What is Tax Evasion? [Definition, Penalties & Examples]

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Tax Evasion

Tax evasion is illegal. U.S. citizens can go to jail and also be charged with substantial penalties for this crime. That’s why it is so important to understand what constitutes tax evasion. If you aren’t comfortable filing your own tax return then it makes sense to hire a professional who can prepare and file your taxes for you.

There is a lot of discussion about taxes when certain dates roll around or during election years. It is no secret that people and companies want to pay as little as possible when it is time to file. While there is plenty of information readily available about tax rates and strategies, there is still a lot of confusion about what is lawfully deductible and what isn’t.

Part of the reason tax laws are so confusing is that they change. Tax codes are complicated at best, and almost impossible to understand for many people with no training in accounting. That explains why a large number of citizens turn to experts when it is time to file their personal or business tax returns.

Table of Contents

IRS

What is considered tax evasion?

There is some confusion about the differences between tax evasion, tax negligence, and tax avoidance. Tax evasion is by far the most serious of these three concepts and is defined as a deliberate attempt at committing fraud for the purpose of lowering your taxes due. Tax evasion is illegally taking intentional steps to avoid paying the tax legally owed.

Some actions considered as tax evasion are reporting false numbers on IRS financial forms. Specifically, under-reporting income is considered tax evasion. Other deliberate actions that often point to tax evasion include: falsifying expenses or income, unreported employee payments in cash, and under-reported tip totals.

Other common tax evasion strategies employed are claiming a dependent that does not exist or using a bogus social security number. IRS agents are likely to uncover these obvious tax evasion strategies since they are common and easily identifiable based on previous tax records.

If you fail to file a tax return, you are also considered to be evading taxes. While there are some people who are not required to file taxes, there are strict guidelines that must be followed to be sure you qualify as a citizen who does not have to file a return. There is a maximum income level that is assigned annually that allows certain low-income citizens to be exempt from filing taxes.

Tax Haven

Usage of Foreign Tax Havens

Tax havens are nothing new. They are believed to date back to the 1920s, and possibly even earlier. While there is no exact definition of a tax haven, there are certain characteristics associated with these locales.

Not surprisingly, a tax haven is a jurisdiction that charges only nominal taxes or no taxes at all. This attribute alone is not enough to qualify a certain country or city as a tax haven. It is noteworthy to mention that there are many countries that offer tax advantages to attract businesses that are not considered a tax haven.

Secondly, tax havens are expected to protect your personal information. That’s why most tax havens have policies in place that prevent foreign authorities from accessing your financial records.

Tax havens are very popular since they don’t usually require companies or individuals to establish a significant local presence. This policy translates into additional savings. Unless a business or individual has a compelling reason to establish and maintain an office for practical purposes, then this benefit is an attractive attribute that draws the attention of businesses and individuals seeking to minimize their taxes.

While there is no argument that secrecy and attractive tax rates are the main requirements of any locale to be considered a tax haven, there are other highly-sought-after attributes. Investors are also seeking places where they can easily incorporate a business and set up a checking account in an hour or so.

Common sense also dictates that a tax haven is in an area that is stable politically and economically. For example, Switzerland has long been heralded as such a place. This country does not go to war or suffer from political turmoil, making it an attractive place to consider as a tax haven.

Favorable corporate laws, banking options, exchange controls, treaties, communication infrastructure, and transportation options also impact the popularity of tax havens. Some popular and well-known tax havens are the Bahamas, Belize, Bermuda, Andorra, Monaco, Hong Kong, Switzerland, and Panama.

tax audit

How does the IRS catch people and companies evading taxes?

The IRS employs many strategies for catching people and companies who are intent on evading their taxes. Computer data analysis, social media footprints, and whistle-blowers are all proven ways to identify tax cheats.

Computer tax analysis involves matching personal and corporate tax returns with the information sent in by employers and other parties filing 1099s and K-1s. If an income tax return does not include the income from these reports, then those discrepancies can trigger an audit.

Earned income tax credits represent another fertile area where tax fraud is possible. IRS computer filters are used to identify tax filers who might be engaged in tax evasion involving the earned income tax credit.

Social media has become a tool used by the IRS to track down many tax cheats. If you are always posting on Facebook about the elaborate trips you take to Europe and you only show a $12,000 income, then you may have some explaining to do when the IRS audits you. The extent of IRS surveillance efforts is not known. But, it is worth noting that you can run but is harder than ever to hide if you are active on social media.

Financial institutions also provide valuable data as the Foreign Account Tax Compliance Act (FATCA), requires non-financial foreign institutions and foreign financial institutions to report all foreign assets being held by United States account holders. This can help expose offshore money laundering and tax evasion activities.

Whistle-blowers contribute their fair share of turning in tax dodgers. Many people contact the IRS to turn in their ex-husband or wife. Disgruntled employees are also likely to call in about an employer they know is cheating the IRS. There is a 15 to 30 percent reward paid for turning someone in. There are minimal requirements that must be met before an informant can be paid. For example, the individual being turned in must make at least $200,000 per year gross income to get a reward.

Tax evasion is illegal

Possible Penalties for Tax Evasion

The penalties for tax evasion are steep. Any taxpayer who purposefully tries to avoid paying their fair share of taxes by under-reporting income or overstating deductions can be charged with tax evasion. If you are found guilty of this crime, you could be fined as much as $250,000 and also spend five years of your life in jail. This is the worst-case scenario.

