In our profession we like to say, “Once is an isolated event, twice is a coincidence, and three times is a pattern.”
“Fraud is deception by misrepresentation of material facts, or silence when good faith requires expression, which results in material damage to one who relies on it and has the right to rely on it. Simply stated, it is obtaining something of value from someone else through deceit,” Internal Revenue Manual 188.8.131.52.
There are many badges, or indicators of fraud, and this is a far reaching subject, so today we are going to focus only on some of the indicators of fraud that the IRS looks for:
- No records, poorly kept records, or attempts to falsify or alter records
- Destroying books and records without plausible explanation, or refusal to make certain records available
- The extent of your control over sales receipts, records and the bank deposits; the unwillingness to delegate those functions to employees
- Engaging in illegal activities
- Dealing in cash instead of using bank accounts, and making large cash transactions
- Concealment of bank accounts, or the co-mingling of bank assets and physical assets between different companies under the full control of the same owner
- Concealment of assets, dissipation of assets, and the transfer of assets (putting your racing boat in your brothers name the day you got the audit letter – too bad they usually take pictures of your house before they send out those letters, and the boat was taking up the entire right-hand side of your driveway that day)
- Having a cash intensive business that hardly deposits any cash into the bank account; a pizzeria that buys 7 times more pizza boxes than the number of pizzas they say they sold
- A pattern of failing to file tax returns
- Fictitious or improper deductions, or deductions that are greater than reported income
- Evading tax – unreported income, false statements, destruction of records, transfers of assets to others, dissipated assets – this is criminal fraud and you can go to jail
- A consistent pattern over several years of reporting less taxable income than is necessary to justify your standard of living
- Education and experience – at what point should you be expected to know better?
The IRS breaks fraud up into two broad categories; civil fraud and criminal fraud. Of course the consequences for anything that goes criminal are far greater than that of a civil matter, and can include jail time. Two elements the IRS considers when developing a case for fraud are the amount of tax due, and fraudulent intent. Intent is difficult to prove in court, and unless the amount at stake is very large, and the intent can be proven, it’s just easier to levy a civil fraud penalty instead of pressing for criminal fraud charges. The civil fraud penalty is 75% of the tax they caught you trying to get out of, and that punishment is usually enough to encourage future compliance.