Tax evasion can consist of either the unlawful nonpayment or underpayment of actual tax obligations.
The IRS can determine tax evasion regardless of whether tax forms have been filed with the agency.
In order to determine tax evasion, the agency must demonstrate that the taxpayer's tax avoidance was intentional. While tax evasion is illegal, tax avoidance involves reducing taxpayer obligations through legal means (within the law).
Understanding Tax Evasion
Tax evasion encompasses both the unlawful nonpayment and the unlawful underpayment of taxes. Even if a taxpayer fails to submit the proper tax forms, the IRS can still determine if taxes are owed based on information required to be sent in by third parties, such as W-2 information or 1099s. Unless the failure to pay is deemed intentional, tax evasion is typically not considered a crime.
Tax evasion occurs when a person or company illegally avoids paying their tax liability, which is a criminal offense punishable by fines and penalties.
Failure to pay taxes as required can result in criminal charges. Before penalties can be assessed, it must be determined that the taxpayer avoided taxes intentionally. In addition to being responsible for any unpaid taxes, a person may be convicted of official charges and sentenced to jail time. According to the Internal Revenue Service, the penalties include imprisonment for up to five years, a fine of up to $250,000 for individuals or $500,000 for corporations, or both, in addition to the costs of prosecution.
Requirements for the Tax Evasion
When determining whether the act of nonpayment was intentional, a number of factors are considered. In most cases, a taxpayer's financial situation will be examined to determine whether the nonpayment was due to fraud or the concealment of reportable income.
In cases where a taxpayer attempted to conceal assets by associating them with a third party, a failure to pay may be deemed fraudulent. This may involve filing a tax return under a false name and Social Security number (SSN), which can also constitute identity theft. A person may be deemed to be concealing income if they fail to report income from non-traditional payment recording methods. This can include accepting a cash payment for goods or services without properly reporting it to the IRS in a tax return.
Tax evasion requires the use of illegal means to avoid paying proper taxes, whereas tax avoidance employs legal means to reduce a taxpayer's tax obligations. This may involve charitable contributions to an approved organization or the investment of income in a tax deferred vehicle, such as an individual retirement account (IRA). In the case of an IRA, taxes are not paid on the invested funds until they are withdrawn, along with any applicable interest payments.
Jail time as well as other penalties for tax evasion
A simple error on a tax return does not automatically constitute tax evasion; intent is a factor. According to the IRS, here are some of the tax evasion penalties you could face if you did intend to evade taxes.
• A conviction for a felony.
• Five years jail time, or
• A maximum fine of $250,000 (or $500,000 for corporations).
• An invoice for the cost of your prosecution.
According to Miller, criminal punishment is a distinct possibility for willful tax evasion, but civil penalties are more likely. According to him, civil penalties can easily double the tax originally owed. Some examples include:
• Failure-to-file penalties.
• Underpayment penalties.
• Penalties related to precision.
• Interest on delinquent penalties
An additional effect of tax evasion is an increased audit risk. Typically, only the three most recent years of tax returns are subject to audit. If you omit at least 25 percent of your gross income, the statute of limitations is extended to six years. Your tax preparer may also abandon you but you have to be careful on tax evasion penalties.
"We can only offer advice as well as guidance and say, 'In this type of situation, you should really change this and pay tax without tax evasion. This is not good,'" says Jacksonville, Florida CPA Greg Freyman. "And if the client refuses or doesn't want to pay tax, it's our responsibility to pay tax and make sure that they don’t get tax evasion penalties. Do we wish to collaborate with this client, and is this client ethical?"
Examples of tax evasion
Tax evasion does not necessitate complex schemes or secret meetings. Here are some examples of how it is easier to occur than you might think.
1. Paying for childcare under the table
Cash compensation of an employee does not constitute tax evasion. What does is a lack of communication with the IRS and failure to pay payroll taxes. He advises that you should report the wages you pay on Schedule H and provide the employee with a W-2 each year. Not sure if this housekeeper qualifies as an employee? Publication 926 of the IRS will help you decide.
2. Ignoring Oversees income
This is a common problem for people who work or own rental properties abroad, according to CPA Greg Freyman.
"We have frequently heard from the clients, 'But my property is not in the U.S. Why on earth should I report any income if it is a rental property?' he asks. "This one always catches people off guard. They believe they do not have to report it if it occurs outside the United States.
3. Banking / Investing in cryptocurrency
Utilizing virtual currencies will not allow you to bypass any hidden loopholes. Although cryptocurrencies are relatively novel, the IRS has already enacted regulations regarding them: Their transactions are subject to tax. And occasionally, taxpayers overlook cryptocurrency holdings whose value has increased.
4. Failing to report earnings from a cash-only business or illegal activities
Miller says that some of the most common cases of tax evasion involve cash-based business owners who pocket money from the cash register without reporting the income.
That is tax evasion, he declares. "This is extremely prevalent, and the IRS is also aware of its prevalence."
Tax evasion also occurs when income from illegal activities, such as drug dealing or prostitution, is not reported. (Yes, you must include this information on your tax return.)
Examples of tax avoidance
When it comes to tax avoidance, there are numerous legitimate ways to reduce your tax liability.
•Utilizing tax-advantaged retirement accounts such as 401(k)s and individual retirement accounts is a common tax avoidance strategy.
•Gain a deeper understanding of the world of tax deductions and credits. You may be eligible if you paid for tuition, child care, medical expenses, or sales taxes. Additionally, charitable contributions may aid you. Your tax preparation software or tax advisor can help you identify legal tax avoidance options.
What to do if you want to come clean
File an amended tax return using Form 1040-X, which allows you to make changes to previously-filed tax returns.
Bottom Line
As a citizen, we are responsible to pay tax. Tax evasion penalties are very high and should be avoided. By properly submitting the bills we can go with tax avoidance.
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