What Is Tax Fraud? Definition, Criteria, vs. Tax Avoidance

What Is Tax Fraud?

Tax fraud occurs when an individual or business entity willfully and intentionally falsifies information on a tax return to limit the amount of tax liability. Tax fraud essentially entails cheating on a tax return in an attempt to avoid paying the entire tax obligation. Examples of tax fraud include claiming false deductions; claiming personal expenses as business expenses; using a false Social Security number; and not reporting income.

Tax evasion, or illegally avoiding payment of taxes owed, may be construed as an example of tax fraud.

Understanding Tax Fraud

In the United States, taxpayers are bound by a legal duty to file a tax return voluntarily and to pay the correct amount of income, employment, sales, and excise taxes.

Failure to do so by falsifying or withholding information is against the law and constitutes tax fraud. Tax fraud is investigated by the Internal Revenue Service Criminal Investigation (CI) unit. Tax fraud is said to be evident if the taxpayer is found to have:

• Purposely failed to file their income tax return
• Misrepresented the actual state of their affairs so as to falsely claim tax deductions or tax credits
• Intentionally failed to pay their tax debt
• Prepared and filed a false return
• Deliberately failed to report all income received

A business that engages in tax fraud may:

• Knowingly fail to file payroll tax reports
• Wittingly fail to report some or all of the cash payments made to employees
• Hire an outside payroll service that doesn't turn over funds to the IRS
• Fail to withhold federal income tax or FICA (Federal Insurance Contributions) taxes from employee paychecks
• Fail to report and pay any withheld payroll taxes

Tax Fraud vs. Negligence or Avoidance

For example, claiming an exemption for a nonexistent dependent to reduce tax liability is clearly fraud, while applying the long-term capital gain rate to a short-term earning may be looked into more to determine whether it is negligence.

Although mistakes attributed to negligence are non-intentional, the IRS may still fine a negligent taxpayer with a penalty of 20% of the underpayment.

Tax fraud is not the same as tax avoidance, which is the legal use of loopholes in tax laws to reduce one’s tax expenses. Although tax avoidance is not a direct violation of the law, it is frowned upon by tax authorities as it may compromise the overall spirit of tax law.

Special Considerations

Tax fraud cheats the government out of millions of dollars every year and is punishable by fines, penalties, interest, or prison time. Generally, an entity is not considered to be guilty of tax evasion unless the failure to pay is deemed intentional. Tax fraud does not include mistakes or accidental reporting, which the IRS calls negligent reporting.

The Bottom Line

Providing false information on your tax report in order to avoid paying taxes or paying less taxes than you owe is considered tax fraud. This is illegal and can result in monetary penalties, imprisonment, and other repercussions. Examples of tax fraud include not reporting certain income or falsely claiming deductions.

It is your responsibility that your taxes are done correctly. If you aren't sure how or need help, there is plenty of software that can help as well as tax professionals.