What is Tax Fraud: Understanding Tax Evasion

  • By David Lukic
  • Published: Oct 30, 2020
  • Last Updated: Mar 18, 2022

Tax fraud is when a person or company falsified information on their tax return to avoid paying taxes. Tax fraud can also apply to not filing tax returns to avoid paying. Some other definitions of tax fraud are: 

  • Failure to file tax returns.

  • Failure to pay or correctly report taxes

  • Fraudulent returns and return preparation schemes.

  • Erroneous claims for real property and tax abatement programs.

  • Tax evasion activity.

  • Unlicensed businesses.

  • Unrecorded payments to employees.

  • Unreported income.

  • Unreported or untaxed Meals and Rentals Tax.

Tax fraud can apply to both federal and state taxes; it makes no difference, but the penalties and consequences may be different. 

According to the IRS, 75% of tax evasion is perpetrated by individuals and not companies. Roughly 17% of all taxpayers incorrectly fill out their taxes because they either do not know the law or make mistakes. These actions are considered negligence rather than fraud. It becomes fraud when the person intentionally makes an effort meant to reduce the amount of tax paid. 

Sometimes fraud could be as simple as falsifying expenses, income, claiming a nonexistent dependent, or using a false social security number. 

Other Types of Tax Evasion

Tax Fraud

There are also reports where the individual and the IRS are both victims of tax evasion perpetrated by employment or payroll companies. According to FindLaw, some examples are “pyramiding, employee leasing, cash payment, filing false payroll tax returns, and failure to file payroll tax returns.” In these cases, the company deducts the taxes from employees’ wages, but they don’t pay the IRS. 

The IRS warns about phishing emails, which results in tax fraud. Someone emails you pretending to be from the IRS about back taxes owed, and they demand payment and threaten arrest. These are scams meant to bilk money from victims who fall for it.

Other tax frauds are people who prepare tax returns, which are fraudsters. They aren’t licensed or qualified to prepare your taxes, but you pay them a fee to do so, and they file on your behalf. The problem is the tax returns are fraudulent and designed to pay fewer taxes or get a bigger refund. You are the one liable because you hired this criminal to file for you. In some cases, they take your fee and never file the return. 

How Does the Internal Revenue Service (IRS) Identify Tax Fraud?

There's a massive problem on the IRS' plate right now. Between 2014 and 2016, there were nearly half a trillion dollars in missing taxes based on the government's estimates. While their agents can't run in-depth investigations on every American, the IRS did check on over 600,000 of the reported returns.

These audits involve investigating the individual's lifestyle, earnings, and spending habits to determine the likelihood they lied in their reporting. 

Checking Social Media

Most investigative processes these days perform preliminary sweeps through people's social media accounts. What you post online says a lot about your financial situation. If your online reputation doesn't match what you're reporting to the IRS, it may prompt them to look deeper.

For example, a fraudster may claim an injured dependent and then post photos of that person being completely healthy. This isn't grounds for prosecution on its own, but it will question the individual's credibility.

Whistleblowing

It's hard to imagine a family member or close friend reporting your tax fraud to the IRS. However, a former partner or disgruntled acquaintance may report your false taxes with the right motivation and evidence. This is one of the benefits for people to keep their finances and filings private.

There are many reasons for whistleblowers to act, including ethical responsibility, revenge, or for monetary gain. After all, the IRS pays a significant "bounty" for reporting on others. The reward can be up to 30 percent of whatever is collected based on the whistleblower's actions.

Comparative Analysis

Employers are required to report to the IRS. These reports include employee information like pay, insurance, and much more. In short, the government has a crystal-clear understanding of how much money you earned, when you earned it, and where it came from.

The IRS compares the information that third parties report on you to what you've documented on yourself. Any errors they find are typically from small mistakes but can be signs of evasive tactics.

Businesses' transition to digital bookkeeping and billing gives the IRS vastly more data to pull from. It's not just your W-2s and 1099s you need to worry about anymore. Your credit cards, doctor's visits, and foreign purchases can be tracked and thrown in your face.

