What Constitutes Tax Evasion or Tax Fraud?In tough economic times such as these many people are struggling to meet their financial obligations given that they are making less in their businesses or may have incurred a job loss. The increased financial pressure brought on by the current economy has motivated many honest people into committing desperate acts. One desperate act that may have devastating consequences is tax evasion by cheating on your taxes in order to attempt to make financial ends meet.
The IRS is well aware that in bad economic climates many individuals experience increased temptation to cheat on their income taxes. The IRS in response to the economy has increased the number of civil audits and criminal tax investigations in an attempt to close the perceived increase in the tax gap associated with the bad economy. The tax gap is the difference between what taxpayers actually pay on their income tax returns as opposed to what they are legally required to pay.
Tax evasion occurs where illegal actions are taken by individuals, corporations’ trusts and other entities in order to evade having to pay the true amount of income tax. Tax evasion is ordinarily accomplished through deliberate misrepresentations or concealment of the taxpayer’s true net income to the taxing authorities in order to reduce their tax liability. Tax evasion is accomplished through under-reporting income, overstating deductions or claiming credits that the taxpayer is not entitled too. The reporting of personal expenses as business expenses is a common method whereby income is evaded through overstating deductions. A tax crime can also be charged where an individual earning income knowingly and intentionally fails to file an income tax return or intentionally falsifies information on a tax return.
The IRS Criminal Investigations Department is the branch of the IRS charged with investigating taxpayers that willfully, knowingly and intentionally violate their legal duty to file true accurate and complete tax returns and thus fail to pay the legal and correct amount of income taxes on an annual basis. Each year, the IRS conducts criminal investigations of individuals and businesses across a broad spectrum of industries, income tax brackets and locations within the United States and abroad. Most of the investigations come from referrals from standard civil audits.
If an individual is caught attempting tax evasion during a civil audit or through a criminal investigation, they will at best face civil consequences and at worst face criminal consequences. Civil consequences can include a whopping 75% fraud penalty on the additional income tax assessed, coupled with the addition of interest on the penalty and additional taxes due, back to the original filing date of the affected return. While criminal penalties generally carry a 5 year statute of limitations, civil penalties can accrue indefinitely where fraud is asserted.
If the IRS asserts that an individual under-report their income by 25% or more, the IRS will be able to examine six years of tax returns as opposed to the normal three years of returns that are open to examination under the normal statute of limitations. Where the IRS can prove a willful intent to evade paying taxes existed, they are able to go back as far as they wish, without limitation, conceivable all the way back to beginning of a taxpayer’s adult life.
Criminal tax charges may be levied against an individual within six years of the date that the tax return was, or should have been, filed. Evasion carries with it a potential five year prison sentence for each count. Each tax year where income tax evasion is proven is a single count. Ordinarily the U.S. Attorney’s office will not prosecute a tax crime unless a three year pattern of evasion can be established. Thus, at a minimum, income tax evaders are staring at a potential 15 year jail sentence if convicted. This sentence can often be pleaded down to one count if the government is spared the burden of having to take the issue to trial. Additionally, non-filers can be fined up to $25,000 per year and face the potential of serving one year in federal prison for each year of non-filing.
Questions and Answers About Tax Evasion
- What is a tax shelter? What are some examples?
- How does the IRS attack tax shelters on IRC Section 183
- Relationship between Section 183 and other tax doctrines
- The difference between tax evasion and tax avoidance
- What is the Step Transaction Doctrine?
- What is the Sham Transaction Doctrine?
- What is the Business Purpose Test?
- What is the Economic Substance Doctrine?
- What is the substance over form doctrine
- What are the passive loss limitation rules
- Does IRC Section 269 Disallow a Net Operating Loss?
- IRC Section 269 and when it disallows a net operating loss
- What are the listed transactions and what do they mean?
- At risk limitation and how it prevents claiming deductions
- What are the reportable transactions?
- Does the government regulate tax advisors?
- Advisor tax opinion letter Circular 230 dictate standards
- Tax advisor fails to meet the minimal competency standards
- Is my tax advisor liable for helping me commit tax evasion?
