25.1.2  Recognizing and Developing Fraud

Manual Transmittal

April 24, 2014

Purpose

(1) This transmits revised IRM 25.1.2, Fraud Handbook, Recognizing and Developing Fraud.

Material Changes

(1) IRM 25.1.2.6(1) - Editorial change to correct hyperlink.

(2) Editorial changes made throughout the document.

Effect on Other Documents

This IRM supersedes IRM 25.1.2 dated July 12, 2013.

Audience

Criminal Investigation (CI), Large Business & International (LB&I), Small Business/Self-Employed (SB/SE), Tax Exempt/Government Entities (TE/GE), and Wage & Investment (W&I)

Effective Date

(04-24-2014)

William P. Marshall, Director, Fraud/BSA, SB/SE

25.1.2.1  (04-24-2014)
Overview

  1. This section discusses recognizing signs of fraud, known as first indicators (or badges) of fraud, and the development process used to prove fraud. Fraud is substantiated by establishing affirmative acts (firm indications) of fraud. Affirmative acts of fraud are actions taken by the taxpayer, return preparer and/or promoter to deceive or defraud. See IRM 25.1.1.3 for further information regarding the difference between indicators of fraud and affirmative acts (firm indicators) of fraud.

  2. Procedures related to a specific operating division or function are covered in other sections of the Fraud Handbook (IRM 25.1).

25.1.2.2  (04-24-2014)
Fraud Development Procedures

  1. When indicators (badges) of fraud are uncovered, the compliance employee must clearly document the potential fraud indicators and initiate a discussion with the compliance employee's group manager. If the compliance employee's group manager concurs there are indicators of fraud warranting fraud development, the compliance employee must contact the fraud technical advisor (FTA) assigned to that area.

    Note:

    For procedures specific to Campus Examination, see IRM 25.1.14.4, Campus Examination Procedures and Fraud Development. Campus Collection procedures are located in IRM 25.1.11.7, Discussion with the Collection Functional Fraud Coordinator.

  2. After reviewing the potential fraud indicators and possible barriers to a successful referral, if the compliance employee, compliance employee's group manager and FTA agree the potential for fraud exists, the compliance employee must prepare Form 11661, Fraud Development Recommendation – Examination or Form 11661-A, Fraud Development Recommendation – Field Collection, and forward the completed form to the compliance employee's group manager for approval.

    Note:

    Transmitting the forms electronically requires use of Microsoft Outlook Secure Messaging because of the confidential nature of the material (taxpayer information) it contains.

    Form 11661/11661-A documents the FTA's involvement and places a case in fraud development status. A case must not be placed in or out of fraud development status without consulting the FTA. If disagreement exists on whether a case should be in fraud development status, the final decision rests with the compliance employee's group manager.

  3. The compliance employee's group manager must review Form 11661 /11661-A and indicate approval by entering his/her name and date, and electronically forward the completed form by secure messaging to the FTA for consideration.

  4. When the FTA concurs with the fraud development determination, the FTA completes Form 11661 /11661-A and returns it to the compliance employee and compliance employee's group manager, using secure messaging. A copy of the form must be placed in the Collection case file or in the Examination work papers; and a copy retained by the FTA. If a case is placed in fraud development status, a plan of action (plan) must be formulated as early as possible to develop and document the affirmative acts of fraud.

    Note:

    The initial plan and those containing follow up action items must be documented in the Collection Integrated Collection System (ICS) history or included in the Examination work papers; and a copy retained by the FTA. All contacts with the FTA and subsequent action plans must be accurately documented in the Collection case file or Examination work papers.

    The plan must:

    1. Outline the steps required to establish affirmative acts (proof) of fraud.

    2. Be the joint effort of the compliance employee, the compliance employee's group manager and the FTA.

    3. Guide the case to its appropriate conclusion in a timely manner.

    4. Specify any direct assistance by the FTA. The role of the FTA can be advisory or consultive in nature.

      Note:

      Consultation with the FTA may or may not be face-to-face. Consultations over the phone or by e-mail are possible; however, in-person contact is preferable.

    There must be a follow up plan documented on Form 11660, Fraud Development Checksheet, Form 11660-C, Campus Fraud Development - Plan of Action, memorandum, or other document intended for this purpose within 60 days of the initial Plan of Action and within 60 days of all subsequent action plans.

  5. The compliance employee, with the compliance employee's group manager's and FTA's concurrence, will place the case in fraud development status.

