What is Tax Evasion?

Tax evasion is like stealing from the government...

The government pays for the services and infrastructure that you use every day, like roads, schools, hospitals, and police, with tax money. When you live in the United States and don’t pay your taxes, you’re using those services without paying for them — just like getting a haircut and walking out the door without paying.

Tax evasion is the criminal act of intentionally not paying or underpaying your tax liabilities. It is a type of tax fraud that occurs when businesses or individuals deliberately misreport their incomes, forge documents, falsely claim dependents, or commit other actions that defraud the government.

To be considered tax evasion, there must be proof that the non-payment or underpayment is intentional. This protects taxpayers who simply made a mistake on their math or forgot to include a few invoice payments from ending up behind bars.

As of March 2020, tax evasion is punishable by up to five years of imprisonment and a maximum fine of $100,000 for individuals and $500,000 for corporations.

Despite the similar names, tax evasion is very different from tax avoidance, which is the commonplace practice of attempting to lower your tax burden through completely legal means, such as taking tax deductions, tax write-offs, etc. Tax avoidance is entirely legal and is one of the main services that tax professionals offer.

The Internal Revenue Service (IRS) recognizes two types of tax crimes that fall under tax evasion:

• Evasion of Assessment refers to any action that intentionally prevents the proper assessment of an individual’s or business’s tax liabilities. This could include concealing sources of income, making false invoices, and any other actions that are meant to mislead the IRS.
• Evasion of Payment refers to intentionally not paying or underpaying a true tax liability. This could include not filing a tax return or not paying the full amount due.

It’s important to remember that both of these actions only become a crime if they were done intentionally.

If a taxpayer simply misunderstands the income tax structure, unintentionally misreports their taxable income, etc., they aren’t guilty of tax evasion. They may be subject to certain fees and tax penalties, but it’s not a criminal violation of US tax law.

The difference between tax evasion and tax avoidance is legality. Tax evasion is an illegal, criminal activity in which a taxpayer purposefully does not pay the full amount of taxes they owe. Tax avoidance is a common practice in which taxpayers look for ways to reduce the amount of taxes they owe.

Common methods of legal tax avoidance include finding any deductions or tax credits for which you qualify. Deductions are tax breaks that lower your taxable income, thus indirectly lowering your tax liability, while tax credits directly lower your taxes.

Examples of common deductions include charitable donations, medical expenses, and property taxes.

Most cases of tax evasion are handled by Section 7201 of the Internal Revenue Code, which states that “Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.”

So, that means:

• Tax evasion is a felony
• It is punishable by up to 5 years of jail time
• Individuals who commit tax evasion can be fined up to $100,000
• Corporations that commit tax evasion can be fined up to $500,000
• Individuals and corporations may need to pay the costs of prosecution as well

The IRS generally only pursues tax evasion charges in exceptional cases. If you simply misreport something by mistake, or even illegally don’t report a one-time $100 payment for watching a friend’s dog while they were away, you likely won’t go to jail (but you may pay fines and penalties).

Typically, the IRS looks for people who are leaving out entire sources of income or major transactions. They also look for people who don’t properly comply with audits (examinations of your tax return) or simply never file a tax return in the first place.

To go to jail for tax evasion, there needs to be a strong case (beyond a reasonable doubt) that you purposefully misreported your income to the IRS.

For example, if you have a side gig as a freelance writer, but only report income from your salaried job, one of your clients may still file a 1099 form with the IRS, indicating that you earned income from them. Then, the IRS might follow up with an audit, since it already knows you didn’t report something correctly.

If you immediately correct the error and make it clear it was an honest mistake, you can probably avoid a tax evasion charge. But if you continually deny that you have any other source of income, the IRS may launch a criminal investigation, and you can end up in jail.

According to a report by the IRS, approximately 16% of all owed federal taxes are not paid due to negligence and evasion.

Between 2014 and 2016, there were 237 sentencings for employment tax evasion (such as paying employees in cash to avoid taxes). The average jail time was approximately 18 months.

In the same years, there were 2,688 sentencings overall for tax fraud. The average jail time for these offenses was approximately 32 months.

Considering that the IRS collected over 240 million tax returns in 2015 and 2016, and there were only 1,177 tax fraud investigations launched in 2016 and only 1,202 in 2015, prosecutions for tax fraud can be considered fairly uncommon.

However, this only accounts for the tax fraud that the IRS noticed to some degree, not the people who got away with it. The real rate of tax fraud and tax evasion in the United States may be much higher.