It’s true. However, these badges aren’t something the federal agency gives out for a job well done. Rather, tax professionals refer to these designations as badges of fraud. As the name suggests, these badges are indicators to the IRS that a taxpayer committed an error with possible fraudulent intent. This puts the taxpayer in danger of having to pay civil or criminal fines. In the most severe cases, prison time is on the table.
What are the Badges of Fraud?
There is no federal statute that definitively lists each badge of fraud. These red flags have been cultivated after years of court decisions. Some common badges include (but are not limited to):
- Understatement or complete omission of income
- Keeping two sets of books (or other accounting irregularities)
- Improper deductions or credits
- Lying to IRS agents, destroying records, or engaging in other deceptive activities
- Manipulating tax returns or documents to conceal illegal activities
- Not keeping adequate records
- Failing to file required tax returns
- Consistently engaging in underreporting or omission of taxable income
Badges alone are not determinative of potential tax fraud. Just because you’ve “earned” a badge of fraud does not mean that you are automatically going to prison. It’s undeniable, though, that the more badges you earn, the greater your chances will be of being subject to civil or criminal tax fraud penalties.
Does the IRS Differentiate Between Fraud and Negligence?
Fortunately, yes. Even the IRS recognizes that the federal tax code is quite complicated, and taxpayers will inevitably make mistakes from time to time. Still, a simple act of negligence associated with tax documents could result in a 20-percent penalty for the taxpayer. It pays not to be sloppy when you’re doing your tax returns.
Civil penalties for willful fraud are much steeper. The IRS is authorized to penalize fraudsters up to 75 percent of the disputed tax bill. This requires “clear and convincing evidence” that the taxpayer’s underpayment of tax was due to fraud.
Badges of Fraud Mark the Beginning of an IRS Investigation
IRS employees often use recognition of badges of fraud to commence an investigation—not end it. If IRS agents continue to uncover indications of fraud on the part of a taxpayer, a fraud technical advisor (FTA) will likely get involved.
By this point, it’s highly advisable to have legal counsel and, possibly, other tax professionals to guide you through the investigation and possible imposition of civil or criminal penalties. Ideally, you should call an experienced tax attorney as soon as you believe the IRS is on to you or as soon as you realize you made a serious mistake on your taxes.
Robert V. Boeshaar, Attorney at Law is prepared to efficiently handle your dispute with the IRS. Call the firm at (206) 984-3739 to schedule a consultation.
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