What Is Tax Evasion?

Tax evasion definition

Tax evasion is a failure to pay or a deliberate underpayment of taxes. It’s illegal and subject to penalties and criminal charges under the IRS code.

Gretchen Roberts is the CEO of Red Bike Advisors, a Wilmington, North Carolina-based firm that provides tax services to small businesses. Roberts defined tax evasion this way: “Tax evasion is not paying taxes at all or deliberately underpaying by underreporting income, paying illegal workers in cash, hiding assets, claiming credits you can't substantiate, etc. You could end up with your bank account and possessions garnished and even with jail time for tax evasion.”

In a nutshell, tax evasion occurs when a taxpayer misrepresents their income to the IRS to evade taxes. This can take the form of underreporting income, hiding money in offshore accounts or inflating deductions to lower their tax bill.

Tax evasion examples

People use a variety of tactics to evade taxes, including:

• Underreporting or omitting income
• Willfully concealing offshore bank accounts
• Hiding interest
• Intentionally failing to file all types of tax returns
• Operating a business in another person’s name
• Keeping different sets of books for your business

Types of tax evasion: assessment vs. payment

While there are multiple ways people evade taxes, they typically fall under two umbrellas: assessment evasion and payment evasion.

Assessment evasion

Assessment evasion is when you willfully prevent the government from knowing your tax liability. This can be in the form of hiding income, keeping two sets of books or otherwise falsely representing your amount of income.

Payment evasion

Payment evasion occurs after assessment, when an individual or business knows they owe money to the IRS. Someone evading payment of taxes may transfer their assets to an offshore account or to a family member in an attempt to avoid IRS collection efforts, for example. They also may claim false debt or other expenses and then say they’re unable to pay their assessed taxes.

What happens if you don't pay your taxes?

Tax evasion can lead to criminal charges. For someone to be convicted of tax evasion, the government must be able to prove:

1. That an unpaid tax liability exists
2. An act to evade or try to evade a tax
3. Intent to evade a known legal duty to pay

According to the IRS, the penalties for tax evasion include a fine of up to $100,000 for individuals ($500,000 for corporations), imprisonment of up to five years or both. The defendant also must pay the costs of prosecution.

What's the difference between tax avoidance and tax evasion?

A major difference between tax avoidance and tax evasion is that the former is legal, while the latter is illegal.

The U.S. income tax system is based on voluntary compliance, allowing taxpayers to freely report their income, calculate their tax liability and file their tax returns on time. Tax evasion happens when taxpayers try to manipulate the system to evade tax.

One way people evade tax is by failing to report all their income, whether from legal side hustles or illegal activities such as selling stolen goods. Regardless of the reason behind tax evasion, the act itself is illegal.

In contrast, tax avoidance is legal. IRS regulations allow taxpayers to claim certain deductions, credits and income adjustments. For example, if you contribute to an individual retirement account (IRA), you can deduct your contribution from your taxable income. This kind of tax relief is perfectly legal as long as you’re eligible.

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How does the IRS find tax evaders?

Criminal investigations can be initiated within the IRS when a revenue agent (auditor) or investigative analyst detects fraudulent activities or receives a tip from the public.

Special agents analyze the information to determine whether criminal tax fraud or another financial crime occurred. The supervisor approves or declines further development once this preliminary process (the primary investigation) is over.

If the investigation is opened, agents use a variety of investigative techniques to obtain violations, such as:

• Executing search warrants
• Interviewing third-party witnesses
• Subpoenaing bank records
• Reviewing financial data
• Conducting surveillance

The case can be referred for prosecution if substantial evidence remains after all the evidence is gathered and analyzed.

According to the IRS, if there is not enough evidence to substantiate criminal charges, an investigation is discontinued.

Bottom line

Paying taxes is no fun. But the consequences for hiding income from the IRS can be harsh. Research and take advantage of legal tax avoidance strategies to keep more money for yourself, and reach out to a tax professional if you have questions.