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

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 Including Prison & Other Criminal Punishment

While all Americans can take steps to minimize their tax liability by taking advantage of existing tax laws and regulations, acting intentionally and illegally in order to avoid paying taxes is tax evasion. In contrast with legally claiming deductions to which they are entitled on their tax returns, people who commit criminal tax evasion break the law, usually by failing to report all of their income, or by claiming certain deductions on their tax returns to which they are not entitled.

Criminal Tax Evasion

In the United States, tax evasion is a criminal activity, with significant criminal penalties. The federal tax evasion statute is located at Sec. 7201 of the Internal Revenue Code, which states the legal definition of tax evasion:

“Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.”

In order to prove that a person has committed tax evasion, the prosecution must prove the following elements beyond a reasonable doubt:

• an unpaid tax liability exists,
• the taxpayer has acted in any manner so as to evade the tax, and
• the taxpayer intended to violate a known legal duty.

A person who is guilty of tax evasion will be liable for the original amount of the income tax due, as well as interest and penalties. Additionally, a person who commits tax evasion faces serious criminal implications, including the lifelong stigma of a felony conviction, substantial fines, and even incarceration.

Facing Federal Prosecution for Tax Evasion

A federal prosecution for income tax evasion starts with a thorough investigation by the Criminal Investigation Division (CID) of the IRS. It is not unusual for tax evasion investigations to last for one year or more. CID is responsible for thoroughly investigating your case, and determining whether it is appropriate to send your case on to the Tax Division of the U.S. Department of Justice for prosecution. The U.S. Department of Justice, which is the body that prosecutes federal crimes, usually holds a grand jury, which can indict, or formally charge a person with the crime of tax evasion under federal law. There is a six-year statute of limitations on federal tax evasion. This means that the U.S. Department of Justice has up to six years from the time of the tax evasion was committed within which to prosecute you for tax evasion.

If the Justice Department decides to accept your case for tax evasion, an assistant U.S. attorney will present your case before a grand jury. If the grand jury hands down an indictment, or a formal charge of tax evasion against you, law enforcement authorities can arrest you. Next, you must post bail as specified by the federal court, or the court may release you without paying bail, depending on the circumstances. At this point, you should be sure to seek the assistance of a criminal defense attorney who is experienced in federal tax evasion crimes.

Criminal Tax Evasion Punishment

Tax evasion is a serious crime that results in a felony conviction under federal law. The punishment for a federal tax evasion conviction is a sentence of incarceration for no more than five years, and a fine of no more than $100,000. As you can see, the penalties for tax evasion are quite significant, and the felony conviction will remain on your criminal record for life. Aside from the obvious disadvantages of being in jail for tax evasion, a felony conviction can prevent you from working in certain industries and at particular jobs, and can negatively affect your rights in other ways, as well.

Civil Tax Evasion Penalties

In addition to the criminal penalties detailed above, a person convicted of tax evasion also is still responsible for the actual tax owed to the IRS, plus interest and penalties allowable under federal law for the past-due tax obligation. The IRS charges interest and penalties on any tax obligation that a taxpayer fails to pay when due. If a taxes owed is several years old, then, the interest and penalties can reach substantial amounts. For example, if you fail to file a tax return at all and you owe taxes, the IRS can assess a penalty of 5% per month, up to a maximum of 25% (failure to file tax penalty). Plus, the amount of the interest and penalties is based on the amount of tax due, and the nature of the tax evasion. For example, a taxpayer with significant taxes owed will face higher amounts of interest and penalties than a taxpayer who owes a small taxes owed. Likewise, a taxpayer who fails to file a tax return altogether, which is tax evasion, faces higher rates of civil penalties than a taxpayer who files a tax return, but simply fails to pay the tax due in a timely fashion, which may not rise to the level of tax evasion. While there is a six-year statute of limitations or time limit on filing criminal tax evasion charges, there is no time limit on the IRS attempting to collect tax owed by you, or the interest and penalties owed for past-due taxes.

Incidence of Criminal Tax Evasion Charges

As a practical matter, CID investigates very few cases for suspected tax evasion, and the U.S. Department of Justice prosecutes even fewer cases for tax evasion. The amount of resources necessary to conducting a full investigation by CID, gathering sufficient evidence, and prosecuting a person for tax evasion is enormous. As a result, the U.S. Department of Justice tends to prosecute only those cases that involve significant tax liabilities, high profile people or businesses, and airtight evidence showing criminal tax evasion has occurred.