Tax Evasion and Tax Fraud

While the two terms are often used interchangeably, they are treated differently under U.S. Tax Law. Tax fraud can be either civil or criminal in nature, but tax evasion is always a tax crime that usually results in criminal prosecution and harsher penalties.

The following sections explain the difference between income tax fraud and tax evasion and the penalties should you be found to have committed either act.

What Is Tax Fraud?

There are many types of tax fraud, but they all involve an intentional or willful act. That willful act is usually filing a false tax return that reduces the amount of tax owed.

Common examples of tax fraud include situations where a taxpayer:

• Underreports income they received
• Claims inflated tax deductions for contributions to tax-exempt organizations
• Claims deductions for business expenses that were actually personal if they are self-employed or own a small business
• Does not file a required tax return
• Uses a false Social Security number

Tax fraud is often discovered during an IRS audit or when someone tells the IRS a taxpayer has committed fraud. The IRS encourages people to report tax crimes by offering a reward for providing the agency with information. The IRS does not take referrals over the phone, so someone who'd like to report a tax crime must do so by filing a report online or by mail. If the IRS determines further action is necessary, it refers the issue to the IRS criminal investigation unit.

Identity Theft

Identity theft scams can result in tax fraud when someone uses stolen personal information to request a large tax refund on behalf of a taxpayer. The refund is then deposited directly into the criminal's bank account or on prepaid debit cards. 

In most cases, the taxpayer whose identity was stolen first learns of the illegal activity when they try to file their income tax returns and the IRS informs them that they have already filed. The IRS will also notify taxpayers when they suspect they have received a fraudulent return.

Examples of Tax Fraud

Other examples of taxpayer behavior that the IRS considers intentionally fraudulent or criminal include:

• Taking payments in cash and failing to deposit them in order to avoid tax consequences
• Inflating the value of business expenses
• Creating false business expenses for tax purposes
• Keeping two sets of financial records for your business
• Claiming an exemption for a spouse when you are single
• Claiming an exemption for a dependent whom you never supported
• Destroying your books to conceal tax evasion
• Creating false checks or receipts to support deductions that don't exist or denying that deposits in your accounts are income when they are
• Concealing financial accounts from the IRS
• Transferring assets to conceal them from the IRS
• Making false statements to the IRS under oath
• Failing to file returns despite having been contacted in prior years by the IRS for failing to file

What Is Tax Evasion?

Tax evasion is when a taxpayer intentionally chooses not to pay their full tax liability. This applies to both the nonpayment and underpayment of taxes. The tax code breaks down evasion into two categories: willful attempts to avoid assessment and willful intent to evade payment of tax.

Evasion of Assessment

The taxpayer performs some action focused on defeating the assessment of a tax. This requires the IRS to do more than prove you were negligent. An intentional under-reporting qualifies as an attempt to evade assessment.

Evasion of Payment

Affirmative acts to evade payment generally involve the concealing of money or assets with which the tax could be paid from tax authorities. Such an act could also take the form of removing assets from the reach of the IRS, such as moving reported income into a foreign bank account in a country recognized as a tax haven. Non-payment of taxes owed is not evasion of payment.

How the IRS Determines Evasive Actions

For someone to be found guilty of tax evasion, the IRS must prove that they acted intentionally. Unfortunately, there are no hard and fast rules regarding when a taxpayer's actions will be found to be intentional because the IRS considers a number of factors when making that determination. However, the IRS will usually find that you have committed tax evasion if it is clear that your lifestyle and spending could not be supported by the income that you reported on your return.

Other situations where a taxpayer may be found to have acted intentionally to avoid paying taxes include reporting that their assets were owned by someone else, or accepting payment for goods or services that were not reported to the IRS.

Examples of Tax Evasion

Here are some actions that federal courts have found to be tax evasion:

• Filing a false return
• Keeping a double set of books
• Making false invoices
• Concealing sources of income
• Destruction of records
• Holding real estate or property in another person's name
• Overstating deductions
• Using credit cards to access accounts the taxpayer held in other people's names

Penalties for Tax Fraud and Tax Evasion

Tax evasion is always considered a criminal act subject to penalties that may include jail time, but tax fraud can either be civil or criminal in nature.

Civil Penalties for Tax Fraud

The tax code provides for civil penalties that can be as high as 75% of your unpaid tax liability, but you will not face jail time. Additionally, the IRS can't impose an accuracy-related penalty on a taxpayer found guilty of civil tax fraud.

While you won't face jail time if you have been charged with civil tax fraud, the IRS has a lower evidentiary standard when it comes to civil fraud. It only needs to prove that it was more likely than not that civil tax fraud occurred while, in a criminal tax case, the IRS must prove guilt beyond a reasonable doubt.

Criminal Penalties for Tax Fraud

The criminal fraud penalties depend on the type of tax fraud committed by the taxpayer.

Willfully failing to file a tax return:

• Up to one year in prison
• A fine of up to $100,000 for individuals ($200,000 for corporations)

Making false or fraudulent statements:

• Up to three years in prison
• A fine of up to $250,000 for individuals ($500,000 for corporations)

Tax Evasion Penalties

Tax evasion is a felony that is punishable by up to five years in prison and a fine of up to $250,000 ($500,000 for corporations). While some people will make reference to "misdemeanor tax evasion," they are generally referring to a tax code provision that states that it is a misdemeanor when a taxpayer fails to file a return or supply information. However, this misdemeanor designation only applies when the taxpayer did not commit an act that was an attempt to evade tax.

State Tax Evasion and Tax Fraud

The IRS isn't the only tax agency fighting tax evasion and tax fraud. Many states have a department of revenue with resources dedicated to ensuring taxpayers are paying their fair share of income, property, and sales taxes. For example, New York State has a criminal investigation division with 170 full-time employees dedicated to conducting criminal investigations.

Avoid Tax Schemes

Unfortunately, some taxpayers who are found to have committed tax fraud or evasion believe they weren't doing anything wrong. Often, these individuals are acting on the advice of a friend, relative, or website that claims they have discovered a secret to avoiding tax payments, receiving an outsized refund, or eliminating tax debt. These individuals often find out too late that they have made an expensive mistake. 

As a general rule, if you receive tax advice that sounds "too good to be true," it is best to consult with a professional tax return preparer, tax lawyer, or CPA to ensure you are not running afoul of the IRS.

Additional Questions? Talk to a Tax Lawyer

If you have questions about whether a tax return you plan to file will create tax problems with the IRS, consulting with a local tax attorney is usually a good idea. A tax attorney understands the tax system and can help you address potential problems with your tax filings before they are discovered by the IRS.