Civil Fraud Penalty

Not every IRS investigation is criminal. Some agents are tasked with handling civil investigations for fraud, and while these cases are not criminal, the consequences remain significant. Being charged with the crime of tax fraud does not prevent the IRS from opening a civil investigation, so you may face additional civil liability after being charged.

If you are under investigation for tax fraud, Whiteford Tax Defense can help. Our tax fraud attorneys review your financial records, communicate with the IRS or state authorities, and develop a defense strategy. The sooner you speak with an experienced tax defense attorney, the more likely you are to avoid a fine or other consequences.

Civil versus criminal IRS investigations

Civil investigations into tax fraud can stem from a taxpayer's honest mistake, such as accidentally failing to fully report income or claiming an unavailable deduction, or from filing errors like filing late or not at all. Their purpose is to recoup what the government is owed with interest, in contrast to punishing wrongdoing.

Criminal cases carry the risk of incarceration and require a higher standard of proof. The IRS is more likely to pursue criminal charges where it believes a taxpayer intentionally underpaid taxes or hid income, using improper deductions, false documents, or offshore concealment. Criminal cases are handled by the IRS Criminal Investigation division, and the higher standard of proof sometimes results in the IRS pursuing a civil case instead, when the evidence of intentional fraud is insufficient.

Common causes of civil fraud investigations

Excessive deductions and credits

You may claim credits and deductions to the fullest extent the law allows, but being too aggressive, in either type or amount, commonly triggers a fraud investigation. The IRS compares your return to prior years for patterns or sudden changes, and reviews your supporting documentation. Fraudulent-looking deductions can lead to an investigation and a referral to a prosecutor.

Failure to report income

Intentionally omitting wages, self-employment earnings, or investment income is a common trigger, and even minor or recurring discrepancies can prompt a review. The IRS runs an automated matching process comparing employer-reported W-2s and bank-reported interest and dividends against your return, so repeated omissions or patterns of concealment are readily detected.

Offshore and hidden accounts

Concealing domestic or offshore accounts to avoid reporting interest, dividends, or gains is a major red flag. The IRS and state tax agencies use tools including the Foreign Bank Account Report and FATCA reporting requirements to uncover hidden accounts, and sudden transfers, large deposits, or complicated ownership structures attract attention. Concealment is treated as an aggravating factor if a case proceeds to criminal sentencing.

Civil tax fraud penalties

A civil case does not carry the risk of incarceration, but the financial consequences can be substantial. Penalties are typically a percentage of what is owed rather than a fixed amount, plus interest that increases each month until the balance is paid in full. If an underpayment comes from negligence, the accuracy-related penalty is 20% of the part of the underpayment it caused. When the underpayment is due to fraud, the assessed penalty may be up to 75% of the underpayment amount.

The IRS civil investigation process

A civil fraud investigation may involve a complex process that looks at multiple financial documents:

• A review of personal banking records, income, business books, and bank accounts
• Evaluation of the tax return, including where and how filing took place
• In-person interviews and reviews of the information provided

Many investigations proceed entirely through the mail, with no in-person meeting. Others require interviews. The IRS will often hold off on assessing civil penalties until a related criminal case resolves, to avoid interfering with that investigation.

The civil fraud penalty is one of several IRS penalties covered in our tax penalties overview, alongside the accuracy-related penalty that applies where the IRS cannot meet the higher fraud standard.