Committing fraud or including false information on a federal or state tax return can lead to severe life-altering consequences, ranging from steep federal or state civil tax penalties to far worse criminal tax charges. Under specific provisions of the Internal Revenue Code (IRC), willfully providing inaccurate details – whether by underreporting income, inflating deductions, or mischaracterizing transactions – may result in imprisonment and fines that could reach $100,000 for individuals or $500,000 for corporations. Even if mistakes are inadvertent, substantial civil tax penalties and interest often follow. The real problem lies in the fact that a federal or state auditor does not know whether an apparent mistake is in fact intentional or not, especially when it’s in the tax payor’s favor and material in size.
Facing an Audit When You Intentionally Committed Tax Fraud
Taxpayers who knowingly filed a false return (e.g., hiding income, reporting fictitious deductions or claiming credits that you are not entitled too) face what is commonly called an eggshell audit. On the one hand, they want to avoid making statements that further reveal their fraud; on the other, they must be careful not to lie to the auditor, as that can trigger new felony charges such as obstructing the IRS or “Spies’ evasion.” The worst-case scenario is that an IRS agent considers your misleading or false statements in the audit as the “last affirmative act of fraud,” turning what might have been a routine civil case into an exponentially worse criminal tax prosecution for evasion, punishable by prison, hefty fines, and restitution.
Common Concerns During State and Federal Tax Audits
- Years Under Audit: The IRS typically starts with a specific tax year but may expand to cover multiple years if “pay dirt” is found.
- Business Entities: If you own interests in corporations or partnerships, those entities may also be audited, especially if you hold more than 50%.
- Scope and Location: A simple letter might become an in-person review if the agent suspects larger issues.
- Potential Spillover to State: IRS findings often lead to amended or triggered state audits if you do business or reside in a state with income tax.
Willfully Making or Subscribing a False Return: A Felony under 26 U.S.C. § 7206(1)
Any person who willfully makes and/or subscribes to a tax return or document under penalties of perjury, knowing it to contain materially false information, is committing a felony. Punishment includes:
- Up to three years in prison
- Fines up to $100,000 for individuals (or $500,000 for corporations)
- A felony criminal record which can irreparably harm professional licenses and future employment opportunities
Government’s Most Powerful Tool
Under § 7206(1), the IRS need not prove the taxpayer intended to evade tax or had any outstanding tax liability. It suffices to show the taxpayer knowingly included a significant falsehood. For example:
- Reporting illicit income correctly but falsely describing it as “pharmaceutical sales” when, in fact, it was from drug trafficking.
- Filing a return with correct total wages but mislabeling the source of the income or forging supporting schedules.
Courts interpret the scope of “return” broadly, encompassing attachments, schedules, letters, or statements attached. Even a single falsified schedule or statement can trigger § 7206(1) liability. If you have additional questions about tax perjury and tax evasion situations, please contact our dual-licensed criminal tax defense attorneys & CPAs at The Tax Law Offices of David W. Klasing at 888-640-3408 or through our online link HERE.
Elements of the Offense
To secure a conviction, the government must establish:
- Making a Return, Statement, or Document – The taxpayer prepared or signed something covered by tax forms (including amendments or attachments).
- Signed Under Penalty of Perjury – Usually a standard jurat on official IRS forms, including electronic PIN signatures.
- Material Falsehood – Any fact likely to affect IRS calculations or decisions is “material.”
- Willfulness – The defendant must have known the statement was false or recklessly disregarded the truth.
“Willfulness” implies a deliberate act such as:
- Omitting large amounts of income
- Creating fictitious or grossly inflated deductions
- Maintaining sham offshore accounts or using nominee entities
Civilly, this can lead to a 75% fraud penalty on underpayment and, criminally, potential felony convictions under § 7206(1) or § 7201 (evasion).
Negligent or Non-Willful Errors
Sometimes, taxpayers fail to declare all income or misapply tax rules due to poor recordkeeping or professional mistakes:
- Accuracy-Related Penalties: Usually 20% (or 40% in some instances), plus interest.
- No Prison for Honest Mistakes: While less severe, such cases can escalate if the IRS discerns elements of deceit.
