How Does an IRS Agent First Notice Tax Fraud? How Does an Indicator of Fraud become a Tax Enforcement Action?

For many taxpayers, the processes employed by the IRS and other tax agencies can seem opaque and random. However, despite the difficulty that tax laypeople can have in understanding the dense U.S. Tax code and nearly equally dense IRS policy and practice manuals, there is rhyme and reason behind the IRS’s actions. An experienced tax attorney who has handled tax audits and investigations in the past is aware of the factors and procedures by which an IRS agent will decide to proceed with an investigation or close a matter. Working with a tax lawyer can help taxpayers avoid common mistakes or errors in handling the audit that can unnecessarily raise red flags or trigger the suspicions of the auditor.

What Signs or Acts Raise First Suspicions of Tax Fraud?

When an IRS agent begins to work a case, he or she will generally look for what are known as “first indicators of fraud.” First indicators of fraud can be summed up as signs that trigger a mere suspicion of tax fraud. Essentially, when you speak to an IRS agent as part of initial investigations or simply to ask why the IRS is asking for information or making changes to your taxes, the agent ask the taxpayer for explanations regarding discrepancies. If he or she asks additional questions that are seemingly tangential to the tax issues, it is possible that the agent is attempting to gauge your state of mind at the time. That is, the agent may be trying to make an initial determination whether you intended to make a misrepresentation or violate the law. Generally, the auditor will seek out not only errors in accounting and in the application of tax law but also irregularities in tax documents such as backdating, inaccurate tax documents, or fraudulent tax forms.

If the IRS agent does detect signs of fraud, he or she will first consult with a manager. In this consultation, the manager and the agent will assess whether the matter is serious enough to warrant a joint conference that would also include a Fraud Technical Advisor. In this conference, it will be determined if the matter presents a potential for fraud. A determination regarding whether imposition of a civil fraud penalty is also considered. At this stage, the indicators of fraud will be documented and a plan for the audit and enforcement action will be developed.

What Will Happen if Clear Evidence of Fraud Exists?

In at least some instances, indicators of fraud will be clear and unambiguous. These are sometimes referred to as “firm indicators of fraud.”  These indicators of fraud should be distinguished from “first indicators of fraud.” Whereas the first indicator of fraud is merely a suspicion, a firm indicator of fraud is a case-specific factual determination. When an agent detects that a firm indicator of fraud is present in a matter, he or she is required to suspend the investigation immediately. Thus, if you have made contact with an IRS agent who abruptly stops your conversation and will not return calls, you may be facing a worst-case scenario where your civil tax violation becomes a criminal matter.

At this point, the IRS agent and other parties will begin weighing whether a referral to IRS Criminal Investigations is appropriate. Even if your matter is not referred to IRS-CI for criminal prosecution, it is highly likely that subsequent proceedings will include civil fraud penalties. However, if the matter is serious and developed enough to warrant referral to IRS-CI, the investigator will begin to prepare a referral on Form 2797, Referral Report of Potential Criminal Fraud Cases. If you face criminal tax allegations, you face the possibility of a prison sentence, penalties, fines, restitution, interest on unpaid taxes, and supervised release following a prison sentence.

Concerned that Mistakes Will Trigger a Criminal Tax Prosecution?

The actions and statements a taxpayer makes when interacting with an IRS agent have the potential to transform a simple and straightforward tax mistake into a criminal tax nightmare. Unfortunately, far too many taxpayers attempt to handle their audit or IRS inquiry themselves and only seek assistance from a tax professional after they find themselves in a precarious legal position.

Working with an experienced tax lawyer from the outset can allow you to establish ground rules for the audit and ensure that all aspects of the audit are handled in a timely and professional manner. The tax lawyers of the Tax Law Offices of David W. Klasing can help guide you through an audit. If you are concerned that you have already made an error in handling your audit, we may be able to seek relief or take other corrective action. To schedule a confidential tax consultation, call 800-681-1295 today.

For more information on what to do if you think that your audit has gone criminal, please see our YouTube video on the topic or our YouTube channel for additional tax videos.