Penalties for Tax Evasion

Tax Evasion

The punishment for tax evasion normally includes a hefty fine, jail time, or some combination of both. Federal law places the maximum penalty for individual tax evasion at $100,000 in addition to settling up what you owe. However, most people won't get such a harsh sentence.

Verdicts depend on the defendant's level of intent, the amount withheld, and the type of evasion. Some cases have seen the defendant walk away completely unscathed.

Lying On Your Tax Return

Knowingly filing an erroneous return allows for a maximum fine of $100,000 and up to five years in prison. The most common lie people tell the IRS is claiming extra deductions. This trend is common among people who use assisted tax programs like TurboTax or when filing with a third-party tax preparer.

Other common ruses include:

  • Claiming additional dependents.
  • Fabricating divorce or alimony fraud.
  • Reporting a lower income.
  • Filing head of household instead of jointly.
  • Mixing personal and business costs.
  • Failing to file.

Willful failure to file your return is typically a misdemeanor, according to IRC 7203. This classification means a max penalty of $25,000 and a low likelihood of jail time. However, if extreme steps are taken to accomplish the evasion, then a failure to file can be considered a felony and lead to the max fine of $100,000.

Late filing penalties are calculated differently. Late fees are based on the amount of unpaid tax based on the original tax date. This means that any extensions you file for won't mitigate the cost of the late fees. The standard penalty is 5 percent of the unpaid taxes for every month the balance remains. This penalty maxes out at 25 percent (5 months).

Failing to Keep Payment Records

Not keeping proof of your reported transactions could lead to a civil tax penalty. Unless you're audited, you'll only face this problem if you submit claims that are clearly false. However, if you rush through the submission process, the IRS may knock and ask for proof.

This proof doesn't have to be paper receipts. In most cases, you'll have a credit card or bank history going back far enough to show your innocence. If you are caught in a lie, then simply not having the records available to help the investigation can lead to a $25,000 penalty.

Concealing Foreign Accounts

Opening bank accounts in foreign countries like Switzerland is a common tactic for the absurdly wealthy. The U.S. frowns on the practice because the government isn't always sure they can take money from foreign banks.

In response, many foreign banks have implemented practices making it harder to take money from U.S. citizens. This is to keep the IRS off their backs and the associated risks of aiding tax fraud. If you're caught trying to conceal funds overseas for tax purposes, it leads to a maximum penalty of $500,000 and ten years in prison. 

What is Voluntary Disclosure?

Voluntary disclosure is the practice of self-reporting erroneous taxes. The IRS Criminal Investigation added this practice for anyone wanting to avoid the worst-case scenario—criminal prosecution.

Understand that voluntarily ousting yourself doesn't provide tax exemptions. It's not a magic eraser that wipes your record clean. You're still responsible for payment of owed taxes, including late fees and accrued interest. Likely, you'll also have to go through an arduous audit process.

With voluntary disclosure, you'll benefit from better payment options and possibly lower interest rates than you'd get if convicted of fraud.

Voluntary disclosure is only available in a timely manner. For your disclosure to be timely, it must meet the following requirements:

  • No IRS Investigation has begun
  • No whistleblowers have reported on you
  • No law enforcement agency has acted

How to Stay Safe from Tax Fraud

How to Report Someone to The IRS

 

If you don’t know how to prepare your own tax returns, hire a professional company like H&R block or a tax attorney to do it for you. Always state your income and expenses accurately. Avoid taking any of the actions below, or you may end up in hot water with the IRS. 

  • “Deliberately underreporting income.

  • 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.

  • Using a false social security number.

  • 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.

  • Reporting personal expenses as business expenses.

  • Claiming more charitable deductions than were made.

  • Failing to file returns even if you make a substantial amount of income.

  • 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.”

If you work for a company and discover that they are committing tax fraud, it is your responsibility to report it. If you know of an individual who has committed tax fraud, you should file a complaint. You may be the victim of a stolen social security number, and you can also report that.

The IRS has a page listing all the different types of tax fraud and how to report them. There are phone numbers you can call. You may also file online or by mail, and if you want to remain anonymous, they have a form you can use to do that as well.

Tax fraud is serious business with hefty fines and prison time. You want to do all you can to avoid any criminal dealings with the IRS.

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