The majority of IRS audits remain civil matters that are resolved via paying back taxes, fines, and penalties. A select few, however, raise red flags that transform a civil matter into a criminal investigation.

These red flags are known as “badges of fraud,” meaning they indicate potential criminal activity or intent. An IRS revenue agent can use these badges as the basis for an investigation and potential criminal charges.

What is the “Badge of Fraud” Checklist?

This isn't a formal list, merely an overview of behaviors or conduct that can indicate criminal intent or activity. That a taxpayer has indicators of fraud in their record or history doesn't mean they actually engaged in fraud.

Common indicators, or badges of fraud:

• Understatement of income
• Improper deductions
• Accounting irregularities
• The taxpayer engaging in obstruction
• Underreporting income on multiple tax years
• Inconsistent or unlikely patterns of behavior
• Engaging in illegal activities
• Attempting to conceal illegal activities
• Dealing in cash
• Not filing tax returns

The more badges a taxpayer has, the more likely that the IRS will pursue a criminal investigation. In essence, the IRS is looking for inconsistencies that suggest a deliberate attempt to hide assets from the IRS or otherwise avoid paying taxes.

Each of these categories covers a broad range of activities. The connecting theme is that, for actions to be considered a crime, taxpayers generally must have the intent to know they were hiding assets to avoid taxes. A simple mistake or omission isn't enough.

A taxpayer who underreports their income because they thought they didn't have to report income from side gigs will likely have to pay penalties and fines, in addition to the outstanding tax, but they're unlikely to face criminal charges.

The taxpayer lacked the intent necessary for criminal charges. Compare this to a taxpayer who underreports income deliberately by not including certain income on their financial books.

If you have questions about audits and when they can become criminal matters, call Senior Partner, Tax Controversy Attorney, and former IRS attorney Brandon A. Keim at (602) 200-7399 or contact him online to discuss your options.