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IRS Statute of Limitations and Civil Fraud

By Joel N. Crouch on August 4, 2021
On July 26th, U.S. Tax Court Judge Lauber issued an opinion in George S. Harrington v. Commissioner, upholding the IRS’ determinations that the taxpayer fraudulently underreported his offshore income and the civil fraud penalty applied. There is nothing particularly unique about the case but it includes a very good discussion of the factors the court will consider when the IRS proposes a civil fraud penalty and the resulting impact on the statute of limitations.

On his 2005-2010 tax returns, Harrington reported his assets in the United States and New Zealand, but he didn’t tell the IRS about his assets in Switzerland, Liechtenstein, and the Cayman Islands. After UBS AG turned over 844 pages of information regarding Harrington as part of its deferred prosecution agreement with the Justice Department, the IRS opened an examination of Harrington’s 2005-2010 tax returns. Unfortunately, during the examination the IRS interviewed Harrington on two occasions. In between the two interviews, two things happened: Harrington changed his story, and he told one of his UBS bankers about the audit so they could tweak some of the transactions to make them look “more explainable, and perhaps less embarrassing.” In addition, Harrington provided the revenue agent with amended returns reflecting previously unreported income from offshore accounts and also filed delinquent FBARs. The court did not buy Harrington’s argument that he wasn’t subject to tax because he didn’t control the accounts nor did it buy Harrington’s explanation that his changing story was due to his age and decades-old transactions, writing, “Petitioner testified intelligently at trial; he did not simply misremember a few trivial facts, but mischaracterized facts and events of critical importance.” Not surprisingly, the court held in favor of the IRS.

In upholding the fraud penalty, the court said the IRS must prove by clear and convincing evidence (1) that there was an underpayment of tax for each year at issue, and (2) that at least some portion of the underpayment for each year was due to fraud. With regard to the underpayment of tax, the court said the amended returns filed by Harrington during the examination were a concession that he underpaid taxes for those years.

The court then turned to the badges of fraud used to prove fraudulent intent:

Circumstances that may indicate fraudulent intent, often called ‘badges of fraud’, include but are not limited to: (1) understating income, (2) keeping inadequate records, (3) giving implausible or inconsistent explanations of behavior, (4) concealing income or assets, (5) failing to cooperate with tax authorities, (6) engaging in illegal activities, (7) supplying incomplete or misleading information to a tax return preparer, (8) providing testimony that lacks credibility, (9) filing false documents (including false tax returns), (10) failing to file tax returns, and (11) dealing in cash….. No single factor is dispositive, but the existence of several factors ‘is persuasive circumstantial evidence of fraud.’”
The court concluded that seven of the badges demonstrated that Harrington acted with fraudulent intent, namely those factors relating to understatement of income, keeping inadequate records, giving implausible or inconsistent explanations, concealing income or assets, failure to cooperate with tax authorities, lack of credible taxpayer and filing false documents.

The fraud determination was very important because the IRS issued the notice of deficiency in 2018, more than 7 years after the last tax return, 2010, was filed. IRC Section 6501(a) generally requires the IRS to assess tax within three years after the return is filed. However, Section 6501(c)(1) provides that, where a taxpayer has filed “a false or fraudulent return with the intent to evade tax,” there is no period of limitations and the tax “may be assessed… at any time.” The court did not agree with any of Harrington’s arguments that the fraud penalty and extended statute of limitations did not apply because he had reasonable cause, acted in good faith and had a good faith misunderstanding of the tax laws.

For questions regarding this blog post or any other civil or criminal tax-related matter, please feel free to contact Joel Crouch at (214) 749-2456 or jcrouch@meadowscollier.com.