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Tax Fraud and Tax Evasion

Tax Evasion

Tax evasion is the practice of not paying your taxes. This is a serious crime if it is not remedied appropriately.

The act of tax evasion is when an individual commits an act intended to defraud the Internal Revenue Service (IRS). Tax evasion has a very broad definition. It allows the IRS to go after an individual for almost any knowing misstatements on their taxes.

Tax evasion typically involves an individual or corporation misrepresenting their income to the IRS.

Misrepresentations may involve actions such as:

  • Underreporting yearly income;
  • Inflating deductions;
  • Hiding taxable money; or
  • Transferring funds to offshore accounts.
  • What Are Some Examples of Tax Evasion?
  • There are numerous tax evasion examples.

These include:

  • Personal income tax evasion, which occurs when an individual falsifies income or other factual data;
  • Business tax evasion, which occurs in connection with a business and may include:
    • Claiming false deductions;
    • Deliberately underreporting or omitting income;
    • Overstating the number of deductions;
    • Keeping more than one set of books, or making false statements in books and records;
    • Claiming personal expenses as business expenses; or
      hiding or transferring assets or income;
  • Employment tax evasion, which occurs in an employment setting and may include:
    • Failure to pay employment taxes;
    • Falsifying payroll;
    • Pyramiding;
    • Employment leasing; or
    • Paying employees in cash.

When Does the IRS Charge You with Tax Evasion?

The IRS can pursue any misstatement on an individual's tax return for six years. The IRS can audit a person at any time.

The IRS must prove the following in tax evasion cases:

  • An unpaid tax liability exists;
  • The defendant committed some act to attempt to hide their taxable income and dodge paying taxes on their money;
  • The defendant had specific intent to dodge paying taxes that they had a legal duty to pay; and
  • The jury must find the defendant, or the accused individual, guilty of each element beyond a reasonable doubt.

Criminal Penalties For Tax Evasion

Tax evasion is a crime in the United States. The crime is punishable by imprisonment, substantial monetary penalties, or both.

Tax evasion can result in harsh punishments, including:

  • Fines as high as $250,000 for individuals and $500,000 for corporations;
  • A 75% civil penalty;
  • Criminal charges, including imprisonment of up to 5 years; and
  • Attorney's fees and court costs.

Employment Tax Evasion

Federal law requires employers to withhold federal income tax, Social Security and Medicare taxes from their employees' paychecks and send the money to the Internal Revenue Service (IRS). Federal and state laws also require businesses to pay an additional unemployment tax. An employer's failure to pay these taxes to the IRS is employment tax evasion.

Employers Evading Taxes

Employment tax evasion schemes can take a variety of forms.  Some of the more prevalent methods of evasion include pyramiding, employee leasing, paying employees in cash, filing false payroll tax returns and failing to file payroll tax returns:

  • Pyramiding -An employer collects employment taxes from its employees but fails to pay those taxes over to the IRS. Instead, the taxes are spent on business or personal expenses.
  • Employee Leasing or Third-Party Payers – An employer legally contracts with an outside business to manage the payroll for its employees. The employee-leasing company collects employment taxes from the employees but fails to pay those taxes over to the IRS.  Instead, the taxes are spent on business or personal expenses.
  • Paying Employees in Cash – Employers can legally pay their employees in cash. Some employers pay employees in whole or partially in cash in order to evade employment taxes without leaving a paper trail of evidence. However, the IRS says that it can prove employment tax evasion even without a paper trail.
  • Filing False Payroll Tax Returns or No Payroll Tax Returns at All – Employers file false payroll tax returns that understate the amount of wages paid to the employees and the amount of taxes are owed. Or, the employers simply fail to file any payroll tax returns altogether.
  • Inaccurate Worker Status and Wages – Employers intentionally misclassify employees as independent contractors to avoid paying employment taxes. Or, small businesses misclassify the wages and salaries paid to its executive officers as corporation distributions to avoid paying employment taxes on those monies.

Employees Preventing Employer's Tax Schemes

Employees should watch for employers engaging in fraudulent conduct when paying employees because the employees may suffer from the scheme by not being able to collect unemployment, social security, and Medicare benefits. There are several ways an employee can determine whether an employer is paying taxes withheld from paychecks:

  • Paycheck stubs should have lines reporting which taxes have been withheld
  • W-2 and tax statements should show which taxes have been withheld

If the employer is not withholding taxes from the employee, the employee is ultimately responsible for paying those taxes. The IRS urge employees to watch for and report any misconduct.

Employee Liability for Employment Tax Evasion

If an employer fails to pay employment taxes, and the IRS is unable to collect these taxes from the employer, the employee is ultimately responsible for his or her share of the federal income tax and Social Security and Medicare taxes.

An employer's failure to report or pay taxes to the IRS ultimately hurts the employee, who may not be able to claim Social Security, Medicare or unemployment benefits in the future..

