If you maximize your tax refund each year when filing your taxes (and take every tax deduction you are entitled to in doing so), then you actually commit one of the above terms. Before you get scared that you are breaking the law, calm down. One of the options is completely legal and you should be taking advantage of it as the tax deadline nears. But which one is it? Do you know?
The definition of tax fraud is when a person, corporation or other business entity intentionally avoids paying their true tax liability. Cases of tax fraud are investigated by the Internal Revenue Service Criminal Investigation unit.
Overall, tax fraud is difficult to prove because the government has to show that the taxpayer intentionally defrauded the government out of tax revenue.
Tax evasion is when a person, corporation or other business entity willfully and intentionally falsifies information on their tax return in order to limit their tax liability. This includes claiming false deductions, not reporting income and claiming personal expenses as business expenses so that they can be written off. If you are caught evading taxes, you are subject to criminal charges as well as penalties.
In essence, tax evasion is a subset of tax fraud. Many times the government will charge people with tax evasion instead of tax fraud because tax evasion is less difficult to prove.
Tax avoidance is when a person, corporation or other business entity uses legal means to reduce their tax liability. This includes taking all allowable tax deductions and tax credits that you are entitled to. This is perfectly legal, as long as you only take those credits and deductions that you qualify for. Once you cross over into taking a deduction you are not qualified for, you enter the world of tax evasion.
If you contribute any money to a 401(k) plan at work, you are practicing tax avoidance. This is because the contribution comes out of your salary before taxes are applied and as a result, reduces your taxable income.
Statute of Limitations
Let’s say someone you know is committing either tax fraud or tax evasion. What is the law in which the IRS can come after them? Since we are talking about the IRS, there are exceptions to the rule. To begin, the IRS has three years from when you file a tax return to complete the audit process. This includes reviewing your return and coming to an agreement with you to pay additional tax or not.
But, if the IRS finds that you failed to report 25% of your gross income, the three year window opens to six years. Note that taking too many deductions won’t put you into this situation, but not reporting all of your income will. While this does not mean tax evasion is occurring, you can bet that the IRS is seriously looking to see if it is present.
If the IRS suspects you are committing tax fraud, it must prove that, as mentioned above, for every year it is suspected. If proven, there is no statute of limitations and the IRS can go back as far as they want.
One final interesting fact about all of this is for those of you that are married and filling jointly. When you sign you name, you are signing that you agree that what is on the tax return is correct. If your spouse is committing tax evasion and you sign, you can be held liable as well. Therefore, it is important to make sure that your spouse is not trying to game the system. It goes back to the old saying of knowing what you are signing.
As you can see, you certainly want to be practicing tax avoidance and not tax evasion or tax fraud. The latter two will find you in jail and owing lots of money to Uncle Sam. Any good accountant will make sure you practice tax avoidance to your legal limit so that you pay the absolute minimum in taxes that is required from you. I hope you found this information helpful.