TEB Phase III - Lesson 5
Fraud
Overview
Introduction
The Internal Revenue Service (IRS) is committed to the promotion of
voluntary compliance with tax laws and regulations by taxpayers. In support
of this effort, the IRS will consider the appropriateness of the application of
penalties and, when warranted, the prosecution of those responsible for
criminal violations of the tax laws.
As a part of the IRS’s overall commitment to foster voluntary compliance,
Tax Exempt Bonds (TEB), a division of the Governmental Entities (GE)
division of the Tax Exempt and Governmental Entities Division (TE/GE) of
the IRS, considers identification and development of fraud to be a critical part
of its program.
This lesson provides an overview of fraud, defines and details the elements of
fraud, and outlines procedures that Examiners should follow when a case
appears to be potentially fraudulent.
National Fraud Program
The National Fraud Program is a service-wide program within SB/SE. The
National Fraud Program Office is responsible for coordinating the
establishment of Service-wide fraud strategies, policies, and procedures to
enhance enforcement of the tax law. It also provides Fraud Referral Program
coordination for all IRS operating divisions to identify fraud, develop fraud
cases, and reduce the cycle time of fraud cases.
The National Fraud Program maintains a website, accessible on the IRS
Intranet, which is designed to provide technical information, contacts, links to
related offices, and news about the Service’s Fraud Program activities.
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 payment of taxes known to be due and
owing.
Continued on next page
Fraud
5-1
Overview, Continued
Introduction
Discovery of Fraud
(continued)
The discovery and development of fraud cases are a normal result of effective
investigative techniques. Techniques employed by the Tax Exempt Bond
function should be designed to disclose not only errors in accounting and
application of tax law, but also irregularities that indicate the possibility of
fraud. Generally, for fraud to be considered, the tax exempt bond examiner
must show:
• An additional tax due and owing due to a deliberate intent to evade tax
• The willful and material submission of false statements or false
documents in connection with a tax-advantaged bond financing and/or
return.
Objectives
After completing this lesson, you will be able to:
• Define fraud
• Define the various legal terms relating to fraud
• Define willfulness
• Distinguish between civil and criminal fraud.
• Identify IRM guidelines that apply to Tax Exempt Bonds
• Identify indicators (badges) of fraud
• Describe your role as an examiner in the identification and
development of fraud
Contents
This lesson contains the following topics:
Topic
See Page
Overview
1
Defining Fraud and Other Related Terms
3
Civil and Criminal Fraud
7
Indicators of Fraud and Affirmative Acts of Fraud
8
Role of the Examiner
12
Resources
13
Summary
14
Fraud
5-2
Defining Fraud and Other Related Terms
Reference
TEB IRM 4.81.5.12,Fraud and IRC 6700 Procedures
Definition of
Fraud
The Fraud Handbook is located in IRM 25.1. Section 25.1.1.2 of the
IRM provides the following definition of fraud:
(1) Fraud is deception by misrepresentation of material facts, or
silence when good faith requires expression, resulting 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.
(2) 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:
• A tax due and owing
• Fraudulent intent
What Fraud is
Fraud cannot be a mistake or an accident, carelessness, or reliance on
Not
others.
Errors do not imply fraud. Errors may indicate an irregularity in
taxpayer compliance. While an irregularity in taxpayer compliance
may be an indicator of the possibility of fraud, a presumption of fraud
cannot be based on an irregularity alone.
Continued on next page
Fraud
5-3
Defining Fraud and Other Related Terms, Continued
Fraud Related
An examiner must be familiar with the following legal terms in order
Legal Terms
to understand the requirements for proof of fraud:
Burden of Proof- the obligation to offer evidence that a court (judge or
jury) could reasonably believe in support of a contention. In tax fraud
cases, the burden of proof is on the Government.
Evidence - data presented to a judge or jury in proof of the facts in
issue and which may include the testimony of witnesses, records,
documents, or objects. Evidence is distinguished from proof in that the
latter is the result or effect of evidence.
a. Direct Evidence - evidence in the form of testimony from a
witness who actually saw, heard, or touched the subject of
questioning. Direct evidence, which is believed, proves
existence of fact in issue without inference or presumption.
b. Circumstantial Evidence - evidence based on inference and not
personal observation.
c. Presumption (of law) - a rule of law that a judge or jury will
draw a particular inference from a particular fact, or from
particular evidence, unless and until the truth of such inference
is disproved.
d. Inference - a logical conclusion from given facts.
e. Preponderance of evidence - evidence that will incline an
impartial mind to one side rather than the other so as to remove
the cause from the realm of speculation. It does not relate
merely to the quantity of evidence. Simply stated, evidence
which is more convincing than the evidence offered in
opposition.
f. Reasonable doubt - a doubt that would cause a prudent person
to hesitate before acting in matters of importance to
themselves. Such a doubt will leave a juror's mind uncertain
after examination of the evidence.
