Fraud and Tax Crimes: Do You Really Have to Worry?

It is a crime to cheat on your taxes. In a recent year, however, fewer than 2,000 people were convicted of tax crimes —0.0022% of all taxpayers. This number is astonishingly small, taking into account that the IRS estimates that 15.5% of us are not complying with the tax laws in some way or another. The number of convictions for tax crimes has increased less than 1% over the most recent five-year period.

The point is that the statistical likelihood of your being convicted of a tax crime is almost nil. Nevertheless, if you are in the unlucky minority of people criminally investigated by the IRS, you need more than this book. Hire the best tax and/or criminal lawyer you can find.

According to the IRS, 75% of the tax cheating is done by individuals—mostly middle-income earners. Most of the rest of the cheating is done by businesses. Cash-intensive businesses and service providers, from self-employed handypeople to doctors, are the worst offenders.

How People Cheat on Their Taxes

Most cheating is from deliberate—actual or willful—underreporting of income. This is called tax evasion—the most commonly charged tax crime. A government study found the most underreporting of income was by self-employed restaurateurs, clothing store owners, and—you’ll no doubt be shocked—car dealers. Telemarketers and salespeople came in next, followed by doctors, lawyers (heavens!), accountants (heavens, again!), and hairdressers.

Business owners who over-deduct business-related expenses—such as car and entertainment—came in a distant second on the cheaters hit parade. Surprisingly, the IRS contends that only 6.8% of deductions are overstated or just plain phony.

If You Are Caught Cheating

Tax crimes are most likely to be first spotted during an audit. If you are caught in a tax lie by an auditor, she can either slap you with a penalty or refer your case to the IRS’s criminal investigation division (CID). In the vast majority of cases, the auditor won’t call in the CID.

The Auditor Suspects You of Fraud

Auditors are trained to look for signs of tax fraud, which is a form of tax evasion. Tax fraud is defined as a willful act done with the intent to defraud the IRS—that dark area beyond honest mistakes. Using a false Social Security number, keeping two sets of financial books, or claiming a blind spouse as a dependent when you are single are all blatant examples of tax fraud. While auditors look for fraud, however, they do not routinely suspect it. They know the tax law is complex and expect to find a few careless mistakes in every tax return. They will give you the benefit of the doubt most of the time.

Even if the auditor does not refer suspected fraud to the CID, she can impose fines, called civil penalties, if you omitted a chunk of income on your tax return. Overstated or phony deductions and exemptions can also be punished by the fraud civil penalty—for example, claiming exemptions for dependents who have long since left home, died, or were never born. Fraud penalties can also be added for exaggerating deductions, such as adding a zero to $200 making it $2,000, or by claiming a casualty loss for a nonexistent accident.

Fraud or Negligence?

A mistake on your tax return might get you a 20% penalty tacked on to your tax bill. While not good, this sure beats the cost of tax fraud—a 75% civil penalty. The line between negligence and fraud is not always clear, however, even to the IRS and the courts.

Auditors are trained to spot common types of wrongdoing, called “badges of fraud.” Examples include a business with two sets of books or without any records at all, freshly made false receipts, and checks altered to increase deductions. Altered cancelled checks are easy to spot by comparing written numbers with computer coding on the check or bank statements.

The Internal Revenue Manual directs auditors suspecting criminal tax fraud to contact the IRS criminal investigation division, or CID. In reality, auditors make very few criminal referrals. Making a fraud referral is too much paperwork. If auditors find a couple of obviously phony receipts, they usually will quietly disallow them and move on. Fraud referrals are more often made in special project audits. These are targeted audits of particular industries and professions, such as building contractors or chiropractors.

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The auditor will not tell you if she has made a criminal fraud referral. One indication, however, may be an audit stopping midstream for no apparent reason. But never assume a fraud referral was made just because months pass and you don’t hear from the auditor. She is probably just behind in her work.

Indirect Methods of Proving Fraud

Direct proof of fraud by the IRS typically consists of finding clearly overstated or phony deductions and exemptions. Direct proof is not usually found by the IRS for income underreporting. Instead, the IRS relies on primarily four indirect methods.

Specific items. If you cashed a check received by your business and pocketed the money without entering it in your books, this check is a “specific item.” It can be viewed as evidence of fraudulent intent. If the auditor suspects fraud, she may talk to your business’s customers to compare your bank account deposits and actual payments you received from customers.

