What is Tax Evasion?

Posted 4/14/2009 1:39:24 PM

The term “tax evasion” encompasses an entire spectrum of actions and schemes undertaken to skirt the required payment of taxes. There is a wide variety of ways to “evade” taxes, perhaps limited only by human ingenuity. Fortunately, the government has a powerful tool to address taxpayers the government believes are skipping out on the civic responsibility to pay taxes: the “evasion” statute. The language of the statute itself is broad and the courts have also interpreted the statute broadly. It could be said that the statute, and its interpretation, necessarily have to be broad to be able to address the wide assortment of evasions and schemes. The government wields the evasion statute in concert with other Internal Revenue Code criminal statutes to prosecute unscrupulous taxpayers. The general evasion statute is cited below.

Attempt to evade or defeat tax – 26 USC § 7201

“Any person who willfully attempts to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof:

Shall be imprisoned not more than 5 years
Or fined not more than $250,000 for individuals ($500,000 for corporations)
Or both, together with the costs of prosecution.”

The statute can result in hefty penalties, if violation is shown. To show an evasion offense, the government must prove the following elements:

1. an additional tax due and owing
2. an attempt to evade or defeat any tax, or the payment thereof
3. willfulness.

Each of the three elements is discussed in further detail below.

Additional Tax Due and Owing

Some amount of additional tax is due. Typically, the amount is something more than what was reported by the taxpayer. However, it can also be an amount reported, but not paid.

Even if the additional amount is not precisely quantified, this element can be met by showing that the additional amount is “substantial.”

There is no set formula for determining if the additional amount is substantial. IRM 9.1.3.3.2.2.1 (05-15-2008).

Attempt to Evade or Defeat Tax or the Payment Thereof

The Internal Revenue Code does not define an “attempt” to evade or defeat. On face, the statute can be read very broadly, and the courts have done so. So long is there is some “affirmative act” this element of the statute can be met. As might be expected, “affirmative act” also includes a broad scope of activities. Some of those acts are listed here, as gleaned in the IRM from court decisions:

• keeping a double set of books
• making false entries, alterations, invoices, or documents
• destroying books or records
• concealing assets or covering up sources of income
• handling one’s affairs to avoid making records usual in transactions of the kind
• any conduct, the likely effect of which would be to mislead or to conceal.

The last bullet is a catch-all, keeping the door open for a species of evasion yet to be described. Continuing the thread of broad interpretation, consider the following:

• an “attempt” does not have to be successful, and
• each tax year can be a separate offense.

Although simply failing to pay a tax by itself does not rise to “evasion,” it does not take much for that failure to move from the civil to the criminal realm. The acts listed below, among others might be sufficient to push a “failure to pay” to “evasion.” IRM 9.1.3.3.2.2.2 (05-15-2008)

• Concealing assets
• Reporting income through others
• Filing late returns
• Failure to properly withhold taxes.

Willfulness

Willfulness, of course, is a state of mind or matter of intent. Therefore, generally, this element will have to be inferred from the taxpayer’s activities (unless there is a confession.) For example, the IRS could discover that a taxpayer failed to report $50,000 of gross receipts. This amounts to an honest mistake without some showing of willfulness. However, if the government discovers the taxpayer has a double set of books and falsified invoices, the willfulness element might be met.

Avoidance versus Evasion

No taxpayer is required to pay more taxes than the law requires—taxpayer can use every available legal tool to avoid payment of taxes. The key is to make sure that avoidance does not turn into evasion. The IRM quote below describes the fine line between avoidance and evasion.

