Auditors are trained to spot common types of fraudulent acts by taxpayers. The acts are called badges of fraud. Auditors know that the tax law is complex and expect to find few errors in every tax return. The most common “badges of fraud” commonly used by taxpayers to deceive or defraud the government include the following:

Income:

Omissions of specific items where similar items are included; omissions of entire sources of income; substantial unexplained increases in net worth; substantial excess of personal expenditures over available resources; bank deposits from unexplained sources; concealment of bank accounts, brokerage accounts, and other property; inadequate explanation for dealing in large sums of currency; failure to deposit receipts to business account; failure to file return, especially for a period of several years; covering up sources of receipts; substantial overstatement of deductions; substantial amounts of personal expenditure deducted as business expenses; claiming fictitious deductions; dependency exemption claimed for non-existent, deceased, or self-supporting persons.

Books & Records:

Keeping 2 sets of books or no books; false entries or alternations, backdated/postdated documents, false invoices, applications, statements or other documents; failure to keep adequate records, concealment of records; intentional under/over footing in journal or ledger; amounts on return not in agreement with amounts in books;

Allocation of income:

Distribution of profits to fictitious partners; inclusion of income/deductions in the return of related taxpayer, when difference in tax rates is a factor.

Conduct of taxpayer:

False statements about material facts; attempts to hinder the examination; failure to answer pertinent questions, repeated cancellations of appointments, or refusal to provide records; testimony of employees concerning irregular business practices; destruction of books/records; transfer of assets for purposes of concealment or diversion of funds; patterns of consistent failure over several years to report income fully; use of false social security numbers; submission of false W4s, affidavits or other documents; attempts to bribe the examiner.

Methods of Concealment:

Inadequacy of consideration; insolvency of transferor; assets placed in other names; transfer of all or nearly all of debtors’ property; close relationship between parties to the transfer; transfers made in anticipation of tax assessments or investigation; retention of possession; transactions surrounded by secrecy; unusual disposition of the consideration received for the property; use of secret bank accounts; conduct of business transaction in false names.