What are the Badges of Fraud: IRS Indicators of Fraud

Badges of Fraud & IRS Indicators 

While there are many different types of tax violations that the Internal Revenue Service may investigate, tax fraud is one of the more common types of tax violations. That is because when the IRS is able to prove tax fraud, then they can use this to pursue other types of violations as well, such as improper transfers of assets, willful violations of international reporting requirements, and more. In addition, the IRS can pursue fraud in the civil and criminal tax arenas. From a technical standpoint, when the IRS investigates tax fraud, they look for what is referred to as the ‘badges of fraud’ or ‘IRS indicators (of fraud)’. Let’s look at five important facts about the badges of fraud, how they are investigated, and what you can do to protect yourself.

Income

One of the most common types of indicators of fraud involves tracking the taxpayer’s income sources. Namely, did the taxpayer intentionally omit income – whether in part or in total? Income-related issues are one of the key indicators of fraud. For example, let’s say a taxpayer has foreign assets worth a few million dollars that generate $100,000 a year. The taxpayer is aware that the income is supposed to be reported on their tax return, but does not report the income, thinking they would not get caught. Meanwhile, some of the foreign financial institutions that he banks with overseas comply with FATCA reporting and disclose the account and income information to the IRS — which reflects tens of thousands of dollars of income generated from each institution. This would be an indicator of fraud.

Expenses or Deductions

Another common situation that can lead to a fraud investigation is when taxpayers intentionally overstate deductions. Some taxpayers even go so far as creating a false business so that they can claim deductions on that business. For example, let’s say a taxpayer earns $400,000 a year in income as a single taxpayer W-2 employee – so they only have limited deductions. In order to try to reduce their taxable income, the taxpayer may create their own false Schedule C business in order to claim deductions that do not exist (or are personal in nature).

Books and Records

When a taxpayer is under audit because of business-related matters in which they own the business, the IRS will delve deeper into their books and accounting records. Sometimes, the IRS may discover that the taxpayer is maintaining two sets of books to try to fool the IRS into believing that their accounting records are accurate.

Conduct of Taxpayer

One of the easiest ways for the IRS to determine whether the taxpayer’s behavior is an indication of fraud is simply investigating the taxpayer’s behavior. For example, is the taxpayer in an audit and was caught making false representations about ownership of foreign accounts or income that was not disclosed (but the IRS already knows about)? Or, does the taxpayer have multiple bank accounts for their business with similar names in order to shuffle money between the accounts and sidestep various withholding and tax requirements? Some taxpayers may even get caught destroying business records so that they can then claim the records do not exist. Unfortunately, taxpayers are often surprised to learn that not only are some employees willing to drop a dime on them to the IRS or DOJ – but many of the accounting programs they may have been using such as QuickBooks maintain autosave versions of documents within a cloud or other drive in which the IRS can then subpoena.

Get an Attorney BEFORE Responding to the IRS

No matter how smart or cunning you are, chances are if the IRS wants to talk to you about a potential fraud investigation, you would be much better served by having an attorney represent you. Once you make incriminating statements, they can put you in a much worse position than you would otherwise be in. Likewise, by speaking with the IRS Special Agents directly, you may actually be providing them with more information that they do not even know about yet.

Current Year vs Prior Year Non-Compliance

Once a taxpayer misses the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead of the Streamlined Procedures. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.