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SALT Blawg – State and Local Tax Blog

State and Local Tax ("SALT") blog issues require state and local tax knowledge. Chamberlain Hrdlicka's SALT Blawg (SALT Blog) provides exactly that knowledge with news updates and commentary about state and local tax issues.

You can expect to find relevant information about topics such as income (corporate and personal) tax, franchise tax, sales and use tax, property (real and personal) tax, fuel tax, capital stock tax, bank tax, gross receipts tax and withholding tax. SALT Blawg, offers tax talk for tax pros … in your neighborhood.

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To Defeat Fraud Penalties the Best Defense is a Good Offense

In every taxing jurisdiction in the United States, tax authorities may assert penalties if a taxpayer commits fraud.  This Blawg entry focuses on the Texas Comptroller’s view of its authority to impose fraud penalties, and considerations for taxpayers when seeking to fight fraud penalties that the Comptroller asserts.

Texas Tax Code § 111.061 authorizes the Texas Comptroller to impose a penalty in the amount of 50% of any underlying tax liability if the failure to pay the underlying tax or report such tax when due “was a result of fraud or an intent to evade the tax.”  This legal authority applies to any taxes under the jurisdiction of the Texas Comptroller, however we see the Comptroller asserting the fraud penalty most often in sales tax audits and gross receipts / mixed beverage tax audits.  In addition to imposing the fraud penalty against businesses, the Comptroller may impose personal liability for fraud against individuals that perpetrate the fraud.

Importantly, findings of fraud come down to “intent.”  Because the fraud penalty is almost always asserted against businesses, most impositions of fraud penalties by the Texas Comptroller are made to legal entities such as corporations and limited liability companies.  This presents the nuanced issue of how to prove (or disprove) a legal entity’s intent.  In general, the Comptroller should respect the legal entity as separate from its owners, and to prove intent will look to acts and omissions of the entity’s officers, directors, managers, or other governing authority of the taxpayer, as well as to any agent or employee with the actual or apparent authority to prepare information for or submit information to the Comptroller.

When the Comptroller asserts fraud penalties, does the taxpayer have the opportunity to show that the fraud penalty is unjustified?  The answer is categorically “yes.”  Whether through an administrative appeal or action in state district court, taxpayers may defend against assertions of fraud.  Here are a handful of strategic pointers that may apply depending upon the facts of the particular case, and which taxpayers may consider raising in their defense in either court or in an administrative appeal:

First, challenge the underlying liability.  Even if unsuccessful in whole or part, a legitimate challenge to the underlying liability may help establish that even if the Comptroller or court believes taxes are ultimately owed there was sufficient question about the issue to negate a finding of fraudulent intent.

Second, place the burden of proof on the Comptroller.  The Texas Comptroller bears the burden to prove by “clear and convincing evidence” that the imposition of additional penalties for willful or fraudulent failure to pay tax is warranted.  “Clear and convincing” is a high standard to meet.  The Comptroller takes the position it requires proof that intent to commit fraud is “highly probable.”  Arguably, the Comptroller is sugar-coating its steep burden.  To meet the “clear and convincing” standard, the Fifth Circuit has required “that weight of proof which produces in the mind of the trier of fact a firm belief or conviction as to the truth of the allegations sought to be established, evidence so clear, direct and weighty and convincing as to enable the fact finder to come to a clear conviction, without hesitancy, of the truth of the precise facts of the case.”  Texas courts have adopted a similar definition.

Third, challenge the Comptroller’s proof.  The Comptroller must prove by clear and convincing evidence an actual intentional wrongdoing with the specific purpose to evade a tax believed to be owed.  Negligence, even gross negligence, is not equivalent to fraud with intent to evade tax.  Indeed, courts and administrative decisions have accepted that a taxpayer's tax reporting that is merely illogical, negligent, grossly negligent, ill-advised, misinformed, or just plain clueless, does not establish fraudulent intent.

Fourth, in the case of fraud penalties asserted against corporations and limited liability companies, defend against imputing the acts or omissions of a person to the legal entity.  The taxpayer should present evidence that the officer or director (or other person the Comptroller relies on to impute a fraudulent intent to the legal entity-taxpayer) was engaged in an independent course of conduct not in furtherance of a purpose that the taxpayer sanctioned.  If applicable, further show that the person was not involved in the day-to-day affairs of the corporation or limited liability company.

Fifth, the Texas Comptroller takes the position that an error rate of 25% or greater is sufficient to prove fraud, particularly when the taxpayer offers no plausible explanation for the underreporting.  If this is the basis of the Comptroller’s fraud determination, taxpayers should consider challenging the Comptroller’s reliance on the 25% rule as contrary to Texas statutes (the Comptroller relies on a statute that on its face distinguishes between fraud and situations involving gross errors of 25% or greater, thus the statute on which the Comptroller relies does not support equating the two).

At the end of the day, taxpayers faced with fraud penalties – whether in connection with an audit of the taxpayer’s sales & use tax, motor fuels tax, franchise tax, gross receipts and mixed beverage taxes, or any other taxes set forth in the Texas Tax Code – should carefully consider their options.  In addition to the cost of paying a 50% penalty, having a fraud penalty on your “record” can have adverse ramifications.  Taxpayers often have legitimate defenses to defeat fraud penalties that the Texas Comptroller imposes, and should, at the first sign the Comptroller may assert the penalty, take steps to get ahead of it.   

Categories: Texas
  • Peter A. Lowy

    Peter A. Lowy, a shareholder in Chamberlain Hrdlicka’s Houston office, is best known for his tax controversy work and deep experience in the energy sector. He also advises corporations and other taxpayers in a broad spectrum of ...