Increased Compliance: Tax Fraud Investigations to Intensify

Amidst an evolving financial landscape, the specter of criminal tax fraud looms larger than ever, posing a significant challenge to individuals and institutions. In September 2023, the Internal Revenue Service (“IRS”) announced its plan to expand tax compliance and hired over 3,700 revenue agents in an attempt to reverse the decline of audits of the wealthy. The new employees will be focused on higher-income individuals making more than $400,000 and complex tax areas, such as partnerships.

In a continuing effort to improve tax compliance, on February 29, 2024, the IRS announced a new initiative focusing on high-income taxpayers who have failed to file federal tax returns since 2017. The IRS expects to issue over 125,000 compliance letters, including 25,000 to those with more than $1 million in income and over 100,000 to people with incomes between $400,000 and $1 million between tax years 2017 and 2021. Taxpayer non-response could lead to other compliance activity and enforcement actions, including collection and audit actions, as well as potential criminal prosecution.

The IRS defines Tax Fraud as “an intentional wrongdoing, on the part of a taxpayer, with the specific purpose of evading a tax known or believed to be owing. Tax fraud requires both: a tax due and owing; and fraudulent intent”.¹

Revenue Agents focus on conducting “audits” of filed returns and ensuring tax compliance. Identified errors on a return may cause the Revenue Agent to assess additional taxes and penalties. While primarily civil in scope, Revenue Agents are trained to recognize badges of fraud, which are indicators of whether or not a person’s actions or omissions were done to commit tax fraud or other types of fraud related to the IRS.

The IRS identified six categories of fraud badges, which include, but are not limited to:

1. Income – omitting entire sources of income, inability to explain substantial increases in net worth, concealment of domestic or foreign bank accounts, failing to deposit receipts in a business bank account, and cashing checks at a check cashing service.
2. Expenses or Deductions – claiming fictitious or substantially overstated deductions and claiming personal expenses as business.
3. Books and Records – maintaining multiple sets of books, failing to maintain adequate records, making false or altered entries, and invoices that are irregularly numbered, unnumbered, or altered.
4. Allocations of Income – distribution of profits to fictitious partners.
5. Conduct of Taxpayer – making false statements about material facts pertaining to investigation, failure to fully disclose relevant facts to the accountant, attorney, or return preparer, and destruction of books and records.
6. Method of Concealment – inadequate consideration, placing asset ownership in other names, using secret bank accounts for income, and conducting business transactions in false names.

If evidence of fraud is discovered during an audit, the Revenue Agent may refer the matter for further investigation to Special Agents in the IRS’ Criminal Investigation Division (“CI”). The CI investigation could lead to prosecution and incarceration. In fiscal year 2022, IRS CI completed 2,552 investigations.² They identified $5.7 billion in tax fraud and referred 1,837 investigations for prosecution, with a conviction rate of 90.6 percent.³

If criminal criteria have not been met, the case will be returned by CI to the Revenue Agent, who may elect to assess the civil fraud penalty pursuant to IRC 6663. However, the IRS must show clear and convincing evidence to prove that some part of the underpayment of tax was due to fraud, demonstrating both knowledge and intent. The civil fraud penalty is equal to 75 percent of the underpayment of tax attributable to fraud.

How Can a Forensic Accountant Help?

Forensic accountants have the specialized knowledge and investigative skills to collect, analyze, and evaluate evidential matter. Additionally, many forensic accountants have experience dealing with IRS investigations and the knowledge and skills necessary to interact with both revenue and special agents.

More specifically, forensic accountants can assist taxpayers and their counsel in both civil and criminal audits by:

• Conducting thorough forensic financial analysis of business and personal records;
• Gathering evidence associated with/supporting financial analysis;
• Assisting counsel with interviews of subjects and key witnesses;
• Identifying and tracing funding sources and interrelated transactions;
• Dissection and analysis of the government’s accountant/”expert’s” calculations;
• Completion of Net Worth Statement for Probation (PROB 48); and
• Analysis of fraud loss in relation to sentencing guidelines.

With the impending increase in IRS activities, the role of forensic accountants in tax fraud cases is indispensable and continues to grow in significance. Their expertise is not merely advantageous but often crucial in substantiating tax losses and challenging allegations of fraud. As the final line of defense in a tax fraud case, the detailed analyses provided by forensic accountants can make a definitive difference, potentially altering the outcome in favor of the defense.

Sources

1. IRS Internal Revenue Manual, Part 25.1 Fraud Handbook.
2. IRS Tax Data Book, FY22.
3. IRS-CI FY22 Annual Report.