How does the IRS distinguish between tax fraud and negligence? -- II

Last time, our blog discussed how the busy pace of life more than likely prevented many people from giving their tax returns the sort of in-depth review they would have preferred, meaning there could be mistakes.

We also discussed how even though this isn’t the sort of thing people want to hear given their fear of possible income tax fraud charges, they should know that these fears are likely unfounded. To reiterate, that's because the U.S. tax code provides that income tax fraud charges can only be brought where an individual is believed to have willfully attempted to evade taxes.

This naturally raises the question as to how exactly the Internal Revenue Service is able to distinguish between willful acts and oversights or, in other words, fraud and negligence.

The answer is relatively simple: tax auditors understand that the tax code is arcane and therefore assume that the majority of mistakes are the product of unintentional slip-ups. Indeed, their extensive training and vast experience enables them to identify certain telltale signs or suspicious behaviors that are often deployed to mask income tax fraud.

Some of these telltale signs or suspicious behaviors include:

  • Claiming an excessive number of exemptions and/or deductions
  • Transferring or attempting to conceal income
  • Possessing what appear to be false documents
  • Misclassifying personal expenses as business expenses
  • Claiming exemptions for nonexistent dependents
  • Maintaining two sets of financial ledgers

Those who commit simple errors on their tax returns should understand that the IRS won't just let them off the hook. Indeed, even otherwise unintentional errors can result in a fine of up to 20 percent of the amount owed.

The next question to arise in the context of income tax fraud versus negligence is whether tax auditors have identified any subsets of workers who are perhaps more likely to commit income tax fraud.

Here again the answer is simple: self-employed individuals who run cash-based operations and service workers paid largely in cash have been identified as being more prone to committing tax fraud given the ease with which they can hide cash.

It would be a mistake to think that this means tax auditors are only paying extra attention to the returns of restaurant servers, repair people, hairdressers and nail salon owners. The reality is that this definition could encompass a host of parties from car dealers and store owners to accountants and salespeople.

We'll conclude this discussion in a future post, focusing on the potential penalties for income tax fraud.

Consider speaking with a skilled legal professional as soon as possible if you learn that you are under investigation for tax evasion or some other manner of federal tax crime.

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