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Looking at tax fraud vs. tax negligence, and some factors that impact penalties, P.1

When significant discrepancies are noticed in a tax return, the Internal Revenue Service will take notice and reserves the right to conduct an audit to determine the reason for noncompliance. In the audit process, the IRS is particularly concerned about determining whether noncompliance is due to negligence or fraud.

The question of whether noncompliance can be characterized as fraud or negligence is an important one from the standpoint of penalties. Taxpayers who made a mistake on a tax return are not punished as severely as taxpayers who attempt to defraud the IRS. The general difference between fraud and negligence, of course, is that tax fraud is intentional noncompliance, whereas negligence is unintentional noncompliance.

While each case is unique, there are certain patterns tax authorities look for to determine whether they are dealing with fraud or negligence. 

In looking out for fraud, tax authorities tend to look for things like: false explanations for understatements or omissions in income; concealing the sources of income; numerous errors in favor of the taxpayer; false records; verbal misrepresentations of facts and circumstances; and failure to provide records. Investigators generally do not consider only one of these factors to form a definitive case of fraud.

Negligence is different in that tax authorities are looking for signs that a taxpayer did not have the specific intent to skirt tax laws. Authorities will look for signs that the taxpayer disregarded rules or regulations rather than engaged in intentional violations. Some of the indicators authorities look out for include: a history of noncompliance; sloppy record-keeping; failure to establish internal processes for reporting business transactions; under-reporting or understating income and failure to offer a reasonable explanation; and utilizing generic deduction descriptions in order to hide the true nature of a deduction.

In our next post, we’ll consider the importance of working with an experienced attorney during the audit process. 

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