Tax Fraud Penalties: What Happens If You Commit Tax Fraud?

Criminal tax fraud can lead to felony or misdemeanor charges, significant monetary penalties, imprisonment, and supervised release. However, in most cases, tax fraud is considered to be a civil issue, and the IRS assesses a civil fraud penalty of 75% of the unpaid or underreported tax.

But what is fraud? The IRS defines tax fraud as "an intentional wrongdoing with the purpose of evading a tax known or believed to be owing." Although evading tax is part of the definition of fraud, tax evasion is only one type of tax fraud. There are many other types of tax fraud including filing false returns, providing the IRS with false documents or statements, giving employees false W2s, falsifying the W4 you give to your employees, and similar fraudulent acts. 

To commit fraud, you must have had willful intent. Making a mistake on your return or not being able to afford your tax bill is not considered fraud. Not filing a return, underreporting income, and many other actions can be fraud in some cases but not others. It boils down to the severity of the action and the intentions of the taxpayer. 

In the following sections, we outline the most common types of tax fraud and their penalties. If you want to specifically read about tax evasion, check out this guide to tax evasion penalties. Note that while tax fraud can be criminal or civil, tax evasion is always criminal.

Key takeaways

• Civil fraud leads to penalties.
• Criminal fraud leads to higher penalties and imprisonment.
• The burden of proof is higher for criminal fraud than civil fraud.
• Most cases of fraud lead to civil penalties.
• Evasion is one type of tax fraud. 
• Tax evasion is always criminal, while other types of tax fraud may be civil or criminal.

Civil Vs. Criminal Tax Fraud

Civil tax fraud leads to monetary penalties, while criminal tax fraud leads to much higher penalties and possible imprisonment. In a criminal case, the government must prove guilt beyond a reasonable doubt. With civil fraud, the burden of proof is lower, and the government only needs to establish fraud by clear and convincing evidence.

In both situations, you may have taken the same action, but the consequences are based on the government's ability to prove your guilt. 

To give you a basic example, let's say you didn't file tax returns, and the IRS suspects that you failed to file in an attempt to commit fraud. If the government has clear evidence of the fraud, they may just assess a civil fraud penalty. However, if the IRS believes that you have committed criminal fraud, they will refer the case to the IRS Criminal Investigation (CI).

CI will put the case through several rounds of review before deciding whether or not to recommend persecution from the Department of Justice (DOJ) Tax Division. Then, you can either accept a plea or go through a criminal case, and to convict you of criminal tax fraud, the prosecutors must prove guilt beyond a reasonable doubt.

You can incur both civil and criminal penalties for tax fraud in some cases. However, in the majority of situations, if someone doesn't file a tax return, neither of those things will happen. Instead, you will just face failure to file penalties, late payment penalties, and interest when you finally do file. 

Remember, with both civil and criminal fraud, the government must establish that you willfully intend to defraud the government. Just making a mistake, forgetting to file, or failing to pay your taxes is not tax fraud.

Civil Tax Fraud Penalties for Underpayment of Tax

If you do not pay a tax due to fraud, the IRS can assess a 75% civil fraud penalty based on Title 26 U.S. Code § 6663. For example, if the government determines that you fraudulently failed to pay $100,000 in tax, the penalty will be $75,000. With a jointly filed tax return, the government will only assess the penalty on the spouse(s) who committed fraud.

Again, to be considered fraudulent, your acts must include a willful attempt to defraud the government. In order for the IRS to prove this, such examples might include :

• Purposefully avoiding recordkeeping
• Hiding or omitting income or assets
• Destroying or altering books, logs, receipts, or other records that could be used as evidence.
• Lying to IRS agents during an audit investigation.
• Keeping separate books for a business.
• Claiming a deduction for a dependent that doesn't exist or that you know you're not entitled to claim.
• Using a false Social Security Number
• Utilizing cash only to conceal income.
• Using offshore entities, shell accounts, or trusts to hide income

In most cases, if the IRS proves that a part of the tax underpayment was due to fraud, it will assume that the whole tax understatement is attributed to fraud unless you the taxpayer can prove them wrong.

Civil Fraud Penalties for Failure to File

If the IRS establishes that your failure to file was fraudulent, you can face a civil penalty of 15% of the unpaid tax per month, and the penalty can get up to 75%. 

Title 26 U.S. Code § 6651 outlines that the failure-to-file penalty is usually 5% of the unpaid tax per month, up to 25%, but it also notes that these penalties increase to 15% and 75% respectively in cases of fraud.

For example, let's say that you haven't filed for several years, and the IRS issues substitutes for returns (SFRs) for the years you didn't file. The SFRs show a total tax due of $250,000. You don't dispute the SFR or file your own returns, and the IRS moves forward with assessing the tax liability. 

If the IRS applies a civil fraud penalty, it will be $187,500 (assuming that all of your returns are at least five months late). That gets added to your tax liability, and the agency also backdates interest to the original due dates of the returns. Now, you're facing a tax liability that is likely more than double the original bill.

