No one wants to pay more in taxes than they legally have to—and decreasing your tax burden via legal means isn’t against the law. There’s a very significant difference between tax evasion and tax avoidance, and if your efforts to lower your taxes teeter into the former, you can expect heavy penalties to follow. However, taking advantage of legally permitted tools to reduce your taxes is simply being smart about your finances. 

If you aren’t sure if your tax strategies run afoul of the law, talking to a tax attorney is a wise move—you can either get some reassurance or come up with a plan to minimize the damage.

An Introduction to Tax Evasion and Avoidance

People use a wide range of strategies to limit their tax burden—while there are many legal ways to do so, sometimes these efforts shift into illegal territory. Tax evasion is a massive problem for the U.S. government, costing the IRS hundreds of billions of dollars per year. As a result, they have steadily ramped up their enforcement of tax laws and committed more resources to uncovering and investigating tax evasion. 

When they find damning evidence, they refer these findings to the Department of Justice to recommend prosecution. If you actively take steps to lower your tax bill—as most of us do—it’s very important to know the differences between tax evasion and tax avoidance.

Tax Avoidance

Tax avoidance is legally minimizing the amount of taxes you owe to the government. People may decrease their tax bill by utilizing tax credits, deductions, and adjustments that they are eligible to claim. For example, if you are a working parent who pays a daycare center to care for your child while you work, it’s not tax evasion to claim the childcare credit. It’s simply a smart way of decreasing your tax bill and engaging in thoughtful tax planning. 

The same is true for a self-employed individual who keeps meticulous records of their business lunches, small purchases made for their business, and mileage to and from business appointments. As long as you are legally eligible for a credit or deduction and you are able to prove that you qualify, you are well within your rights to decrease your tax bill this way.

Tax Evasion

Tax evasion, similar to tax avoidance, is a way of lowering how much you pay in taxes. However, evasion involves using illegal methods to do so. People may evade taxes by not reporting sources of income, claiming deductions or credits they are not entitled to, or hiding income or assets in accounts or countries where they believe the IRS cannot track them down. 

Let’s use the examples from above. Imagine you claim the child daycare credit and report that you paid $12,000 for daycare, which substantially lowers your taxes. However, you did not use any daycare service and in fact your child stayed home with you while you worked. 

In the example of the self-employed worker, they too kept meticulous records—but they were entirely falsified. They listed $500 personal luxury meals as business expenses, claimed their own personal purchases as business deductions, and falsified business purchases for the purpose of decreasing their tax bill. That is illegal, and if the IRS catches it—and they are likely to—there will be consequences.

Types of Tax Evasion

There are many types of tax evasion; people have found numerous ways to drive down their tax bill illegally. Wondering if your efforts to save money on taxes are illegal or not? Keep reading to learn about some of the most common forms of tax evasion.

False Financial Statements

When companies or individuals create fake accounting records or manipulate existing accounting records to inflate expenses, alter profits, or otherwise change their financial records, they may be engaging in tax evasion. When they do this, they intentionally seek to mislead tax authorities in a way that leads to an inaccurate tax assessment.

Fake Deductions

As we discussed above, tax deductions are completely legal when you only use ones you are eligible for. But when a taxpayer claims deductions they are not entitled to, they are likely engaging in tax evasion. This may involve falsifying charitable donations, making fake receipts for childcare payments, lying about interest paid on student loans, or otherwise claiming deductions they are ineligible for.

Exaggerated Expenses

This is particularly common among self-employed individuals and those who are able to deduct certain business-related expenses on their taxes. Inflating these expenses can artificially reduce your tax bill. Essentially, doing this reduces the profits of your business, reducing the amount you have to pay. Exaggerating expenses for a non-self-employed individual is basically claiming or exaggerating a deduction.

Hidden Income

Hiding streams of income is one of the most common forms of tax evasion. Individuals may not report W2 or 1099 income, deal strictly in cash or unreported payments, not report interest earned on bank accounts or investments, or otherwise reduce their taxable income on paper. This is more common in some areas than others; for example, those who babysit, perform services as a self-employed individual, or work in a minimally regulated industry may find it much easier to hide their earnings.