The IRS wants more than just one specific item to make a fraud case—unless the item was for many thousands of dollars. While you might argue that one or two items were negligently left off the books (or your computer crashed or you lost your records), 15 or 20 omitted items shows a pattern of fraud.

Bank deposits. This is the IRS’s favorite indirect method to prove unreported income, because it is so easy. The auditor simply adds up all deposits in your bank accounts. If the total exceeds your reported income, you may be suspected of fraud.

There may be a perfectly legitimate explanation, such as nontaxable sources of bank deposits—loans, gifts, inheritances, sales of assets, and tax-exempt income, such as municipal bond interest. Also, transfers from one bank account to another appear to be multiple deposits under this simplistic method. Point this out to the suspicious auditor. Or, deposits in your accounts may belong to relatives or friends who did not use their own accounts for some reason.

Expenditures. The auditor calculates your living expenses by totaling up the credit charges you paid, checks you wrote, and adding known or estimated expenses you paid by cash. If the total is greater than your tax-reported income, the auditor will suspect fraud. Auditors can refer to statistical reference books showing average costs of various necessities such as food and shelter in your community.

To counter this, explain where you got the money to pay your bills. It could be savings from prior years, selling assets, or receiving loans or gifts. To figure your living expenses, auditors often ask you to complete IRS Form 4822, Statement of Annual Living Expenses.

tip

Never fill out IRS Form 4822 listing your living expenses. Just say you didn’t keep track of every penny you spent for the year and don’t want to guess. Or, diplomatically tell the auditor you will consider it and then throw the form away. The IRS cannot punish you for refusing to fill out this form. If an auditor is intent on proving fraud, he will do it with or without your cooperation. Don’t do his job for him.

Net worth. Under this indirect method, an auditor adds up all of your assets and deducts all of your liabilities at the start and end of the tax year under audit. If there was an increase in your net worth—what you own minus what you owe—without an increase in income from the previous tax year, you may be suspected of fraud.

Again, there are many valid explanations as to how your net worth can increase besides unreported income. For example, you may have received nontaxable gifts or loans or inheritances. Or the auditor may have mistakenly included appreciation in his calculations.

Penalties for Civil Tax Fraud

You will probably never face criminal fraud penalties. At least 98% of the time, the IRS punishes fraud with civil penalties—fines of 75% added to the tax due. For example, if the additional tax due from fraud is $10,000, the penalty is $7,500, for a total of $17,500. Interest is added on to both the tax and the fraud penalty, starting on the date the return was due or filed, whichever is later.

Defending Against Alleged Tax Fraud

The three defenses most often raised against tax fraud allegations are cash hoard, nontaxable income, and honest mistake. Don’t expect the IRS to accept any of these defenses at face value. A skilled attorney is better able to persuade the IRS than you are. Combatting tax fraud, like brain surgery, is not a do-it-yourself project.

I lived off my cash hoard. This defense can be raised whenever the IRS uses the bank deposits, expenditures, or net worth methods of proving fraud. There is no law (not yet, anyway) against having cash of any amount buried in your back yard or kept in a safe deposit box. The IRS’s only legitimate concerns with your cash holdings are whether or not it was from taxable income, and if you reported it and paid tax on it. The IRS understandably is suspicious of people who hold large amounts of cash rather than putting it in an interest-bearing account.

I lived off a nontaxable source. The receipt of money is not always taxable income, as discussed above. You may innocently acquire tax-free wealth by gift, loans, inheritances, and other ways. This defense can be coupled with the cash hoard defense.

I made an honest mistake. If you make an error on your tax return, it is not necessarily fraud. For example, you didn’t report profit from a sale of investment real estate because you believed you had two years to reinvest the proceeds without tax consequences. In reality, the law only allows you 180 days. Because intent to cheat the IRS is required for fraud, your mistaken belief is a valid defense to a tax fraud charge—but you may have to convince a judge or jury that it really was a mistake.

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Don’t try to lie your way out of a fraud charge. If in doubt, keep your mouth closed. Lying to the IRS can make matters worse. The right against self-incrimination is guaranteed by the Fifth Amendment. You have the absolute right to remain silent before the IRS whenever there is a possibility you may be charged with a crime. Lying to an IRS employee can result in a felony conviction with up to three years in prison and a $100,000 fine.

Options When the IRS Finds Fraud

If an IRS auditor believes you’ve cheated on your taxes, she has several options.

