Carlson v. United States: Panel Creates Circuit Split with Second and Eighth Circuits in Determining that the Government Must Prove that Civil Tax Fraud by Clear and Convincing Evidence

Carlson v. United States, No. 12-13736, from MDFla

Senior Circuit Judge Cox, Chief Circuit Judge Carnes and Circuit Judge Hull

Summary:  The plaintiff filed a declaratory action against the IRS to determine her liability for $148,000 in tax penalties assessed by the IRS for aiding and abetting an understatement of tax liability in violation of I.R.C. § 6701.  The plaintiff worked for Jackson Hewitt for approximately five years as a tax return preparer.  She prepared individual and corporate tax returns using a computer program.  The IRS eventually audited the Jackson Hewitt for which the plaintiff worked and determined that deductions could not be substantiated on approximately 40 of the 1200 returns on which she worked. She was assessed penalties, of which she paid 15% and then filed for a refund.  After the refund claim was denied, she filed this suit to determine her liability.

The government conceded 13 of the penalties at summary judgment, but the remaining 27 were tried to a jury.  On appeal, the plaintiff raised two issues.  

First, the plaintiff argued that the district court had erred by instructing the jury that the standard of proof was a preponderance of the evidence.  The panel concluded that the proper burden of proof was clear and convincing evidence, because the government must prove fraud in civil tax cases by such a standard.  This was required because § 6701 has a requirement of actual knowledge, meaning that the government must prove fraud, which in turn must be proved by clear and convincing evidence.

This conclusion differed from decisions reached by the Second and Eighth Circuits, which have held that the proper standard of proof is only a preponderance of the evidence and thus creates a circuit split.  Because many of the penalties were supported by only weak evidence, the panel concluded that this error was not harmless. 

Second, the plaintiff argued that the district court erred by denying her motion for judgment as a matter of law with respect to several penalties. Since the panel concluded that for each of the challenged penalties the government presented no evidence suggesting actual knowledge that the returns understated the correct tax, it concluded that no reasonable jury could find for the government on these penalties and accordingly reversed the district court’s denial of the motion for judgment as a matter of law.  Interestingly, the panel noted that an auditor’s finding that a return understated the correct tax did not show actual knowledge of inaccuracy because “[h]igh error rates are normal even among the IRS’s own tax preparers.”

The district court’s judgment was accordingly reversed in part with respect to the denial of the motion for judgment as a matter of law, and vacated and remanded in part for a new trial using the proper standard of proof.