“Avoidance of taxes is not a criminal offense. Any attempt to reduce, avoid, minimize, or alleviate taxes by legitimate means is permissible. The distinction between avoidance and evasion is fine, yet definite. One who avoids tax does not conceal or misrepresent. He/she shapes events to reduce or eliminate tax liability and, upon the happening of the events, makes a complete disclosure. Evasion, on the other hand, involves deceit, subterfuge, camouflage, concealment, some attempt to color or obscure events or to make things seem other than they are. For example, the creation of a bona fide partnership to reduce the tax liability of a business by dividing the income among several individual partners is tax avoidance. However, the facts of a particular investigation may show that an alleged partnership was not, in fact, established and that one or more of the alleged partners secretly returned his/her share of the profits to the real owner of the business, who, in turn, did not report this income. This would be an instance of attempted evasion.” IRM 9.1.3.3.2.1 (05-15-2008) (emphasis added).

Recent Cases of Tax Evasion

Common types of evasion include individual evasion, abusive trust schemes, payroll tax schemes, offshore account schemes, corporate evasion, and home-based business schemes, among others. Two example cases are included below. In many case descriptions, including the first one below, the taxpayer was uncooperative or did not make “complete disclosure” when the IRS started looking into the taxpayer’s circumstances. Although the brief case descriptions do not say for sure, the failure to make “complete disclosure” may well have been the event that persuaded the government to pursue criminal charges in some of these cases.

Self-Employed Schedule C Evasion

“On February 23, 2009, in San Jose, Calif., Huy Quoc Nguyen was sentenced to 15 months in prison and ordered to pay $549,000 restitution, plus interest and penalties for tax evasion. Nguyen, owner of Valley Technology Services (VTS), pleaded guilty in November 2008, admitting in his plea agreement that during an IRS audit, he told a revenue agent that his business checking account was used strictly for business and that he had used that account to prepare his Schedule C (Profit or loss from business) for his 2000 tax return. Nguyen told the revenue agent that all deposits made to the business checking account were due to business income and that all checks from that account were for business expenses. Later in the process of conducting the audit, the revenue agent noted that there was numerous non-business checks that did not reconcile to any of the expense categories stated on the Schedule C. Nguyen admitted that those checks were for personal and not business expenses. Nguyen further admitted that he knowingly failed to report gross receipts, ordinary income and interest income from VTS. He also improperly deducted non-business expenses as well as mortgage interest payments and real estate tax payments for property that he did not own. Nguyen admitted that the total amount of tax loss arising from his false 2000 and 2001 personal income tax returns was $549,000.”

(Source: IRS.gov)

Abusive Tax Schemes—Sham Trusts

“On December 1, 2008, in Grand Rapids, Mich., June Marie Young, was sentenced to 30 months in prison and was ordered to perform 300 hours of community service, cooperate with the Internal Revenue Service (IRS), and pay $164,550 in restitution to the IRS. Young was convicted by a jury in July 2008 on four counts of willful tax evasion. According to court records, Young was a self-employed commercial artist who created mass-produced paintings that were sold through a contract distributor. As her business grew, Young established a sham trust known as the Black Gold Foundation. From 2000 to 2003, Young arranged for her commercial art earnings to be deposited into this trust to avoid the appearance of having income in her own name. But, she controlled the trust, and more importantly the trust’s checkbook. Although Young filed personal income tax returns for 2000 through 2003, her returns did not report any of the funds paid on her behalf to the Black Gold Foundation. Instead, she filed income tax returns on behalf of the Foundation listing exorbitant business expense deductions that exceeded trust income. She claimed that no tax was due and owing from the foundation, despite knowing that a substantial portion of the deductions she claimed on its behalf were illegitimate. As a result of her actions, Young paid only $28,000 in taxes on business receipts exceeding $1.2 million. Among the items paid for with foundation checks signed by Young – and deducted as business expenses – were house payments on two homes in Michigan, the down payment for a $406,000 luxury home in Florida, lease payments on a $49,000 Jaguar sedan, and gifts to family members disguised as payments for “services rendered.” In addition, she transferred over $100,000 to herself from the trust each year, disguised as payment for “consulting” and “loans” that were never repaid. Young used this money for luxury purchases, including a home theater system and indoor spa.”

(Source: IRS.gov)