Tax Fraud vs. Tax Evasion (Explained)
Tax fraud means deliberately falsifying tax documents to deceive tax authorities. Tax evasion, on the other hand, means using illegal means to avoid paying taxes. This might mean failing to file a tax return at all. While tax fraud and tax evasion are both serious crimes, the penalties for tax fraud are more severe. These should be distinguished from tax avoidance, which is using legal means to reduce tax.
Key Takeaways
- Tax fraud involves intentionally falsifying tax returns or committing other fraudulent activities, which can lead to felony charges and significant penalties.
- Tax evasion involves illegal tactics to avoid paying taxes, often resulting in both civil and criminal penalties.
- Both acts are serious crimes, and proper care should always be taken to ensure income is accurately reported and all required taxes paid.
What Is Tax Fraud?
Tax fraud occurs when a taxpayer intentionally deceives the IRS by lying on their tax return, such as by claiming false deductions, exemptions, or credits. Other forms of tax fraud include submitting fraudulent refund claims or participating in identity theft schemes. According to the IRS, fraudulent refund claims in 2023 amounted to $2.8 billion, up significantly from the previous year.
Identity Theft
One common form of tax fraud is identity theft. This means someone illegally using another person’s Social Security number and other personal information to file a tax return and claim a refund. This type of fraud can lead to severe penalties for the perpetrator — after a thorough investigation to determine fault.
What Is Tax Evasion?
Tax evasion involves intentionally avoiding tax obligations through illegal methods. Common tactics include:
- Underreporting income
- Overestimating deductions
- Failing to file tax returns altogether
Underreporting income is the most common type of tax evasion, accounting for over 80% of the US tax gap and contributing to roughly $400 billion in lost revenue every year.
Tax evasion is not the same as tax avoidance, which is legal. To learn more, see this free guide: Understanding the Fine Line Between Tax Evasion and Tax Avoidance for Expats.
Penalties for Tax Fraud
The penalties for tax fraud and tax evasion can be severe, including fines, imprisonment, or both. The specific penalties depend on whether the violation is civil or criminal.
Civil Penalties for Tax Fraud
Civil penalties are often imposed when the IRS determines that fraud occurred but does not pursue criminal charges. Civil tax fraud penalties typically involve:
- Accuracy-Related Penalty: If a taxpayer underpays due to negligence or disregarding IRS rules, the penalty is usually 20% of the underpayment amount. However, if the underpayment is due to fraud, the penalty jumps to 75% of the underpaid tax.
- Failure-to-File Penalty: When a taxpayer does not file a return by the due date, the IRS imposes a penalty of 5% of the unpaid tax for each month the return is late, up to 25%. If the failure is deemed fraudulent, this penalty increases significantly, up to 75%.
Criminal Penalties for Tax Fraud
When tax fraud rises to the level of a criminal offense, the penalties are more severe. Common criminal tax fraud charges include:
- Tax Evasion (26 U.S.C. Section 7201): This charge applies when a taxpayer willfully attempts to evade paying taxes. The penalty can include a fine of up to $100,000 ($500,000 for corporations) and up to five years in prison.
- Filing a False Return (26 U.S.C. Section 7206): Knowingly submitting a false tax return carries penalties of up to $100,000 in fines ($500,000 for corporations) and up to three years in prison.
- Fraudulent Refund Claims: Filing a false tax refund claim or using stolen identities to claim refunds is a growing problem. In 2023 alone, the IRS identified fraudulent refund claims totaling $2.8 billion.
Penalties for Tax Evasion
Tax evasion penalties can be civil, criminal, or both, depending on the extent and nature of the violation. Key penalties include:
- Failure-to-Pay Penalty: If a taxpayer fails to pay their taxes, the penalty is 0.5% of the unpaid tax per month, up to 25%. However, if the IRS determines that the failure was fraudulent, the penalties are substantially higher.
- Imprisonment: Criminal tax evasion can lead to a sentence of up to five years in federal prison, plus fines.
Always keep detailed and accurate records of your income, deductions, and credits. The more transparent and organized your documentation, the easier it is to defend yourself against any potential IRS audits or inquiries.
Tax Evasion and Tax Fraud at the State Level
State-level penalties for tax evasion and fraud often mirror federal penalties, but can vary significantly depending on the jurisdiction. Some states impose additional fines, interest, or require restitution payments for tax violations.
Severe cases can lead to felony charges at the state level, resulting in prison sentences. For example, New York imposes up to 25 years in prison for tax evasion of more than $1 million.
Avoiding Tax Schemes
Taxpayers sometimes unknowingly commit tax fraud or evasion because they rely on misleading advice. This advice may even come from well-meaning friends or relatives. More often, they come from unreliable websites or organizations. Engaging in such schemes often results in severe penalties — even if taxpayers are unaware that they are participating in fraud.
As a rule of thumb, if tax advice sounds too good to be true, it probably is. Before acting on such advice, it’s crucial to consult with a professional tax preparer who can verify the legality and safety of any tax strategy. Trustworthy professionals can help avoid costly pitfalls while ensuring compliance with US tax laws.
If you receive an unexpected tax refund or notice from the IRS, don’t ignore it. Promptly review the situation with a qualified tax professional, as this could be a sign of tax identity theft or a mistake on your return.
Greenback Can Help You Avoid Accidental Tax Fraud or Tax Evasion
Now that you have a better understanding of tax fraud vs. tax evasion, you can take steps to protect yourself from unwanted inquiries from the IRS. As an American living overseas, it’s easy to accidentally trigger a red flag. But with a little help, you can give yourself true peace of mind.
At Greenback Expat Tax Services, we help Americans around the world file their taxes accurately and on time. That way, you can rest easy knowing you’re in complete compliance with US tax law.
Contact Greenback today to talk to one of our Customer Champions. You can also click below to get a consultation with one of our expat tax experts! We look forward to hearing from you.
This article is for informational purposes only and does not constitute legal or tax advice. Always consult with a tax professional or legal advisor regarding your specific situation.
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