What is TAX Fraud?
Key Takeaways:
- Tax fraud is the willful failure to file or intentional reporting of false information on a federal income tax return.
- Tax avoidance is not considered tax fraud. Tax avoidance is a legal method of reducing tax liability through deductions, tax credits, and income adjustments.
- Tax evasion is a type of tax fraud that involves the illegal evasion of paying income taxes by neglecting to report all forms of income on your federal tax return.
- Some types of tax fraud include willful failure to pay income taxes, frivolous tax claims, employment and payroll tax fraud, and tax preparer fraud.
When tax season rolls around and it is time to file a tax return, many individuals feel stressed by the possibility of making a mistake – after all, no one wants to be in trouble with the IRS. Regardless, if you are worried about tax fraud, it is beneficial to know that this is not some accidental error on your income tax return. Instead, it is when someone willfully makes an error on their tax return in an attempt to avoid paying what they owe in taxes.
How does the IRS determine what is tax fraud?
If a business or individual willfully falsifies an income tax return with the intention of reducing what they owe in taxes or trying to eliminate tax liability altogether, this is considered tax fraud. Some examples of ways people evade taxes when they commit tax fraud include claiming false deductions on their tax return, claiming personal expenses as business expenses, filing a tax return using a false social security number, or failing to report income.
Tax fraud is defined as the willful submission of false or inaccurate statements or documents within a tax return. For an inaccuracy on a tax return to be considered tax fraud, the error must be more than a mistake – there must have been a willful intention to hide information from the IRS to avoid paying taxes, which is illegal. There are several factors of an application or tax return that the IRS will evaluate when investigating tax fraud, including:
- The failure to file a tax return
- The incorrect or underreporting of income
- Presenting a false social security number
- The falsification of documents
- The intentional failure to pay the tax liability
If an IRS investigation notices one or more of these offenses on your account, it is likely that rather than accuse you of tax evasion, these mistakes will be considered unintentional negligence. If this is the case, you normally will not be accused of criminal tax fraud, and instead, the case will be pursued as accidental and you will face the consequences of accuracy-related penalties. This type of penalty is not considered a criminal charge and equates to 20% of the total tax underpayment.
In order to avoid being charged with additional fines and penalties from inaccurate tax filings, it is beneficial to diligently check and confirm that all of the information you are submitting in your tax return is correct. If you are looking for a way to lower your payments, seeking assistance from a tax professional like Ideal Tax is an excellent way to reduce your charges to a fraction of the cost with the Fresh Start Program.
Tax Evasion Vs. Tax Avoidance
Although it is never enjoyable for individuals to pay taxes, the methods by which people avoid paying taxes can have varying outcomes with the Internal Revenue Service. The income tax system in the United States of America revolves around the voluntary compliance of taxpayers in paying their owed tax liability. In general, while the IRS will pursue various methods to ensure an individual’s tax debt is paid, there are limits to how much the IRS can reasonably collect in the case that paying taxes would cause someone to experience financial hardship and struggle to pay their essential monthly living expenses. It turns out that there is a difference between avoiding taxes and evading taxes.
Tax Avoidance
Tax avoidance is an action that taxpayers can take to reduce what is owed in tax liability and maximize their personal income after taxes are paid. Contrary to what many people believe, tax avoidance is a perfectly legal process you can use to reduce what you owe in federal income taxes. There are several strategies people can use to reduce their tax debt through tax avoidance, including tax deductions, tax credits, and making adjustments to how much income tax is withheld from their paychecks.
Tax Evasion
Unlike the legal reduction of tax liability through tax avoidance strategies, evading taxes is illegal and can result in criminal charges. One of the commonly attempted strategies people use to evade taxes is failing to report some or all of their personal income. There are several situations in which income could be neglected in a tax return, such as when an individual earns tip income by working at a restaurant or in the hospitality industry. Another instance in which people avoid reporting income is when they earn money through various forms of freelancing, such as tutoring, babysitting, or yard work. Additionally, if you fail to report income from estate sales, garage sales, or selling other items or property you could also be accused of tax evasion.
The money you earn and fail to report in your income tax return is considered to be an activity within the underground economy. The underground economy exists as a fraudulent strategy to avoid paying taxes, but if the IRS identifies that a taxpayer has not paid what they owe in income taxes, they will be subject to paying the back taxes and any additional penalties.
Penalties for Tax Evasion
Due to the intentional nature of tax evasion, there are varying levels of consequences you must be aware of.
- You could be reported as a felon on your legal records.
- You could be subject to a penalty of up to 5 years in jail
- Individuals could be fined up to $250,000
- Corporations could be fined up to $500,000
- You could be billed for the cost of what it took to prosecute you
In general, your compliance with IRS laws directly correlates to the severity of your punishment for tax evasion. If you commit fraudulent activities with your taxes and fail to comply, prison time is a real possibility as your punishment. However, for most taxpayers, a civil penalty is much more likely. However, even though civil penalties are less severe than prison time, the cumulative charges of a civil penalty can lead to the tax liability owed almost doubling in quantity.
Some of the common civil penalties for tax evasion include:
- A failure-to-file penalty
- A penalty for underpayment
- Penalties that are accuracy-related
- Interest on the total penalties owed
Additionally, if you are being investigated for tax evasion, your account is much more likely to be audited in the future. When you are at a higher risk of being audited by the IRS, it is especially important to maintain organized financial documents and tax records so you can more easily provide proof of income and payment history to the IRS.
