Court upholds fraud penalties against tax preparer over false business costs

A tax preparer tried to shave down his tax bill. He got a few deductions, but the 75% civil fraud penalty stuck for 2008 and 2009. Not exactly a win.

Holding

The Tax Court mostly sided with the IRS. Pinckney’s fraud penalties survived for both years. The Court did trim Daitech’s 2008 gross receipts to $376,712 and bumped up 2009 business expenses to $66,963. S corporation status? Not happening. The final numbers are still pending under Rule 155.

Why It Matters

• Proving fraud on one adjustment can expose the entire underpayment to the fraud penalty. The IRS proved that Pinckney fraudulently claimed nonexistent costs of goods sold. Section 6663(b) then required him to establish which remaining portions of each underpayment did not result from fraud. He failed to do so.

• A new income reconstruction can shift the burden to the IRS. The IRS introduced a bank-deposit analysis that the notice of deficiency had not described and that required different evidence. The Court treated that analysis as a new matter. For 2008, the IRS failed to prove that $3,613 of unidentified deposits represented taxable income.

• Business-account payments do not establish business deductions. Bank records documented payments, but many entries did not establish what Pinckney bought or how the purchase served Daitech. The Court allowed supported expenses while rejecting vague descriptions and unsupported claims of business use.

• The opinion applies established rules to an extensive factual record. It does not treat every substantiation failure as fraud. The IRS separately proved intentional misconduct. That finding also kept the assessment periods open under the fraud exception.

Key Facts

Pinckney owned and operated Daitech (a South Carolina tax return preparation business organised as a single member LLC). Daitech provided services. It did not sell goods.

His original returns nevertheless show Daitech COGS at $23,231 for 2008 and $30,667 for 2009. COGS is sales less the cost of the merchandise sold. Pinckney also underreported business income and claimed disputed business and personal deductions.

The IRS 2019 notice said Pinckney was liable for $71,581 in 2008 and $75,638 in 2009 plus fraud penalties in excess of $53,000 each year. That was just the beginning. The final bill is not yet determined.

The civil examination started in 2010 after the 2008 return was randomly selected. It was expanded to cover 2009 and then suspended in April 2012. A criminal investigation ensued. Pinckney pleaded guilty in 2015 to a charge of conspiracy to file false income tax returns under 18 U.S.C. section 371. He admitted to having lied on his own returns during a codefendant's 2016 trial.

The IRS reopened the civil audit. They got Daitech's bank records and reconstituted the numbers from scratch. The Court didn't just take anyone's totals at face value. Every transaction was looked at.