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Tax fraud is a serious criminal offense, with penalties as severe as five years imprisonment, a fine of up to $250,000, or both. However, the vast majority of erroneous tax returns are not treated as fraud. In fact, the IRS estimates that 17% of taxpayers fail to comply in one way or another. However, in a recent year, just 0.0022% of the taxpaying population was convicted of a tax crime. So, what separates tax fraud from simple negligence?

What is tax fraud?
Simply put, tax fraud is the act of intentionally defrauding the government in order to not pay taxes that are legally due. Some examples of things that can be considered tax fraud include, but are not limited to:

  • Preparing or filing a false tax return.
  • Using a false Social Security number to file a return.
  • Failing to file a return if you earned taxable income.
  • Failure to pay taxes due.
  • Making a false claim on a tax return.
  • Creating or submitting false documents with a tax return.
  • Claiming exemptions for nonexistent dependents.

It's also worth mentioning that tax evasion is a type of tax fraud -- and a rather serious one. Tax evasion refers specifically to fraud that deliberately attempts to misrepresent one's taxable income, such as not declaring earned income, or not filing a tax return at all.

Tax fraud is punishable by both civil and criminal penalties, and these can be rather stiff -- particularly for evasion. As I mentioned before, committing tax fraud can result in both jail time and hefty fines.

However, tax fraud is difficult to prove, mainly because the IRS has the burden of proving that the underpayment was intentional. There are obviously some clear-cut examples of fraud, such as failing to file a return or using a fabricated (or stolen) Social Security number to file. But the majority of errors on tax returns involve miscalculations, and it's difficult to prove that numerical errors were intentional beyond a reasonable doubt.

Negligence: More common, and not a crime
The IRS realizes the tax code is complicated, and mistakes do happen. It's not uncommon to honestly mistake something as a deductible item or to make a mathematical error when calculating items on a tax return.

For this reason, the majority of errors found on tax returns are treated as simple negligence and not fraud unless there are clear signs that taxpayers deliberately attempted to misrepresent the amount of taxes they owe. Claiming exemptions for three children who don't exist is highly likely to trigger a fraud investigation. On the other hand, incorrectly typing in the amount of mortgage interest you paid is unlikely to bring any fraud charges.

Now, negligence can still cost you. Not only can the IRS send you a bill for the amount you underpaid, but you can also be assessed a fine equal to 20% of the underpayment amount. This is a stiff penalty, but it's nothing when compared to the civil and criminal penalties you could face for committing tax fraud.

Just be honest
Although many returns contain mistakes, in practice, few tax errors are actually treated as fraud. So, as long as you fill out your tax return to the best of your knowledge, declare all of your income, and pay whatever taxes you owe, the chances of being accused of tax fraud are extremely low. The bottom line is to make sure your tax return is accurate, and you should have nothing to worry about.