Below is a list of Frequently Asked Questions. Select the appropriate FAQ to view the questions and answers. We hope that you find this information both useful and informative. Please remember that the information contained herein is general in nature and is not intended, and should not be construed, as legal advice or as an opinion by the law firm. The material may not be applicable to, or suitable for, your specific circumstances or needs, and may require considerations of non-tax and other factors if any action is to be contemplated.  You should contact tax counsel prior to taking any action based on this information.

We are here to help you, and so please feel free to contact us about your specific case.

Generally, a trust is subject to tax in California “if the fiduciary or beneficiary (other than a beneficiary whose interest in such trust is contingent) is a resident, regardless of the residence of the settlor.”  <em>See </em>Cal. Rev. &amp; Tax 1774(a).  This means that a trust has a California income tax return filing obligation if the trustee or any beneficiary, whose interest is non-contingent, is a California resident.

A trust can be subject to substantial penalties for failing to comply with its California tax obligations including failure to file and failure to pay penalties.  The Franchise Tax Board also imposes interest running from the due date for the tax return.

Generally, the California statute of limitations is four years from the due date of the return or from the date filed, whichever is later.  <em>See</em> Revenue and Taxation Code section 19066.   However, there is no time limit for the FTB to assess tax if the trust did not file a tax return.  <em>See</em> Revenue and Taxation Code section 19087.  There are risks for not complying. Trust, with delinquent California tax returns potentially owe substantial tax, interest, and penalties to the FTB.

There is a solution for trusts that are not compliant with their California tax obligations.  The California Franchise Tax Board has a Voluntary Disclosure Program, which allows qualified entities, such as trusts, that may have incurred an unpaid California tax liability or an unfulfilled filing requirement to disclose their liability voluntarily.  The Franchise Tax Board (FTB) will waive penalties associated with the return filings, and has a six-year lookback period.  The Voluntary Disclosure Program allows trusts to become tax compliant.

Fiduciaries or beneficiaries of trusts, who may be concerned about a California tax compliance issue, should contact competent tax counsel, who evaluate whether a voluntary disclosure makes sense.

Locally assessed real property subject to Proposition 13 is reassessed upon a change in ownership or new construction. See Assessor’s Handbook, Section 401, Change in Ownership, page 3. A change in ownership as a transfer of a present interest in real property, including the beneficial use thereof, the value of which is substantially equal to the value of the fee interest. Rev. and Tax Code § 60.

A change in ownership results in the establishment of a new base year value for the portion of a property that has undergone such change in ownership, unless an exclusion applies. See Assessor’s Handbook, Section 401, Change in Ownership, page 13. When a transfer occurs, the Assessor determines if a reappraisal is required under State law.

Individuals who are considering changing ownership to real property should contact competent tax counsel, who can evaluate the case, explain the options, and provide legal advice as to whether the change in ownership will trigger a reappraisal.

The IRS has a Penalty Handbook that sets forth the criteria for relief from penalties. A criterial for relief of some civil penalties is a showing of reasonable cause. See IRM 20.1.1.3 (11-25-2011). The IRS Penalty Handbook provides, “[r]easonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining his or her tax obligations but nevertheless failed to comply with those obligations.” See IRM 20.1.1.3.2 (11-25-2011).

The IRS Penalty further states:

Ordinary business care and prudence includes making provisions for business obligations to be met when reasonably foreseeable events occur. A taxpayer may establish reasonable cause by providing facts and circumstances showing that he or she exercised ordinary business care and prudence (taking that degree of care that a reasonably prudent person would exercise), but nevertheless were unable to comply with the law.

See IRM 20.1.1.3.2.2 (02-22-2008). In determining if a taxpayer exercised ordinary business care and prudence, IRS agents review the following:

• Taxpayer’s reason for why the penalty should be abated

• Compliance history.

• Length of time between the event cited and the reason for the noncompliance and subsequent compliance.

• Whether the taxpayer could have anticipated the event that caused the noncompliance.

Id. Individuals or companies seeking relief from civil penalties should contact competent tax counsel, who can explain your options and develop a defensible solution.

Lawful permanent residents of the United States, also known as “green card holders”, have tax filing obligations with the Internal Revenue Service, even if they are living abroad. The following apply to green card holders:

• A green card holder generally must report and pay tax in the same manner as a United States citizen, which means that they report and pay tax on their world-wide income and file a Form 1040.

• A green card holder may be considered a dual resident, which means that the individual is both a resident of the United States and a resident of a foreign country, such as Mexico. A dual resident taxpayer, who determines that he or she is a resident of another country under a tax treaty, is considered a nonresident alien for purposes of computing that individual’s income tax liability. Treas. Reg. § 301.7701(b)-7(a)(1). A dual resident taxpayer, who determines his or her U.S. tax liability as if he or she were a nonresident alien, files a Form 1040NR (U.S. Nonresident Alien Income Tax Return). Treas. Reg. § 301.7701(b)-7(b).