- Statute of limitations for preparing false tax returns
Tax Evasion or Fraud: Voluntary Disclosures
Historically, between 1934 and 1952, the IRS had a written policy of refraining from prosecuting taxpayers who made a voluntary disclosure. Today, that written policy has changed so that a taxpayer’s voluntary disclosure is a factor that is weighed in a facts-and-circumstances evaluation, but the actual of practice of the IRS is quite similar to its past written policy.
The IRS’s behavior is indicative of its true policy. Since 1952, the IRS has only decided to prosecute a handful of cases after the taxpayer’s voluntary disclosure. Because of the IRS’s previous written policy and the IRS’s lack of prosecution of voluntary disclosure cases, tax attorneys are generally convinced that the IRS has an unwritten de facto disclosure policy of refraining from prosecution.
The IRS’s unwritten policy can be seen from its behavior, specifically, its decision to decline prosecution. One court admits, “there appears to have been few, if any, prosecutions of true voluntary disclosures [by] the IRS.” United States v. Hebel, 668 F.2d 995, 998 (8th Cir. 1982).
Indeed, the IRS’s conduct seems to show that it will prosecute after a voluntary disclosure only when extraordinary facts and circumstances are present. A number of tax scholars agree: “[T]he practice of the IRS has been that it will not prosecute taxpayers who satisfy all of the requirements of the voluntary disclosure program because, if it did initiate such prosecutions, no taxpayers ever would be willing to make a voluntary disclosure in the future.” New York University Annual Institute on Federal Taxation § 27.06 (2010).
Thus, even though the IRS’s official, written position is to leave the door open to pursuing criminal prosecution after a voluntary disclosure, it is unlikely it will do so.
Voluntary disclosures typically occurs in two situations:
(a) The taxpayer’s wrongdoing is disclosed to his attorney or accountant because he wants to set matters straight; or
(b) The taxpayer discloses his wrongdoing to an attorney or accountant after he has been personally contacted by the IRS.
Generally, if a taxpayer has not been contacted by the IRS, or is not currently under audit, examination, or investigation, it is not likely he will be prosecuted after a voluntary disclosure – unless the IRS disputes the voluntary disclosure, or the IRS believes the taxpayer has engaged in an illicit income-producing activity (or is a threat to the voluntary assessment system, where the taxpayer is deemed a tax protester).
The decision whether or not to make a voluntary disclosure to the IRS is not a simple one and should never be made without the counsel of an experienced tax attorney. The decision should be made only after weighing the risks involved in one’s case-and that is something the Office of David W. Klasing can definitely help you with. Note: This decision should NEVER be discussed with the original tax preparer as they are the government’s most powerful witness against you.
The following bolded content is the actual language of the IRS’s Voluntary Disclosure Practice:
It is currently the practice of the IRS that a voluntary disclosure will be considered along with all other factors in the investigation in determining whether criminal prosecution will be recommended. This voluntary disclosure practice creates no substantive or procedural rights for taxpayers, but rather is a matter of internal IRS practice, provided solely for guidance to IRS personnel. Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution.
A voluntary disclosure will not automatically guarantee immunity from prosecution; however, a voluntary disclosure may result in prosecution not being recommended. This practice does not apply to taxpayers with illegal source income.
A voluntary disclosure occurs when the communication is truthful, timely, complete, and when:
- The taxpayer shows a willingness to cooperate (and does in fact cooperate) with the IRS in determining his or her correct tax liability; and
- The taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.
A disclosure is timely if it is received before:
- The IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation;
- The IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance;
- The IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or
- The IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).
Any taxpayer who contacts the IRS in person or through a representative regarding voluntary disclosure will be directed to Criminal Investigation for evaluation of the disclosure. Special agents are encouraged to consult Area Counsel, Criminal Tax on voluntary disclosure issues.
Examples of Voluntary Disclosures Include:
1. A letter from an attorney which encloses amended returns from a client which are complete and accurate (reporting legal source income omitted from the original returns), which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full and which meets the timeliness standard set forth above.