Continued on next page
Fraud
5-4
Defining Fraud and Other Related Terms, Continued
Fraud Related
Legal Terms
g. Willful Intent to Defraud - an intentional wrongdoing with the
specific purpose of evading a tax believed by the taxpayer to
be owing.
h. Clear and Convincing Evidence - evidence showing that the
thing to be proved is highly probable or reasonably certain.
This is a greater burden of proof than preponderance of the
evidence but less than beyond a reasonable doubt.
Willfulness
Probably the best place to start in understanding fraud is Willfulness.
Under § 7201, any person who willfully attempts in any manner to evade or
defeat any tax imposed by Title 26 or the payment thereof shall, in addition to
other penalties provided by law, be guilty of a felony and, upon conviction
thereof, shall be fined not more than $100,000 ($500,000 in the case of a
corporation) or imprisoned not more than 5 years, or both, together with the
costs of prosecution.
Willfulness is a major factor in establishing fraud. Willfulness is an element
of both civil and criminal fraud. The definition of willfulness has evolved
from court decisions and is not defined by statute. Willfulness is a state of
mind, a conscious, knowing decision to do or fail to do some act. It is defined
as the "voluntary, intentional violation of a known legal duty.” Cheek v.
United States, 498 U.S. 192 (1991); United States v. Pomponio, 429 U.S. 10
(1976).
For a taxpayer to be guilty of a crime in which willfulness is an element, that
individual must have acted deliberately, knowingly, and with specific intent
to violate the law. A defendant’s good faith belief that he is not violating the
tax laws, no matter how objectively unreasonable that belief may be, is a
defense in a tax prosecution.
Continued on next page
Fraud
5-5
Defining Fraud and Other Related Terms, Continued
Willfulness
Willfulness is composed of three factors:
(continued)
1.Knowledge – Did he know the consequences of his act? Was he aware of
the false statement or document? Was the submission or act deliberate?
Was he aware of the indicated fraud? KNOWLEDGE may be shown by
the taxpayer’s actions.
2.Intent – Deliberate plan to evade is difficult to prove because it involves
defining what is in the taxpayer's mind at the time he submitted the false
document, statement, or return. INTENT can be implied from a
taxpayer's actions.
3.Purpose – To show dishonest intention requires something more than the
fact that the taxpayer acted intentionally or voluntarily. There must be an
attempt to obscure the facts. This will be evidenced by a tax
understatement. A dishonest purpose is closely related to indications of
willful intent. Purpose should not be confused with motive. Motive is the
reason for the act. The taxpayer must know the result of his act; he must
believe that it will result in an illegal understatement of his tax liability.
The taxpayer must intend to do the act, and his purpose must be to
understate the tax liability.
Willfulness is not present where a taxpayer has acted by mistake,
accidentally, or in good faith. Making an honest mistake is not a crime;
deliberately choosing to not comply with the law can be. Mistakes,
inadvertence, reliance on others, honest differences of opinion, and mere
negligence or carelessness do NOT constitute willful intent.
Lack of willfulness is a valid defense to a charge of tax fraud. For example,
not knowing that an individual was required to file a return, or believing that
a return could not be filed without remittance, may constitute a defense in a
failure to file case. Similarly, acting upon the professional advice of an
attorney or CPA who had access to all relevant facts may constitute a defense
of lack of willfulness in a case involving a questionable expense or deduction.
Fraud
5-6
Civil and Criminal Fraud
Civil vs.
Understanding the requirements of proof is essential in establishing fraud. In
Criminal Fraud
all criminal and civil tax fraud cases, the burden of proof is on the
government.
Civil fraud cases are remedial actions taken by the government such as
assessing the correct tax and imposing civil penalties as an addition to tax, as
well as retrieving transferred assets.
Criminal fraud cases are punitive actions with penalties consisting of fines
and/or imprisonment.
Civil penalties are assessed and collected administratively as a part of the tax.
The civil fraud penalty is recommended by the examiner in the audit report
and may be applied with or without pursuit of criminal prosecution.
