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A variety of actions ranging from simply failing to file your tax return to being involved in a complex offshore tax evasion scheme might warrant the imposition of civil penalties or expose you to criminal liability for tax fraud. This may be alarming news to some taxpayers. Yet, of the 200+ million taxpayers in the United States, there were fewer than 2,300 convictions for federal tax crimes in 2022. While the rate of criminal investigation and conviction is relatively minimal, there are also hefty civil penalties that the IRS can impose when taxpayers cheat on their taxes.
This article explains how the IRS defines tax fraud and identifies the circumstances that might subject a taxpayer to claims of civil and/or criminal tax fraud including a discussion of the associated penalties, fines, and punishment.
Tax Fraud Defined
The Internal Revenue Manual (IRM) Section 184.108.40.206 defines tax fraud as an intentional wrongdoing on the part of the taxpayer with the specific purpose of evading a tax known or believed to be owing. Taxpayer must have a fraudulent intent in order to be found guilty of tax fraud.
Fraud will exist where a taxpayer knowingly understates his or her tax liability by willfully failing to file a tax return or willfully filing an incorrect tax return where income is omitted or understated, expenses are overstated, and/or false information is included.
Red flag Indicators of tax fraud on tax returns include:
- Substantial unexplained increases in net worth;
- Substantial spending above available income and assets;
- Bank deposits from unexplained sources that substantially exceed reported income;
- Documents that appear to be altered or false;
- Closing and starting new businesses repeatedly;
- Missing records to support the items claimed on the tax return;
- Suddenly spending more money on luxury items;
- Using cash extensively.
However, tax fraud cannot be established without affirmative acts of fraud which establish that a particular action was deliberately done for the purpose of deceit concealment or to make things seem other than what they are. This gets to the willful element of the tax fraud claim. Examples of affirmative acts in the context of tax fraud include:
- Concealment of bank accounts or other assets;
- Willful failure to deposit receipts to business accounts;
- Covering up sources of receipts;
- Intentional omission of specific items where similar items were included on the tax return;
- Claiming more dependents that you are legally allowed to claim;
- Keeping two sets of books or making false entries in books;
- Claiming false or overstated deductions on your tax return;
- Claiming personal expenses as a business expense;
- Hiding or transferring assets or income.
There are two kinds of federal income tax fraud: civil and criminal. While a taxpayer can be liable for both civil and criminal tax liability for the same activity or activities, there are notable differences between the two.
- Civil tax fraud involves the correction of tax due and the imposition of civil penalties whereas criminal tax fraud involves punitive action with penalties consisting of fines and/or imprisonment.
- Generally, there is no statute of limitations period within which the federal government must assess civil penalties for tax fraud, however most criminal tax fraud cases require the government to bring the criminal action within 6 years;
- The burden of proof in a civil tax fraud case requires a lesser showing of proof of tax fraud by clear and convincing evidence while in criminal cases the government must prove the existence of a tax fraud crime beyond a reasonable doubt.
Civil Tax Fraud Penalties
As explained above, a taxpayer who willfully files a tax return with incorrect information or who willfully fails to file a tax return at all may be subject to civil penalties.
According to Internal Revenue Code (IRC) section 6663 the IRS can impose a civil penalty of up to 75% of the part of the underpayment attributable to fraud. This means that you may have to pay a penalty of up to 75% of the additional tax that the IRS asserts you owe as a result of a collection action, audit, criminal tax investigation, or appeal.
Case law has clarified whether the civil penalty is appropriate in a few common situations. If a joint tax return is at issue, the civil penalty will only apply to the spouse who engaged in fraudulent conduct unless it is shown that both have. Also, even if you die or try to correct a fraudulent tax retur, the IRS will not let you off the hook. Civil penalties associated with tax fraud will survive the death of the taxpayer requiring that the estate be accountable for the penalties. Also, the fraud penalty will not get removed where the taxpayer files an amended return to correct the fraud.
Criminal Tax Fraud and Tax Evasion
Willfulness is a common element of tax fraud crimes. According to IRM Section 220.127.116.11, a taxpayer will be deemed to engage in willful conduct where they voluntarily and intentionally violate a known legal duty.
Criminal tax fraud constitutes a tax crime. There are several different kinds of criminal tax fraud violations codified at 26 USC sections 7201 et seq. many of which are felonies. Examples of conduct that can rise to the level of criminal tax fraud include:
- Intentionally falling to pay taxes owed;
- Willfully failing to file a federal income tax return;
- Failing to report all income;
- Making false or fraudulent claims on your tax return;
- Payroll tax fraud (willfully underreporting workforce, paying employees in cash, failing to collect payroll taxes);
- Refund fraud (filing a false tax return to obtain a refund);
- Abusive offshore tax schemes (failing to file an FBAR or FATCA can subject you to criminal investigation for tax evasion).
Tax evasion is similar to criminal tax fraud however it constitutes a more serious charge. It is distinguishable from criminal tax fraud in that it is only criminal not civil, usually requires an affirmative act, and results in longer incarceration than tax fraud. According to 26 USC section 7201 it is a felony for any person to willfully attempt to evade or defeat tax owed or payment of the tax. Tax evasion can take the form of evasion of assessment (filing a false tax return) or evasion of payment (concealing assets or making false statements about assets to avoid payment).
Do You Need a Tax Attorney?
A tax attorney can help you evaluate your exposure to tax fraud and make recommendations regarding filing compliance including tax return amendment as may be necessary. If you have been assessed civil penalties associated with tax fraud and cannot fully pay them or the associated tax, a tax professional can help you establish an affordable resolution with the IRS. It may possible to participate in a voluntary disclosure and compliance procedure to avoid or reduce tax liabilities and civil penalties and avoid criminal exposure in some cases.
If you are being investigated for tax crimes such as tax fraud or tax evasion, you will want to consult with a tax attorney that specializes in criminal tax matters.
The experienced tax attorneys at Segal, Cohen & Landis have helped clients avoid and resolve civil tax penalties arising out of potential or actual tax fraud claims by providing the following services:
- Obtain IRS account transcripts and wage and income transcripts to assist clients with filing compliance;
- Make recommendations regarding the filing of amended returns to correct information included in an original filing;
- Defend a taxpayer’s return at audit to avoid imposition of additional penalties as well as civil penalties arising out of potential tax fraud claims;
- Help clients participate in disclosure and compliance programs to avoid exposure to criminal tax liability;
- Refer clients to criminal tax attorneys if they become the subject of an active investigations into a tax crime.
If you are interested in having a complimentary consultation with one of our partner attorneys regarding your tax matter, please feel free to contact us at 866-505-1872. We would be happy to advise you as to how we can resolve your case and how much it would cost.