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Understanding Tax Fraud and Its Consequences

Understanding Tax Fraud

So, you made a mistake – an error in judgment. Say you are self-employed and failed to report all your income received for the year? Big deal, right? No. Tax fraud is a pattern or practice of activity done to grossly misstate one’s tax liability.

Tax fraud occurs when an individual or business entity willfully and intentionally falsified information on a tax return to limit the amount of tax liability. It entails cheating on a return in an attempt to avoid paying the entire tax obligation. In this blog, we will touch on the examples as well as consequences of tax fraud and how to detect and avoid tax fraud all together.

Common Examples of Tax Fraud

Underreporting One’s Income – Tax Evasion is a criminal form of tax fraud where an individual knowingly presents false information to the tax authorities i.e., reporting a lower income rather than the actual income earned.

Willful Failure to File Tax Return – If an individual or entity deliberately fails to file tax returns, it is considered an act of civil tax fraud.

Reporting False Numbers – Taxpayers who submit false documents or provide faulty statements pertaining to their income are also considered defaulters.

Claiming Undue Deductions – This pertains to taxpayers who apply for deductions or credits they are not eligible for or do not meet the requirements. Most commonly used false claims include child dependents, charitable donations, alimony deductions, and business deductions.

Consequences of Tax Fraud

Civil Penalties – While not a Criminal Charge, the Civil Fraud Penalty is still a serious matter. It allows the IRS to collect a penalty equal to 75% of the amount by which a taxpayer fraudulently understates they owe.  For example, if a taxpayer who owes $100,000, fraudulently files a return stating that he owes nothing, the IRS can impose a civil fraud penalty of $75,000, raising the taxpayer’s liability to $175,000.  Civil fraud penalties will be asserted when there is clear and convincing evidence to prove that some part of the underpayment of tax was due to fraud. Such evidence must show the taxpayer’s intent to evade the assessment of tax, which the taxpayer believed to be owing. 

Criminal Penalties – The penalties for criminal tax fraud can be severe and include fines, imprisonment, and restitution of taxes owed. Depending on the severity of the offense, an individual can face up to five years in prison and a fine of up to $100,000 and businesses can be fined up to $500,000 for criminal tax fraud. Tax evasion, failure to file a return or supply tax information, and failure to collect or pay over tax all fall under Criminal Penalties.

Glimpse of Severe Tax Fraud Consequences

A sequence of events happen before the IRS sets up a case for criminal prosecution. For most, it begins with the audit of a filed tax return. The IRS will look for trends in the return that indicate a pattern of intentional evasion over several years and the error amounts would likely be significant.  Most taxpayers that face criminal prosecution do so because of unreported income. They make a habit of leaving out significant transactions or even entire sources of income to lower their tax liabilities on purpose. Hiding records or making false statements on purpose during an audit is also a clear indication to IRS auditors that the case warrants criminal prosecution.

How to Detect and Report Tax Fraud

Signs of potential tax fraud – If an individual inadequately explains dealings in large sums of currency, is concealing foreign and domestic bank accounts and is not able to explain sources of bank deposits that exceed their income, then these are signs of potential tax fraud. Another indicator of tax fraud is the inability to explain substantial increases in net worth over a period of years.

Reporting tax fraud to the authorities – If you suspect an individual or a business is not complying with the tax laws, visit the IRS website and submit Form 3949-A, Informational Referral online. Tax violation referrals are not taken over the phone and your identity will be kept confidential when filing the report.

Protection for whistleblowers – The Internal Revenue Service takes the protection of whistleblower identity very seriously. The IRS protects against the disclosure of a whistleblower’s identity, and even the fact that they have provided information, to the maximum extent that the law allows. Whistleblowers are protected from retaliation by their employers under a law passed in 2019.

How to Avoid Tax Fraud – It is imperative to file complete and accurate tax returns to avoid committing tax fraud. While there are numerous tax prep software programs found online, utilizing a professional tax preparer can help prevent inaccurate or incomplete returns and ensure you are using the correct forms to submit.

Always maintain up to date and accurate records. By setting aside some time each week or month to review invoices, payments, and financial records, many tax compliance issues can be avoided.

Consulting with tax professionals – In an effort to stay compliant with tax laws, it is important to seek help from a certified tax professional. Tax professionals and a step further, tax attorneys have a wealth of experience in helping businesses and individuals maintain compliance. Dallo Law Group is proud to have an array of attorneys who are highly experienced and offer a multi-tiered defense for each individual’s situation. Our practice has a proven track record in representing clients in federal matters with positive outcomes. Contact an attorney with Dallo Law Group today to maintain your peace of mind.

Written By: Patrick Nguyen and Jamie Lebeau