    • The revenue officer must request the input of ICS Sub-code 910 and/or upload of TC 971 AC 281 through the employee's group manager, as appropriate (see IRM 25.1.8.8, Aging of Collection Fraud Cases).

    • The examiner must update the Audit Information Management System (AIMS) to Status code 17. Cycle time is excluded from the monthly aging reports to management (Month At a Glance Report) for cases in fraud development status.

  6. The compliance employee must request the original tax returns, if not already secured. See IRM 4.11.17.4, Requesting Returns Filed Electronically, for guidance on requesting returns filed electronically. For Campus examination procedures on securing original returns, see IRM 4.19.10.4, Fraud Referrals. The compliance employee proceeds with the plan until affirmative acts of fraud are established or a determination is made that the potential for fraud no longer exists. Timely action is required on all cases in fraud development status.

    If affirmative acts of fraud are established:

    1. The compliance employee must suspend collection or examination activity, and immediately notify the group manager and the FTA.

    2. The FTA recommends a referral to Criminal Investigation (CI), if criminal criteria are met (see IRM 25.1.3, Criminal Referrals).

    3. If criminal criteria has not been met or the case is returned by CI subsequent to a criminal investigation, consideration of the civil fraud penalty under IRC 6663 and/or the fraudulent failure to file penalty under IRC 6651(f), and/or imposition of the 10-year earned income tax credit (EITC) ban under IRC 32(k) is the shared responsibility of the compliance employee, the compliance employee's group manager and the FTA. The final decision rests with the compliance employee's group manager (see IRM 25.1.6.2, Procedures).

      Note:

      If the case is returned because the criminal criteria has not been met or the case is returned by CI subsequent to a criminal investigation, determine if the taxpayer's actions were due to fraud and the criteria for the EITC 10-year ban has been met. IRC 32(k) allows the IRS to impose bans on future claims of EITC against taxpayers who made prior fraudulent claims for the EITC. The 10-year ban is permitted after a "final determination" is made that the taxpayer's EITC claim was due to fraud. For jointly filed returns, consideration should be given to proposing the 10-year ban separately against each spouse. There should be a separate fraud write-up for each spouse, citing clear and convincing evidence of fraud on the part of each spouse. If the acts of only one spouse are found to be fraudulent, the 10-year ban will apply only to the culpable spouse.

    A determination that the potential for fraud no longer exists:

    1. Is made by agreement of the compliance employee, the compliance employee's group manager, and the FTA. If an agreement cannot be reached, the compliance employee's group manager makes the final decision; and

    2. Requires reversal of the Collection Sub-code 910 and/or TC 971 AC 281 (see IRM 25.1.8.8); or return of the Examination case on AIMS to Status 12 or other prior status code.

    Warning: The compliance employee or the compliance employee's group manager must never seek advice from CI for a specific case under examination/collection activity.

  7. For a case that detracts from the established plan of action, the compliance employee's group manager or FTA should recommend return of the case to Collection field investigative status or to Examination status 12. See IRM 4.19.10.4, Fraud Referrals, for Campus examination procedures for returning the case to a prior status. A case is in fraud development status only while there is active FTA involvement in an ongoing audit or collection activity, or until the FTA recommends one of the following actions:

    • Returning the Examination case to AIMS status 12, when it is determined that the potential for fraud no longer exists as evidenced by the reasons and decisions documented on Form 11661.

    • Removing the Collection Sub-code 910, via Form 11661-A, when it is determined that the potential for fraud no longer exists.

    • Transferring the case, by Campus personnel, to the field for further fraud development via Form 11661.

    • Asserting the civil fraud penalty under IRC 6663 and/or the fraudulent failure to file penalty under IRC 6651(f), and/ or imposition of the 10-year EITC ban under IRC 32(k) via Form 11661.

    Note:

    The FTA also uses Form 11661 to recommend returning a case to Status 17 from Status 18 (CI); transferring a case to the field for initial fraud development (Campus action); or transferring it to the W&I Austin Campus for initial fraud development. The ultimate decision with respect to all case action rests with the compliance employee's group manager.

25.1.2.3  (04-24-2014)
Indicators of Fraud

  1. Listed below are categories of fraud indicators. Each category list is not intended to be all-inclusive, instead citing examples of actions taxpayers may take to deceive or defraud.