Ignore the cheating. If the amount is small, an IRS auditor will overlook it. Typically, an auditor just wants the file closed and off her desk—particularly if she has found other significant adjustments. She will likely leave it at that and never refer your file to the CID.

Impose civil penalties. IRS auditors draw the line at outrageous cheating. Most will add civil, as opposed to criminal, penalties on to your tax bill, especially if your case is deemed too small to send to the CID.

In the case of small mistakes, an auditor can add a 20% penalty to your bill if she finds that your tax error was “accuracy related.” If she concludes you owe an additional $1,500 of taxes, she can add a penalty of $300, bringing the bill to $1,800. The IRS imposes civil penalties about 25 million times each year.

If the auditor finds more serious misdeeds, however—particularly if your omission or overdeduction was fraudulent—she could add a 75% penalty, bringing your $1,500 tax bill to $2,625. And, interest will be added to both the penalty and the taxes.

Begin a criminal investigation. If the IRS suspects that you have gone too far, the CID can investigate.

The CID usually gets information that leads to an investigation from one of the following sources:

  • referrals from other IRS divisions, most often from auditors who discovered unreported income during an examination
  • tips from law enforcement agencies —the IRS isn’t concerned with the nontax crime itself, often a drug-related offense, but whether or not the illegal income was reported.
Example:

When Morgan was arrested for suspected drug trafficking, $150,000 in cash was in his car’s trunk. After his arrest, the local police notified the IRS. The CID looked at Morgan’s last few tax returns, where he reported only $35,000 of income per year. The CID immediately began a formal investigation.

  • tips from citizens—Ex-spouses or disgruntled employees and business associates often contact the IRS. These people are called squeals. The CID usually follows up only on well- documented tips. Many allegations are not provable and are motivated by spite, and the CID doesn’t waste its time on them. It may refer the case to the examination division, however.
  • IRS undercover or sting operations—CID agents often pose as buyers of businesses to find off-the-books income. Unwary sellers who brag about second sets of books and how much cash the business takes in get nailed. Other undercover operations investigate gross discrepancies in reported income and a taxpayer’s lifestyle. This is how the U.S. government finally got Al Capone!
Example:

Roy owned a rather seedy looking pawn shop and was featured in a local newspaper article on successful businesspeople. Roy proudly posed for the paper in front of his waterfront home and Rolls Royce. Soon thereafter, Roy was audited. The IRS wanted to know how someone lived so well while reporting only $20,000 a year income. The audit turned into a lengthy CID investigation. Two CID agents pored over six years of Roy’s financial records, business and personal. Eighteen months later, Roy was indicted for criminal tax evasion.

At the conclusion of the criminal tax investigation, the CID has two options—drop it forever or recommend that the Justice Department prosecute. The IRS, a part of the Treasury Department, cannot directly prosecute anyone. If the investigation is terminated without prosecution, it doesn’t mean you’ve gotten off completely. Your case will be sent to an auditor, who can impose civil fraud penalties.

You will be pleased to know that in the great majority of investigations, the CID does not recommend prosecution. The Justice Department will prosecute only a select few cases. Therefore, the CID won’t waste its time referring (and in some cases even seriously investigating) a case unless it feels it has a sure winner.

If the CID does recommend prosecuting and the Justice Department gets a conviction, you can be imprisoned, put on probation, fined, or all three. For example, if you’re convicted of failing to file a tax return for three separate years, you can be sent to prison for one year and fined up to $25,000 for each year you didn’t file. The total could be three years in prison and $75,000 in fines. You will also have a permanent criminal record.

That’s not all. After a criminal conviction, an auditor will slap civil fraud and other penalties for underpayment of taxes. Combining criminal and civil punishment does not constitute double jeopardy—a constitutional guarantee against being tried, convicted, or sentenced more than once for the same crime.

If you are prosecuted but not convicted, you will nonetheless probably be audited.

IRS Criminal Investigations

The criminal investigation division, or CID, is the IRS police force. It’s made up of 4,500 employees, based in Washington, DC. Investigators are called special agents. They don’t wear uniforms, but they do carry badges and have guns. Make no mistake—they are detectives highly trained by the IRS and FBI. If someone identifies himself as an IRS special agent, you or someone you know is under suspicion. Most special agents travel in pairs, for their protection and to corroborate oral evidence gathered during an investigation.

