What is tax evasion?

Written by: Janet Berry-Johnson, CPA
• •6 min read
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In a Nutshell

You might fear that a tax audit means the IRS suspects you of tax evasion. Unless you’re purposefully trying to cheat the system, an audit is more likely to result in an assessment of additional tax, interest and penalties than prison time. But if the IRS does criminally prosecute and convict you, chances are good you could end up incarcerated.
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This article was fact-checked by our editors and reviewed by Rachel Weatherly, tax product specialist with Credit Karma.

Tax evasion? Now that’s something you definitely don’t want to be accused of.

Fortunately, there’s a big difference between committing tax evasion and making an honest mistake on your federal income tax return or legally taking steps to reduce your tax bill.

If you do your best to file an accurate return on time and pay the full amount you owe, there’s no need to lose sleep over the possibility you tripped up somewhere along the way. Let’s look at what tax evasion is, what it isn’t, and what could happen when the IRS believes you’ve knowingly and willingly tried to avoid paying your fair share.

What is tax evasion?

Many people fear being audited by the IRS. In fact, according to a 2020 IRS Comprehensive Taxpayer Attitude Survey, 61% of U.S. taxpayers say fear of an audit affects how they report and pay their taxes.

Although audits can be scary, time-consuming and potentially costly, they probably won’t land you in jail. Tax evasion, on the other hand, might.

No one wants to pay more tax than their fair share, so taxpayers commonly look for ways to reduce their federal tax liability. Those reductions can take the form of tax avoidance or tax evasion. The difference is, one is legal while the other is not.

Tax avoidance is legal and involves claiming tax credits, tax deductions and other adjustments to income that you’re eligible for. These steps can help reduce your tax liability while maximizing the amount of taxable income you keep in your pocket.

For example, you might reduce your taxable income by contributing to an employer-sponsored 401(k) plan with pretax dollars. As long as you qualify to participate in the plan and follow IRS rules for doing so, the contributions can reduce your taxable income in a perfectly legal manner. Or, you may qualify for deductions and credits that can legally reduce your tax bill. Learn more about tax deductions and tax credits.

Tax evasion is different

Tax evasion, on the other hand, is illegal. It involves deliberately failing to pay or underpaying your fair share of taxes, and it can take several forms. Here are a few hypothetical situations that may be considered tax evasion.

  • Intentionally underreporting income — Candace has a dog-walking business. She pays taxes on the money she receives from clients via check and credit card because she knows there’s a “paper trail.” But she doesn’t report income she receives in cash, assuming it can’t be traced.
  • Intentionally over-reporting deductions — Josh is self-employed and travels for business often. His business travel expenses for the tax year total $10,000, but he adds in $5,000 of personal travel costs to his business expense deduction.
  • Falsely allocating income — Jodi sells handmade jewelry and has a full-time job. When she makes a sale, Jodi has her customers make out the check to her elderly mother, who is in a lower tax bracket.
  • Improperly claiming tax credits or exemptions — Frank claims the earned income tax credit based on his son living with him for more than six months of the year — even though his son lives with Frank’s ex-spouse full time.
  • Concealing assets — Sarah has a foreign bank account. She doesn’t report the account to the IRS or pay taxes on the interest she earns from that account.

If your return is selected for audit and you don’t have documentation to support the income, deductions and credits claimed on your tax return, or if the IRS discovers income you needed to report, in most cases you’ll likely have to pay additional taxes, interest and penalties.

In cases in which the IRS believes an error was particularly egregious or the taxpayer was negligent in making a mistake on the return, the agency can assess a 20% accuracy-related penalty on top of the additional tax owed.

How does a tax evasion case proceed?

It costs the IRS time and money to investigate and prosecute tax evasion cases.

In some cases, a criminal investigation into possible tax evasion does start with an audit, says Peter Gurian, a certified public accountant at Gurian PLLC, an accounting firm in Dallas.

“During the audit, the IRS may find that the taxpayer knowingly and willingly committed errors when filing their taxes,” Gurian says.

The IRS may initiate a criminal investigation based on information from inside the IRS or after receiving a tip that an individual or business is not complying with tax laws. The service may also receive information from law enforcement agencies or a U.S. attorney about possible tax evasion as part of an ongoing investigation into another criminal matter.

The IRS Criminal Investigation Division may act once it receives information. Here are some of the agency’s options.

  1. It may conduct a primary investigation to determine whether there is sufficient evidence to initiate a criminal investigation. At least two managers review the information in this phase.
  2. It can open a criminal investigation and begin collecting evidence. Investigators may interview witnesses, conduct surveillance, review financial data, execute search warrants and subpoena bank records during this phase.
  3. If the IRS believes it has sufficient evidence to prosecute, investigators prepare a “special agent report” and forward tax investigations it to the Department of Justice and non-tax-related cases to the U.S. attorney. They may also decide the evidence doesn’t add up to criminal activity and discontinue the case.
  4. The Department of Justice or the U.S. attorney can choose whether to accept or reject the case. If it is accepted, prosecutors take over management of the investigation.

What are my rights when dealing with the IRS?

In 2014, the IRS adopted a Taxpayer Bill of Rights, which lists 10 fundamental rights every taxpayer has when dealing with the IRS. The code addresses issues such as your right to be informed, to receive quality service, to pay no more than the correct amount of tax you owe and to challenge the IRS if you disagree with its position.

How many people get audited versus prosecuted?

Let’s circle back to our initial statement that getting audited rarely means you’re headed for prison. Consider the following data from the IRS:

  • Of the 199 million tax returns filed in the 2018 calendar year, the IRS audited 771,095 of them — or about 0.4%.
  • In the 2019 fiscal year, the IRS completed 2,797 criminal investigations (some may have been from prior years).
  • Of those completed investigations, 1,360 resulted in incarceration. The IRS uses the term “incarceration” to encompass prison time, house arrest, electronic monitoring or any combination of the three.

These numbers illustrate that even while the IRS audits only a small percentage of taxpayers, it criminally prosecutes even fewer. That said, if the IRS does prosecute you, you could be facing some serious repercussions, including jail time, since more than half of completed criminal investigations result in incarceration.

What to do if you get a letter from the IRS

What could happen if you’re convicted of tax evasion?

Penalties can be severe for taxpayers convicted of tax evasion.

In the U.S., tax evasion is a crime that can lead to fines, prison time or both. According to the Internal Revenue Code, taxpayers convicted of tax evasion can be fined up to $250,000 (or $500,000 in the case of a corporation) and/or imprisoned for up to five years. And they may be held responsible for the costs of their prosecution.

If you’re unsure about your tax obligations, reach out to a CPA or tax professional for help.

Bottom line

No one wants to run afoul of the IRS and risk the repercussions of doing so. But honest mistakes can happen. If you make a mistake on your federal income tax return, it’s highly unlikely it will land you in prison and far more probable that you could owe additional tax, interest or even penalties.

The IRS doesn’t pursue criminal tax evasion cases often. When it does investigate, the IRS follows a set process for assessing whether the person suspected of evasion acted willfully to get out of paying their full tax obligation.

When it comes to your federal income taxes, filing your return on time, double-checking to ensure it’s accurate to the best of your knowledge, and paying the correct amount you owe by the due date is probably the best policy.

Rachel Weatherly is a tax product specialist with Credit Karma. She studied accounting and finance at Western Carolina University and has also worked as a tax analyst. You can find her on LinkedIn.

About the author: Janet Berry-Johnson is a freelance writer with a background in accounting and insurance. She has a bachelor’s degree in accounting from Morrison University. Her writing has appeared in Capitalist Review, Chase News &a… Read more.