Types of Tax Fraud
There are many different types of tax inaccuracies that are considered committing tax fraud by the Internal Revenue Service.
Willful Failure to Pay Income Taxes
The first type of tax fraud a taxpayer may commit is the willful failure to pay federal income taxes. According to the Internal Revenue Service, 1 out of 6 taxpayers fails to comply with the IRS tax code in some form. Despite this high percentage of the population that is estimated to be non-compliant with tax laws, you may notice that one-sixth of U.S. citizens are not in prison for committing tax fraud. This is because the IRS realizes that while some of the tax errors are committed intentionally, many of these instances are due to negligent errors.
Willful failure to pay income taxes is considered tax fraud or tax evasion. The IRS considers an individual or business to have committed tax fraud when:
- They intentionally failed to pay what was owed in taxes
- They intentionally failed to file a federal income tax return
- They failed to report all income in their tax return
- They made false or fraudulent claims in their tax return
While the consequences of tax fraud can be severe, the IRS acknowledges that people make mistakes. Without sufficient evidence that an individual conducted tax fraud or tax evasion, inaccuracies on a tax return will usually be considered accidental and due to an honest mistake. However, even if a tax mistake is unintentional, the taxpayer is still responsible for paying the total taxes owed to the IRS, including any penalties and interest accrued due to tax return errors.
While unintentional errors when filing tax returns are usually written off as negligent, there are still instances in which honest mistakes are assumed to be deliberate by the IRS. Taxpayers can face serious consequences such as prison time if the IRS believes they intentionally attempted to defraud.
If you find yourself in this situation, the best strategy to assist you in the criminal investigation is to get help from an experienced tax professional who can advocate for you. Tax attorneys at Ideal Tax are experts at understanding the Internal Revenue Code and helping taxpayers find the best resolution for tax problems based on each unique situation.
Frivolous Tax Claims
Aside from when someone willfully fails to pay what they owe in income tax, making frivolous tax claims is another tax violation that can be considered income tax fraud by the IRS. There can be nuances that occur when the IRS accuses someone of tax fraud through frivolous tax claims because as a citizen of the United States, taxpayers have the right to argue that federal income tax is illegal. However, the right to argue the illegality of federal income tax does not neglect people from the responsibility of paying what is owed in income taxes.
If you have considered arguing with the IRS that income tax is illegal or immoral, it is beneficial to know that even if your argument appears reasonable based on your research, it is likely that the IRS has heard and denied that exact request in the past. Furthermore, the IRS can issue additional penalties for wasting time and resources during “frivolous arguments,” and these penalties being levied are only getting harsher.
At the end of the day, every U.S. citizen is required to file an accurate tax return and pay the income tax that is owed, so it is usually best to avoid making frivolous tax claims and accruing additional tax liability through penalties.
Employment and Payroll Tax Fraud
Another form of criminal tax fraud can be commonly found in the filing of payroll taxes. There are several schemes that can be pursued by the IRS in regard to employment and payroll taxes, including:
- The underreporting of total workforce numbers
- Inaccuracies in collecting payroll taxes, including withholding taxes, social security taxes, and federal unemployment taxes
- The failure to pay payroll taxes to the IRS
- Paying employees under the table with cash sums
Any of these tax-associated inaccuracies may be considered crimes by the criminal investigation unit of the IRS.
Refund Fraud
Refund fraud or return fraud is a type of income tax fraud often involves identity theft and filing a false income tax return in an attempt to illegally obtain an unearned tax refund. False business expenses, deductions, and exemptions may also be involved in this type of tax fraud.
Abusive Tax Schemes
If U.S. taxpayers do not file regulatory reports they may face an IRS criminal tax investigation. There is a fine line between a tax option that legally reduces your tax liability and an abusive tax scheme that fraudulently utilizes offshore resources, so it is beneficial to utilize a tax professional when exploring tax options to avoid abusive tax schemes.
Employment Tax Fraud
Conviction of employment tax fraud can result in up to 5 years in prison, so it is important to comply with all tax laws as an employer. One common type of employment tax fraud includes employment leasing, in which an employer outsources payroll activities to a third-party company that ends up stealing or misplacing employment taxes and leaving a significant unpaid tax liability behind.
Another type of employment tax fraud is pyramiding, in which business owners withhold income taxes without paying what is owed to the IRS. Cashing out is a third common type of employment tax fraud where employees are paid in cash and the payroll records do not accurately represent the wages issued to employees.
Tax Preparer Fraud
Tax preparers are professionals who assist taxpayers in filing their taxes, so when a tax crime is committed within a false tax return filed by a tax return preparer, it is considered tax preparer fraud. It is extremely important to choose your tax preparer wisely when filing your income tax returns because in the case that the IRS detects false or fraudulent claims on a tax return, it is the taxpayer’s responsibility to pay.
Finding a reputable tax preparer can be more manageable if you avoid people with exaggerated claims to achieve larger refunds, find someone who is willing to communicate with you and answer your questions, or utilize a professional based on a referral by someone you know and trust.
The IRS is diligent about enforcing tax law and ensuring U.S. citizens are filing accurate individual income tax returns. If you are facing a situation regarding tax crimes or tax fraud, it is essential that you respond to the IRS immediately, maintain clear records of your tax filings and financial documentation, and utilize an experienced tax professional to help you work toward a solution.
Contact a tax specialist at Ideal Tax today to learn more about tax fraud and how to manage your tax burden.
Luis serves as the Director of Operations for Ideal Tax, overseeing a multifaceted team including case management, tax professionals, document specialists, customer support, training, and development.
