6.5 Tax evasion

Tax evasion is a serious crime involving illegal nonpayment or underpayment of taxes. It differs from legal tax avoidance and requires proving a tax deficiency, an affirmative act or omission, and willful intent. Common methods include underreporting income, overstating deductions, and hiding assets offshore.

The IRS investigates tax evasion through audits and criminal investigations. Defenses include lack of willfulness and reliance on professionals. Penalties can be severe, including prison time and hefty fines. Understanding the line between legal avoidance and illegal evasion is crucial for taxpayers.

Definition of tax evasion

• Tax evasion involves the illegal nonpayment or underpayment of taxes owed to the government
• Differs from tax avoidance, which uses legal means to minimize tax liability (tax planning)
• Tax evasion often involves deliberately misrepresenting income, expenses, or assets to reduce tax burden

Elements of tax evasion

Existence of tax deficiency

Top images from around the web for Existence of tax deficiency

• 

  Tax Evasion - Tablet Dictionary image View original

  Is this image relevant?

• 

  Tax Evasion - Free of Charge Creative Commons Lever arch file image View original

  Is this image relevant?

• 

  Tax evasion statistics overview | An overview of tax evasion… | Flickr View original

  Is this image relevant?

• 

  Tax Evasion - Tablet Dictionary image View original

  Is this image relevant?

• 

  Tax Evasion - Free of Charge Creative Commons Lever arch file image View original

  Is this image relevant?

1 of 3

Top images from around the web for Existence of tax deficiency

• 

  Tax Evasion - Tablet Dictionary image View original

  Is this image relevant?

• 

  Tax Evasion - Free of Charge Creative Commons Lever arch file image View original

  Is this image relevant?

• 

  Tax evasion statistics overview | An overview of tax evasion… | Flickr View original

  Is this image relevant?

• 

  Tax Evasion - Tablet Dictionary image View original

  Is this image relevant?

• 

  Tax Evasion - Free of Charge Creative Commons Lever arch file image View original

  Is this image relevant?

1 of 3

• Tax deficiency refers to the amount of tax owed that has not been paid
• Determined by calculating the difference between the tax reported and the tax actually owed
• Tax deficiency must be substantial and not merely a minor discrepancy or error

Affirmative act vs omission

• Tax evasion can involve affirmative acts, such as falsifying records or making false statements
• Omissions, like failing to report income or file required tax returns, can also constitute tax evasion
• Distinction between affirmative acts and omissions is important for establishing criminal intent

Willfulness requirement

• Tax evasion requires a willful intent to evade taxes, not merely negligence or mistake
• Willfulness means a voluntary, intentional violation of a known legal duty
• Proving willfulness often involves circumstantial evidence of the taxpayer's knowledge and actions

Common methods of tax evasion

Underreporting income

• Failing to report all taxable income, such as cash payments or offshore accounts
• Examples include not reporting tips, freelance earnings, or rental income
• Underreporting can involve falsifying records or simply not disclosing income sources

Overstating deductions

• Claiming excessive or fraudulent deductions to reduce taxable income
• Examples include inflating business expenses, charitable donations, or home office deductions
• Fabricating deductions or mischaracterizing personal expenses as business expenses

Hiding assets offshore

• Using foreign bank accounts, trusts, or shell companies to conceal assets and income
• Failing to report foreign income or disclose ownership of foreign accounts (FBAR requirements)
• Exploiting secrecy laws and lack of information sharing between countries

Using cash transactions

• Conducting business in cash to avoid creating a paper trail and evade reporting requirements
• Structuring cash transactions to avoid triggering bank reporting thresholds ($10,000)
• Cash-intensive businesses (restaurants, salons) are more susceptible to tax evasion schemes

Investigating tax evasion

Role of IRS

• IRS Criminal Investigation Division (CID) investigates potential tax crimes
• IRS auditors and revenue agents also play a role in detecting tax evasion
• IRS works with other agencies (FBI, DOJ) in complex tax evasion cases

