Tax Fraud and Cheating on Taxes

It is a crime to cheat on your taxes. In a recent year, however, fewer than 2,000 people were convicted of tax crimes —0.0022% of all taxpayers. This number is astonishingly small, taking into account that the IRS estimates that 15.5% of us are not complying with the tax laws in some way or another. The number of convictions for tax crimes has increased less than 1% over the most recent five-year period.

The point is that the statistical likelihood of your being convicted of a tax crime is almost nil. Nevertheless, if you are in the unlucky minority of people criminally investigated by the IRS, you need more than this book. Hire the best tax and/or criminal lawyer you can find.

According to the IRS, 75% of the tax cheating is done by individuals—mostly middle-income earners. Most of the rest of the cheating is done by businesses. Cash-intensive businesses and service providers, from self-employed handypeople to doctors, are the worst offenders.

How People Cheat on Their Taxes

Most cheating is from deliberate—actual or willful—underreporting of income. This is called tax evasion—the most commonly charged tax crime. A government study found the most underreporting of income was by self-employed restaurateurs, clothing store owners, and—you’ll no doubt be shocked—car dealers. Telemarketers and salespeople came in next, followed by doctors, lawyers (heavens!), accountants (heavens, again!), and hairdressers.

Business owners who over-deduct business-related expenses—such as car and entertainment—came in a distant second on the cheaters hit parade. Surprisingly, the IRS contends that only 6.8% of deductions are overstated or just plain phony.

If You Are Caught Cheating

Tax crimes are most likely to be first spotted during an audit. If you are caught in a tax lie by an auditor, she can either slap you with a penalty or refer your case to the IRS’s criminal investigation division (CID). In the vast majority of cases, the auditor won’t call in the CID.

The Auditor Suspects You of Fraud

Auditors are trained to look for signs of tax fraud, which is a form of tax evasion. Tax fraud is defined as a willful act done with the intent to defraud the IRS—that dark area beyond honest mistakes. Using a false Social Security number, keeping two sets of financial books, or claiming a blind spouse as a dependent when you are single are all blatant examples of tax fraud. While auditors look for fraud, however, they do not routinely suspect it. They know the tax law is complex and expect to find a few careless mistakes in every tax return. They will give you the benefit of the doubt most of the time.

Even if the auditor does not refer suspected fraud to the CID, she can impose fines, called civil penalties, if you omitted a chunk of income on your tax return. Overstated or phony deductions and exemptions can also be punished by the fraud civil penalty—for example, claiming exemptions for dependents who have long since left home, died, or were never born. Fraud penalties can also be added for exaggerating deductions, such as adding a zero to $200 making it $2,000, or by claiming a casualty loss for a nonexistent accident.

Fraud or Negligence?

A mistake on your tax return might get you a 20% penalty tacked on to your tax bill. While not good, this sure beats the cost of tax fraud—a 75% civil penalty. The line between negligence and fraud is not always clear, however, even to the IRS and the courts.

Auditors are trained to spot common types of wrongdoing, called “badges of fraud.” Examples include a business with two sets of books or without any records at all, freshly made false receipts, and checks altered to increase deductions. Altered cancelled checks are easy to spot by comparing written numbers with computer coding on the check or bank statements.

The Internal Revenue Manual directs auditors suspecting criminal tax fraud to contact the IRS criminal investigation division, or CID. In reality, auditors make very few criminal referrals. Making a fraud referral is too much paperwork. If auditors find a couple of obviously phony receipts, they usually will quietly disallow them and move on. Fraud referrals are more often made in special project audits. These are targeted audits of particular industries and professions, such as building contractors or chiropractors.


The auditor will not tell you if she has made a criminal fraud referral. One indication, however, may be an audit stopping midstream for no apparent reason. But never assume a fraud referral was made just because months pass and you don’t hear from the auditor. She is probably just behind in her work.