What exactly is tax evasion? You cannot turn on the news these days without hearing references to this “crime.”
Tax Evasion Defined
According to 26 USC § 7201, tax evasion:
is defined as the willful attempt in any manner to evade or defeat any tax imposed by Title 26 of the United States Code or the payment thereof;
individuals found guilty of tax evasion may be subject to penalties as defined by law;
Tax evasion is a a felony, so anyone found guilty of it will have a felony conviction on their record;
A person convicted of tax evasion may be fined not more than $100,000 ($500,000 in the case of a corporation).
A person convicted of tax evasion my be imprisoned not more than 5 years.
Could I be guilty of tax evasion?
Tax evasion can come in many shapes and forms. The tax code is expansive and complex. Individuals and businesses alike need skilled counsel to help them navigate the carefully to avoid getting into hot water. In order for the government to prove an individual or business is guilty of tax evasion, they must prove three elements beyond a reasonable doubt:
The existence of additional tax due and owing;
An attempt by the taxpayer to evade or defeat the tax;
Willfulness on the part of the taxpayer
Additional Tax Due and Owing
Proving that additional tax is due and owing can be quite complex. When entrepreneurs form a business, they can run into trouble if they start a business and do not consult with an attorney or tax professional as to the intricacies of the taxation of the revenue from the business. Taxation depend upon the entity formed for the business. If an entrepreneur starts a business and does not work with counsel to set up an appropriate entity according to their goals and appetite for risk, they may be surprised come tax time or in the event of a lawsuit. Working with experienced counsel early can help to mitigate some of these surprises.
According to a 2017 study by the Tax Foundation, the majority of companies in the US today are pass-through business entities. Several different types of entities are considered pass-through entities, but the three major categories are partnerships, limited liability companies, and S-corporations. Income generated from these types of entities is “passed through” to the owners and the owners are then required to report the business income on their personal tax returns. The business income is subject to federal, state, and local income taxes. These types of entities are attractive to entrepreneurs and investors because they “avoid” the double-taxation that a c-corporation is subject to. Additionally, owners or members of pass-through entities are also subject to self-employment and Net Investment Income taxes. The Net Investment Income Tax applies to partnership income earned by both limited partnerships and s-corporation passive shareholders. In Minnesota in 2017, pass-through entities faced up to 49.7% marginal tax rates, the second highest rate in the nation. The Tax Cuts and Jobs Act (TCJA) passed at the end of 2017 introduced a new deduction for pass-through businesses of up to 20 percent of their qualified business income. While this provides individuals with some relief, it also presents additional opportunities for individuals to try to outwit the chaos caused by tax reform to evade taxes due.
Attempt to Evade or Defeat the Tax
Attempting to evade the tax is where many get into the most trouble. People or businesses may try to evade taxes by improperly classifying expenses, improperly reporting losses, not reporting income, or not filing a tax return at all. Actor/rapper Ja Rule pled guilty to charges of failing to file tax returns for 2 years in 2011. In addition to 28 months in prison for tax evasion and other charges, he also agreed to repay $1.1 million in unpaid taxes. Another well-known example of what happens when you don’t file your income tax returns is actor Wesley Snipes. He was convicted on three counts and was sentenced to 3 years in prison.
Willfulness of Evasion
While some people just have bad luck, while others intentionally try to find ways to evade paying taxes. Willful evasion of taxes can be proven in any number of ways. Businesses who pay employees “under the table” or in cash to avoid paying employment taxes are willfully evading their tax obligations. Businesses who withhold FICA taxes from employees but intentionally fail to report and pay in such payroll taxes can be found guilty of evading taxes.
In the most recent example of tax evasion, Paul Manafort was convicted for filing a false tax return for each of the years from 2010 through 2014. There he listed fictitious loans on his tax returns to reduce his tax liability. While the IRS does provide a number of different provisions that enable businesses to claim different expenses or exemptions from taxes, willfully reporting false information will inevitably end in tax evasion charges. The movie, The Untouchables, gives audiences a great insight to the process that led to the takedown of the infamous gangster Al Capone for tax evasion charges.
Avoiding Tax Evasion
Entrepreneurs and businesses should make sure they work with reputable accountants and legal counsel to help navigate the complexities of tax law. While missteps may lead to penalties and fines, intentional falsities could have more serious consequences. To get started evaluating how your current entity formation affects your tax obligations, contact Kim Lowe at Avisen Legal.
Disclaimer: The information contained in this article is for informational purposes only and does not constitute tax advice.
For almost 20 years Kim Lowe has lawyered from the trenches. Kim lawyers from experience, using her knowledge of the law and understanding of how both for-profit and nonprofit business enterprises operate.
Rachell Henning is a third- year student at Mitchell-Hamline School of Law's innovative Hybrid program. Rachell is an Avisen Fellow who enjoys spending time with her husband and two young daughters when she is not working or studying.