The penalties for negligent errors on your tax return can be high, but they pale in comparison to those imposed if the government (federal and/or state) concludes that your mistakes were intentional. In this post, we are going to focus on the difference between a finding of negligence in the imposition of accuracy-related penalties and criminal tax fraud.
Criminal tax fraud investigations by the IRS and California Franchise Tax Board (FTB) and they are almost always devastating on both a personal and a professional level. Activities that tend to trigger criminal fraud investigations include:
- Submitting false documents to the tax authorities
- Mixing personal and business expenses
- Intentionally misrepresenting income and transfers
- Maintaining two sets of financial records, and/or
- Gross overstatement of deductions and exemptions
The penalty for civil tax fraud is 75% of the tax underpayment – if you are being audited for significant tax understatements, it is crucial to hire a tax attorney to help you convince the government that your case should not be referred for criminal investigation.
Negligence or disregard of tax rules and regulations
If the government cannot meet its burden of proof for tax fraud, it may claim that your tax understatement was due to negligence or disregard of tax rules and regulations.
As noted in Part I, the accuracy-related penalty for negligence under 26 U.S. Code § 6662 or California Revenue and Taxation Code (R&TC) Section 19164 is 20% of the underreported amount of tax, or 40% for tax years prior to January 1, 2003, with exceptions (or for any gross misstatement, see Part III). This penalty may be assessed if the government finds that you:
- Failed to keep adequate books and records that prove what you claimed on your return
- Took a position on a tax return without having a reasonable basis for doing so
- Failed to check the accuracy of a tax deduction or credit
- Neglected to include income on your tax return, particularly where the income appears on a 1099 or other information return, and/or
- Repeatedly make the same mistakes on your tax return, year after year, despite being notified that those particular claims are not permitted.
If you can prove that you followed proper tax procedures and simply made a mistake, you can probably get out of an accuracy-related penalty for negligence. However, if your tax understatement was significant, higher penalties may apply.
Our next post will focus on substantial misstatements of income and asset valuations.