Snow is melting, and the flowers are blooming. It is everyone’s favorite time of year – tax season. Barry Goldwater once said, “the income tax created more criminals than any other single act of government.” The Internal Revenue Service estimates that approximately 83.6% of taxes are actually paid voluntarily and on time each year. The remaining 16.4% amounts to roughly $441 billion of missing tax revenue. When all is said and done, after late payments and enforcement efforts are considered, the “tax gap” is estimated to be $381 billion. So – what should you do if you receive a Notice from the IRS? Panic and start planning the interior design of your prison cell? In most cases, you could be facing civil penalties for failure to pay your taxes. However, in some cases, the IRS may charge you with civil tax fraud (IRC §6663), criminal tax fraud (IRC §7206), and/or tax evasion (IRC §7201).
Civil Tax Fraud: So How Much Do I Owe?
For those of us who need a calculator to figure out the tip on your restaurant tab – the penalty for civil tax fraud is 75% of the portion of the underpayment that is due to fraud. In other words, if you report and pay $20,000 of taxes, but IRS discovers that you owe an additional $10,000 of taxes that were not reflected on the tax return due to fraud, then your fraud penalty would be $7,500 – in addition to paying the $10,000 in taxes you still owe.
The IRS bears the burden of establishing, by clear and convincing evidence, that there has been an underpayment of tax and that the underpayment is due to fraud. Under these circumstances, fraud requires actual, intentional wrongdoing and the specific purpose to evade a tax believed to be owing. Because a person’s intent can be difficult to establish on its face, courts have inferred fraudulent intent from various “badges” of fraud. In contrast to the accolades of a Girl Scout, these “badges” include: (1) understating income, (2) maintaining inadequate records, (3) failing to file tax returns, (4) providing implausible or inconsistent explanations of behavior, (5) concealing income or assets, (6) failing to cooperate with tax authorities, (7) engaging in illegal activities, (8) attempting to conceal illegal activities, (9) dealing in cash, (10) failing to make estimated tax payments; and (11) filing false documents.
If the IRS alleges civil tax fraud, you will receive official notice of such a charge – the mail no one wants to get. To defend yourself, you will need to prove the non-existence of as many “badges” of fraud as possible. The IRS has no magic number of “badges” of fraud that it must prove to assess the penalty for civil tax fraud. For example, proving a taxpayer’s filing of false documents may be sufficient without any other “badges” to justifiably assess the civil tax fraud penalty. You may also avoid civil tax fraud penalties if you can prove that you justifiably relied on third parties (accountants, bookkeepers, etc.) when preparing your tax return.
Criminal Tax Fraud – Yikes – Did I Pull a Wesley Snipes?
The penalty for criminal tax fraud is a fine of no more than $100,000 a person ($500,000 in the case of a corporation), imprisonment of up to three (3) years, and payment of prosecution costs. In comparison to civil tax fraud, in this case, the IRS has to prove its case beyond a reasonable doubt – a more difficult burden. The IRS generally prosecutes a taxpayer for criminal tax fraud when it is too difficult to prosecute the taxpayer for criminal tax evasion. To establish criminal tax fraud, the IRS must prove (1) the person believed that the tax return was not correct, (2) willful intent, (3) significance, and (4) the document in question was made under penalty of perjury. Additionally, if a taxpayer pleads guilty or is convicted of tax fraud– he or she is prevented from contesting the civil penalty, an additional liability that is compounded on top of the fines and costs already owed in the criminal matter.
Criminal Tax Evasion: What If I am in the Same Situation as “The Situation”?
The penalty for criminal tax evasion is a fine of no more than $100,000 per person ($500,000 in the case of a corporation), imprisonment of up to five (5) years, and payment of the costs of prosecution. Like criminal tax fraud, the IRS has the burden of proving tax evasion beyond a reasonable doubt. To be convicted of criminal tax evasion, the IRS must prove that the person willfully attempted in any manner to evade or defeat any tax. More specifically, the IRS must establish through evidence (1) the existence of a tax deficiency, (2) an affirmative act constituting an evasion or attempted evasion of tax, and (3) willfulness. Again, if an individual pleads guilty or is convicted of criminal tax evasion, that taxpayer cannot challenge the civil penalty and will be required to pay the civil fraud penalty in addition to the substantial fines and costs of your criminal case.
Tax fraud and evasion may be charged if you fail to report income, fail to provide information or provide incorrect information on your return, claim wrong or inflated deductions, partake in abusive tax shelters, and/or use an incompetent tax professional to prepare your return – but there are valid defenses that can be pursued on your behalf. In a nutshell, if you get a notice from the IRS – your first call should be to an attorney, not your mom, to see if she will still visit you in prison.