• The IRS takes the position that an individual who is a dual resident must file information returns as a U.S. resident, even though the individual is required to file a Form 1040NR. See IRM 4.26.16.3.1.2 (11-06-2015) (U.S. tax treaty provisions do not affect residency status for FBAR purposes”);

• If a green card holder terminates his or her U.S. resident alien status (give up green card), and the individual is considered a long-term residence under IRC § 7701(b)(6), the individual can trigger the expatriation tax regime under section 877A.

Individuals, who are green card holders and have tax compliance issues should contact competent U.S. tax counsel, who can evaluate the case, explain the options, and formulate a defensible strategy.

An IRS Special Agent works for IRS Criminal Investigation, which is the law enforcement arm of the Internal Revenue Service, and CI investigates potential criminal violations of the Internal Revenue Code and related financial crimes. An example of a tax crime is tax evasion under 26 U.S.C. 7201, which is where any person willfully attempts to evade or defeat the assessment or payment of tax. See DOJ Criminal Tax Manual Section 8.03.

The first contact in an IRS administrative investigation (as opposed to a grand jury investigation) is when two IRS Special Agents travel to the taxpayer’s home and knock on the front door. The second contact often is the taxpayer’s certified public accountant or tax return preparer, where the IRS may seek to obtain copies of any documents provided to the accountant to prepare the tax returns, tax organizers, and tax returns.

After that, the agent(s) makes several third-party contacts, issue administrative summons to financial institutions to obtain bank records, and the agent essentially re-lives the taxpayer’s life for the past three to five years.

The agent works as a financial investigator and reviews the taxpayer’s bank and other records. Financial investigations are usually very document-intensive. Specifically, they involve records, such as bank account information, real estate files, motor vehicle records, etc., which point to the movement of money. The major goal in a financial investigation is to identify and document the movement of money. A special agent may attempt to prove that specific items of income are not reported, and other times, the agent will perform a net worth or bank deposit analysis.

When an IRS Special Agent shows up at a taxpayer’s door, the best course of action is to not say a word, be polite and close the door. However, what usually happens is the individual answers the agent’s questions and may fail to tell the truth about other things. Criminal Investigation’s conviction rate is one of the highest in federal law enforcement.

Individuals who have been contacted by an IRS Special Agent should promptly seek the advice of counsel. Legal counsel can try to develop defenses as soon as practicable and figure out if it makes sense to sit down and attempt to resolve the case at a SAC conference prior to a referral to the Department of Justice for criminal prosecution. There normally are several avenues to speak with the IRS in an IRS administrative case.

A California Franchise Tax Board audit commences with an initial contact letter that explains why the FTB has selected an individual or business’ tax return for audit. Throughout the course of the audit, the FTB auditor will issue Information Document Requests that serve to gather facts and documents necessary to understand and verify items that the taxpayer reported on the tax return.

At the end of the audit, the FTB auditor will provide the results in writing. A notice of proposed assessment shows the additional tax that the FTB believes the taxpayer owes. If a taxpayer does not agree with the proposed adjustments, the taxpayer may be able to file a written protest. At that point, an FTB hearing officer will be assigned to the case, and he or she will determine the correct amount of tax based on the evidence that the taxpayer submits and the law.

An important strategic move is to present new evidence or legal argument and not simply re-hash the information already provided to the FTB auditor. Many cases are lost at protest because the taxpayer re-states the evidence and arguments already made and rejected at audit. Additionally, an in-person protest hearing can be helpful on complex cases as opposed to simply discussing the case over the telephone with the protest hearing officer. Another key point to remember is that a protest hearing officer is not like an IRS Appeals Officer and lacks the ability to negotiate settlement. That occurs at the FTB Settlement Bureau.

If a taxpayer is unable to reach an agreement at protest, the next step may be to enter the FTB Settlement Bureau. The purpose of the settlement program is to negotiate settlements of civil tax matters in dispute consistent with a reasonable evaluation of the costs and risks associated with the protest, appeal or refund claim of these matters. A taxpayer must make a good faith settlement offer as part of the taxpayer’s request for settlement. The FTB Settlement Bureau will then consider the taxpayer’s request for settlement to determine if the case is a proper candidate for the settlement program. Except for a public record statement, the settlement information is confidential and the taxpayer enterers into a Nondisclosure Agreement. This means that there is confidentiality, which is important to many taxpayers seeking to resolve their tax case with the FTB.

For additional information, see FTB Notice 2007-2, Settlement of Administrative Civil Tax Matters in Dispute; FTB 985, Audit/Protest/Appeals (The process).

Individuals or companies with an FTB tax issue should contact competent tax counsel, who can evaluate the case, explain the options, and provide adequate representation.

