As a general matter, the burden of proof in any dispute with the IRS has always been with the taxpayer. However, with the enactment of new Section 7491 of the Internal Revenue Code (IRC), enacted July 22, 1998, the burden of proof has been shifted to the IRS for issues of general burdens of proof, statistical information, and penalties.
Now the question remains: what does this mean for the taxpayer? Basically, in cases that involve factual issues, the IRS now has the burden of proving the factual basis for a tax liability once the taxpayer has provided “credible evidence” regarding the questionable issue. However, expect to see a fair amount of litigation on the definition of “credible evidence” as the Code requires that the burden only shift once the taxpayer has demonstrated that they have complied with all the substantiation requirements; maintained all the records required by the IRC; cooperated with IRS’ reasonable requests for witnesses, information, documents, meetings, and interviews; and met certain net worth requirements in the case of partnerships, corporations, or trusts.
Additionally, if the IRS attempts to assert that a taxpayer has income based exclusively on statistical information acquired through unrelated taxpayers, the burden is on the IRS to prove the existence of income. The taxpayer is not required to maintain records or cooperate with the IRS to validate the IRS’s statistical information. However, taxpayers should be aware that as a practical matter it is anticipated that the IRS will attempt to oppose the shifting of the burden of proof by stringently applying each of the prerequisites to shifting the burden of proof away from the tax payer and thereby maintain as much pressure as possible on the taxpayer during the audit and review process.