The CID is divided into general and special enforcement sections. Special enforcement targets organized crime, drugs, and unions. General enforcement watches ordinary taxpayers and everything else.

Will You Know If You’re Being Investigated?

Unless and until you are formally charged, you may not know that you’re being investigated by the CID. The IRS does not have to tell you, but often does. A friend, an employee, your accountant, your tax preparer, your lawyer, or anyone else contacted by the IRS during the investigation might tell you first. The IRS cannot legally swear these people to secrecy.

You might be able to find out indirectly if you are under investigation. When a criminal investigation begins, IRS personnel must complete and file Form 4135, Criminal Control Notice. This data is entered into your master file in the IRS computer. Your tax account is frozen, meaning that no refunds can be made or payments credited to your account.

To find out if Form 4135 has been filed, send a token tax payment for a year you believe is under investigation—even if you’ve paid the tax already. If a freeze is in effect, you may receive notice that your payment is being held in a suspense account. Also request a computer printout of your account for any year in question by calling 800-829-1040 or visiting your local IRS office. The printout may indicate a Form 4135 filing or show that the payment was not credited to your account without explanation.

Alternatively, the IRS may never send your requested statement if it has a criminal investigation freeze code in the computer. If you call on the phone to find out, IRS employees are told to not answer if you ask whether or not a Form 4135 has been filed.

How Special Agents Conduct Investigations

In a recent year, 4,300 individuals were criminally investigated by the CID. Only if the IRS has strong indications of wrongdoing does it send out its elite police. Cases involving less than $20,000 in taxes are rarely investigated. Criminal investigations start with a special agent interviewing the taxpayer’s friends, business associates, professional advisers, and anyone else who might have information. Later on the special agents usually invite the targeted individual to speak to them.

CID investigations work in the reverse order of regular detective probes. “Columbo,” “NYPD Blue,” or “Miss Marple” start with a dead body—and then figure out whodunnit. Step 1 is the crime; Step 2 is finding the culprit. This is the standard solving-the-mystery approach.

In contrast, IRS investigations begin with an allegation from a source, usually an IRS auditor, collector, or informant, that a tax crime may have been committed by you. Then special agents work at building a case against you. Step 1 is the suspect; Step 2 is finding the crime. Special agents are good at their work, too; they are among the best trained of all federal employees (FBI Academy). And they have the full resources of the federal government behind them.

Contacting Everyone Around the Target

CID investigations are unbelievably thorough, often taking a year or more. The IRS spends more time investigating a criminal tax case than other police departments devote to murder cases. This intensive use of federal resources explains why so few people are charged with tax crimes. The CID recommends prosecution only when it has built a rock solid case.

If you are under investigation, the special agent may talk to your friends, family, neighbors, coworkers, employees, business associates, bankers, insurance agents, and even travel agents and department stores. Even your spouse may be contacted. Your mail may be monitored, in cooperation with the Postal Service. While the IRS can’t open mail, it follows leads from return addresses. The CID may get copies of bills from phone and credit card companies, trail suspects, or get a court order authorizing a phone tap.

Special agents subtly intimidate businesspeople and bankers into giving information. Don’t expect even your most trusted advisors to protect you if the CID comes calling. Even your accountant can be compelled by the IRS to give criminal evidence against you.

Attorney-Client Privilege

In a criminal matter, the only person who can’t be forced to speak about you to the IRS is your lawyer. This is a special relationship given protection under the law—called the attorney-client privilege. Your lawyer cannot disclose to the IRS anything you tell her that relates to a criminal tax matter. And, if an accountant is employed by your attorney to help her render legal advice, the accountant’s work also falls under the attorney-client privilege and cannot be disclosed to the IRS in a criminal matter. The limited tax practitioner–client privilege does not extend to criminal tax matters.

When IRS Special Agents Contact Your Associates and Friends

If you’re contacted by IRS special agents about another person, be wary. Don’t answer any questions if there is any possibility you could be connected to the individual under probe, such as a business partner. And read “connected to” broadly. If you worked as the manager in a shop and the owner is under investigation, you may not yet be a suspect, but there’s a chance you will be. Keep quiet until you speak to a lawyer.

In any event, never lie to the CID. The law does not allow you to protect others by withholding information or lying. It is legal, however, to tell someone that the IRS was asking about them.

If someone tells you that she has been contacted in an IRS criminal investigation of you and asks you what to say, don’t give her any suggestions. It is a separate crime to ask someone to lie to the IRS. Also, resist the urge to call the CID and ask what’s going on. Instead, call a tax or criminal lawyer fast. Let them call the IRS.