How Routine Civil Tax Audits Can Escalate into Criminal Tax Investigations
Red Flags That Trigger Greater Scrutiny
Significant Underreported Income
The IRS and most states match W-2s, 1099s, and other statements against your tax filings. If you fail to report $10,000+ in income, a federal auditor may consult with a Fraud Technical Advisor who will analyze the badges of fraud in your fact pattern for possible criminal tax referral to the criminal investigation division of the IRS.
Exaggerated or Phony Deductions
Claiming personal expenses as business costs or overstating amounts are classic “badges of fraud.”
Multi-Year Patterns
Consecutive suspicious returns intensify agents’ suspicion, prompting an expanded audit scope.
Total Tax Loss Over $30,000
Under federal sentencing guidelines, a $30,000 tax loss equates roughly to one year in prison, embodying the deterrent effect the IRS seeks. (Each state has its own sentencing guidelines)
From Civil Audit to Criminal Tax Referral
- Fraud Referral Specialist (FRS): If strong indicators of willful fraud emerge, the auditor consults an FRS or directly refers the case to IRS-CID (or the state’s criminal tax enforcement branch).
- 90%+ Federal Conviction Rate: Once CID builds a case and the DOJ Tax Division prosecutes, convictions typically exceed 90%. Similarly, California or any other state can also pursue felony tax fraud charges. Remember, the IRS and the state taxing authorities frequently share data. Any adjustments on your federal tax return will require you to amend your state tax returns, compounding your exposure to additional civil and criminal tax penalties and possibly heightening the risk of criminal tax referral if discrepancies are significant.
Additional Concerns: Audits That Reveal Tax Fraud
26 U.S.C. § 7206(2)
To secure a conviction, the federal government must prove each of the following five elements beyond a reasonable doubt:
- (1) The defendant aided, assisted, procured, counselled, or advised another person in the preparation of a tax return (or another document related to a matter under the tax laws);
- (2) The tax return (or other document) contained a false statement;
- (3) The defendant knew that the statement was false;
- (4) The false statement concerning a material matter; and
- (5) The defendant acted willfully—that is, with the intent to violate a known legal duty.
Penalties mirror those under § 7206(1): up to three years in prison and significant fines.
Spies’ Evasion Theory and “Last Affirmative Act”
If, during an eggshell audit, you provide misleading statements or falsified records to conceal earlier tax fraud, the IRS may deem that a “last affirmative act of fraud,” opening the door to a felony tax evasion charges under Spies’ evasion. (potentially exposing you for criminal tax prosecution for tax years outside the normal 5 or 6 year statute of limitations within the criminal tax statutes) Conviction can involve multi-year prison sentences, restitution, and insurmountable fines and interest.
Contact The Tax Law Offices of David W. Klasing If You Have Reported Fraudulent or False Information on a Tax Return
If the IRS or California state taxing authorities suspect your return includes deliberate misreporting, you risk fines, civil tax fraud penalties of up to 75% of the underpayment, and felony tax charges that can lead to multi-year prison sentences. Rather than turning to your original CPA or preparer—who lacks attorney-client privilege and might shift blame—we recommend promptly amending incorrect filings if the IRS or FTB hasn’t yet intervened. Where appropriate, pursuing a federal or state Voluntary Disclosure prior to an audit notice can nearly always avert criminal tax prosecution and mitigate financial damage. For non-willful errors resulting from reliance on bad advice or other hardships, a reasonable cause argument could persuade examiners to waive or reduce penalties. Regardless of your path to compliance, our goal is to guard against further incriminating admissions and to prevent any last-ditch acts of fraud from sealing a felony tax evasion case.
At the Tax Law Offices of David W. Klasing, our dual-licensed Criminal Tax Defense Attorneys & CPAs integrate decades of experience in high-risk civil audits, eggshell audit scenarios, and looming or actual state or federal criminal tax investigations. We carefully assess your return for red flags, handle examiner discussions tactically, and develop a focused defense if you knowingly underreported income or overstated deductions. When remedial actions such as amending returns or enrolling in the Voluntary Disclosure Practice are appropriate, we guide you through every step—bolstering your chance of a purely civil resolution and minimizing the lasting toll of a fraudulent tax return. Call us at (800) 681-1295 or contact us online to schedule a reduced-rate initial consultation. We have the combined legal, tax, and accounting background to protect both your finances and your freedom if your filings have crossed the line from honest mistakes to willful misconduct.
