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Original documents obtained from the taxpayer or third parties should not be marked, indexed, hole punched, or in any way altered by the compliance employee. Also, it is critical that the compliance employee attempt to secure the taxpayer’s explanation(s) for any discrepancies. [iv] Internal Revenue Manual 126.96.36.199 () [v] See Gajewski v. Unusual, inconsistent or incongruous items should alert the IRS examiner to the possibility of fraud and the need for further investigation.
This privilege does not extend to the actual return preparation.
Section 6663(a) provides that, if any part of an underpayment is due to fraud, there shall be added to the tax an amount equal to 75% of the portion of the underpayment which is attributable to fraud.
The IRS bears the burden of proving by clear and convincing evidence that: (1) An underpayment of tax exists; and (2) some portion of the underpayment is attributable to fraud.[i] In the case of a joint return, intent must be established for each spouse separately and the fraud of one spouse cannot be used to impute fraud to the other spouse.
If fraud is discovered, it is important for the IRS to determine who is responsible for the fraudulent act(s) – the taxpayer, the tax return preparer or both.
If the taxpayer is not responsible, then neither criminal and/or civil fraud penalties should apply to the taxpayer although some courts have attributed fraud by the preparer to the taxpayer in the context of the civil fraud penalty and extending the unlimited statute of limitations associated with a fraudulent return.
Indications of fraud may be disclosed in discussions, financial activities and nonresponsive answers. Similarly, nonresponsive answers are to be noted verbatim and the IRS examiner will exercise their judgment in deciding what information is relevant (affidavits may be used).