal fraud potential.

(3) Purpose. This section discusses the procedures to follow in a civil fraud case.

(4) Audience. This handbook is a comprehensive guide for IRS employees servicewide in the recognition and development of potential fraud issues; referrals for criminal fraud; duties and responsibilities in joint investigations; civil fraud cases; and other related fraud issues.

(5) Policy Owner. Director, OFE, Small Business Self Employed (SB/SE) Division.

(6) Program Owner. OFE, Policy, SBSE.

(7) Primary Stakeholders. The primary stakeholders are IRS compliance employees and Criminal Investigation (CI).

(1) The Office of Fraud Enforcement Advisor Program is a servicewide program. The groups are comprised of revenue agents and revenue officers who are located strategically throughout the country to assist with the development of fraud. A list of the groups, FEA group managers and the FEAs can be found on the Fraud Development Knowledge Base website https://portal.ds.irsnet.gov/sites/vl019/lists/fraudawareness/fraudenforcementsadvisorscontactinformation.aspx

(2) The fraud enforcement advisor (FEA) plays a vital role in the development of a potential fraud case. The FEA will be consulted in all cases involving potential criminal fraud, as well as those cases that have potential for a civil fraud penalty. The FEA is available to assist in fraud investigations and offer advice on matters concerning tax fraud. Upon initial recognition of indicators of fraud, the employee will discuss the case at the earliest possible opportunity with his/her manager. If the compliance group manager concurs, the FEA will be contacted immediately through the Specialist Referral System, and both the compliance group manager and FEA will provide guidance to the compliance employee on how to proceed. Compliance managers will encourage the early involvement of the FEA in all potential fraud cases. Local area counsel is also available for consultation and advice when badges of fraud are first identified.

(3) Civil fraud penalties will be asserted when there is clear and convincing evidence to prove that some part of the underpayment of tax was due to fraud. Such evidence must show the taxpayer’s intent to evade the assessment of tax, which the taxpayer believed to be owing. Intent is distinguished from inadvertence, reliance on incorrect technical advice, sincerely-held difference of opinion, negligence or carelessness. In the case of a joint return, intent must be established separately for each spouse as required by IRC 6663(c). The fraud of one spouse cannot be used to impute fraud by the other spouse. Thus, the civil fraud penalty may be asserted only on one spouse, unless there is sufficient evidence that both spouses participated in the fraudulent act(s) resulting in the underpayment reported in their joint return.

(1) The examiner will discuss cases that have first indicators of fraud with his/her group manager. If the group manager agrees there are indicators of fraud then the examiner will contact the FEA using the Specialist Referral System (SRS).

(2) To request a consultation with the FEA, the compliance employee will submit a request through the SRS. The FEA assigned to the examiner’s case will contact the examiner within two business days to discuss the case. The SRS is located at the following website: https://srs.web.irs.gov/default.aspx

(3) Upon concurrence of the compliance group manager and FEA, fraud development cases will be updated on AIMS to status code 17 (Fraud Development), via Form 11661, Fraud Development Recommendation - Examination.

(4) The FEA is required to provide a plan of action on the Form 11661 and forward the form to the examiner and examiner’s group manager.Where the FEA and compliance group manager do not agree on whether a case should be developed for potential fraud, the compliance group manager may update the case to AIMS status code 17 without the FEA’s concurrence. However, the compliance group manager should contact the FEA group manager to discuss the situation prior to updating the status code. Regardless, to ensure consistent treatment of all fraud cases, preparation of Form 11661 is required to document the compliance group manager’s decision for fraud development. Ultimately, the final decision on an examination case rests with the compliance group manager. See Exhibit 25.1.6-1.

(5) Determination of the civil fraud penalty is the shared responsibility of the examiner, his/her group manager and the FEA. For LB&I cases, FEA concurrence is mandatory. See IRM 25.1.10.7(3) .

Each campus' assigned FEA will assist with the development, write-up and review of the civil fraud penalty issues. Each campus also has dedicated Counsel to assist with review and approval of the penalty issues for Statutory Notice of Deficiency (SNOD) purposes, if needed. See IRM 4.19.10.4.10.3, 90-Day Procedures, for additional guidance.

(6) The FEA works with the examiner to ensure the fraud penalty narrative does, in fact, substantiate the assertion of the civil fraud or fraudulent failure to file penalties, see IRM 25.1.7, Failure to File. The FEA will recommend enhancements to the fraud narrative, as needed, to clearly explain the indicators of fraud. The affirmative acts in each case should be described in such detail as to leave no doubt as to why assertion of the civil fraud penalty or fraudulent failure to file penalty is justified. If the FEA recommends that the examiner further develop the case, the FEA will document the reason(s) why and note the required additional steps in the Plan of Action.

