The Internal Revenue Service (IRS) takes tax evasion and fraud very seriously, imposing stiff fines and even prison sentences for those who actively avoid paying their share of income taxes. The IRS also realizes that the tax code is so complex that sometimes honest mistakes, or acts of negligence, can have the appearance of criminal activity. In any case, tax problems can become increasingly troublesome for taxpayers who fail to resolve their issues. This section covers the difference between income tax fraud and negligence, the consequences of not paying one's taxes and how to avoid tax-filing behavior the IRS may consider criminal or fraudulent.
Income Tax: Fraud vs. Negligence
The IRS estimate that 17% of individual taxpayers fail to comply with the tax code in some way. Surprisingly, it is private individuals, not corporations, which are responsible for 75% of income tax fraud. However, there are a number of violations of the tax code that do not amount to fraud. Some violations amount to negligence and may still be punished, but generally speaking negligence is much less serious than fraud.
Fraud occurs when a person or company intentionally fails to file an income tax return, willfully fails to pay taxes that are due, intentionally fails to report all income received, make false claims, or prepares and files a false tax return. Each of these kinds of fraud involves intentional or willful acts on the part of the taxpayer. Negligence, generally speaking, refers to the careless errors and other mistakes that might result in incorrect tax filing or payment. Where negligence is found the taxpayer may still be penalized up to 20% of their underpayment, though they may avoid the more serious consequences associated with a finding of fraud.
Other acts that generally indicate that fraud has occurred, rather than mere negligence, include situations where the taxpayer falsified documents, ledgers, personal expenses, used a false Social Security number, or claimed exemption for a nonexistent dependent. Willfully overstating deductions and exemptions or willfully underreporting income is also generally considered to be fraud.
Employment Tax Evasion Schemes
Tax evasion is not always the fault of private individuals, however, and there are a number of schemes that can result in both the IRS and the private taxpayer are victims of fraud perpetuated by an employing company. Some of the schemes for tax evasion by employers include pyramiding, employee leasing, cash payment, filing false payroll tax returns, and failure to file payroll tax returns.
Pyramiding refers to a practice where businesses withhold taxes from employees but do not remit them to the IRS. Businesses that engage in this practice frequently file for bankruptcy to discharge their liabilities and then start a new business under a different name and repeat the process. Employee leasing is when a business contracts with a third party business to handle administrative, personnel, and payroll for their employees. The scheme occurs when the third party business fails to pay the IRS the collected employment taxes.
Failing to file payroll or filing false payroll returns are obvious and traditional forms of fraud. Paying employees in cash, while not itself a wrongdoing, is a common practice where an employer is evading their employment and income tax responsibilities with the IRS.