If the taxpayer fails to respond to the 30-day letter and/or if no agreement is reached with the Appeals Officer, the IRS will issue a statutory notice of deficiency (also known as a 90-day letter or a “ticket to Tax Court”). At this point, the taxpayer has 90 days from the date of the notice to file a petition in Tax Court. After the petitioner files a Tax Court Petition, the government (who is called the “respondent”) will file an answer and the case becomes a docketed U.S. Tax Court case. The case, however, still may be settled prior to trial by an IRS Appeals Officer, if the taxpayer previously did not have an opportunity to go to Appeals. If the case settles prior to trial, the parties will execute a Decision and file it with the Tax Court.

If the case proceeds to litigation in U.S. Tax Court, an attorney from the Office of Chief Counsel will be assigned to handle the case. Just like any other type of litigation, there is discovery, depositions, motions and ultimately a trial, which is held before a Tax Court Judge in San Francisco, California. After the trial, the Tax Court may require that the parties file post-trial briefs, and the Judge ultimately will issue an opinion in the case. It sometimes can take up to a year (or longer) to receive an opinion from the Court. If the taxpayer disagrees with the Court’s decision, the taxpayer has the right to appeal the case to the Court of Appeals for the Ninth Circuit.

Practically speaking, most cases are resolved at IRS Appeals because litigation in Tax Court, for most taxpayers, can be quite expensive and there is uncertainty involved in any trial. There are cases, however, where the government and the taxpayer are unable to reach a basis for settlement, and the case proceeds to trial in Tax Court. A Tax Court opinion is a published document, so if privacy or confidentiality is an issue, a taxpayer should consider settling the case at IRS Office of Appeals.

Individuals or companies who are facing litigation in Tax Court should contact competent tax counsel, who can evaluate the case, explain the options, and provide adequate representing in court.

An audit (more properly known as a civil examination) can last a few months or can span a year or longer (depending upon the complexity of the taxpayer’s return, the taxpayer’s level of cooperation and the issues involved in the case). At the end of the audit, the IRS Revenue Agent will inform the taxpayer of the proposed changes to the taxpayer’s return by issuing a 30-day letter.

If the taxpayer agrees with the proposed changes, the taxpayer signs an agreement and pays any additional tax, interest and penalties that may be due. If the taxpayer does not agree, the taxpayer has the right to file a written protest to appeal the proposed changes to IRS Office of Appeals. At that point, an IRS Appeals Officer has jurisdiction over the case and will attempt to settle the case by taking into consideration the hazards of litigation for the government, if the case were to proceed to trial in Tax Court. IRS Appeals, however, will not settle a case based upon nuisance, and this means, to be successful, the taxpayer must demonstrate that hazards of litigation exist if the case proceeds to U.S. Tax Court. If a basis of settlement is not reached, the case proceeds to Tax Court.

If you are a taxpayer facing an audit, you should contact competent tax counsel, who can explain your options and develop a defensible solution.

Assume, for example, that a company is the subject of an IRS civil examination, and the IRS Revenue Agent issues an Information Document Request seeking a voluminous amount of information, including documents concerning the company’s activities offshore. The CFO of the company does not want to produce the documentation out of concern that cooperating may simply expand the scope of the examination. At this stage in the proceedings, what options does the CFO have to resist the summons?

During an IRS investigation, the IRS has the authority to issue an administrative summons seeking records and testimony (Sec. 7602). The IRS may summon records, whether they are in the taxpayer’s or a third party’s possession, including in the possession of the taxpayer’s business associates, acquaintances, prior employers, and even financial institutions (Internal Revenue Manual (IRM) §25.5.5.2). (One exception to this sweeping rule is that the IRS may not issue a summons or commence an enforcement proceeding if the IRS has referred a criminal tax case to the Department of Justice (Sec. 7602(d)).)

If a taxpayer refuses to produce the requested documentation, there is a risk that the IRS will seek an order enforcing the summons from a district court. To enforce the summons, the IRS must establish all four of the so-called Powell factors: (1) The investigation will be conducted pursuant to a legitimate purpose; (2) the inquiry may be relevant to the purpose; (3) the information sought is not already within the IRS’s possession; and (4) the administrative steps required by the IRS have been followed (Powell, 379 U.S. 48, 57–58 (1964)).

To meet these requirements, the IRS agent prepares a declaration that the Powell factors are satisfied. Once the IRS makes its initial showing of good faith, the burden is on the party challenging a summons to disprove one of the Powell factors or to demonstrate that enforcing the summons would constitute an abuse of the court’s process (Nero Trading, LLC, 570 F.3d 1244, 1249 (11th Cir. 2009)).

If the IRS issues a summons that contains broad language that seeks almost everything under the sun, the taxpayer should object to the summons. The taxpayer should seek to work with the agency to modify the language of the summons prior to enforcement proceedings. “A summons will be deemed unreasonable and will not be enforced if it is overbroad and disproportionate to the end sought, and a “fishing expedition” through a taxpayer's records exceeds the relevant scope of the summons power.” United States v. Richards, 631 F.2d 341, 345 (4th Cir. 1980).