(7) If the FEA concurs with the examiner's fraud narrative and no additional information is required, the FEA will indicate his/her concurrence with the assertion of the civil fraud penalty or fraudulent failure to file penalty on Form 11661. A copy of the Form 11661 will be forwarded to the compliance group manager and the original will be returned to the examiner for inclusion in the administrative case file.

(8) If the compliance group manager disagrees with the FEA recommendation that the civil fraud penalty should be asserted, this should be documented and discussed with the examiner and his/her group manager. The case will be returned to AIMS status code 12 and the Form 11661 will be documented by the FEA to reflect the compliance group manager’s decision. Ultimately, the final decision on such a case rests with the compliance group manager.

(9) If the compliance group manager disagrees with the FEA recommendation that the civil fraud penalty should not be asserted, this should also be documented and discussed with the examiner and his/her group manager. The case will remain in AIMS status code 17 and the Form 11661 will be documented by the FEA to reflect the compliance group manager’s decision. Ultimately, the final decision on such a case rests with the compliance group manager.

(10) For civil disposition of a post-prosecution case, the examiner should contact Cl to ascertain the criminal statutes under which the taxpayer was convicted before attempting to resolve the related civil fraud penalty. If a taxpayer is criminally convicted under IRC 7201, the conviction precludes the taxpayer from objecting to the civil fraud penalty for the year at issue under the doctrine of collateral estoppel. See IRM 25.1.6.5 for additional information. However, the amount of the liability and the "underpayment" upon which the civil fraud penalty is based must be fully developed. Further, collateral estoppel would only apply to the year or years for which a conviction under IRC 7201 was obtained. For years where the conviction was obtained under a statute other than IRC 7201, or for years for which the taxpayer was not criminally convicted, the examiner must develop the civil fraud penalty prior to recommending its assertion. The examiner should consult the local FEA and Area Counsel for assistance in developing the case. The examiner should obtain a copy of the plea agreement or judgment notating the applicable criminal statutes and years. See IRM 25.1.5, Grand Jury Investigations, for procedures in securing information for use in the civil settlement of cases investigated through grand jury procedures.

(11) In cases where fraud was considered and the civil fraud penalty is not recommended, the examiner must explain fully in the work papers consideration of the penalty and why it was not asserted.

(12) The civil fraud penalty and/or the fraudulent failure to file penalty must be asserted if a taxpayer was successfully prosecuted by the Department of Justice under Title 26 (i.e. IRC 7201, 7203, 7206(1) ) and the prosecution involved additional tax assessment(s) as opposed to payment of existing assessment(s). Any exceptions to this rule must be approved by Area Counsel. In unsuccessful prosecution cases, non-assertion of the civil fraud penalty and/or the fraudulent failure to file penalty is the discretion of the compliance group manager in charge of the civil disposition case. Compliance group managers are encouraged to consult with their local FEA for assistance. This rule also applies in the case of any related taxpayer involved in the same transaction and to any other year or period of the same taxpayer which is related to or affects the year or period for which criminal prosecution was successful.

(13) Assertion of the civil fraud penalty or fraudulent failure to file penalty should be considered when a taxpayer is successfully prosecuted by the Department of Justice under Title 18 and the facts underlying the criminal case directly relate to additional assessments. The nature and scope of the civil action in such cases is at the discretion of the compliance group manager. Compliance group managers are encouraged to consult with their local FEA for assistance and Area Counsel should be consulted as appropriate.

(14) For SB/SE cases where criminal restitution can be assessed as a tax under IRC 6201(a)(4), contact SB/SE Area Counsel for further guidance.

(15) For LB&I cases with criminal restitution, contact the LB&I fraud coordinator upon receipt for guidance.

(16) Cases returned to the field from fraud or grand jury suspense for civil disposition are returned in AIMS status code 17. Based on the facts and circumstances of the case, if and when a joint determination by the examiner, his/her manager and the FEA is made to not develop and/or assert the civil fraud penalty, the case will be updated to AIMS status code 12. The case must clearly document the reason(s) for such determination.

(17) Area Counsel must approve the civil fraud penalty prior to issuance of a SNOD.

