Section 6663 imposes a 75% penalty in the event that any portion of a tax underpayment is attributable to fraud. The problem, of course, is that an allegation of fraud speaks to a taxpayers’ intent, which as you might imagine can be a rather difficult thing to establish. That’s not to say that fraud can’t be proven, however, because like pornography or the infield fly rule, while we may not be able to define it, we typically know it when we see it.
And the Tax Court certainly saw it today, assessing fraud penalties against a corporation and its sole shareholder. Earlier this week, we warned against using a corporation as an incorporated pocketbook, but this is precisely what Gary Garcia did. When revenue came into his wholly-owned airplane repair company, he redirected many of the funds to pay his personal expenses, including his home mortgage. Making matters worse, the funds were paid out of a bank account that was hidden from his CPA.
Over time, the IRS came calling, and Garcia again neglected to turn over detail of the corporation’s secret account. Unfortunately for Gary, the IRS — as opposed to your run-of-the-mill CPA — has the power to issue a summons to a bank requesting all of a taxpayer’s data, and the Service did just that, bringing to light Garcia’s shenanigans.
While Garcia eventually conceded to the additions to tax at both the corporate and personal level — for under-reported corporate income and the assessment of constructive dividend income on his individual return — he fought the imposition of the fraud penalty.
As part of his argument, Garcia maintained that he did not act fraudulently because he relied in good faith on his accountant to prepare his personal return. This is relevant because prior decisions have established that a taxpayer’s justifiable reliance on an accountant to prepare income tax returns may indicate an absence of fraudulent intent.[i]
There was just one small hole in Garcia’s argument: you cannot rely on the fact that a CPA prepared your returns if you concealed the information necessary for your accountant to prepare an accurate tax return. In fact, the purposeful suppression of relevant tax information works the other way; it is evidence of a taxpayer’s intent to conceal and deceive, one of the major indicia of fraud.
The lesson? Be honest with your tax preparer. Give them all of the information necessary to file a complete return, and if they screw up or do something unethical, while an increased tax liability may be coming your way, at least you won’t be stuck with a 75% fraud penalty, like poor Gary Garcia.
[i] Marinzulich v. Commissioner, 31 T.C. 487 (1958).