  2. Indicators of Fraud—Income

    1. Omitting specific items where similar items are included.

    2. Omitting entire sources of income.

    3. Failing to report or explain substantial amounts of income identified as received.

    4. Inability to explain substantial increases in net worth, especially over a period of years.

    5. Substantial personal expenditures exceeding reported resources.

    6. Inability to explain sources of bank deposits substantially exceeding reported income.

    7. Concealing bank accounts, brokerage accounts, and other property.

    8. Inadequately explaining dealings in large sums of currency, or the unexplained expenditure of currency.

    9. Consistent concealment of unexplained currency, especially in a business not routinely requiring large cash transactions.

    10. Failing to deposit receipts in a business account, contrary to established practices.

    11. Failing to file a tax return, especially for a period of several years, despite evidence of receipt of substantial amounts of taxable income.

    12. Cashing checks, representing income, at check cashing services and at banks where the taxpayer does not maintain an account.

    13. Concealing sources of receipts by false description of the source(s) of disclosed income, and/or nontaxable receipts.

  3. Indicators of Fraud—Expenses or Deductions

    1. Claiming fictitious or substantially overstated deductions.

    2. Claiming substantial business expense deductions for personal expenditures.

    3. Claiming dependency exemptions for nonexistent, deceased, or self-supporting persons. Providing false or altered documents, such as birth certificates, lease documents, school/medical records, for the purpose of claiming the education credit, additional child tax credit, earned income tax credit (EITC), or other refundable credits.

    4. Disguising trust fund loans as expenses or deductions.

  4. Indicators of Fraud—Books and Records

    1. Multiple sets of books or no records.

    2. Failure to keep adequate records, concealment of records, or refusal to make records available.

    3. False entries, or alterations made on the books and records; back-dated or post-dated documents; false invoices, false applications, false statements, or other false documents or applications.

    4. Invoices are irregularly numbered, unnumbered or altered.

    5. Checks made payable to third parties that are endorsed back to the taxpayer. Checks made payable to vendors and other business payees that are cashed by the taxpayer.

    6. Variances between treatment of questionable items as reflected on the tax return, and representations within the books.

    7. Intentional under- or over-footing of columns in journal or ledger.

    8. Amounts on tax return not in agreement with amounts in books.

    9. Amounts posted to ledger accounts not in agreement with source books or records.

    10. Journalizing questionable items out of correct account.

    11. Recording income items in suspense or asset accounts.

    12. False receipts to donors by exempt organizations.

  5. Indicators of Fraud—Allocations of Income

    1. Distribution of profits to fictitious partners.

    2. Inclusion of income or deductions in the tax return of a related taxpayer, when tax rate differences are a factor.

  6. Indicators of Fraud—Conduct of Taxpayer

    1. False statement about a material fact pertaining to the examination.

    2. Attempt to hinder or obstruct the examination. For example, failure to answer questions; repeated cancelled or rescheduled appointments; refusal to provide records; threatening potential witnesses, including the examiner; or assaulting the examiner.

    3. Failure to follow the advice of accountant, attorney or return preparer.

    4. Failure to make full disclosure of relevant facts to the accountant, attorney or return preparer.

    5. The taxpayer’s knowledge of taxes and business practices where numerous questionable items appear on the tax returns.

    6. Testimony of employees concerning irregular business practices by the taxpayer.

    7. Destruction of books and records, especially if just after examination was started.

    8. Transfer of assets for purposes of concealment, or diversion of funds and/or assets by officials or trustees.

    9. Pattern of consistent failure over several years to report income fully.

    10. Proof that the tax return was incorrect to such an extent and in respect to items of such magnitude and character as to compel the conclusion that the falsity was known and deliberate.

    11. Payment of improper expenses by or for officials or trustees.

    12. Willful and intentional failure to execute pension plan amendments

    13. Backdated applications and related documents.

    14. False statements on Tax Exempt/Government Entity (TE/GE) determination letter applications.

    15. Use of false social security numbers.

    16. Submission of false Form W–4.

    17. Submission of a false affidavit.

    18. Attempt to bribe the examiner.

    19. Submission of tax returns with false claims of withholding (Form 1099-OID, Form W-2) or refundable credits (Form 4136, Form 2439) resulting in a substantial refund.

    20. Intentional submission of a bad check resulting in erroneous refunds and releases of liens.

    21. Submission of false Form W-7 information to secure Individual Taxpayer Identification Number (ITIN) for self and dependants.

