Fraudulent intent lands CPA in hot water

By James A. Beavers, CPA, CGMA, J.D., LL.M.

In a consolidated case involving a professional services corporation and a taxpayer, who owned and managed the company, and his wife as individual taxpayers, the Tax Court upheld the assessment of fraud penalties against the corporation and the husband, but not against the wife.


Al Benavides was a CPA who from 1991 on was the sole owner and manager of Benavides & Co. PC (BCO), a professional services corporation in Montana that offered various accounting and tax services. During the years in question in the case, his wife, Louise, performed clerical work, including data entry and some bookkeeping services, for BCO.

The couple also owned a partnership in Montana called Sunrise that was in the business of real estate management and development. They also owned other entities in Montana that owned property in the state, including La-Jam Properties LP. In 2004, Sunrise paid for construction of a 3,500-square-foot shop on La-Jam's land that the Benavideses used for storage.

In 2011, Mr. Benavides entered a guilty plea to one count of assisting in the preparation of a false or fraudulent income tax return in violation of Sec. 7206(2). Mr. Benavides, through BCO, collected "fees for services" from a client, purchased a personal item for the client, and then assisted in preparing the client's tax return claiming a business expense deduction for the cost of the personal item mischaracterized as "fees." Mr. Benavides was sentenced to a prison term of 12 months and one day, was on supervised release for one year, and paid a $25,000 fine.

BCO and Sunrise audit: Mr. Benavides, in addition to helping a client gin up a deduction, had been up to many other tax improprieties on behalf of BCO, himself, and, by extension, his wife. On auditing BCO's returns, the IRS found that BCO did not report all of the payments it received from clients as taxable income. Instead, Mr. Benavides divided up the payments received from clients and treated some of them as BCO's income and some as income of Sunrise and other entities owned by Mr. Benavides and his wife.

BCO also in some cases received merchandise or services in return for accounting services but failed to include the value of these so-called trades in income. Furthermore, the IRS found that under Mr. Benavides's direction, Sunrise had taken large amounts of improper depreciation, Sec. 179, and other deductions.

As a result of the audit, the IRS made significant upward adjustments to BCO's income. It also made significant downward adjustments to the income of Sunrise, which was the main recipient of client payments that were diverted from BCO. However, it also disallowed a large amount of deductions taken by Sunrise, with the net result that Sunrise had an increase in income each year for the years in question, and the increase flowed through to the Benavideses.

In Tax Court, Mr. Benavides offered up various arguments that the IRS adjustments were incorrect or overstated. The Tax Court rejected all these arguments, which it characterized as "weak" and "self-serving," and upheld the IRS's adjustments to BCO's and Sunrise's taxable income, and the assessments of tax against BCO based on these adjustments.

Benavides audit: The Benavideses were audited for the same tax years as BCO: 2003, 2004, and 2005, years in which they filed joint returns. The Benavideses did not report the gross receipts that were diverted from BCO to Sunrise and other entities on their joint returns as income from BCO. The IRS determined that the diverted funds should have been treated as constructive dividends to the couple and included on their returns as qualified dividends. In addition, related to the additional gross income due to the adjustments to Sunrise's income and expenses, the IRS also found that the couple had self-employment income. Finally, the Service made related adjustments to the couple's adjusted gross income, itemized deductions, and exemptions. Again, the court rejected the arguments made against these adjustments and upheld the adjustments and the corresponding assessments of tax to the couple.

Fraud penalties under Sec. 6663(a)

Sec. 6663(a) provides: "If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud." For purposes of federal tax, fraud is an intentional wrongdoing on the part of a taxpayer with the specific purpose to evade a tax believed to be owed.

The IRS has the burden of proving fraud and must show, by clear and convincing evidence for each year, that (1) an underpayment of tax exists and (2) some portion is attributable to fraud. If taxpayers file joint returns, the IRS must prove separately that each spouse committed fraud. An underpayment for a year is attributable to fraud if a taxpayer intends to conceal, mislead, or otherwise prevent the collection of taxes known or believed to be owing. If any portion of the underpayment for a year is shown to be attributable to fraud, the entire underpayment is treated as attributable to fraud, except any portion that the taxpayer establishes under the preponderance-of-the-evidence standard is not attributable to fraud.

Underpayment of tax: Whether there was an underpayment of tax for both BCO and the Benavideses was an easy question for the Tax Court. It found that because Mr. Benavides admitted to diverting gross receipts from BCO to Sunrise, and the diverted funds were taxable income to BCO and constructive dividends to the Benavideses, the IRS had proved some underpayments of tax with respect to BCO and the couple.

