Underpayments of taxes happen often, yet they result in relatively few criminal convictions. Perhaps surprisingly, people in the middle tax brackets underreport or fail to pay taxes most often, although some businesses also fail to keep up with their tax obligations. The service industry is especially likely to witness underreporting. People who are self-employed also underreport often, such as salespeople, car dealers, doctors, lawyers, and accountants.
You might suspect that some people cut corners when they claim deductions, especially deductions for costs allegedly related to a business. However, the statistics do not support this theory. Only a small percentage of deductions are inaccurately claimed, and underpayment of taxes due to claiming excessive deductions is relatively rare.
The Difference Between Negligence and Tax Fraud
Two things can happen if an IRS auditor determines that a taxpayer has not paid the appropriate amount of taxes or has not reported their tax obligation accurately. The auditor might impose civil fines and penalties, or they might ask the Criminal Investigations department of the IRS to decide whether the taxpayer should be prosecuted. Often, the choice between these options depends on whether the taxpayer acted negligently or fraudulently. Negligence involves making a careless mistake, while fraud consists of an intentional act designed to deceive the IRS. If you misreported or underpaid your taxes negligently, you might face a civil penalty of about 20 percent added to your tax obligation. If your actions were fraudulent, you could face a civil penalty of 75 percent, in addition to criminal charges in some cases.
Negligence = a careless or reckless mistake, possibly resulting in a civil penalty of 20 percent of the underpayment Tax Fraud = an intentionally deceptive act, possibly resulting in a civil penalty of 75 percent of the underpayment and criminal charges
Recognizing the complexity of federal tax laws, auditors usually assume that a mistake is innocent unless the evidence suggests otherwise. However, some actions clearly constitute fraud because they have no innocent explanation. Inventing the existence of a spouse, keeping multiple financial records, or providing false identifying information are examples of fraud. If your business or you do not have any records, an auditor may start to suspect fraud. They also may investigate more closely if they find that you have seemingly altered checks or falsified receipts. The line between negligence and fraud is often hard to draw, though, and you should consult an attorney if you are concerned about being suspected of tax fraud. Even if you avoid a formal conviction or a prison sentence, like the vast majority of people who commit tax crimes, the monetary consequences can be devastating and long-lasting.