Tax evasion is the willful and illegal failure to pay taxes to the government. Taxpayers found guilty of federal tax evasion are subject to criminal prosecution by the U.S. Department of Justice under the IRS tax code.
The U.S. tax code is complicated and based on voluntary compliance, so taxpayers employ numerous strategies to minimize their tax liability. Some of these strategies are legal and some are not.
Illegal avoidance is referred to as tax evasion. It is important to be able to distinguish between tax evasion and legal methods of tax minimization.
Definition and Examples of Tax Evasion
Tax evasion refers to the willful and illegal failure to pay taxes to the federal government. Tax evasion strategies include deliberately underreporting or omitting income, overstating the amount of one’s deductions, keeping two sets of financial records, false accounting entries, claiming personal expenses as business expenses, and hiding income.
How Tax Evasion Works
All U.S. citizens and residents whose income meets a specific threshold are obligated to pay taxes to the IRS. Unscrupulous individuals who seek to pay as little as possible may resort to illegal methods of hiding their income and assets to avoid making these payments.
The IRS Criminal Investigation division is tasked with finding these tax cheats and bringing them to justice. Once IRS Criminal Investigation builds a strong case against a tax evader, it refers the case to the Department of Justice for prosecution.
Individuals evade taxes both by misreporting their income or failing to pay taxes owed, which can take the form of either underpaying taxes or failing to pay them at all. The common denominators are intent and the use of illegal means to avoid payment.
What Constitutes Tax Evasion?
In order for the federal government to prosecute tax evasion, it must prove intent. To meet the threshold for intent, the prosecution must prove the following three elements beyond a reasonable doubt:
- An unpaid tax liability exists
- An act by the defendant to evade or attempt to evade a tax
- The defendant possessed the specific intent to evade a known legal duty to pay
The government demonstrates intent by finding proof that the defendant made an effort to conceal or misreport their income.
Tax cheats rely on numerous tactics and the complexity of the U.S. tax code to illegally avoid tax payments. For example, waitstaff might underreport their cash tips and file a fraudulent tax return that reflects a lower income than their actual earnings. As long as the income concealment is willful, this behavior constitutes tax evasion.
What Are the Penalties for Tax Evasion?
People found guilty of tax evasion pay a steep price for their deception. Tax evaders must pay the taxes owed plus interest, and may be subject to fines of up to $100,000 (as much as $500,000 for corporations) and up to five years in prison. In addition, defendants under investigation for tax evasion often face significant legal expenses.
Tax Evasion vs. Tax Avoidance
Not all tax-minimization strategies are illegal. Legal methods of reducing tax liabilities are called tax avoidance. Individuals may hire tax attorneys or accountants who specialize in leveraging the U.S. tax code to their clients’ benefit. This is how billionaires like Jeff Bezos and George Soros often go years paying little in taxes—or nothing.
People also legally minimize their taxes through mechanisms like charitable contributions and tax-deferred retirement accounts.
- Tax evasion is the legal and willful failure to pay taxes owed to the U.S. or other federal or state governments.
- Tax evasion can take the form of failure to pay taxes owed or underpayment of taxes. In either case, the lack of payment must be willful to be punishable by law.
- Federal tax evaders are subject to investigation by the IRS and prosecution by the Department of Justice. Those found guilty may be subject to significant penalties or jail time.
- Tax evasion differs from tax avoidance, which is the legal minimization of tax payment.