(1) Since direct proof of fraudulent intent is rarely available, fraud must be proven by circumstantial evidence and reasonable inferences. Fraud generally involves one or more of the following elements:

• Deception

• Misrepresentation of material facts

• False or altered documents

• Evasion (i.e., diversion or omission)

(2) The courts focus on key badges, also known as indicators, of fraud in determining whether there was an "intent to evade" tax. A determination of fraud is based on the taxpayer's entire course of conduct, with each badge of fraud given the weight appropriate to a particular case. An evaluation of fraud is based on the weight of the evidence rather than the quantity of the factors. Some of the common "first indicators (or badges) of fraud" include:

• Understatement of income (e.g., omissions of specific items or entire sources of income, failure to report substantial amounts of income received)

• Fictitious or improper deductions (e.g., overstatement of deductions, personal items deducted as business expenses)

• Accounting irregularities (e.g., two sets of books, false entries on documents)

• Obstructive actions of the taxpayer (e.g., false statements, destruction of records, transfer of assets, failure to cooperate with the examiner, concealment of assets)

• A consistent pattern over several years of underreporting taxable income

• Implausible or inconsistent explanations of behavior

• Engaging in illegal activities (e.g., drug dealing), or attempting to conceal illegal activities

• Inadequate records

• Dealing in cash, and

• Failure to file returns

(3) The Facts section of the penalty narrative should include a detailed description of all applicable badges of fraud. Additionally the examiner should include other items of deception or instances where the taxpayer may have misled or misrepresented facts to the government.

(4) A comment regarding consideration of fraud must be documented by all compliance examination field operations employees on cases involving adjustments to taxable income and/or credits resulting in an underpayment of tax due.

(1) Examiners and managers should be aware of collateral estoppel and the important impact it can have in civil fraud penalty cases.

(2) Collateral estoppel is a legal doctrine that prevents a taxpayer, who has been previously convicted of criminal tax evasion under IRC 7201, from asserting a defense to the civil fraud penalty. "Collateral estoppel, like the related doctrine of res judicata, has the dual purpose of protecting litigants from the burden of relitigating an identical issue with the same party or his privy and of promoting judicial economy by preventing needless litigation." (Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326 (1979)). The courts routinely look to the presence of several factors in applying collateral estoppel;

• The issue for which estoppel is being sought must have been necessary in reaching the original decision (see Parklane case cited above),

• The party to be estopped had a "full and fair opportunity to litigate" the issue in the original suit (Montana v. United States, 440 U.S. 147, 154 (1979)), and

• The issue must have been part of a valid and final judgment. (Ashe v. Swenson, 397 U.S. 436, 443 (1970)).

(3) A conviction under IRC 7206(1), False return, does not collaterally estop the taxpayer from asserting a defense to the civil fraud penalty since conviction under IRC 7206(1) does not require proof of fraudulent intent to evade federal income taxes. In these cases, additional development is required to establish the taxpayer’s intent to evade assessment of a tax to be due and owing.

(1) Monitoring fraud-related activities on AIMS:

1. Form 5344, Examination Closing Record, is used to capture the following information in item 38:

• Enter "F" if criminal prosecution has been successfully concluded,

• Enter "C" if the 75% fraud penalty was asserted under IRC 6663 or

• Enter "B" if both apply.

2. Form 5599, TE/GE Examined Closing Record, is used by TE/GE to capture the same information in item 38.

(2) Form 3198, Special Handling Notice, must be used for routing of civil fraud penalty cases. The examiner must identify the applicable penalty code section and computed penalty amount for each tax period on this form and provide any special closing instructions for Centralized Case Processing (CCP) and/or Technical Services.

(3) Mandatory review by Technical Services:

1. Certain civil resolution cases (after the criminal prosecution) require mandatory review by Technical Services prior to closure. This includes:

• Cases successfully prosecuted under Title 26. See IRM 25.1.6.3 (12) .

• Cases with tax-related (specifically Examination-related) conditions of probation. IRM 25.1.4.5, Special Conditions of Probation.

• Cases where restitution is assessable under IRC 6201(a)(4). IRM 25.26.1.3.2.2(1)c, Field Examination Restitution-Based Responsibility.

2. These cases will generally include AIMS Freeze Code "P", Civil Disposition, and/or AIMS Criminal Restitution Code "1". Refer to IRM 4.8.11.6.1(6) , Responsibilities of Examination for Tax-Related Conditions of Probation and IRM 4.8.11.7.2 , AIMS Criminal Restitution Code.

   Note: For any cases identified under (a), even if the AIMS Freeze Code "P" or Criminal Restitution Code "1" are not posted on AIMS, the case must still be transferred to Technical Services for mandatory review prior to closure

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