  7. Indicators of Fraud—Methods of Concealment

    1. Inadequacy of consideration.

    2. Insolvency of transferor.

    3. Asset ownership placed in other names.

    4. Transfer of all or nearly all of debtor's property.

    5. Close relationship between parties to the transfer.

    6. Transfer made in anticipation of a tax assessment or while the investigation of a deficiency is pending.

    7. Reservation of any interest in the property transferred.

    8. Transaction not in the usual course of business.

    9. Retention of possession or continued use of asset.

    10. Transactions surrounded by secrecy.

    11. False entries in books of transferor or transferee.

    12. Unusual disposition of the consideration received for the property.

    13. Use of secret bank accounts for income.

    14. Deposits into bank accounts under nominee names.

    15. Conduct of business transactions in false names.

25.1.2.4  (04-24-2014)
Investigative Techniques

  1. The minimum plan of action must include following up on all leads identified as fraud indicators (signs or symptoms); securing copies of all relevant data relating to indicators of fraud; and noting from whom and when obtained.

    Note:

    Original documents obtained from the taxpayer or third parties should not be marked, indexed, hole punched, or in any way altered by the compliance employee. Also, it is critical that the compliance employee attempt to secure the taxpayer's explanation(s) for any discrepancies.

  2. In cases where a return has not been filed and fraud is suspected, the compliance employee must not demand a return from the taxpayer. A Letter 3798, Non-filer Appointment Letter, should be used in place of the regular initial appointment letter. Books and records pertaining to the unfiled year(s) should still be requested.

  3. A Revenue Agent Report (Form 4549 or similar) must not be sent to the taxpayer and/or power of attorney unless and until this action is specifically discussed with the FTA.

  4. Most fraud cases involve individual and business taxpayers with poor or nonexistent internal controls and/or where there is little or no separation of duties. When these occur, there is a greater potential for material misstatement of taxable income than in cases involving individuals earning salaries and wages. However, fraud may be present in any type of tax return.

  5. Unusual, inconsistent or incongruous items should alert compliance employees to the possibility of fraud and the need for further investigation. Taxpayer misconduct is an early warning sign of possible fraudulent conduct. The method of operating a business (i.e., lack of internal controls, dealing in cash, etc.) may be indicative of improperly filed tax returns. Consider all facts when determining the fraud risk factor. For example, when examining a cash-only business, consider the size and industry type.

  6. The initial contact provides the opportunity to obtain valuable information, which may not be readily available later. Indications of fraud may be disclosed in discussions, financial activities and nonresponsive answers. Questions asked should be recorded verbatim. Similarly, nonresponsive answers should be noted verbatim and judgment used in deciding what information is relevant (affidavits may be used). Examination work papers should be noted as to the tax year, the date of the contact, who was present during the contact, and the author of the examination work papers.

    Examination work papers must include the following information:

    • Who prepared the information used to complete the tax return,

    • Who approved and classified expense items,

    • Who deposited business receipts, and

    • How business gross receipts, per the tax return, were determined.

  7. The compliance employee must prepare a Memorandum of Interview, summarizing information obtained and statements made. This becomes part of the Collection case file or Examination work papers, and aids in the fraud development.

  8. Throughout the investigation, it is important to keep a current and accurate historical record of all contacts and conversations with the taxpayer. This is necessary to track statements when records were received and from whom; and steps taken to determine the accuracy of the information volunteered. Annotations must not be made on records and other evidence received. See IRM 25.1.2.4(1) for additional guidance. It is important that the chain of custody for evidence obtained is clearly established through the historical record. Although necessary in any investigation, this action can be critical in sustaining fraud.

  9. Fraud is not ordinarily discovered when compliance employees readily accept the completeness and accuracy of records presented and explanations offered by the taxpayer. It is necessary to go behind the books and to probe beneath the surface to validate and determine the consistency of information provided and statements made to evaluate the credibility of evidence and testimony provided by the taxpayer. The judgment of the employee will determine the techniques used. The investigation is extended to the point where the employee is satisfied and the conclusions are substantially correct.

    Note:

    The compliance employee must also consider identity theft issues during the course of an investigation. See IRM 10.5.3, Identity Protection Program for additional guidance.

25.1.2.5  (04-24-2014)
Aiding and Abetting

  1. It is important to determine who is responsible for the fraudulent act(s). If the taxpayer is not responsible, then neither criminal and/or civil fraud penalties apply. If the preparer is culpable, then the Return Preparer Coordinator in your Area Planning and Special Programs (PSP) must be contacted. See IRM 20.1.6.3, Overview - Preparer, Promoter, Material Advisor, and Failure to Disclose Reportable Transaction Penalties, IRC 6694 Understatement of Taxpayer's Liability by Tax Return Preparer and IRM 25.1.2.9, Return Preparer Fraud, for additional guidance.