If the CID Contacts You

If the CID is building a case against you, chances are you will be the last person interviewed. By the time the CID agents contact you, they may have looked at thousands of records and spoken to 20 potential witnesses—your banker, ex-spouse, accountant, former employees, and others with knowledge of your financial affairs. If the CID still wants to talk to you, more than likely you are about to be recommended for prosecution. The only purpose for the CID questioning you is to get a confession or other damaging admission—the icing on the IRS’s cake.

Once you’re contacted as the target of an investigation, a special agent must tell you so immediately. He must read to you a version of the Miranda rights—the right to remain silent, the right to have an attorney, and the warning that anything you say can be used against you. Believe him, it will be. Answer only the question, “Are you August Fondue?”

It is highly unlikely that you’ll be arrested on the spot or even invited to go to the IRS office. Simply state that you want to contact an attorney and that someone will get back to them. Don’t call an attorney while the special agents are present, unless they threaten you with immediate arrest, or something similar, if you don’t cooperate. Wait until they leave, you have calmed down, and you can speak freely. If you don’t know a criminal-tax attorney, see Chapter 13 for tips on finding one.

How about trying to talk the special agents out of pursuing their case against you? Forget it—it’s a terrible mistake. It makes no difference to them if your mother is dying, you have money problems, or your marriage is falling apart. Mentioning your problems, only strengthens the IRS’s position; giving an excuse often shows that you knew what you did was wrong. Similarly, don’t lie. Lying is as serious a crime as tax evasion.

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Keep your mouth shut—take this advice seriously. If you give the CID agents any opening, you’re dead. They’ll start with soft background questions, but before you know it, will have trapped you. And many CID questions won’t be genuine—that is, the special agents already know the answers and are asking only to see if you will lie or confess.

Questions typically asked by CID agents include:

Have you reported all of your income?

Where are your bank accounts and safe deposit boxes?

Can you tell us about the cars, boats, planes, and real estate that you own?

Do you gamble?

What is the procedure for reporting sales in your business?

Do you keep a lot of cash on hand?

Who are your business associates?

Have you traveled out of the country recently?

Have you or any of your businesses been audited?

Faced with a barrage of questions from two trained agents who show up unannounced, most people fall apart. They either blurt out a confession or a transparent lie within five minutes. This gives the Justice Department the rope to hang them with.

IRS Considerations in Deciding Whether or Not to Recommend Prosecution

The CID’s chief considerations in deciding to recommend prosecution is how strong a case it has. If you were caught red-handed or confessed, you can be sure of prosecution. But remember—for any crime, including a tax crime, the government must prove your guilt beyond a reasonable doubt. If you keep your mouth closed, a good criminal-tax lawyer may be able to mount a decent defense. As a general rule, if you have some facts in your favor, the IRS may not recommend prosecution and impose civil penalties (fines) instead.

The IRS looks closely at the case’s publicity value—locally or nationwide. A prominent local doctor or movie star is a juicy plum. The agency firmly believes that front-page headlines make would-be tax cheaters think twice.

The CID also analyzes personality traits of the individual target, including age, physical and mental health, and previous criminal record. How would a jury react to the person? Leona “Only the Little People Pay Taxes” Helmsley was no doubt selected for prosecution because the IRS guessed she’d be an unsympathetic figure. The judge and jury (and most Americans) obviously agreed.

Finally, the CID looks at the amount you cheated the government out of. The larger your indiscretion, the more likely the agents will recommend prosecution. The typical amount of taxes owed in criminal cases is over $70,000 and covers three or more years of cheating.

The bad news: When the CID recommends prosecution, and the Justice Department accepts the case, the chances of conviction are at least 80%. More than half of the people convicted go to prison even if they have no prior criminal record.

The good news: The government is quite concerned with maintaining this high rate of conviction. For every two people prosecuted, another one person under suspicion is passed by or just tried in a civil proceeding.

Crimes With Which You Can Be Charged

If the CID recommends prosecution, it will turn its evidence over to the Justice Department to decide the special charges. Individuals are typically charged with one or more of three crimes: tax evasion, filing a false return, or not filing a tax return.

Tax evasion or fraud. Tax evasion is defined as “intentional conduct to defeat the income tax laws.” Any sort of tax scheme to cheat the government can fall into this broad category. Tax evasion is a felony, the most serious type of crime. The maximum prison sentence is five years; the maximum fine is $100,000. (Internal Revenue Code § 7201.)

