IRS Fraud Penalty & Examples (2018) – Badges of Fraud | IRS Tax Fraud
IRS Fraud Penalty & Examples (2018) – Badges of Fraud | IRS Tax Fraud
IRS penalties can be tough, this is especially true if the IRS determines that you acted fraudulently.
Unlike other types of monetary penalties, in order for the IRS to show you acted fraudulently, the IRS must meet a higher standard of proof, which is called Clear and Convincing Evidence.
IRS Fraud Penalty
If the IRS is able to prove that with clear and convincing evidence you acted fraudulently, the IRS may issue penalties upwards of 75%, in addition to other penalties for other related matters – as well as a potential referral the IRS Special Agents at the Department of Criminal Investigations.
What is Tax Fraud (Generally)?
Tax fraud occurs when a person knowingly or intentionally files fraudulent tax returns or fails to file any returns it all — and many things in-between.
There are various common ways to commit tax fraud, including:
- Omitting income
- Falsifying Business expenses
- Taking deductions that you know are improper.
IRS Tax Fraud (Civil) – The Basics
Civil Tax Fraud is a comprehensive subject. In order to make it palpable to you (while keeping you awake), we will use examples to break it down into various topics as provided in the IRS IRM (Internal Revenue Manual)
When Does the IRS Issue Civil Tax Fraud Penalties?
As provided by the IRS: “Civil fraud penalties will be asserted when there is clear and convincing evidence to prove that some part of the underpayment of tax was due to fraud. Such evidence must show the taxpayer’s intent to evade the assessment of tax, which the taxpayer believed to be owing. Intent is distinguished from inadvertence, reliance on incorrect technical advice, sincerely-held difference of opinion, negligence or carelessness.
In the case of a joint return, intent must be established separately for each spouse as required by IRC 6663(c) . The fraud of one spouse cannot be used to impute fraud by the other spouse. Thus, the civil fraud penalty may be asserted only on one spouse, unless there is sufficient evidence that both spouses participated in the fraudulent act(s) resulting in the underpayment reported in their joint return.”
Breaking Down the Elements of Civil Tax Fraud
It is important to understand the words being used to establish civil tax fraud. These are called “elements,” and the elements to civil tax fraud are as follows:
– Underpayment of Tax
– Due to Fraud (aka the IRS must show the taxpayer’s intent to evade the assessment of tax, which the taxpayer believed to be owing)
– Intent is distinguished from inadvertence, reliance on incorrect technical advice, sincerely-held difference of opinion, negligence or carelessness
– In the case of a joint return, intent must be established separately for each spouse as required by IRC 6663(c).
– The fraud of one spouse cannot be used to impute fraud by the other spouse.
– Thus, the civil fraud penalty may be asserted only on one spouse, unless there is sufficient evidence that both spouses participated in the fraudulent act(s) resulting in the underpayment reported in their joint return.”
Omitting Income Example
Steven resides in the United States but has various investments overseas that earn income abroad. Steven knows he’s supposed to report the earnings to the IRS. But, Steven also knows that the IRS has not entered into a tax treaty with this particular country, and that the Foreign Financial Institutions (FFIs) of this country are not reporting Stevens financial information to the IRS on a U.S. equivalent form 1099.
Therefore, Steven intentionally excludes this income on his US tax return. This would be an example of intentionally falsifying a tax return in order to reduce the amount of income — and therefore Reduce tax liability.
Falsifying Business Expenses
Falsifying business expenses comes in many different shapes and sizes. For example, Michelle has a foreign consulting business in which she travels around the country trying to retain clients to purchase her design services.
Michelle also likes to travel as a hobby, eat at fine restaurants, and drive fancy cars. Therefore, Michelle expenses certain pricey dinners and vacations as business expenses, when clearly Michelle was not engaging in any business at the time she claim these expenses.
Therefore, Michelle has falsified her tax return by including expenses which are false (aka not business expenses).
Taking Improper Tax Deductions
This is also very common scenario in which a person includes deductions on their tax return that are simply not true. For example, David does not have a home office which he uses specifically for business, but he claims a portion of a very large den in his home as a home office in order to reduce his taxes.
In addition, David also included medical expenses that he never really had in order to increase his schedule A itemized deductions, and there by reducing his tax liability.