A taxpayer also may be able to successful resist a summons if the IRS issued the summons for an improper purpose. This has come to be known as the improper purpose doctrine. See United States v. Clarke, 134 S. Ct. 2361, 2367-68 (2014) (“As part of the adversarial process concerning a summons’s validity, the taxpayer is entitled to examine an IRS agent when he can point to specific facts or circumstances plausibly raising an inference of bad faith.”)

An important point to remember is that Congress authorized the Service’s use of the summon power by the phraseology “may be” relevant, rather than “is” relevant. Section 7602(a)(1) states, “[t]o examine any books papers records or other data which may be relevant or material to such inquiry” (emphasis added). This choice of words indicates acknowledgement that the IRS often cannot be certain that the documents are, in fact, relevant or material until after an agent sees them. Courts have interpreted this language broadly and have held that “’[r]elevance’ under the Powell test does not depend, however, on whether the information sought would be relevant in an evidentiary sense, but merely whether that information might shed some light on the tax return.” See U.S. v. Norwest, 116 F3d 1227, 1233 (8th Cir. 1997). Practically speaking, this means that a taxpayer facing an IRS summons should view the summons from the point of view that the government may be able to obtain the requested information, if the case proceeds to district court.

In short, individuals and businesses facing an IRS summons should seek the advice of competent tax counsel, who can evaluate the situation and formulate a defensible strategy.

Are you an individual who claims to be an innocent spouse? Perhaps you are going through a divorce and are concerned about being held responsible for your spouse’s tax liabilities, which you did not know about. Although your divorce attorney may be negotiating a divorce decree or other legally binding agreement in state court that will allocate responsibility to pay the taxes between you and your spouse, you may be surprised to learn that the IRS is not bound by a state court order and can still take collection against one or both spouses. An option that does exist, however, is the innocent spouse provisions of the Internal Revenue Code.

Section 6015(f) authorizes the IRS to grant equitable relief from joint and several liability if, taking into account all the facts and circumstances, it is inequitable to hold the individual taxpayer liable for the unpaid tax or any income tax deficiency arising from a jointly filed return.

Rev. Proc. 2013-34, 2013-43 IRB 397, provides guidance for taxpayers seeking equitable relief from income tax liability under section 66(c) or 6015(f). Most notably, the IRS now gives greater deference to the presence of abuse or financial control by the non-requesting spouse. It also recognizes that abuse can come in many forms, including physical, psychological, sexual, or emotional abuse. The IRS acknowledges that abuse or financial control may mitigate other factors that might otherwise weigh against granting equitable relief. This and other significant policy changes are a breath of fresh air to taxpayers seeking relief from unpaid taxes because of a former spouse who was abusive or maintained control over the household finances by restricting access to financial information.

The revenue procedure was preceded by a chief counsel notice, CC-2013-011, providing litigation guidance for cases involving claims for relief under section 6015(f). The notice discusses important policy changes and new procedural rules regarding how the IRS Office of Chief Counsel handles section 6015(f) cases docketed in the Tax Court.

Both Rev. Proc. 2013-34 and CC-2013-011 are important documents for practitioners to read when counseling clients on innocent spouse cases. The rules are less rigid and consider all the facts and circumstances of a particular case. Thus, individuals who believe they may be entitled to equitable relief under section 6015(f) may now have a greater chance of success at the administrative and judicial levels.

Individuals, who believe that they may be entitled to innocent spouse relief, should contact competent tax counsel who can evaluate the case, explain the options, and develop a defensible strategy.

U.S. citizens and residents are subject to a maximum rate of 40% with exemption of $5 million indexed for inflation. Nonresidents are subject to the same tax rates, but with exemption of $60,000 for transfers at death only. Sections 6018(a)(2); 2501(a)(1). Below is the table for computing the gift tax.

• U.S. citizens and residents are subject to a maximum rate of 40% with exemption of $5 million indexed for inflation.

• Nonresidents are subject to same tax rates, but with exemption of $60,000 for transfers at death only.

The tax applies to all transfers by gift of property, wherever situated, by an individual who is a citizen or resident of the United States, to the extent the value of the transfers exceeds the amount of the exclusions authorized by section 2503 (unified credit against gift tax) and the deductions authorized under section 2522 (charitable and similar gifts) and 2523 (gift to spouse). Section 2501(a)(1); Treas. Reg. §25.2501-1(a)(1).

Example. Tom is a U.S. citizen and lives in Hong Kong. Tom transfers legal title to his apartment in Hong Kong to his brother. Although the property is located outside the United States, the gift tax applies to this transfer because Tom is a citizen. The same result applies if Tom is not a U.S. citizen but rather a resident of the United States (Tom lives in California).

A resident is an individual who has his domicile in the United States at the time of the gift. A person acquires a domicile in a place by living there, for even a brief period of time, with no definite present intention of moving therefrom. Treas. Reg. §25.2501-1(b). An individual can be a resident for income tax purposes (e.g., green card holder or individual who passes the substantial presence test) but not a domiciled for gift tax purposes.

