The mission of the Office of Fraud Enforcement (OFE) is to promote compliance by strengthening the IRS response to fraud and by mitigating emerging threats. This includes:

Purpose: The primary purpose of this handbook is to assist civil compliance employees in recognizing indicators of fraud and to set forth the development process used to prove fraud.

Audience: This handbook is a comprehensive guide for IRS civil employees Servicewide in the recognition and development of potential fraud issues, referrals for criminal fraud, duties and responsibilities in joint investigations, civil fraud cases, and other related fraud issues.

Policy Owner: Director, Office of Fraud Enforcement, Small Business Self Employed (SB/SE).

Program Owner: Office of Fraud Enforcement Policy, SB/SE.

Primary Stakeholders: Employees in IRS compliance and the OFE.

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 enforcement advisor (FEA). Initial contact with the FEA should be completed by submitting a request through the Specialist Referral System (SRS). Campus employees do not use the SRS.

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

Form 11661/11661-A documents the FEA’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 FEA. If disagreement exists on whether a case should be in fraud development status, the final decision rests with the compliance employee's group manager.

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

When the FEA concurs with the fraud development determination, the FEA 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 FEA. 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.

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 FEA. All contacts with the FEA and subsequent action plans must be accurately documented in the Collection case file or Examination work papers. The plan must:

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

The compliance employee must request the original tax returns, if not already secured. 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:

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 a 10-year ban have been met. IRC 32(k) allows the IRS to impose bans on future claims of Earned Income Tax Credit (EITC) against taxpayers who made prior fraudulent claims for the EITC. The EITC 10-year ban is permitted after a final determination is made that the taxpayer's EITC claim was due to fraud. IRC 24(g)(1)(B)(i) allows the IRS to impose 10-year bans on future claims of Additional Child Tax Credit (ACTC)/Other Dependent Credit (ODC), against taxpayers where it is determined the taxpayer’s actions were due to fraud. IRC 25A(b)(4)(A)(ii)(l) allows the IRS to impose 10-year bans on future claims of the American Opportunity Tax Credit (AOTC), against taxpayers where it is determined the taxpayer’s actions were due to fraud. For jointly filed returns, consideration should be given to proposing a 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. See IRM 20.1.5.3.5, Two and Ten Year Bans on Claiming the Earned Income Tax Credit (EITC), Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), and American Opportunity Tax Credit (AOTC) and IRM 4.19.14.7.1, 2/10 Year Ban - Correspondence Guidelines for Examination Technicians (CET), for additional information.

A determination that the potential for fraud no longer exists:

For a case that deviates from the established plan of action, the compliance employee's group manager or FEA 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 FEA involvement in an ongoing audit or collection activity, or until the FEA recommends one of the following actions:

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.

The following table shows indicators of fraud based on the taxpayer’s income:

The following table shows indicators of fraud based on the taxpayer’s expenses and deductions:

The following table shows indicators of fraud based on the taxpayer’s books and record keeping:

The following table shows indicators of fraud based on how the taxpayer allocates income:

The following table shows indicators of fraud based on the conduct and actions of the taxpayer:

The following table shows indicators of fraud based on how a taxpayer may hold title in, or use assets:

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.

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.

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 FEA.

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.

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.

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:

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.

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), Investigative Techniques, 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.

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.

It is important to determine who is responsible for the fraudulent act(s). If it is determined that the taxpayer is not the responsible party, then consideration should be given to determine if other related parties such as the preparer can be held responsible. 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 and Promoter Penalties, IRC 6694 Understatement of Taxpayer's Liability by Tax Return Preparer and IRM 25.1.2.9, Return Preparer Fraud, for additional guidance.

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 4.32.2.2, Overview of Abusive Transactions (AT) Program.

This section provides insight into 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.

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 USC. 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.

Preferably, bankruptcy fraud will be charged in conjunction with violations of the tax, money laundering, or currency statutes with CI’s statutory jurisdiction. In instances where prosecution of these offenses is not practicable, prosecution can be recommended for bankruptcy fraud alone.

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, U.S. Code, Title 11, 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 generally 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; however, see 11 U.S.C. 1104, Appointment of Trustee or Examiner , which provides for appointing a Chapter 11 trustee in certain circumstances. In cases filed under Chapter 13 of the Bankruptcy Code, a trustee is appointed, but the debtor retains control of their 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. See IRM 5.9.2.4, Chapters in Bankruptcy, for additional information.

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.

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.

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:

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 request a FEA via the Specialist Referral System (SRS) at the earliest possible opportunity.

IRM 1.2.1.5.2, Policy Statement 4-4, pertains to the examination of employment tax liabilities. Frequently, taxpayers fail to appropriately treat 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, Civil Fraud Procedures. See IRM 25.1.8.3, Employment Tax 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, Criminal Fraud Procedures - General, for guidance on assessing the trust fund recovery penalty in cases that may involve criminal proceedings.

"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.

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 TEGEDC Area Counsel must be contacted for guidance on how best to pursue the tax deficiencies.

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 4.26.5.5.1, 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 Form W-2 and Form 1099.

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, Form W-2 or Form 1099. The shell companies have a propensity for turnover, often to avoid detection.

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.

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:

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 IRC 4271. See IRM 20.1.11.4, IRC 6672 Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax, for additional guidance on how the trust fund recovery penalty may be used in excise tax cases.

There is an exemption for excise taxes on any article that is exported, see IRC 4221(a)(2). Therefore, this excise tax exemption may lead taxpayers to provide false information and fraudulent documentation which claims the taxpayer exported articles when in fact the article was not exported.

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. For example:

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

Taxpayers must complete Form 14157-A, Tax Return Preparer Fraud or Misconduct Affidavit, to file a claim of preparer fraud or misconduct.

FinCEN Query (FCQ) is an on-line database query application. The FCQ application was developed by the Financial Crimes Enforcement Network (FinCEN) as part of the BSA Information Technology Modernization Program and is accessed via the secure FinCEN Portal, https://bsa.fincen.gov. The FCQ application supports a wide range of law enforcement and regulatory users for access to perform report and data information queries on the millions of BSA reports housed within the FCQ database. The system is designed to provide users with expanded query capabilities, including the ability to query multiple fields, use of four available search options, and use of various search methods to narrow or expand query results.

FEAs and Emerging Threats Mitigation Team (EMT) members are authorized to request access to FCQ to use as a tool in case development.

As mentioned in IRM 5.1.18.20, Definition of Digital Assets, digital assets may be a capital asset, inventory, a form of payment to acquire goods or services, compensation, or held as an investment. Since digital assets can be used in many of the same ways as non-digital assets, the general indicators of fraud, located at IRM 25.1.2.3, Indicators of Fraud, can also apply to digital asset cases. While the use of digital assets is not itself an indicator of fraud, there are indicators of fraud that are specific to digital asset cases. Some of these indicators of fraud are listed below.