Finally, David also has two rental properties, in which he falsified improvements to make it seem like they were expensive repairs (so he could deduct instead of amortize the expenses), and thereby reduce the net income that was generated from the rental properties. This also reduces income and thereby artificially reduces his tax liability – which is illegal.
What are Badges of Fraud?
Badges of fraud are indicators of fraud. In other words, a “Badge of Fraud” is a behavior that would lend itself for a reasonable person to believe that someone may be acting fraudulently. The IRS has developed many different badges of fraud, which we have reproduced below for your benefit.
They include the following:
Indicators of Fraud—Income
- Omitting specific items where similar items are included.
- Omitting entire sources of income.
- Failing to report or explain substantial amounts of income identified as received.
- Inability to explain substantial increases in net worth, especially over a period of years.
- Substantial personal expenditures exceeding reported resources.
- Inability to explain sources of bank deposits substantially exceeding reported income.
- Concealing bank accounts, brokerage accounts, and other property.
- Inadequately explaining dealings in large sums of currency, or the unexplained expenditure of currency.
- Consistent concealment of unexplained currency, especially in a business not routinely requiring large cash transactions.
- Failing to deposit receipts in a business account, contrary to established practices.
- Failing to file a tax return, especially for a period of several years (even though it should have been filed)
- Cashing checks, representing income, at check cashing services and at banks where the taxpayer does not maintain an account.
- Concealing sources of receipts by false description of the source(s) of disclosed income, and/or nontaxable receipts.
Indicators of Fraud—Expenses or Deductions
- Claiming fictitious or substantially overstated deductions.
- Claiming substantial business expense deductions for personal expenditures.
- Claiming dependency exemptions for nonexistent, deceased, or self-supporting persons.
- Disguising trust fund loans as expenses or deductions.
Indicators of Fraud—Books and Records
- Multiple sets of books or no records.
- Failure to keep adequate records, concealment of records, or refusal to make records available.
- False entries, or alterations made on the books and records; back-dated or post-dated documents; false invoices, etc.
- Invoices are irregularly numbered, unnumbered or altered.
- Checks made payable to third parties that are endorsed back to the taxpayer.
- Variances between treatment of questionable items as reflected on the tax return, and representations within the books.
- Intentional under- or over-footing of columns in journal or ledger.
- Amounts on tax return not in agreement with amounts in books.
- Amounts posted to ledger accounts not in agreement with source books or records.
- Journalizing questionable items out of correct account.
- Recording income items in suspense or asset accounts.
- False receipts to donors by exempt organizations.
Indicators of Fraud—Allocations of Income
- Distribution of profits to fictitious partners.
- Inclusion of income or deductions in the tax return of a related taxpayer, when tax rate differences are a factor.
Indicators of Fraud—Conduct of Taxpayer
- False statement about a material fact pertaining to the examination.
- Attempt to hinder or obstruct the examination. For example, failure to answer questions, etc.
- Failure to follow the advice of accountant, attorney or return preparer.
- Failure to make full disclosure of relevant facts to the accountant, attorney or return preparer.
- The taxpayer’s knowledge of taxes and business practices where numerous questionable items appear on the tax returns.
- Testimony of employees concerning irregular business practices by the taxpayer.
- Destruction of books and records, especially if just after examination was started.
- Transfer of assets for purposes of concealment, or diversion of funds and/or assets by officials or trustees.
- Pattern of consistent failure over several years to report income fully.
- Proof that the tax return was incorrect to such an extent and in respect to items of such magnitude and character.
- Payment of improper expenses by or for officials or trustees.
- Willful and intentional failure to execute pension plan amendments.
- Backdated applications and related documents.
- False statements on Tax Exempt/Government Entity (TE/GE) determination letter applications.
- Use of false social security numbers.
- Submission of false Form W-4.
- Submission of a false affidavit.
- Attempt to bribe the examiner.
- Submission of tax returns with false claims of withholding (Form 1099-OID, Form W-2) or refundable credits.
- Intentional submission of a bad check resulting in erroneous refunds and releases of liens.
- Submission of false Form W-7 information to secure Individual Taxpayer Identification Number (ITIN) for self and dependants.
Indicators of Fraud—Methods of Concealment
- Inadequacy of consideration.