Audit procedures

• Tax returns are selected for audit based on various factors (random selection, red flags)
• Audits can be conducted by mail, in-person interviews, or field examinations
• Auditors review financial records, bank statements, and other documents to identify discrepancies

Gathering evidence

• Investigators gather financial records, witness statements, and other evidence of tax evasion
• Subpoenas, search warrants, and surveillance may be used in criminal investigations
• Forensic accounting techniques help trace funds and uncover hidden assets

Defenses to tax evasion charges

Lack of willfulness

• Arguing that the tax deficiency was due to negligence, mistake, or reliance on professional advice
• Showing a good faith effort to comply with tax laws and no intent to evade taxes
• Lack of willfulness is a common defense, but the burden of proof is on the taxpayer

Reliance on tax professionals

• Claiming reliance on the advice of accountants, tax preparers, or attorneys
• Must show that the reliance was reasonable and in good faith
• Tax professional's advice must be based on all relevant facts and circumstances

Statute of limitations

• Criminal charges for tax evasion generally must be brought within six years
• Statute of limitations may be extended in cases of substantial omissions or foreign assets
• Civil penalties and collection of back taxes have a longer statute of limitations (10 years)

Penalties for tax evasion

Criminal penalties

• Felony conviction punishable by up to five years in prison and a fine of up to $250,000
• Actual sentence depends on factors such as the amount of tax evaded and the defendant's role
• Other related charges (filing false returns, conspiracy) may also apply

Civil penalties

• Civil fraud penalty of 75% of the underpaid tax attributable to fraud
• Accuracy-related penalties for negligence or substantial understatement of tax (20-40%)
• Failure-to-file and failure-to-pay penalties for late or non-filed returns

Restitution and back taxes

• In addition to penalties, tax evaders must pay back the taxes owed plus interest
• Restitution may be ordered as part of a criminal sentence or plea agreement
• IRS can pursue collection of back taxes through liens, levies, and seizure of assets

Tax evasion vs tax avoidance

Legal vs illegal

• Tax avoidance uses legal means to minimize taxes, while tax evasion is illegal
• Examples of tax avoidance include claiming legitimate deductions, tax credits, and tax-deferred accounts
• Tax evasion involves fraud, concealment, or other illegal means to avoid paying taxes

Gray areas in tax law

• Some tax strategies fall into a gray area between legal avoidance and illegal evasion
• Aggressive tax planning, such as abusive tax shelters or offshore schemes, may cross the line
• Courts often look at the economic substance and business purpose of transactions

Famous tax evasion cases

Celebrities and politicians

• Actor Wesley Snipes served three years in prison for failing to file tax returns
• Former U.S. Vice President Spiro Agnew pleaded no contest to tax evasion charges
• Leona Helmsley, hotel magnate, convicted of tax evasion for billing personal expenses to her business

Lessons learned

• High-profile cases demonstrate that no one is above the law when it comes to paying taxes
• Importance of accurate record-keeping, transparency, and compliance with tax laws
• Consequences of tax evasion can include prison time, hefty fines, and damage to reputation

Preventing tax evasion

Improving tax compliance

• Simplifying tax laws and regulations to reduce confusion and non-compliance
• Increasing taxpayer education and outreach to promote voluntary compliance
• Implementing stronger withholding and reporting requirements for businesses

Closing loopholes

• Identifying and closing tax loopholes that enable tax evasion schemes
• Examples include strengthening FATCA (Foreign Account Tax Compliance Act) and FBAR reporting
• Limiting the use of tax havens and shell corporations for tax evasion purposes

International cooperation

• Promoting greater information sharing and cooperation among countries to combat offshore tax evasion
• Implementing bilateral tax treaties and Tax Information Exchange Agreements (TIEAs)
• Supporting global initiatives such as the OECD's Base Erosion and Profit Shifting (BEPS) project