Common Badges of Tax Fraud Uncovered

Abstract

Tax practitioners must be sensitive to the process by which an IRS civil tax examination might wind its way through the administrative system to imposition of a civil fraud penalty or, perhaps, to a recommendation for criminal prosecution by the Department of Justice.

The conduct of the taxpayer during an examination can rapidly transform a civil inquiry into a criminal investigation. There is no substitute for mastering the facts and anticipating which, if any, “badges of fraud” may arise so as to be able to prepare a cogent response during a civil IRS examination.

Circumstances that may indicate fraudulent intent, commonly referred to as “badges of fraud,” include: (1) understatements of income (e.g., omissions of specific items or entire sources of income, failure to report relatively substantial amounts of income received) particularly if part of a consistent pattern of underreporting over several years; (2) maintaining inadequate records or accounting irregularities (e.g., two sets of books, false entries on documents); (3) giving implausible or inconsistent explanations of behavior or other acts of the taxpayer evidencing an intent to evade tax (e.g., false statements, destruction of records, transfer of assets); (4) concealing income or assets; (5) failing to cooperate with tax authorities; (6) engaging in illegal activities; (7) providing incomplete or misleading information to one’s tax preparer; (8) lack of credibility of the taxpayer’s testimony; (9) filing false documents, including false income tax returns; (10) failing to file tax returns; and (11) dealing in cash.

Keywords: mination, irs audit, tax dispute, tax fraud, criminal tax