Shell Companies

A shell company is a legal entity that exists solely to transport money in a way that hides assets and makes it harder for tax authorities to figure out who those assets belong to. These companies don’t actually have any business operations (or if they do, they are minimal), and this type of tax evasion may be considered money laundering.

The Use of Cryptocurrency

To be clear, investing in or trading cryptocurrency is not tax evasion. However, those who trade cryptocurrency may do so in an effort to evade taxes. People believe that cryptocurrency cannot be traced by the IRS or other government agencies, and so they do not report profits earned on trades. This is as serious as failing to report any other sources of income.

Evasion of Assessment vs. Evasion of Payment

When it comes down to it, there are two ways taxpayers evade taxes. They either evade the assessment of taxes or the payment of taxes. The examples given above are ways to evade accurate tax assessment; if the IRS does not know what you genuinely earn or own, they cannot assess taxes accurately and appropriately. Although it’s rare, you can face tax evasion charges and jail time for not filing.

When people evade tax payment, the appropriate taxes may have been assessed. However, the taxpayer may then give away or hide assets to make it impossible for the IRS to collect what they are owed.

Penalties for Tax Evasion

Federal sentencing guidelines specify how long you can go to prison for tax evasion. One question that commonly comes up in these discussions is, “Is tax evasion a felony?” Section 7201 of the U.S. Internal Revenue Code recognizes tax evasion as a felony. 

A number of factors determine your actual punishment for tax evasion, including the seriousness of the offense, the individual’s criminal history, a guilty or not guilty plea, and their cooperation with the government. Per section 7201 of the U.S. Internal Revenue Code, someone convicted of tax evasion may spend up to five years in prison. 

On top of that, they will also face hefty financial penalties. Those convicted of fraud or tax evasion could be fined up to $100,000. Corporations convicted of fraud or tax evasion may pay up to $500,000. 

How the IRS Detects Tax Evasion

Those who attempt to evade taxes often do not realize the sheer amount of tools and resources available to the IRS. We’ll look at some of the more common ways the IRS detects tax evasion.

Information Returns Processing System

The IRS matches forms submitted by taxpayers to forms submitted by employers, service providers, and others. This makes it easy to catch unreported income and falsified deductions. For example, if someone claims the childcare deduction with falsified receipts and forms, it’s fairly easy for the IRS to see that there is no matching form from a childcare provider. If someone submits a form 1099 for $10,000 they paid to a taxpayer but the taxpayer did not include that 1099 on their tax return, the IRS can catch this discrepancy immediately.

Whistleblowers

This is a significant source of information for the IRS. Not only do they have specialized hotlines for those who have information to report to the authorities, the IRS also pay awards to those whose information leads to the collection of unpaid taxes. If the IRS catches tax evasion committed by someone who earns more than $200,000 per year, they may pay the informant between 15% and 30% of what they collect. 

Anyone can turn someone else in—disgruntled former employees, household service providers, friends or family members who have heard a taxpayer brag about fleecing the IRS, or those who have conspired with someone to defraud the IRS.

Artificial Intelligence

In recent years, the IRS has utilized artificial intelligence to catch tax evasion. AI detects trends and patterns in tax reporting, and when something falls far outside the norm, it triggers the IRS to dig a little deeper.

Forensic Evidence

The IRS can examine digital evidence to trace money, identify falsified documents and forms, and follow money trails to the actual person in charge. They have significant authority to do so, and those who are under investigation often do not realize it until they are charged.

This is just a selection of the tools used by the IRS to catch those attempting to evade their taxes—as their budget grows each year, so too does their ability to catch wrongdoers in their tracks.

Defending Yourself Against Tax Evasion Charges

There are numerous criminal defenses against tax evasion—the sooner you connect with an attorney, the more time they have to sort out a defense that fits your circumstances. Depending on the circumstances, your attorney may fight your charges based on insufficient evidence, claim that your tax errors are a result of ignorance and not intention, or that you are beyond the statute of limitations. Note, though, that the IRS is very thorough in its investigations. This is absolutely a situation where you need an attorney.

If you’re worried about potential tax evasion charges or you’re not entirely certain that you’ve handled your tax returns properly, there’s no better time to talk to the team at Damiens Law. Call us at 601-873-6510 or get in touch online to schedule a consultation now.