Understatement of income not fraudulent.

• Author: Beavers, James A.
• Position: 2016 Tax Court memorandum decision in Ericson v. Commissioner

The Tax Court held that the IRS's claim of a pattern of fraudulent conduct in a tax accountant's preparation of his clients' returns was not sufficient to prove that the underpayments of tax on his and his wife's own returns were due to fraud.

Background

James and Rebecca Ericson filed joint returns for the years 2006 through 2008. Rebecca worked as a registered nurse and operated a side business that primarily involved the sale of fashion jewelry. James operated a business through which he provided tax preparation services, took and sold photographs, and sold merchandise.

Mr. Ericson had prepared tax returns as part of his business for over 20 years. Although he had a bachelor's degree in business and a master's degree, when he started preparing returns, he had little education and training specifically related to taxes and tax return preparation. Nonetheless, his tax preparation activity flourished, and during the years in question he prepared over 2,500 returns.

The IRS audited the Ericsons' returns for the years 2006 through 2008. The Service found that the Ericsons had a liberal concept of what qualified as deductible business expenses for their activities, which they balanced out with a conservative approach to what qualified as taxable income of the activities. The IRS determined a deficiency in excess of $30,000 for each year and imposed a Sec. 6663 fraud penalty for each year. The Ericsons challenged the IRS's determination in Tax Court.

The Fraud Penalties

Under Sec. 6663, if any part of any underpayment of tax required to be shown on a return is due to fraud, an amount equal to 75% of the portion of the underpayment that is attributable to the fraud is added to the tax. If any portion of an underpayment is attributable to fraud, the entire underpayment will be considered due to fraud except for the part of the underpayment that the taxpayer can prove is not due to fraud.

A determination of fraud will be sustained against an individual taxpayer only if the IRS can prove by clear and convincing evidence that the taxpayer underpaid his or her tax and at least some part of the underpayment was due to fraud. To prove fraud, the IRS must show that a taxpayer had the requisite fraudulent intent for each year in issue. A taxpayer has fraudulent intent if the taxpayer filed his or her tax returns for the years at issue intending to conceal, mislead, or otherwise prevent the collection of tax that the taxpayer knew he or she owed.

Whether...