Example. Tom, who is originally from Australia, lives with his wife and two children in Cupertino, California. Tom is a resident for gift tax purposes because his domicile is in the United States. If Tom makes a gift of an apartment located in Australia, the transaction is subject to the gift tax.

If you are a U.S. citizen or resident of the United States, contact competent tax counsel who can explain the planning opportunities that may exist with respect to gifting property.

What are the U.S. gift tax rules for nonresidents not a citizen of the United States?

Are you a non-U.S. citizen who lives in a foreign country and you plan to make a gift of property located in the United States? You may be surprised to learn that the U.S gift tax rules apply to you, even though you are not a U.S. citizen.

If a gift is made by a nonresident not a citizen of the United States who was not an expatriate, the gift tax applies only to the transfer of real property and tangible personal property situated in the United States at the time of the transfer. Treas. Reg. §25.2511-3.

The gift tax does not apply to any transfer by gift of intangible property by a nonresident not a citizen of the United States (whether or not he was engaged in business in the United States), unless the donor is an expatriate and certain other rules apply. Section 2501(a)(2); Treas. Reg. §25.2501-1(a)(3).

Example. Chris is not a U.S. citizen, and lives and works in Beijing, China. Chris transferred legal title of his house in San Francisco, California to his daughter, Susi, who is attending school at the University of San Francisco. The gift tax applies because this is a transfer of real property situated in the United States, even though Chris is a nonresident and not a citizen of the United States.

Example. Tom is a nonresident not a citizen, and he transfers money on deposit in an American bank to his daughter, who lives in San Francisco. Money is treated as tangible personal property and is subject to gift tax.

Individuals with gift tax issues should contact competent tax counsel, who can explain the planning opportunities that may exist with respect to the transfer of property by gift.

When does a taxpayer’s negligence, inadvertence, mistake, or good-faith misunderstanding of the law rise to the level of a civil fraud penalty or criminal offense, such as tax evasion? Stated differently, when does the government view failing to report income, claiming false deductions, or filing an incorrect tax return trigger a criminal investigation and possibly a referral to the Department of Justice for prosecution?

Many taxpayers understandably want to know whether their cases will be investigated by CI. The answer is never clear cut. However, the Internal Revenue Manual provides some insight into the selection process, stating that the following should be considered in determining whether an investigation meets the definition of CI’s mission:

• high profile;

• egregious allegations;

• deterrent effect; and

• conformity with CI’s annual business plan.

See IRM section 9.1.1.4. The IRM makes a point of distinguishing tax avoidance from tax evasion, noting that the distinction is ‘‘fine, yet definite’’:

Avoidance of taxes is not a criminal offense. Any attempt to reduce, avoid, minimize, or alleviate taxes by legitimate means is permissible. The distinction between avoidance and evasion is fine, yet definite. One who avoids tax does not conceal or misrepresent. He/she shapes events to reduce or eliminate tax liability and, upon the happening of the events, makes a complete disclosure. Evasion, on the other hand, involves deceit, subterfuge, camouflage, concealment, some attempt to color or obscure events or to make things seem other than they are. For example, the creation of a bona fide partnership to reduce the tax liability of a business by dividing the income among several individual partners is tax avoidance. However, the facts of a particular investigation may show that an alleged partnership was not, in fact, established and that one or more of the alleged partners secretly returned his/her share of the profits to the real owner of the business, who, in turn, did not report this income. This would be an instance of attempted evasion.

See IRM section 9.1.3.3.2.1.

Often what can make or break a case from going criminal is whether the amount of the tax loss is sufficient to meet the Justice Department’s guidelines — information that is not publicly available. Other key factors are whether the case involves a pattern of unreported income (multiple years of non-compliance) and who is the taxpayer (age, health, level of sophistication, and education).

Critical to the government’s case in both a charge of tax evasion under section 7201 and a civil fraud penalty under section 6663 is the ability to show that the taxpayer’s conduct was willful. This is in sharp contrast to conduct attributable to negligence, inadvertence, mistake, or conduct that results from a good-faith misunderstanding of the requirements of the law. Specific intent to violate the law is an element of some federal criminal tax offenses such as tax evasion.

Individuals or businesses facing an IRS criminal investigation should contact competent counsel who can formulate a defensible strategy and plan.

Both the IRS and FTB have the authority to collect a balance due through various enforcement actions including levies on wages, salary, and other income; (2) filing a Notice of federal tax lien; (3) Seizure and sale of assets; and (4) with respect to the IRS, suits by the U.S. government in federal district court such as a suit to reduce a tax assessment to judgment.

