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What are the Top Signs a Criminal Tax Investigation is Forthcoming? Part I


While many people think that a criminal tax prosecution is something that cannot happen to them unless they deliberately set out to defraud the IRS, the truth is that criminal tax charges can be triggered by even a seemingly minor misstep. Mistakes on your taxes that are perceived by the IRS as willful misstatements or accountant or tax preparer malpractice are but a couple of the common ways that well-meaning taxpayers find themselves facing serious criminal penalties including a federal prison sentence.

In short, things that an average person does not know about tax law or tax crimes can hurt them when faced with an IRS audit or criminal investigation. A tax lawyer can help a taxpayer by providing context for any actions or inactions that might be misinterpreted by the agent, and negotiate a more favorable outcome.

Clients sometimes ask: "How does the IRS determine if I committed tax fraud?"

The IRS' Internal Revenue Manual provides guidance for IRS agents in investigative techniques to be used in identifying tax fraud. One of the methods utilized by agents is to look for indicators, or "badges" of fraud. The IRS has developed lists of these badges of fraud regarding a taxpayer's income, expenses and deductions, financial books and records kept, income allocations, the taxpayer's conduct, and the methods of concealment utilized. By category they include:

  • Income: This includes entire sources of income being omitted, unexplained increases in net worth, expenditures substantially exceed income, no explanation for the source of certain bank deposits, concealing accounts or assets, excessive dealing in cash, and cashing checks considered as income at check cashing services.
  • Expenses or Deductions: Claiming dependency status for independent, deceased, or nonexistent individuals, claiming false deductions, and claiming business deductions that are actually personal expenses are all considered badges of fraud.
  • Books and Records: Keeping multiple sets of books, irregularly numbering invoices, making false entries in the records, failing to keep records, providing false receipts, and engaging in nonstandard accounting practices can all lead to tax problems.
  • Taxpayer Conduct: Rude or abusive behavior toward the agent, making false statements, incomplete disclosures, failure to follow the advice of an accountant, backdated documents, submission of a false W-4 and other similar acts are all considered badges of fraud.
  • Concealing Assets: Placing assets in the names of others, transferring property in anticipation of tax bills, secret transactions, transactions outside the typical course of business, and reservation of rights or interests in purportedly transferred property are all considered to be as badges of fraud.

The foregoing is not a comprehensive list of all items considered badges of fraud by the IRS, but it does indicate the types of issues they are looking for. In the next video, I will discuss which actions by IRS agents may reveal a forthcoming criminal investigation.

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