Filing a false return. Filing a false return is what it sounds like. Your tax return contained a material misstatement, such as describing your line of work as bricklaying when you are a bookie. More people are charged with filing a false return than with tax evasion because in a filing-a-false-return case, the government does not have to prove an intent to evade the income tax laws—only an intent to file a false return. Filing a false return is a less serious felony than tax evasion that carries a maximum prison term of three years and a maximum fine of $100,000. (Internal Revenue Code § 7206 (1).)

Failure to file a tax return. Not filing a return is the least serious tax crime. It’s defined as intentionally failing to file a return when you were obligated to do so. Not everyone must file tax returns. For example, only those people earning above a specified amount must file. The minimum changes from year to year. Not filing a tax return is a misdemeanor. The maximum prison sentence is one year in jail and/or a fine of $25,000 for each year not filed. The vast majority of nonfilers are never prosecuted criminally, and only hit with civil fines.

Although technically not tax crimes, the CID also investigates and can recommend prosecution for money laundering and filing false claims against the IRS. Typically, these crimes are charged in the same case along with tax crimes against the same individual or entity.

If You Are Prosecuted

Once the Justice Department receives a file recommended for criminal prosecution, an Assistant U.S. Attorney reviews it. If he feels that the IRS has a strong felony case, he will seek an indictment from a federal grand jury, which usually goes along with the prosecution. You can be criminally charged for a tax misdemeanor—such as not filing a tax return—without a grand jury indictment.

If formally charged, you will either be arrested or, if you are not deemed a flight risk, ordered to report before a federal judge to plead guilty or not guilty. You might be required to post bail or be released on your own recognizance.

If you ever find yourself in this position and don’t already have a criminal or tax lawyer, get one immediately. Don’t delay, as the government has already completed its investigation. Your lawyer will need time to catch up and learn the government’s case. Keep heart; the government’s case may be legally defective, or your attorney may recognize defenses to the charges.

Should You Plead Not Guilty?

Unless you have made a plea bargain with the government before your first court appearance, you should initially plead not guilty. Remember: The IRS recommends for prosecution only those cases in which conviction seems a near certainty. Justice Department weeds these cases out even further. Therefore, it’s not surprising that over two-thirds of all defendants eventually plead guilty without going to trial.

Most of these are plea bargains, meaning the accused agrees to plead guilty if the Justice Department agrees to reduce or drop some charges, or both. For example, if you are charged with three years of tax evasion, the government may drop two years for a guilty plea to one year. Sometimes the government will also agree to a favorable sentencing recommendation. However, the final sentence will depend on a probation report, federal laws governing minimum sentences, and the judge’s discretion.

What the Government Must Prove in a Tax Case

If you don’t plead guilty, you will eventually have a trial. At the trial, the Justice Department and the IRS, working together, must prove you are guilty of the crimes charged. Essentially, the government must show you acted intentionally and that you are guilty beyond a reasonable doubt. You are entitled to a trial by a jury, or you can choose to be tried by the judge alone.

Intent. The primary element of any tax crime is intent. In legalese, this intent is called willfulness. If the government can’t prove you acted intentionally, you can’t be convicted. Put another way, you can’t be convicted of a tax crime if you only made a mistake, even if it was a big mistake. For example, if you didn’t file a tax return because you honestly believed that 65-year-olds didn’t have to file any longer, you did not act intentionally.

Before you senior citizens get carried away with this example, bear in mind that to succeed, you will have to convince a jury that your mistaken belief was honest. Given that most people remember watching their parents or grandparents fill out returns—and many people, in fact, completed those returns for their elderly relatives—you will have a hard time convincing your 12 peers that your omission was an honest mistake. More believable is a recent immigrant who did not report his income from investments made back home, which he wrongly thought was tax-exempt.

Beyond a reasonable doubt. All crimes must be proven beyond a reasonable doubt. If a judge or jury has any degree of doubt that you did what you were accused of or acted intentionally, the government’s case will fail. For instance, without additional evidence showing an intent to cheat the IRS, a juror may not believe beyond a reasonable doubt that the immigrant who omitted his foreign investment income was filing a false tax return. The reasonable doubt standard is why the Justice Department prosecutes only airtight cases.