Criminal Tax Fraud Penalties

If your actions rise to the level of constituting criminal tax fraud, the penalties include jail time and fines that vary based on the type of fraud. 

Here are the main types of criminal tax fraud, their associated statutes, and the maximum penalties. Note that penalties can stack so if you are convicted of multiple counts of tax fraud or evasion, you can face much more significant penalties and longer prison terms.

Keep in mind that all of the acts listed below may also be classified as civil fraud and subject to civil fraud penalties. The difference is the burden of proof.

Willful attempt to evade tax - Title 26 USC § 7201 is the only tax fraud statute that addresses tax evasion. If found guilty, you can face up to five years in prison and a penalty of up to $250,000 for individuals and up to $500,000 for corporations. Proving tax evasion can be difficult, so prosecutors often pursue charges related to other tax fraud statutes.

Failure to collect or pay over tax - If you're supposed to collect a tax and you don't (for example payroll taxes for your employees or excise taxes), you can face fraud charges based on Title 26 USC § 7202. You can also incur these charges if you collected but didn't pay the tax. The penalty is up to five years in prison and fines up to $10,000.

Failure to file returns, supply information, or pay tax - Statute 7203 can lead to misdemeanor charges if you don't file a return, and the penalty is up to one year in prison and a fine of up to $25,000 for individuals and $100,000 for corporations. 

This statute also applies when a business fails to report a large cash transaction. Then, the crime becomes a felony and the possible prison sentence can be up to five years.

Fraudulent statements or failure to make statements to employees - Giving your employees a false W2 or refusing to give them a wage document can lead to fraud penalties of up to one year in prison and fines of up to $1,000 for each occurrence based on statute 7204.

Fraudulent withholding certificate - When you fill out a W4 for your employer, you are expected to provide the right information, and you also must update your employer if your withholding increases. Under statute 7205, you can face criminal fraud charges leading to up to one year in prison and fines of up to $1,000 for failing to meet these requirements.

Fraud or false statements - Making false statements or helping someone make false statements on a tax return or IRS form such as an offer in compromise application can be considered criminal fraud under statute 7206. Penalties include up to three years imprisonment and fines of up to $100,000 for individuals and up to $500,000 fines for corporations.

Fraudulent returns, statements, or other documents - Statutute 7207 is similar to 7206, but it usually applies when the action is a misdemeanor rather than a felony. Typically, charges under this statute occur if you provide an auditor with false information. 

The penalty is up to one year imprisonment and fines of up to $10,000 for individuals and up to $50,000 for corporations.

Misuse of information by tax preparers - If you disclose or use information obtained from clients for a tax return, you can face fraud penalties of up to one year imprisonment and up to a $1,000 fine. However, if you used the information to commit identity theft, the fine can increase to up to $100,000.

Conspiracy charges can occur if you worked with one or more other people to commit any of the tax frauds listed above. Covered under Title 18, US code § 371, conspiracy to defraud the government can lead to a punishment of up to five years in prison and a fine of up to $250,000 for individuals and up to $500,000 for corporations.

There is also a law (18 USC 3571) that allows the courts to increase the penalties listed above in certain cases. If subject to this statute, you may also be required to repay any financial gain you earned from the fraud or any loss you caused to another person due to the fraud, and sometimes, you may have to pay double this amount.

Alternatives to Civil Fraud Penalties

 A lot of actions don't rise to the level of civil or criminal fraud, and in these situations, the IRS may apply an accuracy-related penalty of 20% which can increase to 40% in certain situations.

Accuracy-related penalties are 20% of the understated tax and they apply if you understate your tax liability by the greater of 10% or $5,000. For example, say you file a return that shows $50,000 due in tax but you failed to report income that would have increased your tax liability to $60,000. In this case, you understated your tax liability by 16.7%, and thus, the IRS may decide to assess this penalty. The penalty applies to the tax that was understated, and thus, in this situation, the penalty would be $2,000.

However, if you claim a qualified business income deduction on your tax return, the standards for the accuracy-related penalty are even stricter. You can face the penalty if you understate your tax liability by the greater of 5% or $5,000. 

Here's an example, say that you were claimed the QBI, your tax return showed that you owed $19,000, but you really were supposed to owe $20,000. You have understated your tax liability by 5%, however, because the understatement is less than $5,000, you will not face this penalty.

The accuracy-related penalty also applies if you had a significant valuation misstatement of an asset that leads to an understatement of tax as explained above. A significant valuation misstatement is when you overstate the value of an asset by 200% or more. 

For example, say that your business claimed $120,000 in depreciation for a business asset, but in an audit, the IRS discovered that the asset was actually worth just $50,000. Your claim overstated the value by more than 200% and provided that this reduced your tax liability by the greater of 10% or $5,000, you can face the 20% penalty.

However, if the understatement of tax is due to the gross valuation misstatement, the penalty can increase to 40%. Gross mis-valuation occurs if you misstate the value of an asset by 400% or more. To return to the above example, that would entail claiming a $200,000 or more deduction for an asset that was only worth $50,000. 