If a taxpayer lacks the ability to pay in full, there are several collection alternatives that exist, and they include the following:

1. Extension of time to pay

2. Installment agreement

3. Offer in Compromise (doubt as to liability or doubt as to collectability)

4. Currently not collectable status (based upon financial analysis)

5. Innocent spouse relief

6. Penalty abatement (file Form 843, Claim for Refund and Request for Abatement, and request abatement of civil penalties by establishing reasonable cause)

7. Request for audit reconsideration (an audit reconsideration is the process the IRS uses to reevaluate the results of a prior audit where additional tax was assessed and remains unpaid, or a tax credit was reversed). See Publication 3598 and IRM 4.13.1.2 (12-16-2015).

8. Bankruptcy (debtor may be able to discharge taxes and/or bring an adversary proceeding to litigate the amount owed in federal bankruptcy court)

9. Claim for credit or refund. There is a limitation period on filing a claim. See I.R.C. sec. 6511(a). If the IRS denies the claim, the taxpayer may have an administrative hearing before the IRS Office of Appeals, and ultimately may file a refund suit in federal district court.

Individuals or businesses facing tax collection should contact competent tax counsel, who can

evaluate the case, explain the options, and develop a defensible strategy.

WHAT IS TAX FRAUD?

Tax fraud is often defined as an intentional wrongdoing on the part of a taxpayer, with the specific purpose of evading a tax known or believed to be owing. Tax fraud requires both an underpayment of tax due and fraudulent intent

KEY TAKE AWAYS

• Fraud requires willfulness - a willful violation is one committed knowingly.

• Every Revenue Agent has a checklist on his or her desk with a list of badges of fraud; the more boxes checked, the more likely the agent will can prove fraud.

• Look for a pattern of unreported income, inadequate books and records, and hidden bank accounts (agents do not like false statements).

• Government must prove fraud by clear and convincing evidence.

• A good-faith belief that one is not violating the law negates willfulness; in other words, a mistake or reliance on an accountant is not fraud.

Internal Revenue Manual

The Internal Revenue Service has a Fraud Handbook that is contained in Part 25.1 of the Internal Revenue Manual. Fraud is defined in the Manual as follows:

• Fraud is deception by misrepresentation of material facts, or silence when good faith requires expression, which results in material damage to one who relies on it and has the right to rely on it. Simply stated, it is obtaining something of value from someone else through deceit.

See IRM 25.1.1.2 (01-23-2014). The Fraud Handbook provides an overview and definitions of fraud, and instructs IRS employees such as an IRS Revenue Agent how to recognize and develop fraud. The primary objective of the fraud program is to foster voluntary compliance through the recommendation of criminal prosecutions and/or civil penalties against taxpayers who evade the assessment and/or payment of taxes known to be due and owing. See IRM 25.1.1.1 (01-23-2014). Generally, for fraud to be considered, an IRS Revenue Agent must show:

• An additional tax due and owing as the result of a deliberate intent to evade tax; or

• The willful and material submission of false statements or false documents in connection with an application and/or return.

Id. The Government has the burden of proof in establishing fraud, and the major difference between civil and criminal fraud is the degree of proof required. See IRM 25.1.1.2.2 (01-23-2014). In criminal cases, the Government must present sufficient evidence to prove guilt beyond a reasonable doubt. Id. In civil fraud cases, the Government must prove fraud by clear and convincing evidence. Id.

Fraudulent Intent

If any part of any underpayment of tax required to be shown on a return is attributable to fraud, section 6663(a) imposes a penalty equal to 75% of the portion of the underpayment which is attributable to fraud. Section 6663(b) provides that once the Commissioner establishes that any portion of the underpayment is due to fraud, the entire underpayment is to be treated as attributable to fraud except with respect to any portion that the taxpayer establishes, by a preponderance of the evidence, is not attributable to fraud. The entire taxable year remains open under section 6501(c)(1) even if only a part of the underpayment for a year is attributable to fraud. Lowy v. Commissioner, 288 F.2d 517, 520 (2d Cir. 1961), aff'g, T.C. Memo. 1960-32. “Thus, where fraud is alleged and proven, respondent is free to determine a deficiency with respect to all items for the particular taxable year without regard to the period of limitations.” Colestock v. Commissioner, 102 T.C. 380, 385 (1994).

Once an underpayment has been proven, the second prong of the fraud test requires the Commissioner to prove that, for each year at issue, at least some portion of the underpayment is due to fraud, defined as an intentional wrongdoing designed to evade tax believed to be owing. DiLeo v. Commissioner, 96 T.C. at 874. The Court may examine the taxpayer's whole course of conduct to determine whether fraud exists. Stone v. Commissioner, 56 T.C. 213, 224 (1971). The existence of fraud is a question of fact to be resolved from the entire record. Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), aff'd without published opinion, 578 F.2d 1383 (8th Cir. 1978). Fraud is never imputed or presumed, and therefore the Commissioner must meet his burden through affirmative evidence. See Niedringhaus v. Commissioner, 99 T.C. 202, 210 (1992); Petzoldt v. Commissioner, 92 T.C. 661, 699 (1989); Beaver v. Commissioner, 55 T.C. 85, 92 (1970). Fraud may be proved by circumstantial evidence and reasonable inferences drawn from the facts because direct proof of a taxpayer's intent is rarely available. Toushin v. Commissioner, 223 F.3d 642, 647 (7th Cir. 2000), aff'g, T.C. Memo. 1999-171; Petzoldt v. Commissioner, 92 T.C. at 699. Fraud is not imputed from one spouse to another. Stone v. Commissioner, 56 T.C. at 227-228. In the case of a joint return, the section 6663 penalty does not apply with respect to a spouse unless some part of the underpayment is due to the fraud of such spouse. Section 6663(c).

