Sometimes an individual will come to me with a pesky problem – they have filed a tax return, but it fraudulently omitted income. Typically, a lot of income. Typically, from foreign sources. Always, in hopes the omission will go unnoticed by the IRS. The thinking is along the lines that since the omission involves foreign income from a foreign payor, Forms W-2 or 1099 are not filed by the payor to the IRS. The reasoning follows that “the IRS will never know”.
Then, some sleepless night occur – a guilty conscience, fear of detection due to FATCA or an IRS audit, or perhaps an audit that is already underway. The individual has a change of heart and wants to rectify his prior fraud. He wants to know if he can file an amended return reporting the previously omitted income.
Here’s the scoop:
Play Now, Pay Later
Once a taxpayer files an incorrect tax return (e.g., omitting income) with the intent to evade tax, that is a fraudulent return. Filing a fraudulent tax return can be a criminal offense, carries significant penalties, and its filing does not start the statute of limitations (this means the IRS can come after you “forever” with respect to that particular tax year). With one possible exception, discussed more fully below, that filing cannot be “undone” by a later filing of a correct amended tax return. Think of it as the tax return equivalent of the “play now, pay later” principle.
Gary and Jessie Gaskin recently learned this lesson the hard way in the US Tax Court. In Gary Gaskin and Jessie Gaskin v. Commissioner, T.C. Memo. 2018-89 (June 20, 2018), Judge Buch let them know in no uncertain terms that filing an amended return could not erase their previously committed tax fraud.
Taxpayers in the position of having filed fraudulent tax returns need to obtain proper advice. With the closure of the IRS Offshore Voluntary Disclosure Program (OVDP), choices are limited. You can learn more here.
Possible Escape Route?
Is every fraudulent tax filing completely irredeemable? Maybe not!
In Haggar Co. v. Helvering, 308 U.S. 389 (1940), the United States Supreme Court held that if the taxpayer files a timely amended return, that later return is generally treated as the taxpayer’s return for most purposes. With this as backdrop, in SCA 1998-024 the IRS has applied this principle to the hypothetical case of a taxpayer who files a fraudulent return, followed by the filing of a timely nonfraudulent amended return. IRS concluded that the statute of limitations period is the typical 3 years, under Internal Revenue Code § 6501(a), rather than the unlimited (“forever”) statute under Internal Revenue Code § 6501(c)(1). In this discussion IRS points out that the term “timely amended return” means a return filed on or before the original or extended tax return due date. This differs from the usage for refund purposes in § 6511, where an amended return claiming a refund is “timely” if filed within the refund limitations period, generally 3 years from the filing of the original return. A “timely amended return” in the sense used in this discussion is sometimes referred to as a “substitute,” “supplemental,” or “superseding” return.
For example, if your 2017 tax return was properly put on extension until October 15, 2018 and it was a fraudulent return that you filed just last week, you might be able to save yourself if you act FAST!
While the SCA was limited in scope to the statute of limitations context, it may be possible that a taxpayer can also avoid imposition of the fraud penalties by filing an accurate “timely amended return” (i.e., a return filed on or before the original or extended tax return due date).
A so-called SCA is what is known as “Service Center Advice”, a form of advice concerning tax administration responsibilities issued by the Office of Chief Counsel of the IRS. The Office of Chief Counsel prepares various types of internal advice, typically issued to revenue agents within the IRS. It is very important to note that an SCA has no precedential value and cannot be relied on by taxpayers. Nonetheless, an SCA may be useful for background or insight into a position the IRS might take when other guidance is not available.
I take this opportunity to remind taxpayers that the IRS has quietly confirmed in an internal memo that tax guidance published on its website holds no legal authority. Instead, binding rules can be found only in an obscure collection of more than 2000 pages per year – the Internal Revenue Bulletin. Typically, IRS Publications, tax form instructions, FAQs and similar IRS information cannot be relied upon. More detail on this sad state of affairs can be found at my tax blog post here.
When it comes to tax returns, “playing now and paying later” is not a good idea. In the context of filing a fraudulent tax return, paying later might mean jail time. Think twice!
Posted October 9, 2018
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