Criminal fraud results in a punitive action with penalties consisting of fines
and/or imprisonment. Criminal penalties:
• Are enforced only by prosecution
• Are provided to punish the taxpayer for wrongdoings
• Serve as a deterrent to other taxpayers
The major difference between civil and criminal fraud is the degree of proof
required, in:
• Civil fraud cases - the government must prove fraud by clear and
convincing evidence.
• Criminal cases - the government must present sufficient evidence to
prove guilt beyond a reasonable doubt.
Civil penalties are assessed and collected administratively as a part of the tax.
The civil fraud penalty is recommended by the examiner in the audit report
and may be applied with or without pursuit of criminal prosecution.
A tax fraud offense may result in both civil and criminal penalties. The
normal 3-year statute of limitations does not apply if civil fraud can be
sustained. If fraud is established, there is no statute of limitation for civil
assessments, IRC § 6501(c)(1) and (2). The criminal statute of limitations is
usually 6 years from the time the offense was committed (5 years in some
cases).
Fraud
5-7
Indicators of Fraud and Affirmative Acts of Fraud
Indicators
(Badges) of
Fraud
Signs of fraud are referred to as indicators or badges of fraud. Fraud
indicators are an action, omission, or both. An action is defined as an
activity deliberately undertaken in order to accomplish some
objective. An omission is a failure to take action in a particular matter.
Taxpayers who knowingly take actions that result in the
understatement of a tax liability often leave evidence in the form of
identifying earmarks (or indicators). These indicators serve as a sign
or symptom, or signify that actions may have been done for the
purpose of deceit, concealment or to make things seem other than
what they are.
Indicators may only suggest that actions may have occurred for the
purpose of evading tax, however, indicators alone do not establish
fraud.
The following can be indicators of fraud:
• Taxpayers who knowingly understate their tax liability often
leave evidence in the form of identifying earmarks (or
indicators).
• Serve as a sign or symptom, or signify that actions may have
been done for the purpose of deceit, concealment or to make
things seem other than what they are. Indications in and of
themselves do not establish that a particular action was done.
• Examples include substantial unexplained increases in net
worth, substantial excess of personal expenditures over
available resources, bank deposits from unexplained sources
substantially exceeding reported income, and documents that
appear to be altered or false. Although the appearance of a
suspicion is the first indication of a potential fraud, indicators
alone do not establish fraud.
Continued on next page
Fraud
5-8
Indicators of Fraud and Affirmative Acts of Fraud, Continued
Affirmative
In order to establish fraud, the taxpayer must have committed some
Acts of Fraud
type of affirmative act of concealment or misrepresentation.
An affirmative act is a firm indicator that the taxpayer did or did not
do something in order to evade or defeat tax. Affirmative acts
establish the taxpayer’s willful intent to evade payment of tax.
Affirmative acts of fraud are:
• Actions taken by the taxpayer, return preparer, promoter or
other parties to a transaction with the intent to deceive or
defraud. Fraud cannot be established without affirmative acts
of fraud.
• Those actions that establish that a particular process was
deliberately done for the purpose of deceit, subterfuge,
camouflage, concealment, some attempt to color or obscure
events, or make things seem other than what they are.
Affirmative acts might be discovered by analyzing the substance of a
transaction that is in reality something other than what it is purported
to be based on a review of the relevant documents; i.e., a substance vs.
form analysis.
Continued on next page
Fraud
5-9
Indicators of Fraud and Affirmative Acts of Fraud, Continued
Indicators of
Fraud vs.
Affirmative
Acts of Fraud
As indicated previously, indicators of fraud alone are insufficient to
prove fraud. The taxpayer must have committed some act to perpetrate
the fraud.
Affirmative acts establish that the taxpayer committed certain actions
with the specific purpose and willful intent of evading a tax liability.
Examples of affirmative acts are deceit, subterfuge, camouflage,
concealment, attempts to color or obscure events, or make things seem
other than they are.
Affirmative acts include:
• Deceit/Misrepresentation – For example, the submission of
false or altered documents during the examination in an effort
to establish compliance with laws or regulations.
• Concealment – Hiding during an examination the existence of
bank accounts, brokerage accounts and other property or the
existence of agreements and contracts that include parties to
the transaction being examined is an example of concealment.
• Subterfuge – Maintaining two sets of books is an example of
subterfuge on the part of the taxpayer.