Determination of Fraudulent Intent

Over the years, courts have developed a nonexclusive list of factors that demonstrate fraudulent intent. These badges of fraud include

1. Understatement of income,

2. Inadequate maintenance of records,

3. Implausible or inconsistent explanations of behavior,

4. Concealment of assets or income,

5. Failure to cooperate with tax authorities,

6. Engaging in illegal activities,

7. An intent to mislead which may be inferred from a pattern of conduct,

8. Lack of credibility of the taxpayer's testimony,

9. Failure to file tax returns,

10. Filing false documents,

11. Failure to make estimated tax payments, and

12. Dealing in cash.

See Spies v. United States, 317 U.S. 492, 499 (1943); Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), aff'g, T.C. Memo. 1984-601; Niedringhaus v. Commissioner, 99 T.C. at 211. A taxpayer's intelligence, education, and tax expertise are relevant for purposes of determining fraudulent intent. See Stephenson v. Commissioner, 79 T.C. 995, 1006 (1982), aff'd, 748 F.2d 331 (6th Cir. 1984); Iley v. Commissioner, 19 T.C. 631, 635 (1952).

Courts discuss the factors in turn in deciding whether a taxpayer is liable for a civil fraud penalty. See O'Neal v. Commissioner, T.C. Memo 2016-49, where the Tax Court applied the factors to determine that married individuals were liable for the civil fraud penalty. In a fraud case, it can be helpful to prepare a fraud evidence chart. A sample chart is here Fraud Evidence Chart

Defense

A good-faith misunderstanding of the law or a good-faith belief that one is not violating the law negates willfulness, whether or not the claimed belief or misunderstanding is objectively reasonable. Cheek v. United States, 498 U.S. 192 (1991).

Joint Tax Return

Fraud is not inputted to from one spouse to another, in the case of a joint return. The IRS must establish that some part of the underpayment is due to the fraud of such spouse. A possible defense is showing that there was no fraud by the other spouse under section 6663(c) because the other spouse was uninvolved in the business. Another possible defense is establishing that the other spouse is entitled to innocent spouse relief under section 6015(c) or 6015(f). There, they key issues are establishing that the other spouse did not know or have reason to know, and no benefit.

How Can We Help?

Individuals who are concerned about possible tax fraud should contact competent tax counsel, who can evaluate the case, explain the options, and develop a defensible strategy. See the following fraud evidence chart.

The Internal Revenue Code imposes a special alternative tax regime on U.S. citizens who renounce their citizenship. The Internal Revenue Code provides for a deemed sale of a covered expatriate’s worldwide assets on the day before the renunciation of U.S. citizenship. See section 877A. Additionally, there is a tax on future gifts or bequests made to a U.S. citizen or resident.

In short, renouncing U.S. citizenship carries with it an expensive price tag, and individuals who are considering expatriations should consider the substantial tax burdens associated with this action. Since the tax applies to an individual’s world-wide assets, the expatriation tax on high net worth individuals can make it prohibitive for certain individuals to expatriate. But for certain individuals, expatriation can be the right move.

Covered Expatriate The expatriation tax applies to an individual who is considered a covered expatriate. A covered expatriate includes any U.S. citizen who relinquishes citizenship, if the individual:

• Has an average annual net income tax liability for the five proceeding years ending before expatriation that exceeds $161,000 for 2016 ($162,000 for 2017);

• Has a net worth of $2 million or more on the expatriation date; or

• Fails to certify under penalties of perjury that he or she has complied with all U.S. tax obligations for the proceeding five years or fails to submit evidence of compliance required by the IRS on Form 8854. See Section 877A; Notice 2009-85; Rev. Proc. 2015-53; Rev. Proc. 2016-55.

Calculation of Expatriation Tax An individual who is a covered expatriate is subject to a mark-to-market tax regime under which the individual is taxed on the unrealized gain on his or her property to the extent it exceeds $693,000 for 2016 ($699,000 for 2017). See Section 877A; IRS Notice 2009-85; Rev. Proc. 2015-53; Rev. Proc. 2016-55. For this purpose, a covered expatriate is considered to own any interest in property that would generally be taxable as part of her gross estate for federal estate tax purposes if the individual died on the day before the expatriation date.

