How do criminals carry out tax evasion and tax fraud?

How Criminals Carry Out Tax Evasion and Fraud

Paying taxes is a civic duty that most people take seriously. However, some criminals try to avoid paying their fair share through illegal means like tax evasion and fraud. While both are illegal, tax evasion and fraud have some key differences.

What is Tax Evasion?

Tax evasion is when someone intentionally avoids paying taxes that they owe. This could mean underreporting income, inflating deductions, hiding money in offshore accounts, or just not filing a return at all. Tax evasion is a purposeful attempt to not pay taxes that are legally due.

Some common ways criminals evade taxes include:

• Not reporting cash income – Many businesses deal in cash, which makes it easier to hide income. Criminals skim cash profits and don’t report it on their taxes.
• Hiding money offshore – Criminals open accounts in foreign countries to shift money into and avoid reporting it. This could be through shell companies in tax havens.
• Taking improper deductions – Claiming deductions for personal expenses as business expenses is a way to lower taxable income.
• Not filing a return – Simply not filing a tax return is an easy way to evade. But the IRS will eventually follow up.

Tax evasion often involves hiding income or assets altogether. The goal is trying to make it look like less money is available to tax in the first place. Tax evaders know they owe more tax but don’t want to pay it.

What is Tax Fraud?

Tax fraud is falsifying information on a tax return to reduce the amount of tax owed. This could mean reporting false income, expenses, deductions, credits, or exemptions. The key difference with tax evasion is that tax fraud involves lying on a tax return.

Some ways criminals commit tax fraud include:

• Claiming false deductions – Putting personal expenses as business deductions is common tax fraud.
• Hiding the source of income – Failing to report income from illegal activities is fraud.
• Reporting false expenses – Inflating or falsifying business expenses lowers taxable profit.
• Claiming false tax credits – Lying about eligibility for tax credits like the Earned Income Credit.

With tax fraud, a return is filed with false information instead of avoiding filing altogether. But both tax evasion and fraud have the goal of cheating on taxes owed.

How Tax Evasion & Fraud Schemes Work

Criminals go to great lengths to set up complex schemes to evade taxes and commit fraud. Some tactics include:

• Shell companies – Forming corporations that exist only on paper can disguise ownership of assets and income.
• Fake charities – Setting up sham charities allows people to donate money tax-free then get it back for personal use.
• Phony expenses – Filing business expenses for things like supplies or travel that didn’t really happen lowers taxable profit.
• Paying in cash – Paying contractors or employees in cash for services makes income harder to track for tax purposes.
• Fake invoices – Submitting invoices for services or items that were never actually purchased can be claimed as business expenses.

These types of schemes make it possible to hide income, fabricate deductions, and disguise the paper trail. Criminals also exploit loopholes and weak oversight to avoid getting caught.

Offshore Tax Havens

One popular technique is hiding money in offshore accounts in tax haven countries. Places like Switzerland, the Cayman Islands, and Panama have secretive banking laws that make accounts difficult to trace. Criminals open up offshore shell companies to move funds out of the country into these tax haven banks. This makes the income harder to track for tax authorities.

The IRS has increased efforts to crack down on offshore tax evasion. The Foreign Account Tax Compliance Act requires foreign banks to report info on accounts held by U.S. taxpayers. This has made offshore evasion more difficult. But criminals always adapt to find new loopholes and stay ahead of enforcement.

Consequences of Tax Evasion & Fraud

There are a number of civil and criminal penalties for both tax evasion and fraud. On the civil side, the IRS will seek back taxes plus interest and penalties. The IRS typically audits returns for up to 3 years, but there is no statute of limitations for tax fraud. Penalties can add up to as much as 75% of the unpaid tax.

Criminal penalties for tax evasion can include:

• Up to 5 years in prison
• Fines up to $250,000
• Probation and community service

For tax fraud, penalties can be:

• Up to 3 years in prison
• Fines up to $250,000
• Probation and community service

Tax evasion cases involving larger amounts of unpaid taxes can face up to 10 years in prison. Tax fraud over $100,000 in owed taxes can be up to 5 years imprisonment. Committing tax fraud multiple times can mean harsher punishment.

Famous Tax Evasion Cases

Some notorious cases of tax evasion and fraud include:

• Al Capone – The famous mob boss was convicted of tax evasion in 1931 for not paying taxes on his illegal income. He served 7 years in prison.
• Richard Hatch – The winner of Survivor failed to pay taxes on his $1 million prize and spent 51 months in prison for tax evasion.
• Wesley Snipes – The actor served a 3-year sentence for not filing tax returns for several years and owing over $7 million.
• Fat Joe – The rapper pleaded guilty to not paying income taxes for over $3 million between 2007-2010 and paid a fine.

These cases show that anyone from average citizens to the rich and famous can commit tax evasion and fraud. And they face serious jail time if caught.

Tax Avoidance vs. Tax Evasion

Tax avoidance utilizes legal methods to minimize taxes owed. This can include claiming tax deductions, sheltering income in legal retirement plans, or using tax credits. The key difference is tax avoidance works within the law. Tax evasion and fraud break the law by misreporting or hiding income.

That said, some wealthy individuals and corporations take tax avoidance to the extreme. They exploit loopholes and complex structuring to reduce taxes in ways lawmakers didn’t intend. So while not technically illegal, aggressive tax avoidance circumvents the spirit of the tax code.

How the IRS Catches Tax Cheats

The IRS deploys a variety of tools and techniques to catch tax evaders and fraudsters, including:

• Audits – The IRS flags suspicious returns for review to verify income, deductions, and other info.
• Bank reporting – Banks must report interest income earned by account holders to the IRS.
• Whistleblowers – Informants can receive a cut of recovered taxes for reporting evaders.
• Investigations – IRS criminal agents open in-depth probes of complex tax schemes.

New requirements for foreign banks to share account info have also helped crack down on offshore evasion. And computer algorithms help identify patterns suggesting potential tax schemes.

While enforcement has improved, some estimate the IRS fails to collect over $400 billion in owed taxes each year. Criminals are constantly innovating new ways to outsmart authorities and avoid getting caught. So tax evasion and fraud will likely remain an ongoing cat-and-mouse game.

The Bottom Line

Tax evasion and fraud divert public funds, add unfair burden to honest taxpayers, and undermine trust in the system. While some perpetrators are brought to justice, many more evade consequences through clever schemes. Authorities must continue improving technology and cooperation across borders to detect and deter financial crimes.

But as long as governments impose taxes, criminals will keep searching for new ways to cheat the system. Although penalties can be severe, for some the potential rewards of extra wealth make the risk of evasion worth trying to get away with.