Tax fraud is a general term for illegitimately and purposefully not paying taxes owed to the government. In other words, you can be fined or go to jail for evading your taxes, fabricating information on your tax return, failing to file a return, or violating tax laws. Usually, tax fraudsters are large businesses or wealthy people.
Another term, tax avoidance, is not considered tax fraud. Tax avoidance happens when you discover legal loopholes within tax law to lower your tax liability. Tax avoidance is completely legal because it works inside the law and not outside of it. Some examples of avoiding tax include claiming deductions, credits, and adjustments. You just have to be able to prove that you legally qualify to claim these adjustments to income.
Lastly, another important item to watch out for is tax negligence. This is when you do report your taxes, but do not carefully abide by tax regulations. For example, a taxpayer may not keep adequate records which may result in them paying the wrong amount of tax. While negligence is not categorized as fraud, you may be subject to a 20% penalty of the tax owed but not paid. The Internal Revenue Service (IRS) also charges interest on the penalty.
Determination of Fraud
First, tax fraud can be split into civil fraud and criminal fraud. In a civil fraud case, the victim that has been defrauded pursues the case. On the other hand, prosecutors may pursue a criminal fraud case when they believe the defendant not only tried to defraud someone but also did so for their own benefit. Civil fraud is usually less severe than criminal fraud as the punishment generally compensates the victim for any damages incurred by the fraud. In criminal fraud, the fraudster not only pays fines and penalties but may also face prison time.
The Internal Revenue Service looks at a variety of factors to determine if fraud is being committed or not. Usually, these factors are indicative of suspicious activity, like reporting your income lower than it actually is, not even bothering to pay your taxes when required, using a fake or stolen Social Security number, faking documents, and more.
Different Types of Tax Fraud
To begin, there are multiple types of tax fraud including claiming credits and deductions that you are not eligible for, deliberately not paying taxes or concealing relevant information, falsifying information on documents, and not filing a tax return when required.
When claiming certain credits and deductions on your tax return, you should be careful to double-check that you are actually qualified to claim them. Otherwise, you could inadvertently be committing fraud.
People who default on their taxes present documents with false information or fake income-related documents. They also may hide relevant income information or just not pay their taxes at all.
Generally, you must file a tax return by the deadline (unless you have a particular circumstance where you are not required to file taxes but should do so anyways to get a refund due to overwithholding). If you fail to file a tax return before the due date, you may be penalized with interest until you pay your tax obligations. However, it is civil tax fraud if you intentionally plan to not file a return.
The most lucrative and common form of tax fraud is tax evasion. This is when you intentionally give the IRS or other tax authorities income information that you know is erroneous. Besides individual tax evasion, tax preparers may also participate as accomplices. These preparers may also be prosecuted for evading taxes. However, when tax preparers do commit tax evasion, they do not always defraud the government with their clients’ knowledge and instead pocket the profit.
Consequences for the Taxpayer
If you commit civil tax fraud, you may be punished by the civil fraud penalty. This penalty allows the IRS to claim up to 75% of the amount you falsely understated that you have to pay in addition to the amount that you still owe. For instance, if you owe the IRS $10,000 but only pay $1000, your total liability may be $15,750 after being penalized. In addition, you may also have to waive certain protections like the statute of limitations.
The punishment for criminal tax fraud is even more severe. Monetary fines can be as high as $250,000 per individual, or $500,000 for businesses. Additionally, criminal fraudsters that are convicted can be sentenced to less than or equal to five years in prison and can be also penalized with a fine. In any case, you should be wary of evading your taxes.
Economical Consequences of Tax Fraud
On a larger scale, tax fraud can affect an entire nation. Tax is an important stream of revenue for any nation. When people evade paying their taxes, the government suffers a loss of revenue which is critical to its operations. As such, tax fraud can create a butterfly effect that affects more than just the individual who will not pay their taxes.