Let's get the scary stuff out of the way first. In fiscal year 2022, IRS Criminal Investigation initiated over 2,550 criminal investigations and obtained a 90.6% conviction rate of those cases accepted for prosecution. However, that was out of more than 134 million tax returns filed for tax year 2022.
Why would the IRS go to so much trouble only to investigate 2,550 or so parties? According to the tax agency, it identified over $31 billion in tax and financial crimes. That's a whole lot of money that could go back into government coffers.
But what about you? Have you ever worried about being audited or, worse yet, accused of tax evasion? If so, this article is for you. We dug into what it takes for the average taxpayer to show up on the IRS's radar, and here's what we found.
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The reality
Very few taxpayers go to jail for evading their taxes. That said, it pays to be honest. Most tax evasion cases begin with a taxpayer who:
- Doesn't file required tax returns
- Fails to report or misreports income
- Lies about credits or deductions on their return
- Says they are unable to pay back taxes, even though they have the means to do so
- Makes false statements to the IRS or purposely hides records, such as bank accounts
'Badges of fraud'
The IRS calls dodgy behavior "badges of fraud," and those badges attract audits and, sometimes, prosecution. Here are three samples of situations that trigger a fraud investigation.
Margaret
Let's say Margaret works as a teacher, but she runs a tutoring business on the side. Margaret's primary source of income is teaching, but over the years, her tutoring business has grown and now generates a fair amount of cash. As the money comes in, Margaret deposits it in her personal checking account and never reports it to the IRS. Between 2018 and 2022, Margaret's tutoring gig cleared $40,000.
Several of the children Margaret tutors have special needs. As the parents of special needs students, their families can claim tutoring expenses as a federal tax deduction. While doing so, they provide the IRS with Margaret's identifying information.
After receiving an audit letter from the IRS and interviewing with an auditor, Margaret insists her only income is from her job as a school teacher. For the auditor, this represents a badge of fraud. Thinking there's something "off" with her story, the auditor orders Margaret's bank statements for the past five years and finds regular deposits in the same amount each week.
Because Margaret won't cooperate, the case is referred to the IRS Criminal Investigation Division for probable tax fraud.
John
John is transient and hasn't held down a regular job in years. Still, he files income tax returns like clockwork. The trick for John is to steal an identity, falsify information regarding the person he's pretending to be, and file for a tax refund before that person has time to file their legitimate return. Typically, John files "his" tax return on the first day of tax season. Unless the person whose identity John stole also files that day, John manages to get away with it.
Once the IRS receives a complaint from the victim, an investigation begins. However, because John has no permanent address and no place of employment, he's difficult to locate.
Laurie
Laurie owns a landscaping business and, at any given time, employs at least a dozen people. Laurie uses payroll software to carefully deduct payroll taxes, including Social Security, federal unemployment, and withholding taxes. However, she never turns those taxes over to the IRS as required. In addition, Laurie takes on extra workers during the busy season and pays them under the table.
She's a prime candidate for an audit and charges of tax evasion.
When no charges are filed
Once a taxpayer has been caught blurring the truth, they are unlikely to be charged with tax evasion. However, they can count on paying a harsh financial penalty. If they refuse to pay the fine, they may face up to five years in jail.
For the vast majority of Americans
The IRS knows that people make innocent mistakes. A letter from the IRS pointing out a potential error does not signal that a person is in trouble. It's simply an attempt to get on the same page with the taxpayer. After all, it may be the IRS that made the mistake. If so, the taxpayer has an opportunity to provide evidence.
The IRS can be surprisingly understanding as long as a taxpayer makes a good-faith effort to pay their taxes accurately -- even if that means setting up a payment plan.
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