The Internal Revenue Service (IRS) estimates that the “tax gap”—meaning the difference between the amount of tax payments received by the IRS and the amount owed by individuals and businesses—is as high as $450 to $500 billion per year. This number does not necessarily include taxes that are owed to state and local tax jurisdictions. No one likes to pay taxes, and no one agrees on the best way for the government to use tax revenues. That said, taxes are necessary for our government, and by extension many features of our society, to function. Intentional efforts to evade payment of taxes are considered a criminal offense known as “tax evasion.”
What Is Tax Evasion?
Federal law makes it a crime to “willfully attempt in any manner to evade or defeat” the assessment or payment of any federal tax. This includes many forms of tax fraud, as well as other efforts to conceal income or assets from the government.
Not all efforts to avoid paying taxes are considered criminal. The U.S. Supreme Court recognized in Gregory v. Helvering that taxpayers have a “legal right . . . to decrease the amount of what otherwise would be [their] taxes, or altogether avoid them, by means which the law permits.”
“Tax avoidance” refers to the lawful use of the Internal Revenue Code and other tax regimes to one’s own advantage. For individuals, this might involve the strategic use of tax deductions, tax credits, and “loopholes” in the various tax codes to reduce one’s total tax bill.
The most common form of tax evasion involves basic elements of fraud, such as false or misleading statements in a tax return. This might involve overstating the total amount of deductions, such as charitable contributions, under-reporting total income, or not reporting some income at all.
Individuals who work in areas that involve cash transactions, such as restaurant workers who receive tips, may find themselves accused of tax evasion if they do not report all of their tip income to the IRS. Self-employed people and anyone with income that does not involve the receipt of a W-2 or 1099 form must fully disclose all income. Failure to report non-monetary income, such as barter income from side jobs, could also be viewed as tax evasion.
Overseas Tax Havens
Some foreign jurisdictions have tax laws that many U.S. corporations, as well as individuals with enough assets to make such a plan worthwhile, find preferable to those in the United States. The use of financial institutions and business entities in these jurisdictions, often known as “tax havens,” can be both a legal and illegal means of reducing overall tax payments. Congress passed the Foreign Account Tax Compliance Act in 2010 in an effort to improve enforcement of tax regulations overseas.
Reporting Illegal Income
Many of the most famous prosecutions for tax evasion involved people who failed to report income from illegal activities to the federal government. The U.S. Supreme Court held in United States v. Sullivan, that the Fifth Amendment right against self-incrimination does not allow a taxpayer to refuse to disclose such income. This allowed the government to charge the notorious gangster Al Capone with tax evasion. Capone was convicted in 1931 and sentenced to eleven years in prison.
The Fifth Amendment may allow people to refuse to disclose the source of illegal earnings, but they are required to report it as income. Garner v. United States. This type of tax evasion is closely related to money laundering, since individuals may try to report income from illegal activity as coming from lawful sources.