Fraudulent intent: In determining whether fraudulent intent exists, courts consider whether certain badges of fraud are present: (1) understating income; (2) maintaining inadequate records; (3) failing to file tax returns; (4) giving implausible or inconsistent explanations of behavior; (5) concealing assets; (6) failing to cooperate with tax authorities; (7) engaging in illegal activities; (8) attempting to conceal illegal activities; (9) dealing in cash; and (10) failing to make estimated payments. This list is not exhaustive, however, and no single factor is dispositive of fraud, although the combination of several factors may constitute persuasive evidence of fraud.

A corporation acts through its officers and, therefore, is responsible for the acts of officers in their capacity as such. Consequently, to determine whether BCO had fraudulent intent, the court looked to the actions of Mr. Benavides, who was its sole owner and manager.

The Tax Court found that diverting gross receipts from BCO to Sunrise and other entities was a badge of fraud because it showed a consistent pattern of underreporting by both BCO and Mr. Benavides, which was evidence of an intent to avoid both corporate tax and individual income tax.

The Tax Court then found that BCO had maintained inadequate records because it maintained two sets of books to track payments to BCO, one for accounts receivable and one for tax, and failed to include the diverted receipts in BCO's tax books. This also was a badge of fraud for Mr. Benavides because he was instrumental in BCO's double-bookkeeping practices and the failure to deposit all of BCO's receipts in its own accounts. The Tax Court found that the maintenance of two sets of books also indicated an effort to conceal taxable income, citing its decision in Potter, T.C. Memo. 2014-18, in which it held that the taxpayer's double bookkeeping to conceal the diversion of corporate receipts was "clear circumstantial evidence of fraudulent intent."

The Tax Court further concluded that Mr. Benavides's criminal conviction was indicative of his fraudulent intent vis-á-vis the IRS and federal income taxes. In the underlying scheme that was the basis of the conviction, Mr. Benavides collected fees from a client, purchased a personal item for the client, and then helped prepare a return claiming a deduction for the alleged fees that were actually used to purchase the personal item. The court found that he had intentionally done the same thing with BCO for the corporation's and his benefit by diverting BCO's income to hide it from the IRS and avoid tax on the income.

Finally, according to the court, another badge of fraud, inconsistent and implausible explanations for behavior, was clearly evident for BCO and Mr. Benavides in his explanations regarding the diversion of income. Mr. Benavides claimed that while gross receipts of BCO may have been redirected, they all ended up as taxable income somewhere on the Benavideses' joint return or the returns of one of the entities they owned, which he said indicated a lack of fraudulent intent. Mr. Benavides also claimed that it was "rather silly" for the IRS to suggest that he had tried to evade corporate taxes because he was just paying himself reasonable compensation by "stripping" taxable income out of BCO. In addition, he admitted to engaging in "hurried, short-circuited bookkeeping practices," but that he intended only to engage in legitimate tax planning by paying himself a reasonable salary.

The Tax Court took special umbrage with this last contention. The court found that given his education, his CPA credential, and his years of experience in tax matters, Mr. Benavides should have known he could not ignore the separate existence of BCO, and the fact that he did was evidence of fraudulent intent. The court further stated that an argument that taxpayers whose business involved handling "the tax and accounting matters of others should escape the fraud penalty because of sloppy bookkeeping — itself a badge of fraud — is risible."

In conclusion, the court found that Mr. Benavides's intentional acts to decrease BCO's and his own taxable income were clear and convincing evidence of the necessary fraudulent intent for both him and BCO, and that there were "ample indicia of fraud" for both him and the company for all of the years at issue.

Mrs. Benavides: While the court took a hard stance against Mr. Benavides on fraudulent intent, it was more lenient on Mrs. Benavides because of her more limited involvement with BCO and Sunrise and her limited expertise in accounting and tax. While the court found that the tasks she performed at BCO, along with her relationship with Mr. Benavides, suggested that she may have known about the diverted BCO gross receipts, it found that it could not presume that she did without additional indicia of fraud. Therefore, it held that the IRS had not proved by clear and convincing evidence that Mrs. Benavides had the fraudulent intent necessary to assess a Sec. 6663(a) fraud penalty against her separately.


Under the rules in Sec. 6663, although Mrs. Benavides cannot be assessed for any of the fraud penalty, Mr. Benavides can nonetheless be assessed the penalty on the full amount of the underpayment of tax attributable to fraud on the couple's joint return. Thus, even if the IRS could have proved Mrs. Benavides was also guilty of fraud under Sec. 6663, it had little incentive to make the effort to do so.

Benavides & Co, P.C., T.C. Memo. 2019-115

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