Proving intent is difficult, if not impossible, as it requires an understanding of what the taxpayer was thinking when he understated his tax bill.To address that situation, the IRS has developed a list of factors it calls Badges of Fraud.

While no one factor is determinative, a combination of factors or totality of circumstances points to intent. The Internal Revenue Manual includes the following as Badges of Fraud:

  • Understatement of income (e.g., omissions of specific items or entire sources of income, failure to report substantial amounts of income received)
  • Fictitious or improper deductions (e.g., overstatement of deductions, personal items deducted as business expenses)
  • Accounting irregularities (e.g., two sets of books, false entries on documents)
  • Obstructive actions of the taxpayer (e.g., false statements, destruction of records, transfer of assets, failure to cooperate with the examiner, concealment of assets)
  • A consistent pattern over several years of underreporting taxable income
  • Implausible or inconsistent explanations of behavior
  • Engaging in illegal activities (e.g., drug dealing), or attempting to conceal illegal activities
  • Inadequate records
  • Dealing in cash, and
  • Failure to file returns

Taxpayers are motivated to minimize their tax bill, as the story goes, the devil is in the details.

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Disclaimer: Please note this blog does not provide accounting, tax or legal advice and is intended for informational purposes only. Consult your Withum advisor with any specific questions.