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IRS Badges of Fraud

By Joel N. Crouch on June 27, 2023
On June 22nd, the U.S. Tax Court released a memorandum decision in Kamal v. Commissioner, T.C. Memo 2023-80, which is a helpful reminder of what evidence a court will consider when the IRS has proposed a 75% civil fraud penalty. In addition, Kamal is another example of the potential risks of filing a Tax Court petition.

The courts and IRS have developed a list of “badges of fraud” from which fraudulent intent may be inferred. Some common indicators of fraud include the following:

  1. Understatement of income (e.g., by omissions of specific items or entire sources of income, failure to report substantial amounts of income received)
  2. Fictitious or improper deductions (e.g., overstatement of deductions, personal items deducted as business expenses)
  3. Accounting irregularities (e.g., two sets of books, false entries on documents)
  4. Acts of the taxpayer evidencing an intention to evade tax (e.g., false statements, destruction of records, transfer of assets)
  5. A consistent pattern over several years of underreporting taxable income
  6. Implausible or inconsistent explanations of behavior
  7. Failure to cooperate with the examining agent
  8. Concealment of assets
  9. Engaging in illegal activities or attempting to conceal illegal activities
  10. Inadequate recor
  11. Dealing in cash

The IRS Fraud Handbook includes a more extensive list of fraud indicators.

In Kamal, the court found that the taxpayer had fictitious business expenses for a phantom company, submitted forged documents to the IRS and provided implausible trial testimony. Interestingly, the IRS did not propose a 75% civil fraud penalty until after the close of trial, to which Kamal did not provide a response. I’ve previously written about the “hidden” risks of filing a Tax Court petition, HERE and HERE . Both blog posts discuss taxpayers who received Notices of Deficiency, filed Tax Court petitions and were surprised by the IRS answer, wherein the IRS increased the stakes by proposing a 75% fraud penalty for the first time. As I said at the end of the second blog post:

“The lesson from Wegbreit and Buckelew is that an IRS Notice of Deficiency does not foreclose the IRS from raising new issues in a Tax Court case. Filing a petition in the Tax Court allows the IRS an opportunity to propose new substantive issues involving tax or penalties. If the IRS does so, it will bear the burden of proof on those issues; however, the IRS has the burden of proving civil fraud whether it is initially proposed in the Notice of Deficiency or raised in a subsequent answer.”

Mr. Kamal’s situation is even more egregious. According to the court, the IRS told Kamal several times before trial that it might propose a civil fraud penalty depending on the evidence gathered in discovery and offered at trial but he insisted on going to trial. If Mr. Kamal had subscribed to the Meadows Collier Blog, he might have realized the risk he was taking by disputing the IRS notice of deficiency.

For questions regarding this blog post or any other civil or criminal tax related matter, please feel free to contact me at jcrouch@meadowscollier.com.