  2. Civil penalties apply to anyone who aids and abets an understatement of tax liability under IRC 6701. An individual who willfully aids and assists with the understatement of a tax liability can be criminally charged under Title 26 USC 7206(2). The individual must be directly involved in the preparation or presentation of the false or fraudulent document. This may include independent parties such as lawyers, accountants, return preparers, and appraisers who counsel on a course of action. It is possible for criminal referrals and/or civil penalties to apply to both the taxpayer and the person assisting the taxpayer. See IRM 4.32.2.1, Overview of Abusive Transactions (AT) Program.

25.1.2.6  (04-24-2014)
Bankruptcy Fraud

  1. This section provides insight to the bankruptcy process and the ways a taxpayer may use bankruptcy to further an overt act in evading payment. For an in-depth discussion of bankruptcy fraud, compliance employees should refer to Document 9762, Desk Guide for Bankruptcy Tax Crime Referrals.http://publish.no.irs.gov/cat12.cgi?request=CAT2&itemtyp=D&itemb=9762&items=

  2. Bankruptcy is a federally authorized procedure by which a debtor (an individual, corporation, LLC, partnership or municipality) may be relieved of liability for certain debts pursuant to the statutory scheme contained in the Bankruptcy Code, 11 U.S.C. In bankruptcy, creditors may be paid through the liquidation of the debtor's assets or through a court-approved repayment plan, depending on the type of bankruptcy filed. Individual debtors are allowed to claim some assets as "exempt" , and those assets are not liquidated. Bankruptcy is intended to provide the debtor with a fresh start.

  3. Bankruptcy fraud statutes, found in Title 18 of the United States Code, typically are the jurisdiction of the Federal Bureau of Investigation (FBI). However, CI will investigates Title 18 crimes when there is a corresponding Title 26 violation of the Internal Revenue Code.

  4. A bankruptcy case begins with the filing of a "petition" in the U.S. Bankruptcy Court. Creditors may also commence a bankruptcy case, however this is rare. Once the petition is filed, the bankruptcy "estate" is automatically created, which includes all of the debtor's property and interests in property, regardless of where the property is located and who is holding it. This includes real and personal property of all types, including cash. Further, if the debtor made a fraudulent transfer of any property within two years of filing the petition, that property may be brought into the bankruptcy estate. The Bankruptcy Code provides a list of specific types of property that are excluded from the estate. In addition, debtors may exempt certain property from the estate by electing to apply statutory exemptions found in either state law or in the bankruptcy Code. In many cases a trustee is appointed as a representative of the estate. In cases filed under Chapter 7 of the Bankruptcy Code, a trustee is appointed to gather and liquidate those assets of the debtor that are not exempt. In a Chapter 11 case, the debtor remains in control of the assets and can continue to operate the debtor's business, if there is one. No trustee is appointed in these cases, and the debtor is responsible for paying current operating expenses and making payments to creditors pursuant to a court-approved plan. In cases filed under Chapter 13 of the Bankruptcy Code, a trustee is appointed, but the debtor retains control of his or her assets, and the trustee's role is to collect payments from the debtor and to distribute the funds to the creditors pursuant to a court-approved plan. The trustee, if there is one, and any creditor may object to the allowance of the exemptions claimed. A trustee may also recover property, which was fraudulently transferred in the two-year period prior to the filing of the bankruptcy, or property that was a preferential transfer made to a creditor up to one year prior to the bankruptcy, depending on the creditor. A preferential transfer is one that gives the creditor a better recovery than the creditor would receive in the bankruptcy. If it is discovered that a debtor made fraudulent or preferential transfers and there is no trustee in the case, the transfers will serve as the basis for a creditor to request that a trustee be appointed to take control of the debtor's assets.

  5. A fraudulent conveyance is any transaction made with the intention of hindering the payment of tax due or to defraud the government through some other act, such as concealment or transfer of assets for less than the fair market value at a time when tax was due or would have become due if the return were filed. Most indications of bankruptcy fraud mirror those encountered by compliance employees in the course of routine investigations. Oftentimes, these cases involve entities that fail to keep ordinary records or follow generally accepted business practices.

