Whistleblower FAQ: Tax fraud vs. tax evasion

Tax fraud is a general term used to describe the taxpayer’s intent to defraud the government by evading tax. Mere negligence is not enough to establish fraud. The Internal Revenue Service (IRS) may charge individuals suspected of tax fraud with either civil penalties, under the Internal Revenue Code (IRC), or criminal penalties, under the United States Code (USC).

The government tends to file civil penalties rather than criminal penalties due to the taxpayer’s frequent ability to beat criminal charges based on a reasonable legal argument for why the tax due was not paid or underpaid; however, both civil and criminal tax fraud is taken seriously by the IRS and taxpayers should understand the difference between them.

Significantly, civil tax fraud penalties are monetary penalties—it does not result in criminal prosecution. The civil tax fraud penalty is described under IRC §6663(a), which provides that:
If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

Furthermore, the IRS emphasizes that:
If the Secretary establishes that any portion of an underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud, except with respect to any portion of the underpayment which the taxpayer establishes (by a preponderance of the evidence) is not attributable to fraud.

A common example of civil fraud is the filing of a fraudulent return. If such action is established as fraudulent, the taxpayer incurs a penalty in the amount of 75% of the underpayment amount.

On the other hand, criminal tax fraud can result in monetary penalties and jail time. Criminal tax fraud, also known as “tax evasion,” is treated under IRC §7201, which states that:
Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.

In other words, IRC §7201 creates two offenses: (1) the willful attempt to evade or defeat the assessment of a tax, and (2) the willful attempt to evade or defeat the payment of a tax.

1. Evasion of Assessment is the most common form of tax evasion. This occurs when there is a willful attempt to evade or defeat the assessment of a tax through filing a false return that omits income, credit, or deductions to which the taxpayer was not entitled. This can also occur when the tax reported on a deduction is falsely and purposefully understated. Consequently, willful under reporting is an attempt to evade or defeat the assessment of tax.

2. Evasion of Payment occurs when (1) there is an attempt to evade or defeat a payment (2) of an established owed tax, and (3) there was an affirmative or willful act of concealment of money or assets from which the tax could have been paid.

In other words, tax evaders intend to avoid tax assessment and/or payment of taxes owed. Anyone found guilty of evading taxes can face jail time and/or significant fines.

Examples of tax evasion include, but are not limited to:
– Intentionally concealing assets to hinder the IRS’s ability to determine how much tax is owed;
– Under reporting income; 
– Claiming fake business expenses; 
– Claiming illegitimate dependents; and 
– Not filing returns

It is also important to understand that the broad scope of the language of IRC §7201 means that anyone helping the taxpayer evade taxes, such as an accountant or bookkeeper, may be prosecuted, as well.