# What Is Tax Fraud? Definition, Criteria, vs. Tax Avoidance

> **Definition**
>
> Tax fraud is the intentional falsification of information on a tax return to reduce or eliminate any tax liability, which can result in severe penalties, including fines and imprisonment.

## What Is Tax Fraud?

Tax fraud occurs when an individual or business entity willfully and intentionally falsifies information on a tax return to limit the amount of tax liability. Tax fraud essentially entails [cheating on a tax return](https://www.investopedia.com/articles/personal-finance/041515/how-irs-catches-tax-cheats-liars.asp) in an attempt to avoid paying the entire tax obligation. Examples of tax fraud include claiming false deductions; claiming personal expenses as business expenses; using a false Social Security number; and not reporting income.

[Tax evasion](https://www.investopedia.com/terms/t/taxevasion.asp), or illegally avoiding payment of taxes owed, may be construed as an example of tax fraud.

### Key Takeaways

*   Tax fraud involves the deliberate misrepresentation or omission of data on a tax return to avoid paying any taxes or to reduce one's total tax liability.
*   It can include not reporting income or falsely claiming deductions.
*   The government loses out on millions of dollars of tax revenue due to tax fraud. 
*   Tax avoidance or negligence is different from tax fraud, which can be punished by monetary penalties or imprisonment.

## Understanding Tax Fraud

In the United States, taxpayers are bound by a legal duty to file a tax return voluntarily and to pay the correct amount of income, employment, sales, and excise taxes.

Failure to do so by falsifying or withholding information is against the law and constitutes tax fraud. Tax fraud is investigated by the Internal Revenue Service Criminal Investigation (CI) unit. Tax fraud is said to be evident if the taxpayer is found to have:

*   Purposely failed to file their income tax return
*   Misrepresented the actual state of their affairs so as to falsely claim tax deductions or tax credits
*   Intentionally failed to pay their tax debt
*   Prepared and filed a false return
*   Deliberately failed to report all income received

A business that engages in tax fraud may:

*   Knowingly fail to file [payroll tax](https://www.investopedia.com/terms/p/payrolltax.asp) reports
*   Wittingly fail to report some or all of the cash payments made to employees
*   Hire an outside payroll service that doesn't turn over funds to the IRS
*   Fail to withhold federal income tax or FICA (Federal Insurance Contributions) taxes from employee paychecks
*   Fail to report and pay any withheld payroll taxes

## Tax Fraud vs. Negligence or Avoidance

For example, claiming an exemption for a nonexistent dependent to reduce tax liability is clearly fraud, while applying the [long-term capital gain](https://www.investopedia.com/terms/l/long-term_capital_gain_loss.asp) rate to a short-term earning may be looked into more to determine whether it is negligence.

Although mistakes attributed to negligence are non-intentional, the IRS may still fine a negligent taxpayer with a penalty of 20% of the underpayment.

> **Important**
>
> Given that the tax code in the U.S. is a complex compilation of tax imposition and laws, a lot of tax preparers are bound to make careless errors.

Tax fraud is not the same as [tax avoidance](https://www.investopedia.com/terms/t/tax_avoidance.asp), which is the legal use of loopholes in tax laws to reduce one’s tax expenses. Although tax avoidance is not a direct violation of the law, it is frowned upon by tax authorities as it may compromise the overall spirit of tax law.

## Special Considerations

Tax fraud cheats the government out of millions of dollars every year and is punishable by fines, penalties, interest, or prison time. Generally, an entity is not considered to be guilty of tax evasion unless the failure to pay is deemed intentional. Tax fraud does not include mistakes or accidental reporting, which the IRS calls negligent reporting.

## Is Tax Fraud a Big Crime?

Yes, tax fraud is a big crime that can be punishable by monetary penalties or imprisonment. According to the IRS, people who commit tax fraud are charged with a felony crime and can be fined up to $100,000 ($500,000 for a corporation), imprisoned for up to three years, or required to pay the costs of prosecution.

## How Does the IRS Know If You Cheated on Your Taxes?

The IRS uses a system, the Information Returns Process System, to determine if you cheated on your taxes. It aligns the information sent by employers and other parties to the IRS, such as your W-2 from your employer or your dividend statement from your broker, with your tax filing.

## What Triggers an IRS Criminal Investigation?

According to the IRS, a criminal investigation is triggered "when a revenue agent (auditor), revenue officer (collection), or investigative analyst detects possible fraud." Other information the IRS receives, such as from law enforcement agencies, can trigger a criminal investigation.

## The Bottom Line

Providing false information on your tax report in order to avoid paying taxes or paying less taxes than you owe is considered tax fraud. This is illegal and can result in monetary penalties, imprisonment, and other repercussions. Examples of tax fraud include not reporting certain income or falsely claiming deductions.

It is your responsibility that your taxes are done correctly. If you aren't sure how or need help, there is plenty of software that can help as well as tax professionals.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Accuracy-Related Penalty](https://www.irs.gov/payments/accuracy-related-penalty)."
>     
> 2.  Internal Revenue Service. "[The Difference Between Tax Avoidance and Tax Evasion](https://apps.irs.gov/app/understandingTaxes/whys/thm01/les03/media/ws_ans_thm01_les03.pdf)." Page 1.
>     
> 3.  United States Sentencing Commission. "[Quick Facts — Tax Fraud Offenses](https://www.ussc.gov/sites/default/files/pdf/research-and-publications/quick-facts/Tax_Fraud_FY20.pdf)."
>     
> 4.  Internal Revenue Service. "[Tax Preparer Penalties](https://www.irs.gov/payments/tax-preparer-penalties)."
>     
> 5.  U.S. Government Accountability Office. "[Tax Enforcement: IRS Can Improve Use of Information Returns to Enhance Compliance](https://www.gao.gov/products/gao-24-107095)."
>     
> 6.  Internal Revenue Service. "[How Criminal Investigations Are Initiated](https://www.irs.gov/compliance/criminal-investigation/how-criminal-investigations-are-initiated)."