  6. A debtor must fully disclose its financial condition, including all assets, through a Statement of Financial Affairs (SOFA) filed at the beginning of the bankruptcy case. The SOFA contains numerous schedules that detail financial facts, income facts, details about the debtor's assets and creditors, transfers made within a certain period prior to the bankruptcy filing, and other pertinent information. The compliance or Insolvency employee compares the bankruptcy petition and SOFA with financial records obtained in other internal investigations. Details can also be matched against public records. Where inconsistencies are found, there is a potential that the debtor committed fraud . Employees may question the debtor about incongruities at the "341 meeting" , also known as the first meeting of creditors. See 11 USC 341. The debtor is required to attend the 341 meeting and testify under oath and penalties of perjury about their financial affairs and the information provided in the schedules and statements. Any creditor may attend the 341 meeting and question the debtor. The court can also compel the debtor to appear and be examined under oath and penalties of perjury about any issue in the bankruptcy case at the request of a party in interest, pursuant to Bankruptcy Rule 2004.

  7. Indications of fraud in bankruptcy cases fit the same pattern as those found in other Collection cases. However, there is the advantage of gathering evidence under oath if the debtor intentionally attempts to defraud the government. The debtor may have:

    • Failed to disclose assets (generally held in a different name) in the SOFA.

    • Transferred personal residence, business or other assets for little or no consideration or less than the fair market value within two years of filing bankruptcy.

    • A lifestyle that does not match reported financial standing, e.g. lives in a home or drives a vehicle which he/she doesn’t appear to be able to afford.

    • Claimed no bank accounts in his/her name. He/she pays expenses using a related third-party bank account, money orders, certified checks or cash.

    • Operated or continues to operate more than one business using similar or like names, while failing to file tax returns or pay tax debts on the related entity. The debtor may use the same business equipment while running the related entities. The bankruptcy does not include related businesses.

    • Commingled personal income and expenses with Schedule C income and expenses, or with that of another business entity under the debtor's controls.

    • Little or no income reported by third-parties (IRP) but reports significant expenses, in particular mortgage interest. In these cases a taxpayer rarely would claim his/her allowable expenses in hopes of avoiding detection.

    • Transferred an asset into a trust while retaining control and possession of the asset. The presence of a trust is frequently a key indicator of fraud, both in and outside of bankruptcy. If the transfer occurred within two years of filing bankruptcy, this transaction can be an indication of fraud.

  8. Bankruptcy cases are time-sensitive. A Bankruptcy Specialist must file a "proof of claim" to record the government’s financial interest in the bankruptcy proceeding. When there is an indication of bankruptcy fraud, employees must contact their local FTA at the earliest possible opportunity.

25.1.2.7  (04-24-2014)
Employment Tax Fraud

  1. IRM 1.2.13.1.2, Policy Statement 4-4, pertains to the examination of employment tax liabilities. Frequently taxpayers fail to treat appropriate as employees, those persons misclassified as "self-employed" or "casual labor." The most common employment tax fraud, however, is not remitting trust fund taxes to the government. The following paragraphs describe the major identified schemes designed to evade reporting and payment of employment tax. Some criminal violations associated with employment tax fraud are Title 26 IRC 7202, Title 26 IRC 7203, Title 26 IRC 7206, Title 26 IRC 7212 and Title 26 IRC 7215. See IRM 4.23.9.6.4, Common Fraudulent Devices. IRM 25.1.8.2, Trust Fund Violations, which addresses unpaid payroll taxes, under-reported payroll taxes, and delinquent Form 941, Employer's Quarterly Federal Tax Return, for Field Collection investigations. See IRM 4.23.9.6.3 for guidance on assessing the trust fund recovery penalty in cases that may involve criminal proceedings.

  2. "Pyramiding" : A fraudulent practice involving employment taxes occurs where a business collects and withholds taxes from its employees and intentionally fails to remit those funds held in trust to the IRS. Often, a lack of sufficient operating capital leads the business owner to use the trust funds to pay other liabilities, including overhead. The unpaid quarterly employment tax liabilities accumulate or pyramid. Pyramiding businesses frequently shut down or file for bankruptcy, and then start a new business under a different name. Without sufficient operating capital, the cycle often begins again.

  3. Employee leasing companies: This industry is a growing area of fraud. An employee leasing company contracts with a client company to handle the client company's administrative duties, often hiring some or all of the client company's employees and leasing back those same employees to the client company. When the leasing company fails to pay the employment taxes, significant tax deficiencies can accumulate in a short span of time because the leasing company's services may be used by several clients. Generally, the employee leasing company, as a service company, does not have significant assets to collect against. When indicia suggest an employee leasing company was established purposefully to evade federal employment taxes or "distance" the client company from employment tax liability, a referral to CI should be considered. Whether the leasing company or the client company, or both, is liable for employment tax underpayment involves technical issues and Area Counsel must be contacted for guidance on how best to pursue the tax deficiencies.

