Tax Evasion

Tax evasion is the felony described by Internal Revenue Code section 7201, which reads: "Any person who willfully attempts in any manner 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 fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution." The Supreme Court set out its elements in Sansone v. United States: "the elements of section 7201 are willfulness; the existence of a tax deficiency … and an affirmative act constituting an evasion or attempted evasion of the tax." Evasion is about the accuracy of the facts reported, not about the size of the tax saved, which is what distinguishes it from every lawful method of paying less.

The affirmative act is the element that does the work. Passive failure is not evasion. Section 7203 makes it a misdemeanor to willfully fail to file a return, keep records, supply information or pay a tax, punishable by up to one year and a statutory fine of $25,000 for an individual, which the federal sentencing rule described below lifts to $100,000. Section 7201 requires something more: a step taken to defeat the tax. Keeping a second set of books, paying employees in cash and not recording it, titling assets in another person's name, moving funds through accounts that are not disclosed, and giving false explanations to a revenue agent are the recurring examples. This is why the same conduct can be a misdemeanor or a felony depending on what the taxpayer did after the return was due.

Willfulness has a specific and surprisingly protective meaning. In Cheek v. United States the Supreme Court confirmed that statutory willfulness is "the voluntary, intentional violation of a known legal duty," and held that a defendant's genuine good-faith misunderstanding of what the law required negates willfulness "however unreasonable a court might deem such a belief." The standard is subjective, so the question for a jury is what the defendant actually believed rather than what a reasonable person would have believed. The Court drew one hard line: a claim that the tax laws are unconstitutional is irrelevant to willfulness and may be kept from the jury, because such a claim "reveals full knowledge of the provisions at issue and a studied conclusion that those provisions are invalid." Someone who thinks the income tax is void is expected to pay, sue for a refund, and argue the point in court.

"Tax fraud" names several different things and only one of them is section 7201. The civil fraud penalty in section 6663 adds 75 percent of the underpayment attributable to fraud, and it is imposed by the IRS in a civil examination with no criminal charge. Section 7206(1) is a separate felony, carrying up to three years, for willfully signing a return that the signer does not believe to be true and correct as to every material matter, and unlike section 7201 it does not require any tax to be due at all, which is one reason prosecutors use it. Section 7206(2) reaches the person who prepared or advised on a false return. Reading "tax fraud" as a single offense collapses four different provisions with four different elements.

The civil consequences run longer than the criminal ones, which is the opposite of what most people assume. Section 6531 gives the government six years, rather than the usual three, to bring a section 7201 charge. But section 6501(c)(1) provides that in the case of a false or fraudulent return filed with intent to evade tax, "the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time." There is no deadline at all on the civil side. Section 6663(b) adds a burden that is easy to overlook: once the government establishes that any portion of an underpayment is attributable to fraud, the entire underpayment is treated as fraudulent unless the taxpayer proves otherwise by a preponderance of the evidence. Section 6663(c) at least confines the penalty to the spouse whose own conduct was fraudulent on a joint return.

The fine in the statute is not the fine a court can impose. Section 7201's $100,000 has not been updated since 1982, but 18 U.S.C. 3571(b) permits a fine of "the greatest of" the amount specified in the statute creating the offense, the alternative amount based on gain or loss, and $250,000 for a felony. For an individual convicted under section 7201 the ceiling is therefore $250,000, not $100,000, and under 3571(d) a court may instead impose twice the gross gain or twice the gross loss where the offense produced either. For an organization both section 7201 and the felony default land at $500,000. Any source quoting the $100,000 alone is quoting a number a court is not bound by.

A case generally develops in this order.

1. A civil examination identifies an understatement. Most stop here, with tax, interest and an accuracy-related penalty.
2. Indicators of fraud move the file toward IRS Criminal Investigation. Concealment, falsified documents and false statements to examiners are the usual triggers.
3. A criminal referral and prosecution, which must be brought within six years for a section 7201 charge under section 6531(2).
4. The civil case continues regardless, and on a fraudulent return there is no limitations period at all under section 6501(c)(1).

A hypothetical example of the arithmetic on the civil side, which is where most of the financial damage sits. Over three years Dev omitted $180,000 of cash receipts from his returns, understating his tax by $54,000. The section 6663 civil fraud penalty is 75 percent of the underpayment attributable to fraud, which is $40,500. His exposure is $54,000 of tax plus $40,500 of penalty, or $94,500, before interest, which runs from each original due date. Because the returns were fraudulent, none of those years has ever closed, so the oldest one is still assessable however long ago it was filed.

On the criminal side the same conduct carries up to five years of imprisonment and, under 18 U.S.C. 3571(b)(3), a fine of up to $250,000 for an individual notwithstanding the $100,000 written into section 7201. The government generally charges each tax year as a separate count.