What's cheating? Determining the liability for tax fraud under Section 6653 after Parks

National Public Accountant, The, Jan, 1992 by Patricia S. Wall

What's Cheating?

Determining Liability For TAX FRAUD Under Section 6653 (B) After Parks(1)

Tax liability has become an area of concern with the upswing of "white collar" crime and the increased emphasis society places on ethical issues. Tax liability may be understated in two obvious ways: income may be understated or deductions overstated. The Internal Revenue Service has the challenging job of trying to determine whether this has occurred. A recent tax court decision, Parks v. Commissioner(2) has just made the job a little easier. This paper reviews this recent decision and also surveys a number of other cases to determine the criteria the tax court considers in civil fraud cases.

Tax Fraud Provisions Involved

Under IRC Section 6653(b), the civil fraud penalty provision, the penalty for returns due prior to 1987 is the sum of 50% of the underpayment of tax due plus 50% of the interest since the due date of the return without extensions.(3) The 1986 Tax Reform Act increased this penalty for returns after 1986 from 50% to 75%.(4)

Burden of Proof

According to case law, the IRS has the burden of proving by clear and convincing evidence that there is an underpayment of tax for each year in question, and that some part of this underpayment is due to fraud. Until the Tax Reform Act of 1986, the penalty was applied to the entire amount of the underpayment for each year, so that the exact amount of under statement due to fraud was irrelevant. Since the Tax Reform Act of 1986, the 75% penalty is applied to the entire amount, except for any portion that the taxpayer can prove is not due to fraud. When unable to prove fraud, the IRS has three years after the due date of the return to assess the taxpayer.(5) In cases where the IRS can prove fraud, however, there is no statute of limitations.(6) In the event the Service is unable to prove fraud, the deficiency stands unless the taxpayer proves by a preponderance of the evidence that it is incorrect.(7)

Fraud may be defined as a matter of intent and refers to a deliberate action on the part of the taxpayer.(8) Fraud is a question of fact to be determined from the entire record.(9) Usually, fraudulent intent cannot be determined by direct evidence, so the defendant's entire course of conduct must be considered(10)

Parks v. Commissioner

Ruth B. Parks, ironically employed by the IRS Memphis Service Center, was what one would term loosely a "big spender." Although her monthly take-home pay was only about $800, Ms. Parks banked and spent tens of thousands of dollars. She made cash deposits of $11,635 in addition to her wages to four bank accounts during 1983. She purchased six cashier's checks during 1983 totaling $12,575 to make a down payment on a Cadillac, and paid the car off two months later with another $12,000 in cashier's checks. Moreover, during 1984 Ms. Parks made cash deposits of $8,585, purchased a $571 cashier's check, and paid doctors' bills of $1,925 in cash, without withdrawing any cash from her savings accounts or writing any checks to cash. None of this was reported on her 1984 tax return. After the IRS made a bank deposit and expenditure reconstruction of her unreported income, she was assessed deficiencies and fraud penalties for 1983 and 1984. The IRS, however, was unable to determine the source of this income.

Ms. Parks claimed that the source of this money was nontaxable -- a cash hoard of child-support money including a $40,000 lump sum child-support payment her ex-husband (a gambler) made in 1980. Ms. Parks received a divorce in 1975 for cruel and inhuman treatment as Mr. Parks beat her on several occasions, threatened to kill her and their daughter, and shot her. (Petitioner was later arrested for firing shots at Mr. Parks during another domestic battle.) Mr. Parks was ordered to pay $10 per week child support to the Clerk of the Circuit Court of Shelby County, Tennessee. As Mr. Parks was delinquent in his child support payments, Ms. Parks petitioned the court for a garnishment order and thus received $290 in child support because of this during 1976. Mr. Parks made no further child support payments through the court and the parties later stipulated in the tax case that no checks from Mr. Parks were deposited in Ms. Parks bank account during 1983 and 1984. In fact, during the initial audit of her tax return, Ms. Parks stated that she received no child support in 1983 or 1984 and failed to mention receipt of any cash child support payments for previous years which she used for expenditures in 1983 or 1984. Ms. Parks later invoked the Fifth Amendment after her case was referred to the Criminal Investigative Division of the IRS.

The Tax Court set out a two-pronged test for a fraud penalty in cases involving indirectly reconstructed income. Under the Parks test, the IRS must satisfy by clear and convincing evidence both prongs. First, it must prove that an underpayment exists, by proving a likely source of income(11) or by disproving a nontaxable source alleged by the taxpayer.(12) Either will satisfy the first prong. To satisfy the second, the IRS must prove the taxpayer had the required fraudulent intent.