Tax Fraud: What is it and Common Examples

It is estimated that tax fraud costs the United States close to $500 billion a year, and that doesn’t include the huge sums lost by state tax jurisdictions. This is a serious problem, but it’s also a vast and diverse one, so much so that you might find yourself breaking the law without even realizing it.

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What is Tax Fraud?

Tax fraud is defined as the willful defrauding of the Internal Revenue Service (IRS) to pay less money or acquire larger tax refunds. It’s something that costs the US economy billions of dollars a year and it occurs at all levels.

Service workers and self-employed individuals are the most likely to commit tax fraud according to the IRS, as the former may receive a lot of income in cash that they can easily hide from the government, while it’s easier for the latter to underreport income.

It is the legal duty of every employee and self-employed individual to pay tax and failure to do so may result in a fine or, in extreme cases, prison time.

Negligence vs Fraud

According to the IRS, 17% of taxpayers break tax code in some way, and while the media always tends to focus on the big corporations and the billions they swindle, 75% of tax crimes are committed by individual taxpayers.

The tax system is complicated, and mistakes can be made, especially by first-time filers, so the IRS is keen to separate fraudulent filings from negligent ones. A negligent filing can still lead to penalties, but it won’t trigger a criminal conviction. The goal of the auditor, therefore, is to establish whether the taxpayer was willfully committing fraud or just making an honest mistake. To establish this, they will look for the following:

  • Have deductions been overstated?
  • Were documents intentionally falsified?
  • Has a substantial amount of income been hidden?
  • Were personal expenses filed as business expenses or vice versa?
  • Did they use a false Social Security number?
  • Did they claim an exemption for a dependent they do not have?

Unless it is clear and obvious, it likely won’t be considered fraud. Of course, serious mistakes can also be made, so it’s hard to establish if anything was done with intent, but if someone makes $500,000 a year and only declares $100,000, it’s safe to assume that they willfully hid their income, just as it’s safe to assume that anyone who submits false or stolen details is trying to defraud the system.

The Most Common Types of Tax Fraud

Tax fraud can assume many forms, some intentional, some not. In some cases, the fraud may not actually be committed by you, but you’ll still suffer the consequences.

Identity Theft

Identity theft can impact your life in many ways. It can damage your credit score, leave a lasting mark on your credit report, and leave you in hot water with creditors, lenders, and even the IRS.

Fraudsters steal your identity to apply for credit cards and loans in your name. They can also use it to access your bank account and other credit accounts. They can also file a tax return in your name to claim a tax refund. It’s rare, but scammers are getting creative these days and if they have your details, they’ll try your luck.

If the IRS bites back, it’s you they’ll come after, not the fraudster, at least not initially. This is also known as “return preparer tax fraud”, as it can be performed by tax preparers who commit fraud using your personal information.

You can protect yourself from identity theft by keeping an eye out for phishing scams, never giving your personal details to anyone, and practicing caution when dealing with your bank, the IRS, the government, and anyone who requests your personal information.

Hiding Income Offshore

Citizens use tax havens and offshore bank accounts to hide money and avoid paying tax. It’s believed that countless billions of dollars are held in offshore accounts and the problem with this is that some of it is held legally.

For instance, companies use loopholes to collect and store profits overseas and avoid paying tax in the United States. It’s frowned upon, but it’s also performed by some of the biggest companies in the world. It becomes illegal when the profits are earned in the US and are subject to state and federal income taxes, but are not declared, and are moved offshore to be hidden from prying eyes.

Not Declaring Income

If you have a criminal side hustle, earn several million dollars and stay out of reach of the US government, you may be arrested for federal tax fraud. You’ve no doubt heard stories of this happening to organized criminals and as bizarre as it sounds, it’s true. By law, you’re required to report all earnings to the IRS, including any money acquired through illegal activity.

Of course, no self-respecting criminal will do that, but if they don’t, they’re breaking the law, and if the authorities can’t get them for the actual crime, they can just follow the money and get them that way.

It’s not just criminal activity, either. Millions of Americans are turning to freelancing to earn a few extra bucks on the side and countless more have sold on eBay, Amazon, and Craigslist. If you’re making any money on the side and you’re not reporting it, then you’re committing tax fraud.

Of course, you’re probably not going to serve prison time for neglecting to mention the profits you made selling an old computer, but if you’ve turned that side hustle into a business and are earning a consistent profit, you could be in serious trouble if you don’t report it.

Filing Fraudulent Returns

This is arguably the most common form of tax fraud and it’s one that countless Americans break every single year. We mentioned one of the biggest causes above, as citizens underreport their earnings, but they’re also committing tax fraud if they declare personal expenses that they didn’t pay or income they didn’t earn.

This is a big issue with self-employed taxpayers but may also result from a lack of knowledge or simple forgetfulness, and while this is still fraud to some degree, it likely won’t result in any serious consequences as it can’t be proven that it was done intentionally.

Other Causes of Tax Fraud

Generally, any time you try to defraud the IRS you’re in direct contradiction of US tax law. Other instances where you may be committing tax fraud include filings that don’t include complete information for “moral” or “personal” reasons, such as believing that taxes are optional or that your money is not be used properly. 

The IRS won’t back down just because you’ve taken the moral high ground, and until you file tax returns on time and pay the full amount you owe, you could find yourself in serious trouble. 

It’s also illegal to avoid paying taxes by creating fake charities and trusts and trying to move your money around to avoid owing taxes.

When to Report Tax Fraud

The IRS is pretty powerless to stop tax evasion without help from US citizens. It relies on people reporting their employees and even their friends, all of which goes through the Whistleblower Office. There is even an Informant Award offered to whistleblowers who help to bring down fraudsters. 

However, they don’t care if you “think” that your neighbor is “probably” earning a few hundred bucks cash-in-hand or your employer “is definitely doing something suspicious”. They are only interested in those who seriously abuse the system and defraud the IRS of large sums of money. 

If any of the following have happened to you, then you should consider filing a report:

  • You know someone who is selling items and not paying tax
  • Your employer asks to pay you “under the table” in cash
  • Your employer is hiring undocumented migrants
  • Your ex-spouse is wrongly claiming your child as a dependent

You can also report to your local tax authorities if you believe someone isn’t paying sales tax or doing any of the things outlined above. However, you likely won’t get a reward in this instance.