The Meaning and Consequences of a "Fraudulent" Tax Return
By: STEVEN Z. KAPLAN
July 2004
Most are familiar with the adage that “ignorance of the law is no excuse.” In the area of “tax fraud,” however, this cliché may not apply. Under federal law, a tax return is “fraudulent” if the taxpayer files it knowing that the return either omits taxable income or claims one or more deductions that are not allowable. To prove “fraud” (either for civil penalty or criminal tax-evasion purposes), the government must establish that the taxpayer knew the tax law did not permit the treatment reported (or not reported) on the return and that, despite such actual knowledge, the taxpayer nonetheless willfully and deliberately filed the return.
Under this test, a taxpayer who files a tax return subjectively believing that it is correct does not file a “fraudulent” return, even if the return contains errors that, in the light of objective fact and reason, are not merely wrong, but entirely misguided. For example, a tax protester who reports certain income or deductions in a manner this is patently wrong would not be liable for fraud—either criminally or civilly—so long as he or she sincerely believes the return complies with the law. While those mistaken beliefs may result in civil penalties for late payment, substantial underpayment, or late filing, they will not subject the protester to criminal or civil allegations of tax evasion or fraud, so long as he or she acted in good faith.
To prove the return fraudulent, the government will normally rely on such factors as a taxpayer’s education, experience, and knowledge of financial affairs. The question for the court or jury then becomes one of drawing inferences from the objective facts and weighing them against the taxpayer’s claims that he truly believed that the return was compliant with the tax law.
If the government is able to overcome a taxpayer’s defense of good faith and prove that the return was fraudulent, there may be serious consequences. A knowingly false return may be the predicate to criminal prosecution not only for filing a false return, but also for the more serious crime of tax evasion, if combined with any other act indicating intent to evade reporting or paying the correct tax liability.
The civil consequences may also be severe. A fraudulent return is deemed tantamount to no return at all, meaning that the statute of limitations within which the IRS may assert proposed deficiencies of tax never begins to run. The taxpayer is forever exposed to the potential for additional tax liabilities, as well as civil fraud penalties currently equaling 75 percent of the fraudulently unreported tax. Interest accrues on the penalty amount, as well as on the underreported tax. Given the stakes involved, a taxpayer must never take the obligation to file an honest return cavalierly.