2. A disclosure made by an individual who has not filed tax returns after the individual has received a notice stating that the IRS has no record of receiving a return for a particular year and inquiring into whether the taxpayer filed a return for that year. The individual files complete and accurate returns and makes arrangements with the IRS to pay the tax, interest, and any penalties determined by the IRS to be applicable in full. This is a voluntary disclosure because the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intent to do so and because all other elements of (3), above, are met.
It has been our experience that taxpayers who have in many times blatantly and knowingly violated the tax laws, are none the less able to effectively avoid prosecution by self-reporting their prior tax violations to the IRS before the IRS has had the opportunity to begin an investigation by taking advantage of the IRS Voluntary Disclosure Program for domestic or international issues.
While making a Voluntary Disclosure is not completely without risk and does not provide an absolute guarantee that the IRS will not refer the taxpayer to the Department of Justice for criminal prosecution, it is the IRS’s long-standing policy to refrain from referring for prosecution taxpayers who make a full Voluntary Disclosure of their transgressions by substantially complying with all of the terms of the IRS’s program. As a matter of public policy it makes little sense to prosecute those who attempt to correct their indiscretions voluntarily as this would discourage others that are similarly situated. However, on the other hand, any material indiscretion that is not corrected and subsequently discovered by the IRS is very likely to draw criminal charges as a matter of public policy to discourage others from like behavior.
Given the nature of this program, voluntary disclosures are extremely sensitive and are accompanied by strict rules and guidelines. Once taxpayers are accepted into the voluntary disclosure program, they must provide the IRS with what amounts to a signed confession upon entering the program and full cooperation while their case is being reviewed and processed. Entering the program is a one way trip that cannot be walked away from and thus, a taxpayer’s eligibility for this program must be carefully scrutinized and evaluated prior to contacting the Criminal Investigation Division of the IRS. As a prudent precaution, our office routinely submits a “pre-check” of a taxpayer’s identifying information to the IRS which establishes a taxpayer’s basic eligibility for the program before submitting any potentially incriminating information to the government.
Making the Disclosure (Loud vs. Quiet)
Currently in the tax law profession there are two main schools of thought (and considerable controversy) regarding how to go about making a voluntary disclosure. The first school of thought is that it should be done “quietly” by sending in delinquent original or amended prior tax returns, with a check(s) in full payment through normal channels and gambling that the returns get processed without the taxpayer every hearing from the Criminal Investigation Division of the IRS because of the sheer volume of returns the taxing authority processes. Many Tax Attorneys prefer and thus direct their clients toward this method because in their opinion this method decreases the likelihood that the delinquent original or amended returns will be audited upon submission and avoidance of a perceived negative impact on a taxpayer’s ongoing reputation with the affected taxing authorities which occurs where a taxpayer makes a loud disclosure by knocking on the door of the criminal investigation division and makes the required “loud” admission of the fraudulent activity that is to be corrected.
Our office generally prefers “loud” disclosure over “quiet” disclosures because if a taxing authority has begun an investigation prior to receipt of the “quiet” submission the “quiet” disclosure will not be deemed to be voluntary and thus will not comply with its Voluntary Disclosure Practice. To make matters exponentially worse, the amended return could potentially be viewed as a criminal admission of the amount by which the tax liability was understated on the original return. Thus the amended returns intended to mitigate the client’s criminal exposure can be used by the IRS to meet its burden of proof as to willfulness (which is by far the hardest element of its case to prove) if it decides to prosecute. Additionally there is some support for a growing government position stemming from the 2009 and 2011 Offshore Voluntary Disclosure Initiatives that a quiet disclosure does not comply with the terms of its Voluntary Disclosure Practice because a quite disclosure bypasses the required communication with the Criminal Investigation Division of the IRS and only the Criminal Investigation Division of the IRS can recommend that the taxpayer not be referred to the Justice Department for Criminal Investigation.
The Tax Law Office of David W. Klasing has successfully used both methods based on our assessments of the risk of criminal prosecution associated with a particular client’s fact pattern. A taxpayer that is contemplating a voluntary disclosure should definitely consult with an attorney to discuss the facts and circumstances surrounding unfiled or previously filed erroneous tax returns. Taxpayers in this situation need the Attorney Client Privilege in order to prevent the information which the client discusses with their tax advisor, especially surrounding his state of mind which goes to willfulness, from becoming center stage to a potential IRS criminal prosecution or civil fraud charge.
