Red Flags of Tax Fraud

I’m often asked what the IRS regards as evidence indicative of the presence of tax fraud.   According to IRS Special Agent C. Trevor McMurray who spoke at one of our Chapter’s recent events,  certain circumstances can constitute reasonable evidence of fraud, including:

— unexplained bank deposits or the use of bank accounts in other’s or in fictitious names.  An example might be a taxpayer  who has a tax preparation business on the side but who fails to report the income from the side business.  She might use a relative’s name to deposit income from the side business into a bank demand account.

—false documents submitted to the IRS.  A taxpayer might claim medical deductions but be unable to substantiate he had ever seen the doctors or paid the medical bills.  The taxpayer might attempt to convince revenue agents of the validity of the deductions by submitting false or altered documents.

—false explanations of prior conduct.  A couple owned and operated a restaurant; the wife maintained the books, paid the bills and filed the tax returns while the husband ran the day-to-day business.  The IRS proved a large discrepancy between increases in net worth and the expenditures of the couple and the amount of reported income.  The wife (but not the husband) was found guilty of maintaining a “cash hoard” and criminal tax evasion.   Another taxpayer owned and operated a bar and kept the records on a cash basis based on a cash register tape.  The IRS was successful in proving that the taxpayer destroyed the cash register tapes with the intention of concealing amounts of income.  Additionally, the taxpayer made a series of misleading statements to the agents in an attempt to cover his tracks.

—participation in an illegal business.  The taxpayer was involved in an illegal book wagering business.  The IRS was able to prove that he consistently failed to report large amounts of income over a period of several years.

—false claims of extra withholding exemptions.  A taxpayer claimed 50 exemptions on his W-4.  The court found it to be “inherently incredible, particularly in the absence of any evidence which would support such an outrageous claim.”

The IRS uses the deposit method to prove that the income available to the taxpayer is substantially greater than the income claimed on the taxpayer’s return.  This method, along with the net worth method, according to Agent McMurray, are powerful tools in proving, even circumstantially, that a taxpayer has unreported sources of income.  Many of today’s money laundering and drug cases involve the use of one or both of these methods.





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