Every year, millions of tax returns are filed without issue. Most taxpayers will never hear from the Internal Revenue Service beyond receiving a tax refund or a notice about taxes withheld. But for a small percentage, something on a return, in a financial transaction, or in their behavior raises enough suspicion to trigger an IRS criminal investigation. These cases are rare compared to civil tax audits, but when they happen, the stakes are no longer involve just paying back taxes, but avoiding potential fines and time spent in a federal prison.

Why Triggers Matter

Errors happen on tax returns, and most are handled through civil tax enforcement. A civil tax audit may result in penalties, interest, or additional tax imposed. A criminal tax investigation, however, requires proof that someone willfully violated the Internal Revenue Code.

The primary difference between a civil tax audit and a criminal tax case lies in the intent. If the IRS believes a taxpayer deliberately tried to evade taxes, filed false returns, or engaged in fraudulent conduct, the matter may be referred to IRS-CI and eventually the DOJ and United States Attorney’s Office for prosecution.

Who Reports the Red Flags?

IRS criminal investigations usually begin with a referral from within the IRS or from outside sources.

Internal IRS Referrals

• Revenue agents may uncover signs of fraud during a civil tax audit, such as false documents or unreported income.
• Revenue officers working on collection matters sometimes discover evidence of tax evasion, like hidden assets or false statements.
• Compliance officers reviewing tax returns may flag suspicious patterns, including repeated false tax returns.
• Automated systems compare tax returns with third-party data (W-2s, 1099s, bank reports). Significant mismatches can trigger further review.

External Information Sources

• Whistleblowers and informants often provide tips about tax fraud or unreported income.
• Public tips through IRS reporting programs can spark investigations.
• Other law enforcement agencies, such as the FBI, DEA, or local police, sometimes uncover tax crimes during unrelated investigations.
• Financial institutions file Suspicious Activity Reports under the Bank Secrecy Act, which can alert the IRS to possible money laundering or structuring transactions.
• Foreign governments share information under tax treaties, especially in cases involving international tax avoidance.

Red Flags That Raise Criminal Suspicion

The IRS-CI seeks patterns of behavior that indicate deliberate attempts to evade taxes. These red flags often separate civil mistakes from criminal activity.

Income Reporting Patterns

• Significant underreporting of income, especially across multiple years.
• Omitting entire income sources, such as cash businesses or side jobs.
• Lifestyle inconsistent with reported income, like luxury purchases without sufficient declared earnings.
• Total positive income discrepancies that legitimate deductions cannot explain.

Deduction and Credit Abuse

• Inflated business expenses without receipts or documentation.
• Personal expenses claimed as business deductions, such as vacations or personal vehicles.
• False dependents or credits, including fabricated Social Security numbers.
• Participation in abusive tax shelters designed to conceal income.

Filing Behavior Patterns

• Willful failure to file tax returns for multiple years.
• Submitting false documents with the intent to deceive.
• Suspicious amended returns that appear to cover up prior fraud.
• Consistent late filings with large outstanding balances, suggesting potential avoidance.

Financial Transaction Red Flags

• Structuring cash deposits under $10,000 to avoid reporting requirements.
• Currency transaction violations under federal law.
• Multiple bank accounts are used to obscure income.
• Cash-intensive businesses with poor or missing records.

Business-Specific Triggers

Businesses face unique risks that can lead to criminal tax cases.

Employment Tax Issues

• Failure to pay employment taxes withheld from employees is known as a trust fund tax violation.
• Payroll tax pyramiding occurs when businesses repeatedly fail to remit payroll taxes on time.
• Misclassifying employees as independent contractors to avoid paying employment taxes.
• Cash payroll systems that bypass reporting obligations.

Business Structure Manipulation

• Shell companies or nominee arrangements are used to hide ownership.
• Related-party transactions that are not at arm’s length.
• Profit shifting to avoid taxes.
• Dissolving entities to escape tax obligations.

Industry-Specific Risks

• Cash-heavy industries like restaurants, retail, and construction.
• Professional practices, such as those of doctors, lawyers, and consultants, can have unreported income that can be significant.
• Online businesses with international transactions that complicate tax compliance.

Technology and Data Analytics Triggers

The IRS increasingly relies on technology to detect tax fraud.

Automated Detection Systems

• Document Matching Programs compare tax returns with W-2s, 1099s, and other third-party reports.
• Unreported Income Detection algorithms flag discrepancies.
• Statistical analysis identifies outliers compared to average taxpayers.
• Cross-checking third-party data exposes false returns.

Digital Footprint Analysis

• Social media posts showing luxury lifestyles are inconsistent with reported income.
• Real estate and property records that reveal undisclosed assets.
• Business licenses and permits that contradict reported activity.
• Credit reports showing financial activity not reflected on tax returns.

Cryptocurrency and Digital Assets

• Failure to report virtual currency transactions.
• Exchange reporting discrepancies between taxpayer filings and exchange data.
• Mining income that goes unreported.
• Foreign wallets and exchanges are not disclosed under federal law.

Key Takeaways and Next Steps

If you believe your tax situation could raise red flags, the time to act is before the IRS does. Contact us today to schedule a confidential consultation with an experienced tax attorney. We will review your tax returns, assess potential risks, and help you protect your rights before a civil tax audit becomes a criminal tax case.