The Croatia international is the latest La Liga player to be caught up in a recent clampdown on tax fraud by the Spanish authorities, who have also investigated Modric's team mates Cristiano Ronaldo, Marcelo and his former coach Jose Mourinho among other high profile players.
Modric and his agent were not immediately available for comment.
The investigation also includes Modric's wife and a limited company based in Luxemburg, Ivano S.A.R.L.
The court filing from the prosecutor for the region of Madrid said Modric signed a contract in December 2012 ceding his image rights to Ivano, which received payments of 552,485 euros in 2013 and 729,000 euros in 2014.
Modric's boot sponsor Nike paid Ivano 729,000 euros over those two years, according to the statement.
The filing said Ivano is a "false" company, "created with the only purpose of channelling the player's image rights and avoiding tax".
The Spanish tax authorities added it has asked Spanish courts to contact the authorities of the Isle of Man to hand over details of Modric's accounts there after discovering their existence, which could increase the amount the player is accused of defrauding.
Modric, 32, joined Real Madrid from Tottenham Hotspur in 2012 for 40 million euros and has won a La Liga title, a King's Cup and three Champions Leagues with the club.
In July, Real's all-time top scorer Cristiano Ronaldo appeared in court in an investigation over evading 14.7 million euros in tax. The investigation is ongoing.
Last year Barcelona's Lionel Messi was found guilty of fiscal fraud to the tune 4.1 million euros and was given a suspended sentence of 21 months which was exchanged for a fine.
(Reporting by Richard Martin; Editing by Christian Radnedge)
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