The Civil Fraud Penalty: 75 Percent, and the IRS Has to Prove It

Most IRS penalties are math. Late filing, late payment, accuracy. The civil fraud penalty is different. It is an accusation, and it costs 75 percent of the underpayment it covers.

It also sits at the intersection of civil and criminal tax law. It can follow a declined criminal referral. It can follow a conviction. It is built into the IRS Voluntary Disclosure Practice. If the IRS is asserting it, or if you are worried it might, you should understand how it works.

This is general information drawn from the Internal Revenue Code and the Internal Revenue Manual, not advice about your case.

What the statute says

IRC 6663 has three subsections, and each one matters.

Subsection (a), the penalty. "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."

Subsection (b), the all-or-nothing rule. "If the Secretary establishes that any portion of an underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud, except with respect to any portion of the underpayment which the taxpayer establishes (by a preponderance of the evidence) is not attributable to fraud."

Read that carefully. The IRS has to prove fraud for some portion. Once it does, the burden shifts, and you have to prove which parts were not fraud. If you cannot, the penalty applies to the whole underpayment.

Subsection (c), joint returns. "In the case of a joint return, this section shall not apply with respect to a spouse unless some part of the underpayment is due to the fraud of such spouse." The IRS manual reinforces this in IRM 25.1.6.2: intent must be established separately for each spouse, and the fraud of one spouse cannot be imputed to the other.

Who has to prove it, and how much proof

Fraud is the rare tax issue where the government carries the burden. IRC 7454(a) says that in any proceeding involving whether the petitioner has been guilty of fraud with intent to evade tax, "the burden of proof in respect of such issue shall be upon the Secretary."

The standard is clear and convincing evidence. IRM 25.1.1.3.1 says that in civil fraud cases the government must prove fraud by clear and convincing evidence, and in criminal cases beyond a reasonable doubt. IRM 25.1.3.1.7 defines clear and convincing evidence as evidence showing that the assertion "is highly probable or reasonably certain," a heavier burden than a preponderance but lighter than reasonable doubt.

Owing tax is not enough. IRM 25.1.6.2 says the fact that a taxpayer has tax due "is not sufficient to assert the civil fraud penalty," and that an affirmative act of fraud must also be present. The same section distinguishes fraudulent intent from "inadvertence, reliance on incorrect technical advice, sincerely-held difference of opinion, negligence or carelessness." See badges of fraud for how the IRS builds that proof.

How the IRS decides to assert it

The penalty does not come from one examiner's hunch. Under IRM 25.1.6.3:

• The examiner discusses indicators with the group manager and contacts a Fraud Enforcement Advisor.
• Determination of the civil fraud penalty is the shared responsibility of the examiner, the group manager, and the FEA. For Large Business and International cases, FEA concurrence is mandatory.
• The FEA reviews the examiner's fraud narrative, which should describe the affirmative acts "in such detail as to leave no doubt" about why the penalty is justified.
• If the manager and FEA disagree, the final decision rests with the group manager.
• Area Counsel must approve the civil fraud penalty before a statutory notice of deficiency is issued.

There is also a statutory approval rule. The IRS civil voluntary disclosure manual, IRM 4.63.3.18.2, notes that managerial penalty approval is subject to the requirements of IRC 6751(b)(1). Whether approval was properly obtained is something a lawyer will check.

The fraudulent failure to file cousin

When no return was filed at all, the parallel penalty is in IRC 6651(f). If a failure to file is fraudulent, the usual failure-to-file addition is applied by substituting 15 percent for 5 percent per month, and 75 percent for the 25 percent cap. The IRS manual treats the two penalties together in its fraud procedures.

The connection to criminal cases

The civil fraud penalty has three important links to the criminal side.

After a declined referral. If Criminal Investigation declines a fraud referral, IRM 25.1.3.6 says the civil examination resumes, and the civil fraud penalty and fraudulent failure to file penalty remain under consideration. A declination means no criminal case. It does not mean no fraud penalty. See when an audit turns criminal.

After a conviction. IRM 25.1.6.3 says the civil fraud penalty or fraudulent failure to file penalty must be asserted if a taxpayer was successfully prosecuted under Title 26, such as sections 7201, 7203, or 7206(1), and the prosecution involved additional tax assessments, with exceptions requiring Area Counsel approval. Under IRM 25.1.6.5, a conviction for evasion under section 7201 collaterally estops the taxpayer from contesting fraud for the convicted years, though the amount of the underpayment can still be disputed. A conviction under section 7206(1) does not have that effect, because it does not require proof of intent to evade. See false returns under section 7206(1).

In plea agreements. The Justice Manual, JM 6-4.360, says the Department strongly encourages, but does not require, plea agreements to include civil admissions, including a stipulation that the defendant is liable for the fraud penalty under section 6663 for the years involved.

The civil fraud penalty in voluntary disclosures

The IRS Voluntary Disclosure Practice builds the penalty in. Under the civil framework in IRM 4.63.3.18.2, a civil fraud penalty or fraudulent failure to file penalty applies to at least one year of every voluntary disclosure, asserted in the year with the highest tax deficiency, in lieu of accuracy-related and delinquency penalties for the other years, assuming full cooperation. The IRS has proposed a different framework, announced December 22, 2025, that has not been finalized. See the voluntary disclosure penalty framework.

What the examiner has to write down

The fraud penalty lives or dies on the written record. IRM 25.1.6.4 says the facts section of the penalty narrative should include a detailed description of all applicable badges of fraud, plus other items of deception or instances where the taxpayer may have misled or misrepresented facts. When fraud was considered and not recommended, IRM 25.1.6.3 says the examiner must explain in the workpapers why it was not asserted.

That means your statements during the audit can end up in the narrative supporting the penalty. It is one more reason to have counsel managing communication with the IRS once fraud is in the conversation.

Defending against the penalty

Every case turns on its facts, and this is not advice for yours. In general terms, the defense focuses on the elements the IRS must prove:

1. Underpayment. Is the underlying tax actually owed? If not, there is nothing for the penalty to attach to.
2. Intent. Is there clear and convincing evidence of intent to evade, or is the record consistent with negligence, reliance on advice, or an honest disagreement?
3. Affirmative acts. Has the IRS identified actual affirmative acts, or only indicators?
4. Allocation. Under section 6663(b), which portions of the underpayment can be shown not to be due to fraud?
5. Spouses. Under section 6663(c), what is the evidence against each spouse separately?
6. Procedure. Were required approvals obtained?

In the U.S. Tax Court, the government carries the burden on fraud under IRC 7454(a). That can change the dynamic of a case.

Collateral estoppel has limits. IRM 25.1.6.5 says the doctrine applies only to the years for which the taxpayer was convicted, and that intent must be established for non-conviction years. For those years, the IRS has to develop and prove fraud the ordinary way.

General information only, not legal advice. Reading this page does not create an attorney-client relationship. Laws and IRS procedures change; the sources cited were reviewed on the date shown above.