• Camouflage – Diverting funds to transaction participants that
would otherwise be payable to the U.S. Treasury and
disguising such payments as transaction costs.
Continued on next page
Fraud
5-10
Indicators of Fraud and Affirmative Acts of Fraud, Continued
Tax Avoidance
Avoidance of tax is not an indicator of fraud. Taxpayers have the right
vs. Tax Evasion
to reduce, avoid, or minimize their taxes by legitimate means. One
who avoids tax does not conceal or misrepresent, but shapes and
preplans events to reduce or eliminate tax liability within the
perimeters of the law.
Tax evasion involves some affirmative act to evade or defeat a tax, or
payment of tax.
Common evasion schemes include:
• Intentional understatement or omission of income
• Claiming fictitious or improper deductions
• False allocation of income
• Improper claims, credits, or exemptions
For fraudulent tax evasion, the burden of proof rests on the
government. An examiner must establish a taxpayer’s intent to
defraud the government.
Tax fraud or an abusive transaction might not become apparent until
after the initial interview is conducted and the books and records are
examined; therefore, examiners should prepare workpapers and
memoranda that sufficiently document potential indicators of fraud.
Fraud
5-11
Role of the Examiner
Your Role as
The Director, TEB has designated a fraud coordinator to facilitate the
Examiner
development of fraud cases and to serve as a liaison between the National
Fraud Program (NFP) and TEB. The TEB Fraud Coordinator (TEB FC),
individually or in conjunction with the Fraud Technical Advisor (FTA) from
SB/SE, will provide advice and/or guidance to the TEB managers and
specialists on the development of fraud cases.
As soon as a TEB examiner discovers indicators of fraud, he/she should
discuss the issue with the group manager. If the group manager concurs, the
TEB examiner will contact the TEB FC to discuss the indicators of fraud. The
TEB FC will contact a FTA if the case has fraud potential. If the FTA agrees,
the TEB FC will arrange a 4-way conference call or meeting with the TEB
examiner, group manager and FTA to discuss the case. If all parties agree that
the case should be developed for fraud, the TEB examiner will complete
Form 11661, Fraud Development Recommendation - Examination, and
forward it to the TEB FC for signature.
IRM 25.1.2.2, Fraud Development Procedures includes additional fraud
development procedures.
Fraud
5-12
Resources
Fraud Related
Code and IRM
Sections
The following are relevant sections of the Code and IRM for purposes of
fraud:
Title 26 USC §:
• 7201, Attempt to Evade or Defeat Tax
• 7202, Willful Failure to Collect or Pay over Tax
• 7203, Willful Failure to File Return, Supply Information, or Pay Tax
• 7204, Fraudulent Statement or Failure to Make Statement to Employees
• 7205, Fraudulent Withholding Exemption Certificate or Failure to Supply
Information
• 7206, Fraud and False Statements
• 7207, Fraudulent Returns, Statements, or Other Documents
• 7211, False Statements to Purchasers or Lessees Relating to Tax
• 7212, Attempts to Interfere with Administration of Internal Revenue Laws
IRM §:
• 25.1 Fraud Handbook comprehensively addresses fraud and includes a
section that specifically addresses fraud in Tax Exempt Bonds (see IRM
25.1.9.6)
• 4.81.5.12 Fraud and IRC 6700 Procedures.
Fraud
5-13
Summary
Review of
Fraud requires an intentional act and tax fraud requires that there be a tax due
Lesson 5
and owing. A mistake or error is not fraud.
It is important to be aware of the various fraud-related terms, including
willfulness, which is a voluntary intentional violation of a known legal duty,
and a requirement for the presence of fraud.
Signs or symptoms of fraud are indicators which might result from any
affirmative acts committed by a taxpayer. Affirmative acts are firm
indications of a taxpayer’s intent to commit fraud and include among other
things, deceit, subterfuge, camouflage, and concealment.
Avoidance of tax is not an indicator of fraud; however, tax evasion, which
involves some affirmative act to evade or defeat a tax or payment of tax, is
fraud.
Civil and criminal fraud requires different degrees of proof and the
Government is required to establish the burden of proof for each. Criminal
fraud requires that the strictest evidential standard of proof. Criminal fraud
results in a punitive action with penalties consisting of fines and/or
imprisonment.
In addition to the statutory regime of the Code and Regulations, the Internal
Revenue Manual and Fraud Handbook are available to examiners to assist in
the development of fraud.
Fraud
5-14
