What Is Considered Tax Evasion?

businessman with a lot of cash

In the tax industry when clients first start dealing with the IRS there is always the fear and question “Am I going to jail?”. The truth is that very few people go to jail for tax evasion.

The IRS mainly targets people who understate what they owe by either under-reporting income or misreport credits or deductions on their tax returns. They do not typically go after, criminally at least, people who just cannot pay their taxes.

 

The Definition of Tax Evasion

Under Federal law of the United States of America, tax evasion is the purposeful illegal attempt of a taxpayer to evade assessment or payment of a tax imposed by Federal Law. Conviction of tax evasion may result in fines and imprisonment.  The biggest definer of tax evasion is intent.

Innocent mistakes on your tax return do not officially label you a tax evader. Tax evasion is when you intend to evade taxes.

A genuine good faith belief that one is not violating the Federal tax law based on a misunderstanding caused by the complexity is a defense to the charge of tax evasion. A belief that the federal income tax is invalid or unconstitutional is not a misunderstanding caused by the complexity of the law.

 

How Does the IRS Handle Tax Evasion?

As seen on the IRS website, the Internal Revenue Service-Criminal division conducts criminal investigations regarding alleged violations of the Internal Revenue Code, the Bank Secrecy Act, and various money laundering statutes. The findings of these investigations are then referred to the Department of Justice for recommended prosecutions. These criminal investigations can be initiated by the IRS when a revenue agent (auditor) or revenue officer(collections) detects possible fraud.

The IRS also receives tips from the public as well as from law enforcement and United States Attorney offices across the country.

 

Famous Cases of Tax Evasion & Lessons Learned

Probably the most famous time that outside law enforcement reached out to the IRS during an ongoing investigation was in 1931 when the IRS went after Al Capone.  Capone was alleged to be the mastermind behind 30 deaths and government agents had spent years trying to take him down, but he always avoided conviction. On 17 October 1931, he was found guilty of tax evasion and sentenced to 11 years in prison. Before this, he was quoted “They can’t collect legal taxes on illegal money.” 

Capone had been living a lavish lifestyle and was worth up to $100 million yet he had never filed a tax return. Agents began gathering information by following the money and proving that Capone had made millions of dollars of income that was never taxed. He was indicted on 22 counts of federal income tax evasion. Capone reached a plea deal where he would only get 2 years, but the judge refused to accept the deal and the case went to trial where he was sentenced to 11 years in prison, fined $50,00, charged court costs, and ordered to pay back $215,000 in back taxes.

Another way the IRS begins an investigation is when there is reported income and a taxpayer fails to file their tax returns every year. When an employer sends out income forms, W-2 or 1099, to their employees or contracted individuals they also send these to the IRS. So, the IRS is very aware of the income a person is making when they are employed. 

A lot of these W-2 employees who fail to file either has exceptionally low withholdings or go exempt from their employer. With a self-employed person unless they set up estimated payments throughout the year with the IRS no taxes are being turned over throughout the year. This type of taxpayer is not only not filing their taxes but they are also not paying their taxes. This will raise red flags with the IRS and at some point, they will begin filing these taxes on behalf of the taxpayer. These are called substitutes for returns. If the amounts owed are substantial, this is where the IRS may pursue criminal charges.

A case of this nature that a lot have heard about was with actor Wesley Snipes. In 2006 Snipes was indicted on charges of attempting to claim nearly $12 million in fraudulent tax refunds and not filing any tax returns for several years. In the court proceedings, IRS agent Steward Stich testified that Snipes earned almost $40 million in the years 1999 and 2004 and failed to file tax returns or have any money withheld for taxes on any of that income. He also alleged that Snipes also tried to file returns to have taxes refunded to him from years before that in the amount of almost $12 million. 

During his defense, Snipes tried to claim that the IRS was an illegitimate government agency. He also blamed bad tax advisors and challenged his actual residency. None of these excuses worked on the charges of failure to file his tax returns. He was acquitted of tax fraud but was sentenced to up to three years in prison on the charges of failure to file.

After a person serves prison time for an outstanding tax debt the debt is not cleared. They still owe the money and are required to pay it back. Once released Snipes claimed to not have the money to pay it back and filed for an Offer in Compromise.  Everyone has heard the commercials that you can settle your debts for less through the different programs. While these programs do exist and I will discuss them in a later article, they are all “hardship” and “inability to pay” driven. Snipes learned this the hard way as his bid for a reduction was denied. When this failed Snipes even went one step further and petitioned the tax courts with an appeal to this decision. This case dragged on for years and his offer was ultimately rejected.

Another type of tax evasion, which is probably the most common, is when one receives cash income and does not report it to the IRS. All earned income is required to be reported to the IRS, so when one leaves this off a tax filing it would be considered tax evasion. A lot of people call this “working under the table.” This nonreporting of income is very illegal. Some industries where this type of tax evasion is common are barbershops, hairdressers, and the hospitality industry.

There was a major case of this nature recently with MTV reality celebrity Mike “Situation” Sorrentino. In the tax year of 2011, Sorrentino had earned additional cash income on top of his reported income. He not only failed to report this income, but he also admitted to taking certain actions to conceal some of this income to avoid paying taxes. He had deposited this money into his accounts in small deposits less than $10,000 to avoid the IRS becoming aware of them. Sorrentino was sentenced to eight months in prison and forced to pay $123,913 in restitution and a criminal fine of $10,000.

With the IRS and its depleted budget, many of these types of cases go undetected. Studies are showing that many wealthy tax evaders are going undetected and that there is substantial tax evasion at the top. New proposals to hike the budget of the IRS may provide for additional IRS staff for audits of these situations; they may help close what they call the tax gap.

 

Tax Evasion Through Child Tax Credits

Another common practice of tax evasion that has been highly regulated as of late is the claiming of dependents for the child tax credit or the earned income credit. Many people use the social security numbers of people’s children who they may know or even relatives that they do not support so they can receive refunds on their tax returns from the different credits.

Because of the rampant fraud in the use of these credits, the IRS admits that an audit of a return using one of these credits is 4 times more likely than one not.

 

What Does the IRS Typically Do In Cases of Tax Evasion?

Now, these examples that I mentioned had harsh consequences for their actions. They do not typically go after, criminally at least, people who just cannot pay their taxes. These were all high-profile cases of celebrities that had huge media attention. It can be said that they were made an example of. 

In most cases of tax evasion, the IRS simply goes in and fixes the errors and hits the taxpayer with fines of a percentage of the tax debt. These fines can be substantial and if a taxpayer does not comply with collections, then the IRS can pursue enforced collections.

In some cases, in these audits and examinations, a taxpayer can hire the correct representation to refile the tax years correctly like they should have been done the 1st time to reduce what the IRS is saying that they owe.

In conclusion, once the debt is in collections the taxpayer does have rights and a lot of other programs available if they cannot pay the debt off. These I will discuss in future articles. If you are dealing with this situation, it is well worth the investment of hiring a licensed tax professional to get involved.

The best-suited representative for these types of cases is the Enrolled Agent. They are recognized by the IRS as the highest level of representation and are typically former IRS agents that know the in and outs of this process.