Federal Tax Evasion: Criminal vs. Civil Cases

The IRS investigates. The Department of Justice prosecutes. The distinction between those two functions is the line between a civil tax matter and a criminal one, and that line is not always visible from the outside until it has been crossed.

Federal tax evasion under 26 U.S.C. 7201 requires proof that the defendant willfully attempted to evade or defeat any tax imposed by the Internal Revenue Code. The maximum sentence is five years imprisonment and a fine of two hundred fifty thousand dollars. Tax fraud under 26 U.S.C. 7206 addresses the filing of false returns and carries a maximum sentence of three years. The willfulness element is the most significant distinction between criminal tax violations and civil tax deficiencies, and it is the element on which most criminal tax prosecutions turn.

The Civil to Criminal Transition

Most tax matters begin in the civil examination process. An IRS examination of a taxpayer’s return may reveal underreported income, overstated deductions, or other discrepancies that the examination team believes warrant adjustment. The vast majority of these matters are resolved through the civil examination process, with the taxpayer paying the additional tax assessed, along with interest and civil penalties.

A civil tax matter transitions to a criminal investigation when the IRS examination team refers the matter to the IRS Criminal Investigation division. CI is a law enforcement agency within the IRS with approximately two thousand special agents who investigate potential criminal violations of the tax code. A referral to CI means that the civil examination team has observed conduct suggesting willful tax violation rather than negligence or honest error. The taxpayer may not be immediately aware that the matter has been referred to CI; civil examinations are sometimes continued as a cover for the criminal investigation.

The indicator that the matter has reached CI is the most important signal a taxpayer can receive, and it is frequently not communicated directly. A civil examiner who suddenly requests an extension of time, who asks questions that seem to exceed the scope of the examination, or who schedules and cancels meetings without explanation may be deferring to a parallel criminal investigation. Counsel experienced in tax matters recognizes these signals. Taxpayers without counsel typically do not.

The Willfulness Element

Willfulness in federal criminal tax cases means a voluntary, intentional violation of a known legal duty. The standard is drawn from Cheek v. United States, decided by the Supreme Court in 1991, which held that a genuine, good faith belief that one is not violating the tax law negates the willfulness element, even if that belief is objectively unreasonable. The Cheek standard is more favorable to defendants than the willfulness standard applicable in other contexts, because it does not require the belief to be reasonable.

The practical consequence of Cheek is that the criminal tax defendant whose claimed belief in the legality of their conduct is genuine, however eccentric, has a defense that is legally cognizable. The defendant who relied on an aggressive tax professional’s representation that a transaction was legitimate, who documented that reliance at the time, and who had no reason to disbelieve the representation is a defendant whose mental state may not satisfy the willfulness requirement. The documentation of that reliance is the evidence that makes the defense viable.

Offshore Accounts and Unreported Income

The most active area of criminal tax enforcement involves offshore accounts and unreported foreign income. The Foreign Account Tax Compliance Act and the Report of Foreign Bank and Financial Accounts requirements impose disclosure obligations on taxpayers with foreign financial accounts. Willful failure to file an FBAR carries civil penalties of up to fifty percent of the account balance per year and criminal penalties under 31 U.S.C. 5322.

The Department of Justice’s offshore enforcement program, initiated through the Swiss banking investigations beginning around 2007, produced hundreds of criminal referrals, dozens of prosecutions, and more than a hundred deferred prosecution agreements with foreign financial institutions. The program’s reach has extended to accounts in jurisdictions that were not historically associated with tax evasion, as financial institutions across Europe, Asia, and the Caribbean entered disclosure agreements with the Department of Justice.

The taxpayer whose offshore account was never disclosed, who received no inquiry from the IRS for decades, and who assumes the matter has been resolved by the passage of time is a taxpayer who may not have read the treaties their financial institution signed. The disclosure programs the IRS has operated have produced referrals that arrived years after the accounts were opened and years after the taxpayers believed the risk had passed.

DEFENSE TEAM SPOTLIGHT

Todd Spodek

Lead Attorney & Founder

Featured on Netflix's "Inventing Anna," Todd Spodek brings decades of high-stakes criminal defense experience. His aggressive approach has secured dismissals and acquittals in cases others deemed unwinnable.

NY Bar Admitted Multi-State Licensed Federal Courts

Meet the Full Team

Civil Penalties as the Alternative

Civil resolution of a tax matter that might otherwise produce a criminal referral is available where the taxpayer is willing to disclose fully, pay the taxes owed with interest and penalties, and cooperate with the examination. The IRS Voluntary Disclosure Program provides a pathway for taxpayers who have underpaid taxes, including those with unreported foreign income, to come into compliance before the IRS has initiated a criminal investigation.

The program is not a guaranteed protection from prosecution. It requires complete disclosure, payment of the tax, interest, and penalties, and the IRS’s determination that the matter does not warrant criminal referral. Taxpayers who use the voluntary disclosure program after the IRS has already initiated a criminal investigation do not qualify. The program’s protection is available only to those who come forward before the government comes for them.

The assessment of whether a tax matter has crossed or is approaching the civil-to-criminal line is the first task of counsel retained in any significant tax controversy. That assessment requires an experienced tax controversy attorney, not merely a civil tax practitioner, and it requires engagement before the IRS signals that the transition has occurred.