Tax Lawyer's Blog

Cynthia G. Wilcox v. Commissioner- This case involved a taxpayer who claimed foreign tax credits on her individual income tax returns.  The IRS denied the credits because the taxpayer failed to prove that the foreign taxes were actually paid to the foreign taxing authority and assessed a § 6663 (civil fraud) penalty against her for claiming the credits.

The fraud penalty under 6663 is equal to 75% of the underpayment attributable to fraud.

Judge Thomas B. Wells upheld the Commissioner’s disallowance of the taxpayer’s foreign tax credits because the taxpayer could not prove that the foreign taxes were actually paid.

The Judge reversed the assessment of the civil fraud penalty holding that the Commissioner did not meet it’s burden of proving fraud “by clear and convincing evidence.”

To satisfy this burden, the Commissioner must show: (1) An underpayment exists; and (2) the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Parks v. Commissioner, 94 T.C. 654, 660-661 (1990).

Here, the Commissioner attempted to prove that the taxpayer had forged documentation that showed that she worked for a Russian entity called Energia and that taxes were withheld by Energia from her foreign income and remitted to the Russian Ministry of Taxation.  Even though the Court had found the government’s evidence sufficient to deny the taxpayer’s foreign tax credits, it found it insufficient to support the assessment of a civil fraud penalty:

While the circumstances do arouse substantial suspicion, we are mindful that it is respondent’s burden to prove fraud by clear and convincing evidence. We find respondent’s contentions without clear and convincing support in the record. While much of the evidence upon which respondent relies contributed to our holding on the deficiency issues, the evidence is not sufficiently persuasive, on a clear and convincing basis, to prove that petitioner’s contentions are actually false.Accordingly, we hold that respondent has failed to carry respondent’s burden of proof on a clear and convincing basis. Consequently, we hold that petitioner is not liable for the fraud penalty under section 6663.

Author’s Note: The imposition of the civil fraud penalty is rare because it’s difficult to prove. IRS examining agents are not permitted to make the assessment on their own and (at least in statutory notice cases) all proposals to impose the penalty must first get the approval of IRS area counsel. If you are being audited and think there is a possibility of a civil fraud assessment, you should get a tax attorney involved immediately. This will put the IRS on notice that you are prepared to take the matter to court should the assessment be made.

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