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What Is Tax Evasion? Understanding Tax Evasion And How It Works

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What is tax evasion and what are the consequences that come along with it? Let’s take a closer look at it and learn how to best go about filing and paying taxes properly.

In this article:

    1. Tax Evasion Is Against the Law
    2. Determining Intent
    3. What Is Tax Avoidance?
    4. Will the IRS Catch a Missing 1099?
    5. What Happens When Tax Fraud Occurs?
    6. Penalties for Tax Evasion
    7. Who Commits Income Tax Fraud?
    8. Who Goes to Jail for Tax Evasion?

What Is Tax Evasion? | What It Is and What Its Consequences Are

 

Tax Evasion Is Against the Law

Tax evasion by definition is an illegal action that a person can commit by intentionally avoiding their true tax liabilities. Tax evasion is a crime, and those found guilty will be prosecuted accordingly. The Internal Revenue Service Tax Code classifies failure to pay taxes as a federal offense. You can receive a charge of tax evasion for either illegal nonpayment of taxes or illegal underpayment of your taxes. All taxpayers are required to submit appropriate and accurate forms to determine their tax debt. Yet, even if you do not submit all of these forms, the IRS can still determine if there were taxes owed that you failed to report. This information will come from paperwork required by third-party submitters such as:

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  • W-2s
  • 1099s

Determining Intent

The IRS will consider a variety of factors before determining whether or not the failure to pay was intentional. Typically this determination will start with an examination of the taxpayer’s financial situation. This determines whether fraud is committed or income is concealed. Some of the ways fraudulent cases have occurred are by:

  • Associating the income with someone other than themselves by such means as reporting income under a false Social Security number or name.
  • Concealing income by failing to report work that was not paid using traditional payment recording methods, such as cash payment. This can also extend to not reporting goods received for payment.
  • Corporate felony tax evasion will typically occur by having the tax liability underrepresented. This can be done by undervaluing their receipts. It can also occur by not reporting other sources of income, profits, and revenue.

What Is Tax Avoidance?

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While tax evasion involves the use of illegal means to avoid paying your proper taxes, there is also an issue called tax avoidance. Tax avoidance happens when taxpayers try to lower their tax liability. This is most often done by investing in charities or choosing other methods to tax-defer payment such as putting the money into IRA accounts. The IRS looks for errors that are due to negligence versus others that willfully evade.

When an auditor looks at your tax return, there are certain issues they watch for that can flag fraudulent activity.

  • Overstating exemptions and deductions
  • Falsifying tax or payroll documents
  • Concealing income transfer
  • Maintaining multiple financial ledgers
  • Using personal expenses as business expenses
  • Using false identifying information
  • Trying to claim an exemption for a dependent that does not reside with you
  • Underreporting income

One of the first things that the IRS will look for is unreported income. This can include leaving out specific transactions that can result in income such as:

  • The sale of a business or business assets
  • Not reporting income from a side business which has become more common as many taxpayers now have side gigs to make extra income

The IRS will also look at behavior during an audit that might be suspicious. This includes hiding records or having hidden accounts.

Will the IRS Catch a Missing 1099?

A 1099 is issued for income that is not paid through traditional payment methods such as payroll. 1099s are common forms of payment for independent contractors and freelancers. You need to report all of your income, even if you do not receive a 1099 for your services. Not all income requires a 1099 if the amount is small, but taxpayers are still required to report it. Failure to report income that is on a 1099 is a common flag for tax fraud.

What Happens When Tax Fraud Occurs?

When the IRS suspects tax fraud has occurred, they will start by subjecting the taxpayer to an audit. In the audit, the IRS will look for errors on the returns and ask for documentation of all income, expenses, etc. They will look over the returns for a few years, and if there are large errors over multiple years, it will show a pattern of tax evasion.

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Penalties for Tax Evasion

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If you fail to pay your proper tax liability, you can face criminal charges. For the IRS to file these criminal charges, they must determine that the non-payment was a willful act. The taxpayer will not only have liability for the amount of taxes that were not paid, but they also could face:

  • Jail time – The average jail time for tax evasion is one to five years.
  • Fines – Fine will range between $100,000 and $250,000.

The amount of fines and duration of the sentence will largely depend on the charges that the IRS files.

  • Attempts to evade or defeat paying taxes can result in tax evasion penalties of imprisonment for less than five years, a fine of up to $250,000 for an individual and $500,000 for corporations, or both.
  • Fraud or providing false statements can result in tax evasion punishment of up to three years in jail, a fine up to $250,000 for an individual or $500,000 for a corporation, or both plus prosecution legal fees.
  • Willful failure to file a return, supply required information, or pay the taxes at the time they are due can have the taxpayer found guilty of a misdemeanor and subject to a tax evasion prison sentence of up to a year, a fine of $100,000 for individuals and $200,000 for corporations, or both plus the cost of prosecution,

Who Commits Income Tax Fraud?

While anyone can commit tax fraud, income tax fraud is most often committed by people who are self-employed and running a cash-based business. Also, service workers such as wait staff and hairdressers may often fail to report cash tips. Other top reported employment types that have found guilty of tax fraud include:

  • Restaurant owners
  • Retail owners
  • Car dealers
  • Salespeople
  • Doctors
  • Lawyers
  • Accountants
  • Handymen
  • Mechanics

Who Goes to Jail for Tax Evasion?

Many taxpayers are terrified of an audit. It is this fear that makes taxpayers seek out tax filing services to ensure that their taxes are filed promptly. In reality, not many people will go to jail if found guilty of tax evasion. For example, only about 1,300 taxpayers out of 150 million get indicted by the IRS for tax evasion. Yet, this does not mean you may not suffer penalties and interest for unreported income. Most often the IRS will seek out taxpayers that:

  • Misreport income
  • Don’t file a return

It is important to realize that the IRS will not pursue tax evasion charges for those who simply cannot afford to pay their taxes, but any attempt to conceal or misreport income or assets on your taxes can result in a charge and the consequences that come with tax evasion.

 

Tax evasion is a serious violation of the law. A person’s right to earn goes hand-in-hand with a responsibility to pay due taxes. Avoid the complexities and consequences by filing and paying taxes properly and promptly.

How do you prepare for tax season to avoid tax evasion and tax fraud charges? Share some of your practical tips with us.

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