Tax Fraud vs Tax Evasion vs Tax Avoidance
Tax evasion, tax avoidance, and tax fraud are all words that can be used interchangeably but have different meanings. Two of these are legal while the other is not. Individuals and businesses that commit tax fraud and intentionally evade taxes can get into big trouble with the Internal Revenue Service. On the other hand, individuals and businesses are allowed to avoid paying taxes with the help of his or her tax advisor.
Tax fraud is an illegal intentional attempt to evade tax laws or defraud the IRS. It is a very general term with various meanings and is very hard to prove because the government doesn’t have proof that the taxpayer knowingly cheated the government out of tax revenue. Examples of tax fraud are: intentionally failing to file an income tax return, failing to pay taxes due, failing to report all income received, making false claims, preparing and filing a false return, overstating deductions and exemptions, falsifying documents, keeping two sets of financial ledgers, using a fake social security number, and claiming a nonexistent dependent exemption. Adding on to these examples, there are also employment tax frauds such as employer failing to withhold federal income tax from employee paychecks, hiring an outside payroll service that doesn’t give the funds to the IRS, and paying employees in cash and not reporting the cash payments.
Tax evasion is the illegal nonpayment or underpayment of tax by not reporting income, reporting expenses that are illegal, or by not paying taxes owed to the IRS. It is a subset of tax fraud meaning that some things that are considered tax evasion can also classify as tax fraud and the examples of both fraud and evasion are basically the same. If you pay attention to the news, you’d often associate tax evasion with wealthy celebrities and corporations, but don’t be fooled. Low and middle -income earners have also been known to do it as well.
While tax fraud and tax evasion are illegal practices that can result in years of jailtime and thousands of dollars in penalties, tax avoidance is a practice that is legal and uses methods approved by the IRS to minimize taxes. Common examples of tax avoidance include taking legitimate tax deductions to minimize business expenses resulting in lowering the tax bill, setting up a tax deferral plan to delay taxes until later, and taking tax credits offered by the IRS to spend money for valid purposes. Although tax avoidance is a legal practice, taxpayers must follow state tax laws properly otherwise it can become just as illegal as the other two mentioned earlier.
Minor tax evasion cases may be reviewed in tax court, but all the other cases are sent to the IRS criminal division for trial. IRS can bring criminal charges to those who have been caught with tax fraud/evasion, and even if the taxpayer is found innocent, the costs in time and money are not worth even having thoughts about evading taxes. Penalties can range from jail time for about 5 years to paying hundreds and thousands of dollars, or both. Always make sure that you file your taxes on time, and pay what you owe to the IRS within reasonable time or figure out other legal ways to get tax relief from your tax advisor. For more information on tax fraud and its penalties, visit Penalties for General Fraud from the IRS.