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Income Tax: Fraud vs. Negligence

The difference between whether a taxpayer has committed tax fraud or was simply negligent when they filed their returns comes down to intent.

You could pay a penalty but won't be held criminally liable if the Internal Revenue Service (IRS) believes you were simply careless or didn't make an effort to understand the tax code before you filed your return. You could face far tougher penalties for committing a criminal act if the IRS believes you intentionally included false information on your return in the hope of reducing your tax bill.

Fortunately, the IRS also understands that federal tax law is complex, and sometimes mistakes can have the appearance of criminal activity. As a result, few taxpayers face criminal charges for simply misunderstanding the law because the IRS must prove that you acted with the intent of depriving the U.S. government of revenue for you to be convicted of tax fraud. However, tax negligence can still result in the IRS imposing significant penalties on a taxpayer.

The following sections explain the difference between income tax fraud and negligence, the consequences of doing either one, and how to avoid behavior the IRS may consider criminal or fraudulent.

Income Tax: Fraud vs. Negligence

Not all violations of the tax code amount to fraud. Sometimes, a taxpayer's actions resulting in unpaid taxes may just be negligent. Understanding the difference between fraud and negligence is significant because the IRS punishes both, but imposes much harsher punishments on those who act fraudulently.

Negligence, generally speaking, refers to careless mistakes and other errors that might result in incorrect tax filing or payment. Where negligence is found, the taxpayer may still pay a penalty of up to 20% of their underpayment of tax, though they may avoid the more severe consequences associated with a finding of fraud.

There are many types of tax fraud, but they all involve intentional or willful evasion on the taxpayer's part. Often, tax fraud is uncovered during tax audits, and IRS auditors will make a referral to the IRS criminal investigation unit. If the IRS decides to pursue charges, you could end up facing criminal prosecution in a federal court. A conviction for tax fraud often results in a hefty fine and sometimes jail time.

Common actions that are taken by an individual or business that can lead to being criminally charged for a tax crime include:

  • Intentionally failing to file an income tax return
  • Intentionally failing to pay the amount of tax due
  • Intentionally failing to report income received
  • Making false claims
  • Preparing and filing a false tax return

Other examples of tax fraud include falsifying documents, ledgers, personal expenses, using a false Social Security number, or claiming a nonexistent dependent. Small-business owners and the self-employed will sometimes be found guilty of tax fraud if they try to deduct lavish personal spending as business expenses. Willfully overstating deductions and exemptions or willfully underreporting income is also generally considered fraud.

Tax Refund Fraud

Not all tax fraud results from taxpayers reporting false information to the IRS to reduce their tax bill. In recent years, there has been a dramatic increase in criminals using identity theft to file claims for large refunds in the name of an unsuspecting taxpayer. The criminals involved in the scam have the IRS deposit the refund directly into their bank accounts. While generally considered tax fraud, this illegal activity is usually prosecuted under criminal mail and wire fraud statutes.

Penalties for negligence and fraud

While tax fraud is considered a criminal offense and negligence will simply result in an IRS fine, the punishments for both can be severe.

Negligence Penalties

The penalty for negligence is 20% of the amount of your tax underpayment. The IRS can impose a negligence penalty if it finds that your negligence or disregard of tax rules resulted in an underpayment of your tax debts.

However, paying the negligence penalty is just part of the financial cost of negligence. You will also be responsible for paying the unpaid portion of your tax bill and interest. Interest owed to the IRS compounds daily and begins accruing from the date the return was due. The agency also charges interest on penalties.

Tax Fraud Penalties

Tax fraud is a criminal offense and, like most criminal offenses, the penalty depends on the severity of the crime. The IRS also has the option of bringing civil tax fraud charges, criminal tax fraud charges, or both against someone it suspects of fraud.

There are several differences between civil and criminal tax fraud penalties. Probably the most significant is that you can't be sent to jail if found guilty of civil tax fraud. Another significant difference is that the IRS is held to a lower standard of proof for civil charges. For a criminal conviction, a taxpayer must be found guilty "beyond a reasonable doubt," but for civil penalties, only "clear and convincing evidence" is needed.

Civil Tax Fraud Penalties

A taxpayer can't be sent to jail if the IRS decides to charge you with civil tax fraud. But if you are found guilty of civil tax fraud, a court can impose a penalty of up to 75% of the unpaid tax, plus interest. The IRS can't impose other penalties on you if you are convicted of civil tax fraud.

Criminal Tax Fraud Penalties

Federal law divides criminal tax fraud into three separate offenses, with each one having a maximum fine and prison sentence.

Willfully Failing to File a Tax Return
  • Up to one year in prison
  • Fine of up to $100,000 for individuals ($200,000 for corporations)
Making False or Fraudulent Statements
  • Up to three years in prison
  • Fine of up to $250,000 for individuals ($500,000 for corporations)
Felony Tax Evasion
  • Up to five years in prison
  • Fine of up to $250,000 for individuals ($500,000 for corporations)

Additional Questions? Talk to a Tax Lawyer

If you have questions about whether a tax return you plan to file will get you into trouble with the IRS, consulting with a local tax attorney is usually a good idea. A tax attorney understands the tax system and can provide you with legal advice on addressing potential tax problems before you face increased tax liability.

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