This rule also applies to values of non-cash charitable contributions. Say you claim a deduction for art donated to a charity for $100,000, and the IRS discovers that it's worth only $20,000. Provided you meet the other criteria for an accuracy-related penalty, you can also face the 40% gross misstatement penalty. The 40% penalty can also apply to income from undisclosed foreign financial assets.

Examples of Criminal Tax Fraud

When does an action become tax fraud? When does it become criminal? There is a lot of subjectivity in relation to tax fraud, and to help you get a clearer understanding of which actions are likely to be considered criminal, take a look at a few recent tax fraud cases. 

Multi-Million Tax Refund Scheme

Three men from Florida pled guilty to tax fraud related to a tax refund scheme they operated from 2015 to 2018. Two of the men prepared tax returns for clients where they claimed refunds based on non-existent income tax withholdings, and they charged clients fees and a portion of the fraudulently claimed refund. 

They fraudulently claimed $3 million in refunds, and the IRS issued $1.5 million. Two of the men face up to five years in prison for conspiracy charges, and the third faces up to three years for obstructing the IRS in relation to the scheme.

Failure to Pay Employment Taxes

Between 2014 and 2021, the owner of a North Carolina business withheld payroll taxes from his employees' paychecks, but never remitted them to the IRS. He also failed to file employment tax returns. His actions caused a tax loss of $2.27 million to the IRS. He faces a maximum prison sentence of five years plus a period of supervised release, restitution, and monetary penalties.

Employment Tax Crimes and 401(k) Embezzlement

A woman from Maryland who ran a payroll processing company failed to pay over $2.5 million in payroll taxes withheld from employee paychecks. She also stole over $200,000 that was withheld from her employees' paychecks and was supposed to be deposited into their 401(k) accounts. 

She was sentenced to one year and one day in prison and two years of supervised release, and she was ordered to pay $2.67 million in restitution to the IRS and $207,180 in restitution to her former employees.

Tax Evasion

A Florida man evaded nearly $2.4 million in taxes when he failed to file tax returns from 2002 to 2018. He used trusts and multiple bank accounts to hide income from the IRS, and in 2019, when the IRS was investigating the situation, he tried to thwart their actions by forming a new entity to operate his business. 

Note that in this situation, there wasn't just a failure to file. The defendant took specific actions to evade the payment of taxes. For his actions, he faces a maximum penalty of up to five years in prison plus supervised release and monetary penalties.

In another tax evasion case, a Connecticut man failed to report $1.4 million in income over three years. To hide his income, he cashed the checks he received from his clients and spent the cash. He caused a tax loss of about $377,000, and he now faces up to five years in prison, supervised release, restitution, and monetary penalties.

FAQs About Tax Fraud Penalties

Does tax fraud lead to jail time?

Criminal tax fraud can lead to a prison sentence. Civil tax fraud does not lead to jail time.

How long do you go to jail for tax fraud?

You can face up to five years in prison for a single count of tax fraud, but you may face a longer sentence if you are convicted of multiple counts of tax fraud. Civil tax fraud does not lead to any jail or prison time.

Is IRS fraud a felony?

IRS tax fraud can be a felony, but it's often a misdemeanor. In most cases, tax fraud is considered to be a civil act that does not lead to jail time or criminal charges.

What are tax fraud penalties?

The IRS may impose civil penalties of 75% of the unpaid or unreported tax. Criminal tax fraud can lead to up to five years in prison and penalties of up to $250,00 for individuals and up to $500,000 for corporations. You may also be ordered to pay restitution. Prison terms can be longer if you're convicted on multiple counts.

What is the difference between tax fraud and tax evasion?

Tax evasion is one type of tax fraud. Tax fraud includes all willful attempts to provide false or fraudulent statements to the IRS. 

Did I commit a tax crime?

To be classified as fraud, your actions must have been willful, and to convict you of a crime, the government must establish proof beyond a reasonable doubt. If you aren't sure whether your actions were criminal or not, check out this guide to tax crimes and penalties.

Contact a Tax Attorney Today

If you have committed tax fraud, you need a tax attorney to represent you in front of the IRS. Whether you are facing criminal or civil fraud charges, an attorney can help you deal with the IRS or legal investigation and represent you in criminal or Tax Court if necessary. 

A tax attorney can also help you apply for the Voluntary Disclosure program if that is the right option for your situation. Voluntary disclosure is when you come clean to the IRS before they start an audit or a criminal investigation, and this may allow you to avoid criminal charges. But it's not the right option for anyone.

In many cases, you may be worried that you committed fraud, but your actions may not have risen to the level of criminal or civil fraud. An attorney can advise you on the right steps to take in this situation as well. 

Resources:

https://www.law.cornell.edu/uscode/text/26/6663

https://www.law.cornell.edu/uscode/text/26/6651

https://www.irs.gov/payments/accuracy-related-penalty