  4. Cash wages: Payment of cash wages is a common method of avoiding employment tax reporting requirements. Be aware of situations where the taxpayer regularly issues checks to "cash" for large amounts that do not exceed $10,000. These checks may be used to pay employees off the books and to avoid Currency Transaction Reports (CTRs). See IRM 4.26.5.4.1, Currency Transaction Reports. Employers occasionally pay part of their employees' wages by check on the books and the remainder off the books in cash, especially for overtime or bonus payments. Businesses also pay workers, who should be treated as employees, in cash, as though they were contracted, to avoid paying employment taxes. In these situations, the employers generally do not maintain accurate records of cash wage payments. This scheme is often found in the construction and landscaping industries. The cash wage reporting may be commingled with labor expenses in Cost of Goods Sold or disguised as a deduction for subcontracted labor. The cash wages are generally not reported on employment tax returns, or Forms W-2 and 1099.

  5. Fictitious subcontractors: In this scheme, a taxpayer issues checks to shell corporations holding themselves out as legitimate subcontractors. In fact, these entities exist only on paper. They typically do not perform services or have assets. The shell companies are set up by the taxpayer or third parties ("five percenters" ). Checks issued to the subcontractors are cashed by local check-cashing services. The check casher charges a fee and the third party, if used, keeps a small percentage of the cash for their services. The remaining cash is returned to the taxpayer and used to pay its workers. Some of the workers may be paid half on the books by check, and half off the books in cash; while other workers, who should be treated as employees but are not, are paid completely off the books. No social security (also known as Federal Insurance Contributions Act) and/or federal income taxes are withheld from these cash payments, and are generally not reported on the taxpayer's employment tax returns, Forms W-2 or 1099. The shell companies have a propensity for turn over, often to avoid detection.

  6. CAWR: Combined Annual Wage Reporting is a document matching program that compares the employee wage information reported by the employer to the Internal Revenue Service (IRS) and the Social Security Administration (SSA). An investigation related to the CAWR originates when information from the IRS and SSA does not match. For example, the taxpayer files Form W-2, reporting wages paid to its employees and the withheld employment taxes from those wages. However, the taxpayer willingly and knowingly does not make deposits of the withheld taxes or file the associated employment tax or information returns for these periods.

25.1.2.8  (04-24-2014)
Excise Tax Fraud

  1. There are opportunities for fraud in the specialized area of excise tax. In addition to other indications of fraud, the following incidents should be considered to establish taxpayer's knowledge in excise cases:

    1. Previously filed returns and paid excise tax but stopped filing and paying without explanation.

    2. Sale of an article at a tax-included price but did not report or pay tax to the government.

    3. Handling of identical products, considers one taxable and the other not taxable.

    4. Membership in trade or industry organizations for a number of years.

    5. Subscriptions to trade publications.

  2. For excise tax purposes, the Trust Fund Recovery Penalty applies only to the communications tax imposed by IRC 4251 and the air transportation taxes imposed by IRC 4261 and 4271. See IRM 4.24.9.5, IRC 6672 Trust Fund Recovery Penalty, for additional guidance on how the trust fund recovery penalty may be used in excise tax cases.

25.1.2.8.1  (04-24-2014)
Excise Tax Fraud—Fuel Taxes

  1. In most situations, federal claims for refund of motor fuel excise tax may be made by the person who initially filed Form 720, Quarterly Federal Excise Tax Return to remit tax or by the end user of the fuel .

  2. In other situations, claims may be filed by a person who neither paid the tax to the government nor used the fuel. These are commonly referred to as “third-party” claims. See IRM 4.24.8.6.4, Third Party Claims.

  3. In yet other situations, incentive credits may be claimed by persons that neither paid the excise tax, used the fuel for a nontaxable purpose, or registered to file a claim for sales to exempt customers. See IRM 4.24.4.10.1, Taxation of Biodiesel and Biodiesel Mixture Credits.

  4. The potential for abuse increases because there are multiple, interchangeable forms that can be used to submit claims. Consequently, there is the potential for multiple claims made on different forms for the same fuel.

