IRS nonacquiesces to Tax Court fraud holding.

• Author: Beavers, James A.

The IRS nonacquiesced to the Tax Court's decision in Norris, T.C. Memo. 2011-161, in which the Tax Court held that husband and wife taxpayers were not liable for fraud penalties on their unreported income. The IRS believes that the Tax Court improperly used a "rigid" 11-factor test to determine the existence of fraud instead of making the determination by considering the taxpayer's entire course of conduct.

Background--The Norris Case

William Norris and his wife, Sharon, were natives of Nashville, Tennessee. Mr. Norris initially worked strictly as a self-employed specialty welder. Later, the couple bought a convenience store, which Mrs. Norris managed and Mr. Norris also worked at in addition to his welding business. For the years in question, 1996 and 1998, the couple ran an illegal video poker operation in a back room in the store. They also gambled frequently in Las Vegas and, in 1996, in addition to cash winnings, won a car valued at $35,800.

The Norrises were not model taxpayers. Mr. Norris's welding business was largely cash-based, and, allegedly, he did not report all his income from the business. Mrs. Norris, who kept the books for the convenience store, made a gross error in calculating its receipts, leading to an understatement of income from the legal portion of its operations in 1996. The IRS alleged that the Norrises did not pay tax on either any or all of the income from their illegal gambling operation, though it was not able to prove the allegation conclusively because of the state of the couple's records. The couple reported their cash winnings from legal gambling, but failed to report the value of the car that they won in 1996.

In 2005, the government indicted Mr. Norris for two counts of criminal tax evasion, one for 1996 and one for 1998. He pled guilty to the 1998 charge, and the government, as part of the plea deal, dismissed the 1996 charge. Mr. Norris was sentenced to 15 months in jail and ordered to pay restitution of the amount of tax he admitted to underpaying for both years.

The IRS also conducted a civil audit of the Norrises, using the indirect method to determine their income. The audit resulted in the IRS's issuing a notice of deficiency in 2008 for 1996 and 1998, assessing deficiencies for tax owed and fraud penalties against the couple for both years. Although the notice of deficiency was not issued until long after the Sec. 6501(a) deadline for assessing tax had passed, the IRS relied on Sec. 6501(c)(1)...