- Insolvency of transferor.
- Asset ownership placed in other names.
- Transfer of all or nearly all of debtor’s property.
- Close relationship between parties to the transfer.
- Transfer made in anticipation of a tax assessment or while the investigation of a deficiency is pending.
- Reservation of any interest in the property transferred.
- Transaction not in the usual course of business.
- Retention of possession or continued use of asset.
- Transactions surrounded by secrecy.
- False entries in books of transferor or transferee.
- Unusual disposition of the consideration received for the property.
- Use of secret bank accounts for income.
- Deposits into bank accounts under nominee names.
- Conduct of business transactions in false names.
Civil Tax Fraud Penalties
If the IRS believes you acted fraudulently and can prove by clear and convincing evidence that you acted fraudulently, then you may be subject to extremely high fines and penalties.
As provided by the IRS (IRC Section 6663)
Internal Revenue Code Section 6663 can be broken down as follows:
(a) Imposition of penalty
If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.
(b) Determination of portion attributable to fraud
If the Secretary establishes that any portion of an underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud, except with respect to any portion of the underpayment which the taxpayer establishes (by a preponderance of the evidence) is not attributable to fraud.
(c) Special rule for joint returns
Criminal Tax Fraud
If the IRS believes you acted criminally, they may refer you to the IRS Special Agents from the Criminal Investigation department, in order to launch a criminal investigation. This department will investigate you to determine whether they believe you acted with criminal intent, and therefore determine whether you should be submitted for prosecution.
Beyond a Reasonable Doubt
It should be noted that in order to be held accountable in the criminal court of law for tax fraud, the government must show beyond a reasonable doubt, which is typically quantified at 95%.
It is very uncommon that the IRS pursues a referral to the special agents for criminal prosecution, but if you know you acted intentionally, then you should consider getting into compliance — before it is too late!
Domestic and Offshore IRS Voluntary Disclosures
If your noncompliance was related to domestic related activities, you may consider making a Domestic Voluntary Disclosure, what is detailed extensively in the Internal Revenue Manual (IRM).
If your failure was due entirely to offshore related matters or a hybrid of money abroad and domestic related issues, then you may consider doing the traditional OVDP (if you were a willful or acted with intent or reckless disregard, then you would not qualify for the streamline program), noting that OVDP closes on September 28, 2018.
Resource: Domestic Voluntary Disclosure
If I was Only Willful for a Few Years, Do I Need OVDP?
The IRS is clear: If you were willful at all, then you cannot qualify for the IRS Streamlined Program or Reasonable Cause submission. There are no exceptions for people who were only willful for a year or two, and no exceptions for people who only failed to report “small” amounts of income. We find it abhorrent that there are other attorneys putting potential clients in serious financial risk, as well as harm’s way for a potential IRS Criminal Investigation, by pushing them into Streamlined when they know the client was willful.
On multiple occasions, we have had clients come to us after retaining one of these dreadful firms, who were now terrified because they realized that they paid an inexperienced Voluntary Disclosure Attorney a “small fee” to go Streamlined or Reasonable Cause when they admitted to the Attorney they were willful. Click Here for a Case Study Example of what can occur when you go Streamlined when you were willful.
Remember, it is not their money or their freedom on the line – it is yours, so be careful…
IRS Voluntary Disclosure Attorney Fees – How Much?
If you receive an IRS Voluntary Disclosure Fee Quote from a CPA or Attorney that seems too Low…you should be careful.
That is not to say you should resign yourself to mortgaging your house for representation, but there are many CPAs and Attorneys who see a frightened human being as little more than a “Mark” or “Target.”
Golding & Golding, A PLC
At Golding & Golding, we have successfully handled numerous IRS Voluntary Disclosure Applications for individuals and businesses around the globe with outstanding unreported foreign accounts ranging from $50,000.00 to nearly $40,000,000.00 in a single disclosure.
We Take IRS Voluntary Disclosure Representation Very Seriously
We are passionate about representing individuals in voluntary disclosure matters, and feel horrible when a client calls us after having hired an inexperienced Attorney or CPA who either did a sloppy job, charged them more money than they agreed upon, and/or is overall not providing the level of representation a person deserves.
We Can Help You.