The U.S. is under a voluntary compliance tax system. What this means is when tax time rolls around, individuals are expected to voluntarily complete their forms accurately and on time. While fulfilling this obligation, many taxpayers will explore avenues that allow them to minimize tax liabilities, which can lead to an increase in after-tax income. There are a couple of ways taxpayers accomplish this: through tax avoidance or tax evasion. The former is a legal method for lessening tax obligations. In contrast, the latter is an illegal scheme punishable under federal law.
In this blog, we'll explore the differences between tax avoidance and tax evasion and discuss how the IRS investigates and pursues tax fraud.
What Is Tax Avoidance?
Tax avoidance is a legal avenue for lessening tax liability. The IRS tax code allows for taxpayers to claim deductions, credits, and other adjustments. When taxpayers follow the law, they can minimize the amount of tax they owe and possibly get money back from the government without facing criminal penalties.
How Do Taxpayers Engage in Tax Avoidance?
There are several ways taxpayers can seek to legally lower their tax obligations.
Some of the means available include, but are not limited to:
- Giving to charity
- Investing in an individual retirement account
- Taking a child tax credit
- Taking mortgage tax deductions
These methods of reducing taxes, as well as others, may be utilized if appropriate under the tax code.
What Is Tax Evasion?
Tax evasion is another method for minimizing tax obligations. However, it's not the same as tax avoidance. Evasion is illegal and can result in criminal prosecution.
Typically, tax evasion involves providing material false information on tax returns, such as underreporting income or overreporting deductions.
Because tax laws are complex, a person might mistakenly take a deduction or credit that impacts their tax obligations. In most cases, unintentional errors do not equate to tax evasion. The material misrepresentation must have been done willfully to be a crime.
How Do Tax Payers Engage in Tax Evasion?
Just as there is a range of ways to lawfully avoid taxes, there are also numerous methods for unlawfully evading taxes.
A few of the ways tax evasion is committed include:
- Failing to report income gained from unlawful activities
- Failing to report income from a business by scimming cash receipts
- Failing to report income gained through a second job
- Inflating business expenses
- Failing to report income earned outside the U.S.
- Failing to report interest accrued on accounts outside the U.S.
- Failing to report income earned from bitcoin transactions
How Does the IRS Investigate Tax Evasion Offenses?
The government takes seriously any willful conduct that allows a person to unlawfully avoid paying taxes. Typically, a tax evasion matter will involve a civil IRS audit and a criminal investigation.
If the findings of the IRS audit suggest that the taxpayer knowingly evaded or attempted to evade paying their taxes, the case will be referred to an IRS criminal investigator. IRS criminal investigations are lengthy and extensive. By the time someone knows that they are suspected of tax evasion, the IRS criminal investigators already have a substantial amount of evidence.
In many cases, the IRS criminal investigator will go to the suspects home unannounced in order to talk with the taxpayer before he or she can get an attorney. The investigator may state that they are just trying to clear things up or have a few questions. At this point, a person may think it is a civil audit and talk with the IRS Criminal Investigator. Unfortunately, anything a person says may be used as evidence in a criminal prosecution. At this first meeting, the IRS will have already done a significant review of the person’s financial affairs to find evidence against the taxpayer.
Anyone under investigation for tax fraud should talk with an attorney about their situation right away. Attorneys experienced in criminal tax investigations can advise the tax payor on the legal ways to respond to the IRS without incriminating themselves or hurting a potential defense. Because the criminal investigation must establish that the tax payor acted willfully, it is imperative that the tax payor not submit to an interview with the IRS Criminal Investigator. Proving willfullness to evade taxes can occur if the IRS agent believes the tax payor lied during an interview.
What Are the Penalties for Tax Evasion?
The criminal sanctions imposed for tax evasion are harsh.
Under federal law, anyone convicted of tax evasion may face:
- Up to 5 years in prison and/or
- Up to $100,000 in fines
for each year that the tax evasion occurred.