This wasn't exactly the way it was taught in Bookkeeping 101, but was it fraud? The Internal Revenue Service thought it was.

The couple operated a landscape business in Poland, Ohio. Neither of them had finished high school. As a common laborer, Chester learned the difference between a dogwood and a cedar but not between a debit and a credit. His wife didn't understand bookkeeping either. She recorded each job on a memo pad from customers' names which dotted their refrigerator. An accountant prepared their tax returns from her one-page summary of expenses and income, based on the frigid notes.

The IRS discovered large differences between income reported and bank deposits, as well as several math errors. Theresa, in trying to find reasons for the differences, later located some missing jobs written on envelopes still in her purse. The agency increased their taxes $5,806 and added a fraud penalty. The Rutanas agreed with the tax but not the fraud.

The judge reversed the penalty, and because this obviously wasn't fraud, he ordered the government to pay the couple's legal fees. Sure, Theresa used a rudimentary and inherently flawed bookkeeping system, but there was no intentional concealment, deliberate misrepresentation or pattern of errors which could constitute fraud. And the IRS received full cooperation from the couple. Some math errors favored the IRS, the judge noted. The agent had suspected fraud, but suspicion of fraud is not evidence of fraud.

In the Rutana case, the agent considered inaccurate records sufficient evidence to assess a fraud penalty. Usually, the IRS finds one of the following badges of fraud before it adds the penalty: efforts to hide assets, attempts to conceal activities, patterns of understating income, knowledgeable taxpayers who should know better and implausible or inconsistent explanations of behavior.

Leonard D. Poor from Red Bank, New Jersey was under a lot of pressure at work to develop a new technology for Bell Telephone Laboratories. Home was no better: his wife suffered from so much emotional distress that she continuously took medication. The tax problem came after he opened 81 savings accounts at 28 banks over a three year period. He did this to get gifts banks offered new customers. The trauma in Poor's life caused him to lose track of how much interest to report to the IRS.

The agency increased income and added a fraud penalty. Mercifully, the judge reversed the penalty. He considered the lack of accounting experience and the pressure in the poor man's life.

Funeral home owner James J. Dagon buried money under a rug in his office until he could get to the bank. The Hornell, NY mortician's bookkeeping was just as careless.

The IRS said he understated income by $46,000 over four years. It increased his taxes and added a fraud penalty. The judge, however, reversed the penalty. He noted the taxpayer's cooperation with the IRS, the accuracy of available records and the number of legitimate deductions Dagon could have taken but didn't.

As the cases show, at times the IRS is overreaching. To get a fraud conviction, evidence must show the tax underpayment was intentional. As one judge said, it is not enough to prove the taxpayer was careless, stubborn or stupid.

The Moral:  Sometimes, a little knowledge is a good excuse.

A.J. Cook is a lawyer and CPA. His tax column appears weekly in numerous newspapers. Why isn't it published in your hometown newspaper? Ask its Business Editor to subscribe.

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Released 1-10-2000