Your Chance of Being Convicted of a Tax Crime

Not everyone charged with a tax crime is found guilty. For example, keep in mind the story of Dr. Rudy Mays, a former client whose name has been changed.

Example:

Dr. Mays worked at an inner city clinic. Over 80% of his income was from Medicare, with the rest paid mostly in cash. He was indicted for income tax evasion when the IRS found that he had reported $240,000 in total income in a year in which his Medicare income alone was $280,000.

Dr. Mays was offered a plea bargain —if he’d plead guilty, the charge would be reduced and he’d receive probation, not a prison term. But this plea bargain meant that Dr. Mays’ medical license would be revoked, ending his career. He rejected the offer and went to trial.

Dr. Mays testified that he was a man of medicine, not a businessman. He relied on his bookkeeper and accountant; he signed whatever they put in front of him. The prosecuting attorney scoffed at this defense by telling the jury that everyone bears the responsibility for the accuracy of their tax returns. The jury sympathized with the good doctor and found him not guilty.

P.S. Immediately after the trial, the IRS began an audit. Dr. Mays had to pay thousands of dollars in taxes, interest, and fraud penalties, but at least he stayed out of jail and kept his medical license.

In another case, Mr. Cheek, an airline pilot, was found guilty of tax evasion. The U.S. Supreme Court reversed his conviction. (United States v. Cheek, 498 U.S. 192 (1991).) Mr. Cheek claimed that he had formed a belief, based on materials provided by a tax protester group, that certain income tax laws did not apply to him. The trial judge told the jury not to consider this as a defense to tax evasion. The Supreme Court, however, held that his mistaken belief was a valid defense, and ordered Mr. Cheek to be retried. The question in the new trial was whether Mr. Cheek’s belief was a good-faith misunderstanding of the tax laws or was a criminal intent to evade paying taxes.

Mr. Cheek wasn’t as lucky his second time around in court as he was his first. At his new trial, Mr. Cheek raised the Supreme Court-approved defense, but was convicted by a new jury of several tax crimes, anyway. The judge sentenced him to one year and one day in prison and fined him $62,000. (Wall Street Journal, March 25, 1992.)

If You Are Convicted of a Tax Crime

If you are convicted of a tax crime after putting the government to the trouble of a trial, chances are eight in ten that you will be sent to federal prison. The Federal Sentencing Guidelines and the judge determine how long the sentence will be.

If, however, you reach a plea bargain without a trial, chances are better that you will be fined and/ or placed on probation, given home confinement, or sent to a halfway house, rather than sent to jail. Added to the fine may be the costs incurred by the government in prosecuting you.

In general, public figures are most likely to go to jail. Back in the 30s, President Hoover ordered that our income tax evasion law be used to put away the notorious Al Capone. This is the only charge ever made to stick on Scarface, who found his way to Alcatraz.

Today, instead of landing on the Rock, tax convicts are usually sent to a Club Fed minimum security facility filled with bankers, lawyers, politicians, and Wall Street sharpies. The average length of time served for a tax crime is a little less than two years. If this sounds like a breeze, think twice. Tax alumni of the federal prison system all agree that it was a humiliating and crushing experience. And licensed professionals—lawyers, doctors, stockbrokers, and CPAs—lose their professional licenses after conviction.

Phillip S. Fry, author of Pay No Income Tax Without Going to Jail, was apparently unclear on the concept. In 1986, he pleaded guilty to tax fraud and, you guessed it, went to jail. Other tax criminals with whom you are probably familiar and their prison terms include:

  • Pete Rose—five months
  • Chuck Berry—four months
  • Aldo Gucci—one year
  • Sun Myung Moon—18 months
  • Leona Helmsley—four years.

Richard Hatch failed to pay taxes on the $1,000,000 he won on the show Survivor, but he didn’t survive the IRS police; he was sentenced to 51 months in federal prison.

One of my favorite stars of yesteryear, Sophia Loren, served 17 days in jail in her native Italy for tax evasion. It appears that big stars get off lighter in Italy than in the United States. So if you’re thinking of evading taxes, maybe you want to brush up on your Italian and find a job in Venice, Florence, or Rome.

Chapter Highlights

  • Tax fraud is more than carelessness or honest mistakes and can be punished by the IRS either civilly or criminally or both.
  • The IRS seldom puts tax cheaters in jail but often imposes heavy fines.
  • See a criminal or tax attorney if the IRS is investigating you for a tax crime.