Tax Avoidance

Deferring income from one year to another, for example, is an example of tax avoidance.

Avoiding or Minimizing Taxes

Taxes can be minimized or eliminated in several ways:

  • Income Deferral
  • Tax Deductions
  • Charitable Contributions

Income Deferral
Receiving income after midnight on December 31st allows the income to be taxable for the new year and need not be claimed on the current year's tax return.

Tax Deductions
Tax deductions are items you can deduct from your tax bill.

The following are both “above-the-line” and “below-the-line” deductions:

  • Casualty and Theft Losses
  • Charitable Contributions
  • Interest
  • Medical and Dental Expenses
  • Miscellaneous Itemized Deductions
  • Other Taxes

Charitable Contributions
You may deduct contributions to qualified charitable organizations if the deduction does not exceed 50% of your adjusted gross income. The excess deductions can be carried forward to the next five taxable years. Standard and itemized deductions are not included in your adjusted gross income, but your income is adjusted downward by specific deductions.

Penalties for Income Tax Fraud

There may be severe penalties for income tax fraud. Taxpayers who willfully avoid paying their income taxes are subject to criminal and civil penalties. The type of penalty assessed will depend on the type of fraud. Below are two examples of tax fraud.

An individual convicted of evading or defeating taxes is guilty of a felony.

Additionally, they are subject to the following penalties under the law:

  • Imprisonment for no more than five years;
  • A fine or not more than $250,000 for individuals or $500,000 for corporations; or
  • Both penalties, along with the cost of prosecution.

A taxpayer who commits fraud and false statements is guilty of a felony.

Taxpayers are subject to the following penalties:

  • Imprisonment for no more than three years;
  • A fine of not more than $250,000 for individuals or $500,000 for corporations; or
  • Both penalties, along with the cost of prosecution.

Difference Between Negligence and Tax Evasion

In negligent tax errors, an individual makes a careless mistake without intending to defraud the IRS. Most individuals do not realize they have made a mistake until they are informed.

It is not a crime to make a negligent tax error. Penalties could, however, be imposed on the taxpayer.

On the other hand, a taxpayer commits tax fraud when they intentionally commit an act with the intent of defrauding the IRS.

When someone commits tax fraud, they know they are defrauding the IRS. They commit these acts knowing they could face the consequences if prosecuted and convicted.

Income tax fraud differs from negligence. Tax law is a complex set of rules and regulations that are difficult for most people to understand.

So long as there are no other indications of fraud, the IRS typically assumes that a careless error was an honest mistake rather than an intentional violation of the tax code. The tax auditor may consider the mistake negligent in some cases. Under IRS rules, even unintentional violations can result in a fine of 20% of the underpayment.

Tax auditors look for certain types of suspicious and fraudulent activity in order to distinguish between negligence and willful violations, including:

  • The use of a false Social Security number;
  • Falsifying documents;
  • Concealing or transferring income;
  • Claiming too many deductions and exemptions; and
  • Willfully underreporting income.

Possible Defenses Against Tax Evasion

Tax evasion is a crime, but there are several defenses to it. In some cases, they are similar to defenses for other kinds of crimes.

Among them are:

  • Insufficient evidence;
  • Statute of limitations;
  • Entrapment;
  • Mistake;
  • Insanity; and
  • Intentional conduct.

In order to convict an individual of tax evasion, the prosecution must show that they willfully intended not to pay their taxes. For example, an individual may be able to argue they failed to file their return because they forgot, which may be enough to dismiss the case.

A statute of limitations is a time limit in which a claim can be filed. There is a statute of limitation on tax evasion charges. After this time period has passed, the IRS cannot file a tax evasion suit even if sufficient evidence is available. The statute of limitations on tax evasion is 6 years.

Entrapment occurs when the government compels an innocent individual to commit a crime they otherwise would not have. It is important to note, however, that simply providing an individual the opportunity to commit a crime is not considered entrapment. 

The defense of mistake can be used if an individual was mistaken regarding what day taxes are due or what they are required to report. Simply claiming an individual was not aware they needed to file taxes is not a mistake defense. 

Insanity may be a possible defense, but it is difficult to prove. This defense permits the individual to claim they were insane at the time or the offense or during their trial. The success rate of this defense is low in criminal cases and would likely be ineffective in a tax evasion case.

It is important to note that the government is required to prove that the taxpayer intended to evade the IRS and not pay their taxes and they knew of the possible consequences of their wrongdoing. This is a high burden and if the government cannot show intent, they cannot prevail on their claim.

How Can A Lawyer Help With My Tax Evasion Issues?

If you have been accused of Tax Evasion or you are facing an audit, you should speak to a tax lawyer immediately to learn more about your rights, your defenses and the complicated legal system. If you are an employee suspecting a employer engaging in misconduct you may also benefit from contacting a lawyer to assist you in preventing the employer in future misconduct.