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FRAUD = FRAUD? NOT ALWAYS

March 24, 2006

Former attorney Ellis Neder was a bad boy. He...

...was convicted of conspiracy to defraud a financial institution, bank fraud, mail fraud, wire fraud, making false statements to financial institutions, racketeering, and filing false tax returns for 1985 and 1986. He was sentenced to 12 years and 3 months in prison and 5 years of probation, and he was ordered to make restitution totaling more than $25 million to various financial institutions. Petitioner's prison sentence included 3 years for filing a false tax return for 1985.

One of the grim facts of tax crime is that going to jail doesn't get you off the hook. You still have to pay the taxes you evaded, of course. What's more, the IRS can assert a "civil fraud" penalty of 75% of the tax that was dodged. Considering he went to jail on criminal tax evasion penalties, you'd think surely the civil fraud penalty would stick. Think again.

The Tax Court yesterday said that Mr. Neder was only liable for the 25% "substantial understatement" penalty. Tax Court Judge Colvin said there was not enough evidence presented at the criminal trial to show that Mr. Neder "fraudulently intended to evade tax." The burden of proof is on the IRS to show fraudulent intent; without additional proof, the judge declined to slap Mr. Neder with fraud penalties.

Things are turned around with respect to the 25% "substantial understatement" penalty; the burden of proof is on the taxpayer, not the IRS. The taxpayer presented no evidence that his underreporting was justified, so he got the 25% penalty.

The Moral? It's a perverse tax law that can jail you for evasion but not fine you for fraud in the same case.

Cite: Ellis E. Neder, Jr., T.C. Memo. 2006-54

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