Negligence or Tax Fraud? What is “Negligent” and What Is “Willful” Conduct to the IRS?

What does the IRS consider to be negligent or non-wilful conduct when it comes to tax-related activity like filing income tax returns and making deductions? What does it consider wilful conduct? When is such activity tax fraud?

Tax fraud is a general term which is defined as taxpayer’s intent to defraud the government by not paying taxes that the taxpayer knows are lawfully due. Tax fraud can be punishable either civilly, criminally, or both. Under federal law, civil violations are primarily located in Title 26 and criminal violations mainly in Title 18, respectively, of the United States Code (“U.S.C.”).

Finding taxpayers guilty of tax fraud and subjecting them to criminal penalties is a difficult hurdle for the IRS to overcome. Proving that the taxpayer has intentionally defrauded the government of tax revenue is a demanding evidentiary burden.  Thus, the IRS often decides to pursue the taxpayer civilly for underpaying tax and therefore avoids the requirement of demonstrating proof of the taxpayer’s intent or state of mind.  To put it candidly, if taxpayers have any reasonable legal argument explaining why they did not pay their due taxes, they will usually avoid criminal liability.

Tax law makes a distinction between non-willful and willful conduct. Willfully evading federal income taxes is a crime, a felony under 26 U.S.C. § 7203. “Willful” means something done voluntarily or with intent. Willful conduct exists when an individual intentionally violates a legal duty of which he or she is aware. Ignorance in the form of wilful blindness is when you intentionally remain ignorant. Such conduct is considered wilful conduct by the IRS.

As mentioned previously, it is a difficult burden to prove that someone wilfully intended to cheat the government out of tax revenue. Even when a taxpayer completes a form incorrectly he or she may rely on explaining it as a simple mistake to avoid criminal liability. In United States v. J. Bryan Williams, this is exactly what happened. Williams answered a yes/no question incorrectly relating to whether or not he had any foreign bank accounts (FBARs) under penalty of perjury and did not file any FBARs. Nevertheless, the court did not find him guilty of criminal tax evasion. In this case, maybe the court’s finding may be attributed to the fact that it was a genuine misunderstanding of the form and tax law. Apparently, the mistake can be unreasonable provided it is not disingenuous.

However, if a taxpayer is going to assert a good-faith (even though unreasonable) belief that no tax is due, the taxpayer should be prepared to testify. In theory, this would violate a taxpayer’s right against self-incrimination. In United States v. Kokenis, a jury found Kokenis guilty of tax evasion after the District Court ruled that he could not present evidence of good faith unless he waived his Fifth Amendment rights and testified. When he asked for a new trial, Kokenis argued that evidence of his good faith misunderstanding of the tax law was improperly excluded by the trial court.

The court in Kokenis instructed the jury not to draw negative inferences from Kokenis’ failure to take the witness stand in his defense. But the court stated that it didn’t believe that Kokenis could have established this good faith belief any other way. On appeal to the Seventh Circuit, Kokenis’ convictions and sentence were affirmed.

Most Cases Start with Civil Audits

Most criminal tax cases start with civil audits. According to the IRS, willfulness involves a voluntary, intentional violation of a known legal duty. Willfulness is shown by a taxpayer’s knowledge of reporting requirements and his/her conscious choice not to comply. Willfulness means a taxpayer acted with knowledge that the conduct was unlawful—a voluntary, intentional, violation of a known legal duty. Thus, at some point a taxpayer can choose whether or not to comply with the legal duty to pay taxes. It is crucial that the taxpayer make the correct choice to avoid turning a civil audit into a criminal investigation.

The IRS is always vigilant and watching for conduct that implies an intent to conceal activities and assets. Actions such as the organization of trusts or corporations may be an indicator to the IRS of an intent to conceal. Also, using cash or other unconventional forms of payment for business transactions like traveler’s checks is another red flag. Repeated failures of these types of things in addition to failing to report income and incorrectly stating expenses can make neglectful conduct “wilful” thus creating the possibility of a prison sentence. Also, being ‘willfully blind’ is considered to be a conscious effort to not learn and know about tax regulations and reporting requirements, which may also give rise to prison time.

Negligence or Tax Fraud? What is "Negligent" and What Is “Willful” Conduct to the IRS?If you have a question or concern about any legal requirements related to the filing of your taxes under federal tax law, call THE TAX EXPERTS AT THE Thorgood Law Firm For a FREE consultation call 212-490-0704.

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