What Is Tax Evasion? Methods & Penalties Explained

Article Summary:

Tax evasion is when someone underpays or completely avoids paying taxes by illegal means. The person must purposely choose to do these things in order to be considered a tax evader. Tax evasion includes filing a false return, not reporting income, and more. The government takes tax evasion very seriously, and it can result in paying a hefty fine and spending time in prison. Tax preparers can help you fill out an accurate tax return.

Let’s say your tax preparer presents you with the amount of taxes you owe this year, and it’s much higher than expected. You’re pretty stressed and unhappy, but maybe it’ll be OK if you only pay a portion of it? What if you change a few of the numbers around to make it lower? Maybe that’s OK? After all, you’re still paying some taxes.

This, however, is tax evasion and is a serious offense. Tax evasion is purposely not paying or lowering the cost of your taxes. It can lead to criminal charges, and you can even spend time in jail for it. However, there are legal ways to lower your taxes, and you should avoid tax evasion at all costs.

This article outlines what tax evasion is, what the penalties are, and how you can avoid it.

What is tax evasion?

Tax evasion occurs when someone purposely and illegally underpays or does not pay taxes. People most often do this by declaring less income or overstating deductions. Committing tax evasion is a serious offense and can lead to some major consequences.

An honest mistake is not tax evasion. Tax evaders are people who purposely use illegal methods to avoid paying taxes. Intent must be proven, and the IRS won’t punish someone for an honest mistake.That said, everyone realizes that innocent people do get convicted of crimes. Also, the IRS does not consider fees and penalties “punishment,” so even an honest mistake can cost you a fine. Therefore, a mistake on your federal income tax could be very costly.

Nevertheless, barring an undeserved guilty verdict, an honest mistake won’t get you punished as a tax evader.

There are two main types of tax evasion: evasion of payment and evasion of assessment.

Evasion of payment

Evasion of payment is when someone hides taxable money or assets from the Internal Revenue Service (IRS). Two examples of this are hiding money in a family member’s bank accounts or concealing personal offshore accounts from the IRS.

Merely creating an offshore account is not tax evasion. Creating an offshore account is not illegal unless it is done with the intent to evade taxes.

Evasion of assessment

Evasion of assessment is when someone files a false return that leaves out income or claims phony deductions. This is the most common way people attempt to evade taxes.

Examples of tax evasion

You can commit tax evasion using various methods. Let’s review them.

The federal government considers the following actions tax evasion:

  • Assigning your personal income to someone else
  • Claiming a false dependent, such as a child that does not exist
  • Creating fake invoices
  • Concealing income
  • Destroying records
  • Falsifying IRS financial forms
  • Filing a false return
  • Falsifying business income and expenses
  • Hiding interest
  • Intentionally underpaying taxes
  • Not filing tax returns
  • Not reporting income
  • Overstating deductions
  • Paying employees in cash
  • Underpaying taxes
  • Using a fake social security number
  • Using multiple financial ledgers or books
Purposely doing any of these actions is a violation of tax law and can lead to serious repercussions.

 

Tax evasion in the real world

You don’t have to look far to see examples of tax fraud. Many people in the public eye have been jailed or suffered other punishments for committing tax evasion.

Here are a few examples of public figures who’ve been caught evading taxes:

  • Rapper Ja Rule was sentenced to 28 months in jail and a fine of more than $1 million after failing to pay $3 million in income tax over three years.
  • The IRS placed a lien of over $6 million on Nicholas Cage for delinquent taxes, including penalties and interest. The actor also fell under a separate lien for unpaid property taxes.
  • “Survivor” winner Richard Hatch was indicted after failing to report his $1 million prize money on his tax return.
  • Filmmaker Joe Frances falsely claimed $20 million in deductions as business expenses. He was indicted on two counts of tax evasion.
  • Baseball player and manager Pete Rose was fined $50,000 and spent five months in prison for tax evasion after failing to report income from autograph signings and memorabilia sales.

Recent policy changes and tax evasion

As you may have heard, federal executive policy changes could make more and smaller tax evaders more likely to get caught going forward.

The financial reporting proposal will require banks to provide the IRS with two additional data points to the information that is already supplied:

  1. How much money went into the account over the course of the year,
  2. And how much came out.

How would this information be useful to the IRS?

Imagine a taxpayer who reports $50,000 of income but has $5 million coming in and out of their bank account. It doesn’t take a forensic accountant to know something fishy is going on. Having this summary information would help the IRS when high-income people under-report their income (and under-pay their tax obligations). The new focus on enforcement makes avoiding both tax errors and tax evasion more important than ever.

How does the IRS catch tax evaders?

The IRS has software and computer systems that are designed to catch a number of inconsistencies in tax returns.

Here are some things the system catches that the IRS considers warning signs for tax evasion:

  • Incomplete information: IRS software can easily catch math errors or information that has not been filled out.
  • Inconsistencies between state and federal tax returns: The IRS takes note of differences between federal tax returns and state tax returns.
  • Inconsistent earnings: The IRS may be suspicious if your earnings vary greatly. If you can’t explain why this happens, it could lead to an audit.
  • Low income, large deductions: If you have a small business that reports a low income, the IRS could get suspicious if you report large deductions. Although they may be legitimate claims, the IRS still might investigate.
  • Rounded numbers: It is highly unlikely that your earnings or interest will result in a round number.

Although the IRS prefers to use interest and fees to deter tax evasion, it is terribly effective if it does decide to indict tax evaders. As the graphs below show, the IRS has consistently scored impressive indictment to conviction rates.

