There are various types of tax fraud, all of which attract penalties. Without the proper guidance, a small tax problem can quickly spiral and cause problems with the Internal Revenue Service.
You could also get arrested and charged with tax-related criminal offenses.
What Is Tax Fraud?
Tax fraud is when an individual or business intentionally and willfully provides false information on their return to limit tax liability. Essentially, it is cheating on your tax return to evade paying some or the total tax liability.
A business or individual may commit tax fraud by claiming personal expenses as business expenses, claiming false deductions, or not reporting income. Tax evasion is also an example of tax fraud as it is viewed as dodging payment of taxes you owe.
It is common to make mistakes when filing your taxes. However, this does not mean you have committed tax fraud.
You can only be charged with tax fraud if you intentionally filed your tax return incorrectly. Of course, you may owe penalty fees for incorrect filing, but making an error is not a crime.
Understanding Tax Fraud
Taxpayers have a legal duty to voluntarily file returns and pay the correct taxes, including income, sales, excise, and employment taxes. However, the government loses millions of dollars to tax fraud each year.
Many dishonest businesses and individuals falsify and withhold information which is illegal and considered tax fraud. The IRS Criminal Investigation Unit is in charge of investigating tax fraud. As an individual, you may have committed tax fraud if:
- You deliberately failed to file your income tax return.
- You falsified your information to claim tax credits and deductions.
- You prepared and filed false returns.
- You intentionally failed to honor your tax debt.
- You deliberately underreported income.
- You used a fake Social Security number.
Businesses commit tax fraud by:
- Intentionally failing to file payroll tax reports.
- Deliberately failing to report some or all employee payments.
- Hiring an external payroll service that does not report funds to the IRS.
- Failing to withhold Federal Insurance Contributions and income tax on employee paychecks.
- Failing to pay or report withheld payroll taxes.
Tax Fraud vs. Tax Avoidance
The income tax system is built on voluntary compliance. This means that you volunteer to pay your taxes. You may attract criminal tax charges if you do not file your tax return or file fraudulent returns.
The IRS must collect revenue from taxpayers to fund the federal government. The government loses revenue through:
- Tax Fraud: As discussed earlier, tax fraud is intentionally providing false information to avoid or limit tax liability. For instance, if an individual claims a tax exemption for a false dependent to reduce tax liability, it is considered fraud.
- Tax Avoidance: Tax avoidance is when an individual or business uses loopholes in the law to reduce their tax liability. While tax avoidance is not considered a direct violation, it compromises the spirit of tax law and is frowned upon by the IRS.
- Tax Evasion: This is the illegal practice of not paying taxes by underreporting income or taking unallowed deductions.
- Tax Cheat: A tax cheat is an entity that avoids paying its tax liability through dishonesty, fraud, or avoidance.
Generally, you are not considered guilty of committing tax fraud unless you intentionally failed to pay or willfully falsified your information. Tax fraud does not include accidental reporting or mistakes, which the IRS considers negligent reporting.
How The IRS Determines Tax Fraud
For the IRS to determine tax fraud, there must be proof of a willful intention to hide or falsify information to reduce or eliminate the tax liability. The IRS may evaluate several factors when investigating tax fraud.
However, the IRS may consider the mistakes unintentional negligence rather than tax fraud if there is insufficient evidence.
If you are charged with unintentional negligence, your case is pursued as accidental, and you must pay the penalty. In this case, the charge is not criminal, and the penalties applied amount to 20% of the tax underpayment.
It is critical to ensure that all the information you provide when filing a tax return is correct and up to date. Being diligent and providing accurate tax filings can help you avoid penalties and fines. To lower your payments, consider hiring a tax professional to help you reduce your tax liability.
Types of Tax Fraud
In addition to willful failure to fulfill your tax obligations, there are several types of tax fraud.
Frivolous Tax Claims
Making frivolous tax claims may be considered tax fraud. For instance, some taxpayers argue that federal income tax is illegal. However, all U.S. citizens must file accurate tax returns and pay the total income tax owed.
Arguing the illegality of income tax does not absolve citizens from paying tax, and the IRS may issue additional penalties for wasting their resources on frivolous claims. You may also accrue additional liabilities through fines.
Employment and Payroll Tax Fraud
You may be guilty of payroll fraud if you have committed offenses such as:
- Underreporting total workforce numbers
- Inaccurately filing payroll taxes, withholding taxes, federal unemployment taxes, and social security taxes
- Failing to pay payroll taxes.
- Paying employees cash sums under the table
This type of tax fraud is where an entity files a false income tax return to obtain unearned tax refunds. It typically involves identity theft and may also include:
- False business expenses
- False deductions
- False exemptions
Abusive Tax Schemes
There are tax options that can legally reduce your tax liability. However, if a business employs a tax scheme that fraudulently uses offshore resources, it is considered tax fraud. It is always best to consult a tax professional to avoid using abusive tax schemes.
Employment Tax Fraud
There are different types of employment tax fraud. The most common fraud scheme involved outsourcing payroll activities to a company that steals or does not turn over employment taxes, leaving an unpaid tax liability.
The second type of employment tax fraud is pyramiding. This is where employers withhold income tax but do not remit it to the IRS.
The last type of employment tax fraud is cashing out, where employees are paid in cash. As a result, the payroll records do not reflect wages paid to employees.
As an employer, if you are convicted of employment tax fraud, you may end up in prison for up to five years.
Tax Preparer Fraud
Tax preparers are tax professionals who help individuals or businesses file their taxes. When a tax crime occurs within a false tax return filed by these professionals, it is called tax preparer fraud.
If the IRS detects tax preparer fraud, it is still the taxpayer’s responsibility to pay what is owed and any penalties that apply.
You must choose your tax preparer wisely to avoid getting in trouble with the IRS. Confirm their credentials on the Directory of Federal Tax Return Preparers.
Avoid Tax Fraud
While the chances of getting charged with criminal tax fraud are minimal, it is still best to protect yourself. Generally, the IRS must find proof of the taxpayer’s intention to knowingly defraud the government by reducing or eliminating their tax liability.
Should the IRS charge you with tax fraud:
- Respond immediately.
- Preserve your records.
- Engage the process.
- Work towards finding a solution rather than litigation.
Contact a registered tax preparer, CPA, or tax expert to help you accurately file your income tax return to avoid tax fraud. Consider hiring a professional who is familiar with your professional background.
Remember, should the IRS alert you to any problem with your return, contact your tax preparer immediately.