When do tax violations turn into tax crimes?

Tax avoidance is the method of organizing your finances in accord with the legal usage and interpretation of the United States tax code. As the famous quote by Judge Learned Hand accurately states, “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes.” However there can be a very fine line between legal tax avoidance, as stated by Judge Learned Hand, and illegal tax fraud or tax evasion. It can take the experience, knowledge and training of a dedicated tax professional to delineate between aggressive tax avoidance strategies and those practices that cross the line into tax crimes.

However understanding the types of things that IRS agents look for when determining whether a tax crime has been committed can help you avoid serious civil or criminal tax consequences. If the recommendations of your accountant or tax preparer make you feel ill at ease, seek a second opinion. Remember, it is the taxpayer who is ultimately responsible for and liable for the information that is contained in his or her tax return.

IRS agents look for badges of fraud when determining whether a tax crime has occurred.

According to the Internal Revenue Manual, utilized by IRS agents, “. One who avoids tax does not conceal or misrepresent. He shapes events to reduce or eliminate tax liability and upon the happening of the events, makes a complete disclosure. Evasion, on the other hand, involves deceit, subterfuge, camouflage, concealment, some attempt to color or obscure events, or making things seem other than what they are.” This portion of the manual delineates one of the distinctions between mere tax avoidance and a tax crime. That is, one may arrange his or her affairs to minimize tax owed, but actions that are taken solely to conceal the nature of income or to conceal income solely for tax purposes likely cross the line. In short, is there a financial justification for the act beyond the minimization of tax? Possible criminal tax charges include:

  • Tax evasion – Under 26 USC 7201 a tax payer can be charged with a felony for evading the payment of taxes. A five year prison sentence, a fine of $250,000 and other consequences can apply
  • Willful failure to file a return, supply requested tax information or pay tax – Failure to adhere to these tax obligations can result in a misdemeanor conviction along with a fine of up to $25,000 and 1 year in prison.
  • Fraudulent or false statements – As per 26 USC 7206, the making of false statements or false returns can be charged as a felony. Acts of fraud or concealment can be punished by a fine of up to $100,000, a prison sentence of up to 3 years, or both.

Also contained in the Internal Revenue manual are one of the most common factors to set off alarms for an IRS agent: badges of fraud. When one or more signs or badges of fraud is present, the likelihood that charges for a tax crime will be advanced increase. The badges of fraud are often used to detect behavior that is common to tax crimes. Badges of fraud include:

  • Inadequate tax or financial records
  • Implausible explanations for income or expenses
  • Inconsistent explanations for income or expenses
  • Excessive dealings in cash
  • Engaging in other illegal activities
  • Rude or harassing behavior towards an IRS agent
  • Understatements of income
  • Failure to disclose all sources of income
  • Failure to file tax returns.

If you have any of these badges of fraud present and are facing tax audit or tax investigation, it is prudent to contact a tax professional immediately. A Tax Attorney can negotiate and advocate on your behalf.

Tax crimes often have a 6-Year or longer limitations period

Many people who fear that they may have crossed the line from tax avoidance to tax fraud or tax evasion often wonder for how long they must be concerned about prosecution. For tax crimes that involve willfulness the typical statute of limitations runs for 6 years. However, the 6 year limitations period does not tell the whole story. The period can also be paused, or tolled, by certain acts such as if the taxpayer leaves the United States or if he or she is a fugitive. Furthermore, depending on the court you find yourself in, the limitations period will not begin to run until the last act of tax evasion occurred. Theoretically, tolling and additional acts of evasion can result in an open-ended criminal liability, but practically speaking the risks of prosecution decrease as the events become more remote in time.

Rely on our experience resolving tax problems

If you have concerns regarding aggressive tax avoidance strategies that you believe may have crossed the line into illegal tax fraud or evasion, an experience tax professional can help. David W. Klasing is a CPA and Tax Attorney with more than 20 years of experience in tax negotiation and advocacy. To schedule a reduced rate tax consultation call 800-681-1295 or contact us online.