Form 8854 In addition to the other requirements, a covered expatriate must file an information return on Form 8854 in each tax year the individual is subject to the mark-to-market tax. See Section 6039G; Notice 2009-85. The return is also to be used to provide notice that the individual has relinquished his or her U.S. citizenship. Form 8854 and the instructions explain how the expatriation tax is calculated and what information is required. The form requires a substantial amount of financial information to properly calculate the expatriation tax and can be administratively burdensome to complete. See Form 8854 for further details.

Individuals who are considering expatriation should contact competent tax counsel, who can evaluate the case, explain the options and come up with a solution.

Federal law requires individuals to report annually to the Internal Revenue Service any financial interests they have in any bank, securities, or other financial accounts in a foreign country. 31 U.S.C. § 5314(a). The report is made by filing a completed Form TD F 90-22.1 with the Department of the Treasury, and the report must be filed on or before April 15 of each calendar year with respect to foreign financial accounts maintained during the previous calendar year. 31 C.F.R. § 1010.350.

The Secretary of the Treasury may impose a civil money penalty on any person who fails to timely file the report. 31 U.S.C. § 5321(a)(5)(A). In cases where a person “willfully” fails to file the FBAR, the government may impose an increased maximum penalty, up to $100,000 or fifty percent of the balance in the account at the time of the violation. 31 U.S.C. § 5321(a)(5)(C).

The IRS’ investigation may probe the following areas:

• Why the individual failed to file the FBAR reports, when did the person first learn of the FBAR reporting requirements, and did the individual read the information supplied by the government in the tax forms;

• What is the individual’s reasonable cause defense for failing to report the foreign accounts under 35 U.S.C. § 5321(a)(5)(B)(ii) (non-willfulness civil penalty);

• Why the individual answered “no” in response to Question 7a, Part IV of Schedule B, if that is the case;

• What is person’s level of education and sophistication, particularly in the field of business and accounting;

• Did the individual engage in any activity with respect to the funds overseas (e., transferring money overseas, buying and selling securities, or making investments) or is the account a “passive account”; and

• Did the individual know that the funds deposited into the foreign financial account were taxable, and why did the person failed to report the offshore income, if that is the case.

The IRS may seek to interview the individual to obtain answers to its questions. Also, if an accountant or enrolled agent prepared the tax returns at issue, the IRS may interview the return preparer to determine what, if anything, the taxpayer told the accountant about the undisclosed bank accounts. The IRS may want a copy of any tax organizer to see whether the person disclosed the foreign accounts to the return preparer. See e.g., United States v. McBride, 2012 U.S. Dist. LEXIS 161206 (D. Utah 2012); United States v. Williams, 2012 U.S. App. LEXIS 15017 (4th Cir. Va. 2012).

Individuals who fail to report their interest in foreign financial accounts run the risk of substantial civil penalties and possibly a criminal investigation by the IRS. Persons with unfiled foreign bank account reports or unreported income from offshore accounts would be wise to seek the advice of competent tax counsel, who can evaluate the case, explain the options, and develop a defensible strategy.

It is currently the practice of the IRS that a voluntary disclosure will be considered along with all other factors in the investigation in determining whether criminal prosecution will be recommended. This voluntary disclosure practice creates no substantive or procedural rights for taxpayers, but rather is a matter of internal IRS practice, provided solely for guidance to IRS personnel.

A voluntary disclosure will not automatically guarantee immunity from prosecution. However, a voluntary disclosure may result in prosecution not being recommended. This practice does not apply to taxpayers with illegal source income.

A disclosure is timely if it is received before:

• the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation;

• the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance;

• the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or

• the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).

See Internal Revenue Manual 9.5.11.9 (12-02-2009) (Voluntary Disclosure Practice). Individuals or business seeking to make a voluntary disclosure should contact competent tax counsel, who can explain the options and come up with a defensible strategy.

In general, a foreign gift is money or other property received by a U.S. person from a foreign person that the recipient treats as a gift or bequest and excludes from gross income. A “foreign person” is a nonresident alien individual or foreign corporation, partnership, or estate.

The individual must file Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, if, during the current tax year, the individual treats the receipt of money or other property above certain amounts as a foreign gift or bequest. Include on Form 3520:

• Gifts or bequests valued at more than $100,000 from a nonresident alien individual or foreign estate (including foreign persons related to that nonresident alien individual or foreign estate); or

• Gifts valued at more than $15,601 for 2015 (adjusted annually for inflation) from foreign corporations or foreign partnerships (including foreign persons related to the foreign corporations or foreign partnerships).

There are special rules applicable to gifts or bequests from covered expatriates.

See www.irs.gov (Gifts from Foreign Person).

Penalties

In the case of a failure to report foreign gifts described in section 6039F, a penalty equal to 5% of the amount of such foreign gifts applies for each month for which the failure to report continues (not to exceed a total of 25%). No penalty will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect. See section 6039F for additional information. (See Instructions for Form 3520 (2016), Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.)

Individuals who have received, or plan to receive, foreign gifts should contact competent tax counsel, who can explain the options and come up with a defensible plan.