Civil charges can also be filed. Tax cheats do not get off easy in civil court either. If found guilty, you can wind up paying a hefty penalty of 75 percent of the amount of the taxes you owe in addition to the original taxes you should have paid. These figures do not include the legal fees. It is easy to see that crime does not pay.

Differences Between Tax Evasion & Tax Avoidance

There is a distinct and important difference between tax avoidance and tax evasion. The major difference between the two is that tax avoidance is legal and tax evasion is illegal. Specifically, tax avoidance is defined as a legal action to minimize the taxes you owe. Some tax avoidance actions that taxpayers should take include taking all legal deductions possible to lessen the amount of taxable income which will ultimately also lessen the amount of taxes owed.

Comparatively, tax evasion efforts often consist of a deliberate effort to minimize the taxes owed by misrepresenting either the amount of income earned or the number of allowable deductions. Examples of under-reporting income often include not paying taxes on money earned in a garage sale or as the result of gambling. This type of revenue is often labeled as part of the underground economy where record-keeping is voluntary.

How much does tax evasion cost U.S. taxpayers?

Taxpayers who are charged with tax evasion can expect to pay up to 75 percent more in penalties on their taxes owed with fines totaling up to $250,000. Based on the fiscal year 2018, the IRS levied $29.3 billion in penalties related to civil proceedings with 2,886 criminal investigations launched. These investigations were primarily connected to tax crimes, narcotics-related and illegal source crimes.

Fortune reports that tax evasion costs the federal government about $458 billion per year based on estimates for the years 2008 to 2010. That figure represents an $8 billion increase from 2006. The IRS estimates that it will eventually be able to collect about $52 billion of the revenue owed.

Examples of Tax Evasion

Each year there are stories circulated about famous people convicted of tax fraud who face severe penalties and jail time for tax evasion. Below are some recent cases that made the news.

Todd and Julie Chrisley

CNN reports that the reality TV stars, Todd and Julie Chrisley were indicted after being charged with tax evasion and fraud in August 2019. They star in a popular USA Network series entitled, “Chrisley Knows Best.” The indictment claims that the Chrisleys submitted fraudulent financial statements for the purpose of securing loans for millions of dollars between the years from 2007 to 2012. The couple publicly denies the charges.

In an Instagram post, Todd Chrisley implied that the charges are the result of claims made by a disgruntled employee. The reality TV star went on to say that the employee stole from the family and forged their signatures on fraudulent documents.

Wesley snipes Tax Evasion

Wesley Snipes

Wesley Snipes is as well known for his feuds with the IRS as he is for his acting career. Forbes reports that Snipes’s latest loss in federal tax court in 2018 when totaled $23.5 million.

Unfortunately for Snipes, this isn’t the first time the actor has suffered defeat in tax court. Back in 2008, he was convicted of three charges for failing to file his tax return, ultimately avoiding a $7 million tax bill. He claims he got some bad advice from an accountant who told him that he did not legally have to file a return. Taking this advice cost the movie star three years in jail and millions in back taxes, fines, and legal costs.

Mike ‘The Situation’ Sorrentino

Michael Sorrentino, better known as Michael “The Situation” Sorrentino was sentenced to an eight-month stay in federal prison after being convicted of tax evasion in 2018. Best known for his role on “Jersey Shore,” the actor was charged with filing fraudulent tax returns on an estimated $9 million. In addition to jail time, the star must complete 500 hours of community service and also serve two years after he leaves prison on supervised release.

Sorrentino’s brother, Marc and his accountant were also charged with tax crimes. Michael and his brother created businesses to leverage the star’s celebrity earning power without paying the required tax on the income. Additionally, he was found guilty of not filing a 2011 personal tax return.

Teresa and Joe Guidice

Reality stars of “The Real Housewives of New Jersey” got a harsh dose of reality from the court system after learning they would both get jail time and hefty fines for bankruptcy fraud and failing to file a tax return in 2004 on about $1 million earned from 2004 to 2008. Judge Salas sentenced Teresa Guidice to 15 months in jail. Joe got more time and was sentenced to serve 41 months behind bars.

Salas did agree to let the husband and wife serve time back to back so that there would be one parent at home to care for their four children. The couple was also fined $414,588. Even with jail time behind them, things aren’t looking good for the Guidice family, since Joe is not a citizen and risks being deported.

Al Capone

A discussion of tax evasion would not be complete without mentioning one of the most notorious criminals to ever be found guilty of tax evasion. Forbes reports that Capone’s criminal enterprises earned him about $60 million annually in the 1920s. As hard as they tried, Capone eluded the authorities and was impossible to charge with the many crimes he committed.

Then things changed suddenly in 1927 with the case U.S. v. Sullivan. As a result of this case, the Supreme Court ruled that gains from the sale of illicit liquor could be taxed. Finally, there was a way to make charges stick against Capone. Mobster, Al Capone was ultimately convicted of tax evasion in 1931.

Bottom Line

Tax evasion is a crime punishable by fines and jail time in the worst cases. The IRS has established many vehicles for catching tax cheats. While it is easy to make an honest mistake as you navigate intimidating forms and instructions, anyone who purposefully cheats on their taxes risks dire consequences. Unless you want to spend your life looking over your shoulder afraid to open IRS notices, it is a good idea to be sure that you file your taxes every year, report all of your income and never take deductions that are not legally allowable.