  5. More blatant fraud potential exists when the claimant never actually purchased, sold, used, or blended the fuel. These claims are the most abusive and may be perpetrated by individuals who are not even in the motor fuel business or engaged in any other business.

25.1.2.8.2  (04-24-2014)
Excise Tax Fraud—Wagering Tax

  1. The critical fraud elements prevalent in most illegal wagering cases are:

    • The wagering activity must be subject to the wagering tax laws.

    • Failure of the person to register and pay the special tax before accepting the wager and/or failure of the person to file wagering excise tax returns and pay tax.

    • Evidence to prove that the person willfully failed to comply with the law.

  2. Some examples of critical fraud elements are:

    • Destruction of records. The intentional destruction of records is a strong indication of willful intent to avoid the proper computation and payment of income taxes, and can assist in the development of a criminal fraud referral. When direct evidence is not available, it may be necessary to establish the gross revenue and period of operation using indirect evidence.

    • Income from illegal wagering omitted. Often when income tax returns are filed, the income from illegal wagering is omitted. Close attention should be paid to any filed federal tax returns for the presence and omission of assets, income sources and to a personal lifestyle that is extravagant compared to reported income.

    • Criminal/Illegal activity. Most federal excise tax wagering cases are illegal enterprises where the individual(s) is arrested and prosecuted by a state law enforcement agency prior to the Excise Office obtaining the case.

    • Cash transactions. Illegal bookmakers for betting deal in strictly cash transactions with no checks or other bank documents used to leave a paper trail.

25.1.2.8.3  (04-24-2014)
Excise Tax Fraud—Retailer Schemes

  1. The fraud issues in Retail Excise Tax normally relate to the retailer. The retailer collects the tax but does not pay it over to the government. The retailer may cover up the collected tax by altering invoices. The retailer may also give false information about to whom the sales were made (a customer exempt from tax) to avoid applying the tax.

25.1.2.8.4  (04-24-2014)
Excise Tax Fraud—Heavy Highway Vehicle Use Tax

  1. An individual or a company who is required to pay taxes on the Form 2290, Heavy Highway Vehicle Use Tax Return, to obtain state registrations, can falsify documents and understate the number of vehicles to avoid paying the excise tax.

  2. The requirements for filing the Form 2290 are:

    1. A taxable highway motor vehicle, which includes any self-propelled vehicle designed to carry a load over public highways, whether or not also designed to perform other functions, is registered, or required to be registered, under state, District of Columbia, Canadian, or Mexican law at the time of its first use during the taxable period, and

    2. The vehicle has a taxable gross weight of 55,000 pounds or more.

25.1.2.8.5  (04-24-2014)
Excise Taxes—Willful Failure to Pay

  1. See IRM 4.24.9.3 for guidance on the assertion of the willful failure to pay fuel tax penalty under IRC 4103.

25.1.2.8.6  (04-24-2014)
Section 4103 cases—Referrals to Collection Function

  1. See IRM 4.24.9.3.1 for guidance on referring potential IRC 4103 cases to Collection function.

  2. Appropriate notations, such as how the taxpayer designed to avoid reporting and payment of the proper amount of excise tax, must be included in the examination work papers or case file with a copy of the completed referral memorandum. In cases where IRC 4103 does not apply, examiners must annotate the work papers that a referral was considered, but not made, and include the reasons.

25.1.2.9  (04-24-2014)
Return Preparer Fraud

  1. There are tax return preparers who defraud taxpayers and the United States Treasury by inflating income, deductions, credits, or withholding without the taxpayer's knowledge, with the goal of increasing the overall amount of the taxpayer's refund. The preparer then diverts the refund (or portion thereof) into his or her account or that of a nominee.

    1. For example, some cases may involve the preparer filing the return on paper, where the alterations to the return occur after the taxpayer has approved the return. In other cases, however, the taxpayer has indicated approval of the return by signing Form 8879, IRS e-file Signature Authorization, and then the preparer appears to have altered the return before electronically filing it.

    2. In some of the cases, the preparer may split the refund by using Form 8888, Allocation of Refund (Including Savings Bond Purchases), so that the taxpayer gets the amount of refund that he or she is expecting, and the preparer asks the IRS to direct deposit the portion of the refund resulting from the inflated items into a bank account under the preparer's control.

    3. In other cases, the preparer may have the entire refund direct-deposited into his or her account, and then wire transfers the amount the taxpayer was expecting into the taxpayer's bank account.

  2. Taxpayers must provide sufficient documentation to the IRS to support a claim of return preparer fraud.


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