The most common way the government establishes the element of willfulness is to subpoena the original tax preparer, or subsequent non attorney tax adviser, to testify regarding the client’s conversations. Many taxpayers mistakenly believe that the communication privilege they enjoy surrounding communications with their CPAs and enrolled agents can be asserted in a criminal matter. Once a tax attorney has been engaged, the attorney can engage an accountant to assist him in the calculation of the correct tax under a “Kovel letter” in order to bring the client’s communications with the accountant within the umbrella of the attorney client privilege.
What if I do not qualify for a Voluntary Disclosure because I’m already under audit?
If you do not qualify to make a voluntary disclosure because you are already under audit, only two possible strategies exist where income tax evasion exists in the returns under audit or the returns that are likely to be audited. 1. Cooperate with the taxing authority or attempt to 2. make it an uphill battle for the taxing authority to make a case for income tax evasion. Again, this is a decision best left to an experienced tax attorney. Taxpayers who are currently under audit do not qualify to make a voluntary disclosure, but the Tax Law Office of David W. Klasing can help you through the civil audit process. Depending on your case, we may decide to cooperate with the IRS, or make it an uphill battle for the IRS to prove its case against you.
A taxpayer with criminal exposure and his attorney must decide whether to fully or partially cooperate with the examining civil agent. Full cooperation includes producing all requested documents, allowing them to be copied, answering all questions, and extending the three-year statute of limitations. Generally, a protective strategy should be employed, because the IRS instructions require agents not to disclose any suspicion that the taxpayer has committed fraud. Generally, when the taxpayer’s attorney or accountant discovers a borderline tax irregularity, it may be advantageous to insulate the taxpayer from the civil agent, requiring him to work through the attorney. This is because an attorney may be able to discern when the agent has focused on a possible problematic area. Using an attorney would also be advisable so that false or erroneous statements by the taxpayer are not communicated to the IRS.
Because the Supreme Court has ruled the Fifth Amendment privilege against self-incrimination does not protect business records, the effectiveness of non-cooperative strategies are somewhat reduced. Yet, asserting the privilege against self-incrimination in a civil case is likely to result in a fraud referral to the Criminal Investigation Division of the IRS, since agents view this as a significant factor in deciding whether to make a fraud referral. Moreover, when a taxpayer asserts the privilege against self-incrimination, the civil agent is required to consult with his supervisor for fraud indicators. Consequently, because an agent’s fraud referral is to some degree within his subjective discretion, a premature or irresponsible assertion of the privilege will often escalate the case from civil to criminal.
Deciding whether to assert the privilege is a thorny issue. If the civil agent has discovered evidence indicative of tax evasion, and requests documents demonstratively showing so or asks the taxpayer incriminating questions, then serious consideration should be made whether to assert the privilege, even if a fraud referral may result. Our Office can help with that decision.
What if I do not qualify for a Voluntary Disclosure because I’m already under criminal investigation?
After the inception of a criminal tax investigation, whether a taxpayer cooperates or not has little or no influence whether the agent will investigate thoroughly, or whether he will recommend prosecution. The agent will conduct a thorough investigation irrespective of the taxpayer’s cooperation. On the one hand, if the taxpayer is cooperative and the agent develops a case where it is reasonably probable to result in a conviction, the agent will not decline to prosecute simply because the taxpayer was cooperative. On the other hand, if the taxpayer does not cooperate, and the agent does not develop a case reasonably probable to result in conviction, the agent will not decide to prosecute simply because the taxpayer was non-cooperative.
If you have failed to file your tax returns where required or have provided false or incomplete information with respect to any material item on your previously filed tax returns and you are losing sleep at night because of the very real fear of prosecution, please contact the Tax Law Office of David W. Klasing immediately for a reduced rate consultation to speak to a tax evasion or tax fraud attorney at our Los Angeles or Orange County law offices.