Section 6663 covers the information dealing with the civil fraud penalty and how it is administered. The penalty is equal to 75% of the underpayment of tax that is directly or indirectly due to fraud. The burden of proof rests with the IRS on proving that the underpayment was due to fraudulent activity.
In this situation, underpayment means the difference between the correct tax liability and the amount of tax reported on the return plus the amount of additional tax already assessed. It is important to remember however that once it has been proven by the IRS that any of the underpayment is due to fraud, it is assumed the entire underpayment is attributable to fraud.
This shifts the burden of proof responsibility from the IRS to the taxpayer. It is the taxpayer’s job to prove to the IRS which parts of the underpayment are due to fraud and which is not. This is difficult to do because you have to openly admit that you have committed fraud before you can separate what is legitimate underpayment and what is not.
Defining Tax Fraud
The Internal Revenue Manual defines tax fraud as “an intentional wrongdoing on the part of a taxpayer, with the specific purpose to evade a tax known or believed to owe”. This means that for the IRS to assess the civil fraud penalty, they need to establish that a part of the deficiency is due to a knowingly false representation by the taxpayer.