Navigating Tax Fraud: Definitions, Types, and Reporting

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Understanding Tax Fraud: What You Need to Know

Looking for legitimate ways to reduce your tax bill is practically an Olympic sport. But intentionally lying to the IRS, or failing to file or pay your tax bill, isn’t fun: It’s tax fraud. Tax fraud happens when a taxpayer willfully misrepresents the facts or otherwise tries to evade paying taxes they owe or believe they owe. Tax fraud can carry both civil penalties (fines) and criminal sentences (prison), so knowing how to spot, avoid and report tax fraud is key.

What Is Tax Fraud?

Tax fraud occurs when a person intentionally violates tax laws, typically to evade tax liability. Quick examples of tax fraud include underreporting income, wrongly claiming deductions or dependents, falsifying or altering tax documents, failing to file a tax return, or filing a return under the wrong Social Security number.

An important distinction is that tax fraud is intentional. It’s not the same thing as making a mistake on your taxes, accidentally entering the wrong information or misunderstanding IRS requirements. When a taxpayer willfully defrauds the government, they may face civil penalties, criminal charges or both.

If an underpayment of taxes is the result of an honest mistake—or the taxpayer’s bad intentions are difficult to prove—the IRS may simply try to recover the additional tax (plus underpayment or inaccuracy penalties) instead of charging a taxpayer with fraud.

Tax Fraud vs. Tax Evasion

Tax evasion is a form of tax fraud. The IRS defines tax evasion as a willful attempt to evade or defeat a tax. To be found guilty of tax evasion, you must owe a substantial amount of tax and make a willful and affirmative attempt to avoid paying it. Tax evasion is a felony that carries a maximum sentence of five years in prison and/or fines of up to $100,000 ($500,000 for businesses).

Other forms of tax fraud are discrete and can carry different penalties. Intentionally making false statements under penalty of perjury—for example, by filing a false tax return—carries a maximum sentence of three years and/or a fine of $100,000 or $500,000 for businesses. The intentional failure to file a return, pay tax or provide information is a misdemeanor with a maximum one-year sentence and/or $25,000 fine ($100,000 for businesses). The IRS penalty for civil (versus criminal) tax fraud is 75% of the underpayment due to fraud.

Types of Tax Fraud

Tax Fraud by Individuals

Individual taxpayers can run afoul of the IRS when they deliberately take action to avoid paying taxes, including:

• Failing to report or underreporting income
• Failing to file a tax return
• Failing to pay or underpaying taxes owed
• Claiming a deduction or tax credit using false information
• Deducting personal expenses as (self-employed) business expenses

Tax Fraud by Businesses

Businesses have additional avenues to commit fraud, including:

• Failing to withhold payroll taxes
• Failing to pay taxes withheld to the IRS

Other Forms of Tax Fraud

Tax fraud can also involve victimizing the taxpayer through illegal tax scams or tax identity theft. Here are a few examples:

• Promoting an abusive tax scheme, such as foreign accounts that falsely claim to conceal assets from the IRS
• Preparing a tax return using false information
• Using someone else’s identity to file a return and collect a refund or credit

How to Avoid Tax Fraud

The surest way to avoid problems with tax fraud is to follow every tax law to the letter. However, since tax laws can be confusing and the potential for fraud is widespread, these tips may help you steer clear of trouble:

• File an accurate return: Avoid errors, omissions and inaccuracies that can raise red flags with the IRS by checking and double-checking the information in your tax return. If you need to rectify information on a past return, you can file an amended return up to three years after the original tax filing deadline.
• Respond to IRS requests for information: Don’t ignore an IRS letter asking for additional information or documentation related to your tax return. An unresolved inquiry may lead to a full-blown audit. Consult with your tax preparer or a tax attorney if you have questions or concerns.
• Save documents and records: Failing to provide documentation for deductions or credits creates problems with the IRS, so make sure you keep tax records for at least three years after you file, or indefinitely just to be safe.
• Get help with complex tax issues: If you need to report self-employment income (including gig work), have foreign investments or simply have a long list of tax questions, get reliable help by searching the IRS website for answers or consulting a qualified tax advisor. If you are being investigated for tax fraud or tax evasion, consider finding a tax attorney.
• Be wary of tax schemes: Although there are legal ways to shelter your income from taxes, questionable tax schemes involving digital assets, offshore accounts or any scenario that seems too good to be true (or too weird to understand) may be invitations to commit fraud. When in doubt, ask a qualified tax advisor for objective advice.
• Find a tax advisor you trust: An unscrupulous tax preparer may use your identity to file a fake return and collect a refund, or involve you in a fraudulent tax scheme. Competence is an additional issue: You want a tax pro who knows the tax code front to back. The IRS maintains a database of credentialed tax preparers you can use to check an advisor’s qualifications.
• Safeguard your personal information: Protect yourself from identity theft, including tax identity theft, by using secure passwords online, shredding documents with personal identifying information and being on guard against phishing attempts.

How to Report Tax Fraud to the IRS

If you suspect an individual or business of committing tax fraud, you can file a report with the IRS. The reporting process varies depending on the type of fraud and the information you have to report. Here are some basic resources to get you started:

Submit a Confidential Tip

To provide information about suspected tax fraud, including false deductions, illegal drug income, earned income tax credit violations or unreported income, complete Form 3949-A online or mail it to the address listed on the back of the form. You do not need to provide your personal information to report suspected fraud: Your tip can be confidential.

File a Whistleblower Claim

Use Form 211 to file a whistleblower complaint against a person or business you suspect of tax fraud. If original information you provide leads to a conviction, you may be eligible to receive an award of up to 30% of the tax collected. Be prepared to provide detailed information on the illegal activity and disclose information on you and your relationship to the person or business you’re reporting.

File a Complaint Against a Tax Preparer

Report a tax preparer who has filed a return without your knowledge, reported income incorrectly, altered your tax return documents or otherwise filed a problematic return on your behalf. Instructions for filing complaint Form 14157 and an accompanying affidavit are available online.

Report Tax ID Theft

If you think someone has filed a fake tax return using your identity—or the IRS notifies you that this has occurred—report the tax identity theft by completing Form 14039 and submitting it with your tax return. You can also call the IRS tax ID fraud unit at (800) 908-4490 for more information.

The Bottom Line

If you still have questions about a tax tip you recently heard, information you’ve submitted in your tax return or the way your tax return was prepared, talk to your tax preparer; ask an outside, objective tax advisor; or consult a tax attorney for clarification. Though paying your tax bill correctly and completely may feel painful at times, avoiding tax fraud (or any underpayment of taxes) can help you avoid the pain of IRS scrutiny and legal trouble down the road.

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