Tax Evasion: What is IRS Income Tax Evasion, Laws & Examples

tax evasion

What is Tax Evasion?

Tax evasion occurs when a person, company, or other entity uses illegal means to avoid paying taxes. According to the definition of tax evasion, the person already owes the taxes at the time of the illegal conduct. Income tax evasion does not concern taxes that might be owed in the future. Typically, a taxpayer purposely misrepresents certain facts about his or her financial situation to agencies such as the Internal Revenue Service (IRS) or state taxing authority in order to reduce his or her tax liability. One way of carrying out tax evasion is dishonest tax reporting, such as failing to report all of a person’s income on a tax return or overstating deductions on a tax return. The goal of these illegal tactics is to gain a lower tax liability for that particular taxpayer.

Common Examples of Tax Evasion

The most common type of income tax evasion occurs when an individual taxpayer or a business deliberately under-reports taxable income for a particular tax year. People who routinely deal in cash transactions, such as handymen, restaurant owners, hairdressers, and car dealers often fail to report substantial portions of their income, which, in turn, gives them a decreased tax liability. However, doctors, lawyers, accountants, and other professionals are equally guilty of failing to report their taxable income accurately, particularly when they are self-employed.

Another common type of income tax evasion involves false deductions for business-related expenses. For instance, a business owner who claims on his tax return that every meal eaten in a restaurant and every concert attended in a given year is deductible as a business-related expense is probably overstating his deductible business expenses. By including personal food and entertainment expenses, this business owner is claiming expenses that are not legally deductible on an income tax return.

Other common types of tax evasion involve the following actions:

  • claiming charitable deductions that were never made
  • overstating the value of donated property in order to increase charitable deductions
  • omitting property from a tax return
  • receiving cash income and failing to report it on a tax return
  • intentionally understating the value of an estate on a tax return

Each of these actions is illegal, and may lead to prosecution for the crime of tax evasion.

Specific Examples of Tax Evasion

In order to better illustrate what constitutes tax evasion, here are a few typical scenarios involving IRS tax evasion that resulted in federal prosecution and convictions. These examples are based on actual tax evasion cases prosecuted by the IRS.

Example #1

A medical professional stopped filing federal income tax returns, and set up a sham trust in order to conceal the income from his medical practice. After a few years had passed, the IRS investigated and prosecuted the medical professional for federal tax evasion. This person received one year in prison, three years of supervised release, community service hours, and was ordered to pay over $100,000 in restitution to the IRS.

Example #2

A married couple operated a construction business, but used various illegal actions in order to conceal income from the business. They set up a bogus tax-exempt charitable organization to hide their business activities, transferred assets belonging to the construction business or them personally to other people, used misleading names and aliases to further hide income from their construction business, and failed to file several federal income tax returns. After their convictions for tax evasion, the husband served 30 months in prison and three years of supervised release, and the wife was placed on three years of probation.

IRS Investigation of Tax Evasion

The Criminal Investigation Division (CID) of the IRS is responsible for investigating all tax-related crimes. One of the major areas of financial investigation is legal source tax crimes, which includes tax evasion. The crime of tax evasion is considered a legal source tax crime because it typically involves a legal job or business, and income that a person has earned legally. Tax evasion also is referred to as white-collar crime, since it is a financial violation that is committed by a person who usually is not engaged in any other types of criminal activities. CID devotes most of its resources to legal source tax crimes.

Prosecution and Conviction for Tax Evasion

Once CID has completed its investigation, it refers the case to the Civil Tax Division of the U.S. Department of Justice for prosecution. Ultimately, the Department of Justice will determine whether to pursue the case further. Typically, federal prosecution of tax evasion is reserved for the most high-profile cases where large amounts of taxes are owed to the federal government.

Tax Evasion Penalties

Penalties for tax evasion are among the harshest penalties a person can be charged in relation to tax issues. The maximum penalties can be up to $100,000 for individuals and $500,000 for corporations. Other possible consequences are up to 5 years in prison and a felony conviction.

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