Not everyone who commits tax fraud is dealing with multimillion-dollar bills from the IRS. Knowingly or not, many people find themselves in situations where they failed to comply with tax codes. Whether they failed to file, pay due taxes, or misreported income, taxpayers can find themselves in hot water with the Internal Revenue Service (IRS).

Individuals and corporations who commit tax crimes can find themselves hit with steep penalties, including up to 5 years of prison time, probation, fines of up to $250,000 for individuals, and $500,000 for corporations—plus restitution and prosecution fees.

What is tax fraud?

Tax fraud is an umbrella term. It refers to many different tax laws and is defined as a crime where the taxpayer purposefully intended to defraud the government of money by not paying the tax amount actually owed.

Tax law is complicated and U.S. citizens are expected to navigate it every year. Some rely on accountants or software, but others dive headfirst into the dense sea of IRS forms and calculate their earnings and what they owe themselves.

The IRS understands this, which is why the most important distinction when it comes to tax fraud is intent. After all, people make mistakes. The law is written so the burden of proof falls on the U.S. government. The IRS must prove you concealed income and that it was done intentionally. If you knowingly try to hide income or break tax law, you could potentially be charged with tax fraud or a more specific crime like tax evasion.

What is tax evasion?

Tax evasion exists under tax fraud’s umbrella. Tax fraud is a broad term while tax evasion is more specific. Basically, evasion is when you misreport or misrepresent your income intentionally to avoid a higher tax bill. This is done by omitting income, inflating your expenses, claiming deductions or dependents not owed to you, or even keeping false or incorrect records.

How do you commit tax evasion?

• Not filing your income taxes
• Knowingly under-reporting or not declaring your full income
• Overstating the value of your non-cash donations
• Inflating your declared deductions
• Not filing your income taxes or not paying what is owed

For a real-world example, let’s say you work a full-time job and receive a W-2 but also operate a small side business in the evening. Last year, you brought in about $5,000 in extra income. You are expected to report this income to the IRS since your net earnings were more than $400.

In this fictional case, you pocketed all your earnings instead of setting money aside for taxes and realize that declaring this income will increase your tax liability. However, if you only enter your W-2 information, you will get a refund. So, you choose to omit the side business.

By making that choice to willingly hide your income, you could be charged with tax evasion.

How is tax fraud or tax evasion proven?

In some cases, checking your income for the IRS is quite simple. If you received a 1099 for freelance work, this would be reported to the IRS. However, if you received cash under the table, falsify documents, or the company you performed work for did not report your income, there are still ways the IRS can prove suspected fraud through indirect methods during the investigative process.

Bank accounts and deposits

During an audit, the auditor may ask to see your bank account statement. If they add up the individual deposits in your account and it doesn’t match your reported income, it can raise red flags. There may be legal and legitimate explanations for these deposits, but they are a common cause for questions.

High living expenses

If you live or make purchases far beyond your financial means, this can be seen as suspicious. If you are receiving funds as gifts from family, using savings, or selling assets, it’s always best to keep a record of funds.

Specific items

Checks, expenses, or deposits in high amounts or suspicious frequencies will raise red flags with an auditor.

What is the difference between tax evasion and tax avoidance?

There is a legal way to lessen your tax burden, which is known as tax avoidance. This is the process of using tax credits and deductions owed to lower your tax burden.

In the U.S., there is a standard deduction, which is $12,550 for individuals and $25,100 for couples as of 2021, which is used by more than 90% of individual taxpayers. Yet many business owners, self-employed individuals, and private taxpayers find enough benefit in finding every tax deduction or credit they qualify for to save even more.

This is not only legal but encouraged. No one should miss tax breaks they are legally entitled to.

What to keep in mind while filing taxes

The tax process is complicated, and the IRS is aware that some people will make honest mistakes. Document your finances, be honest about your income, and stay aware of tax breaks or deductions you should be entitled to.

If your taxes are complicated or you have self-employment income, working with a tax professional before tax season begins is the best way to protect yourself. Ensure you are keeping accurate records, so when tax season comes around, there is no reason to doubt your accuracy. If you are selected for an audit, you and your tax professional will have everything you need to navigate the process with honesty.

When to seek assistance

Tax fraud and tax evasion can lead to steep fines and jail sentences or probation. If you document your finances well and process your tax returns honestly, it is unlikely you’ll find yourself meeting an IRS auditor. However, if you do find yourself charged with a tax fraud crime, you should seek the advice of an experienced attorney.