Proving tax evasion

Errors on your tax return or unpaid taxes, in and of themselves, are not tax evasion. You can’t be thrown in jail just for a simple mistake on a tax return. The tax code is confusing, so the IRS takes honest mistakes into consideration. Tax evasion occurs when someone purposely uses illegal methods to evade taxes.

But don’t go crazy when making “honest mistakes” on your taxes. Though tax laws do require proof of intent for a tax-evasion conviction, assuming that neither you nor anyone else will ever get convicted unjustly is neither wise nor prudent. Also, while honest mistakes shouldn’t get you convicted of tax evasion, they do not at all guarantee you won’t face fees and penalties that will feel very much like punishment for a crime. If you are not confident that you can avoid errors when preparing your own taxes, it might help to use tax preparation software to help you file your taxes.

So how does the IRS determine if someone was purposely trying to get out of paying taxes?

The IRS has to prove the following to convict someone of federal tax evasion:

  1. The unpaid tax liability exists.
  2. There was an attempt to evade paying taxes.
  3. The person purposely meant to avoid paying taxes.

 

Penalties for tax evasion

Tax law is something the government takes very seriously. Committing tax fraud can have serious, lifelong consequences. The penalties provided for tax evasion depend on how the evasion was accomplished.

Here are some common tax evasion methods and their accompanying penalties:

  • Filing a fake return: A criminal felony. Up to 3 years of prison time and $100,000 in fines.
  • Hiding or misrepresenting financial information: A criminal felony. This can result in 5 years of jail time and $100,000 in fines.
  • Failure to pay taxes owed: A felony offense. This may result in spending 3 years in prison and paying $250,000 in fines.
  • Not filing a return: Extreme cases can result in up to one year in prison and fines of $100,000 for each tax you did not file.

 

Are tax evasion and tax avoidance the same thing?

You may have heard the term tax avoidance before. Although it sounds similar to tax evasion, they are not the same. Tax avoidance and tax evasion share the similar goal of lowering taxes, but tax avoidance is legal.

Tax avoidance uses legal methods to lower income tax. You can do this with:

  • Work deductions
  • Investing in retirement
  • Claiming deductions or tax credits
  • Investing in a health saving account

 

You’ll still have to pay taxes with tax avoidance, but these methods can seriously lower the amount you need to pay.

Learn more about the differences between tax evasion and tax avoidance here.

Avoid both tax evasion and tax penalties

As mentioned before, the IRS cannot punish you for honest mistakes on your tax return. But, as also mentioned, they could still impose a penalty. In that case, they may send you a tax penalty letter or charge you 20% of the underpaid amount. So, although you might be able to get relief from IRS penalties, your best course of action is always to avoid penalties in the first place.

Avoiding tax penalties

There are a few steps you can take to make sure you don’t end up having to pay a tax penalty:

  • File a complete and accurate tax return. Make sure all the information on your return is accurate. Hiring a professional tax preparer or using tax preparation software can help you with this.
  • Be 100% truthful. You may worry you won’t be able to pay taxes, but you’ll be more in trouble if you lie or stretch the truth. If you are not sure you can afford to pay the taxes you owe, seek an installment agreement or payment plan with the IRS.
  • Report all income. This even includes tips. Tipped employees should keep a record of all tips received. If you think some of your income is nontaxable, double-check Publication 525. This document is from the IRS and lays out which income is taxable and nontaxable.
Owe a great deal? If you owe more than $10,000 in taxes, learn about tax debt forgiveness or tax relief programs. These could help you relieve some of the debt you may be facing.

FAQ

What is considered tax evasion?

Tax evasion is when someone uses illegal means to lower the cost of or avoid paying taxes.

Who goes to jail for tax evasion?

Anyone can serve jail time for tax evasion if the IRS can prove that the unpaid tax exists and that the person purposely tried to avoid payment. The convicted taxpayer could be fined or spend time in prison.

What are the types of tax evasion?

Underreporting income, omitting income, or destroying records are common methods of tax evasion. People have also been known to falsify records or underpay taxes intentionally.

Key takeaways

  • Tax evasion is when a person does not pay taxes owed or lowers taxes illegally.
  • Common forms of tax evasion are filing false returns, hiding income, and claiming false dependents.
  • Committing tax fraud can result in a fine and prison time.
  • Tax avoidance is legal and can help lower your taxes.

Avoid tax filing errors with the right assistance

Using tax preparation software can help you avoid making any errors that may result in an audit. It can also help you have an accurate tax return. This can help you avoid accidental errors resembling tax evasion or IRS penalties. Check out this year’s best tax preparation software to help you create a truthful and error-free tax return.

View Article Sources
  1. And the Oscar for not paying taxes goes to … — NBC News
  2. New Tax Policy Changes — Treasury.gov
  3. Are Offshore Tax Havens Legal? — Patrick Cannon
  4. IRS Audit Red Flags: Understand Who & When the IRS Audits — TaxCure
  5. Ja Rule back in jail on tax evasion charges — Los Angeles Times
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  10. Tax Evasion — Transparency International
    Federal and state governments in the U.S. are not alone in having to deal with tax evasion. It is, for example, among the concerns of this international anti-corruption organization with national chapters in over 100 countries.
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  13. Tax Relief Companies: Reviews & Comparisons — SuperMoney
  14. Tax Relief Industry Study — SuperMoney
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  17. IRS Penalties Explained: How To Get Tax Penalties Waived — SuperMoney
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  19. Tax Penalty Waiver Letter Sample — SuperMoney
  20. The Best Tax Relief Companies — SuperMoney
  21. The Definitive Guide to Back Taxes — SuperMoney