Title 26, United States Code, Section 7201 makes attempting to evade or defeat tax a crime, and provides as follows:
Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.
In order for the government to achieve a conviction under § 7201, it must prove the following three elements beyond a reasonable doubt:
- an affirmative act constituting an attempt to evade or defeat a tax or the payment thereof,
- an additional tax due and owing, and
- willfulness.
Tax Evasion
The first element the government must prove in a § 7201 case is that the individual committed an affirmative act in an attempt to evade or defeat the assessment or payment of tax due and owing.
Section 7201 makes it a crime to attempt, “in any manner,” to evade or defeat tax. In order to prove the evasion of assessment and/or payment of tax, the government must show that an individual acted purposely to avoid assessment of their true tax liability or to hide assets. Simply failing to file a tax return does not meet the affirmative act requirement.
The manners by which an individual can attempt to evade are seemingly limitless. However, for tax evasion purposes, any act meant/designed to deceive or hide, establishes an affirmative attempt to evade tax. Even a legal act, such as changing status to that of an independent contractor, can establish an affirmative act, if the individual commits the act with the intent to evade tax.
The government must show one affirmative act for each count of tax evasion. It is essential that an affirmative act be committed during the period alleged in the indictment.
Attempt to Evade Assessment
To evade assessment of tax, an individual usually acts in a manner that will prevent determination of their true tax liability. The filing of a false tax return is the most common practice in attempt to evade or defeat assessment of a tax cases.
Although, the possibilities for affirmative acts designed to deceive or hide in an attempt to evade assessment of tax are limitless, some examples are as follows:
- keeping a double set of books,
- utilizing/preparing false invoices or documents,
- destruction of relevant records,
- concealment of income,
- concealment of sources of income,
- providing false statements to agents,
- instructing employees not to talk to IRS agents,
- using a warehouse bank and depositing income to the warehouse bank,
- paying employees in cash and not reporting their wages to the IRS, and
- use of independent contractor agreements to eliminate withholding.
Even a false statement on an application for an extension of time to file a tax return stating that no tax is owed for the year is sufficient to meet the affirmative act requirement.
Attempt to Evade Payment
To evade payment of tax, an individual usually hides assets from which payment can be collected. In evasion of payment cases, the evasion generally occurs after the existence of a tax due and owing.
The affirmative acts related to evasion of payment cases generally involve some form of concealment of the individual’s ability to pay the tax due and owing and/or the removal of assets from which payment can be obtained by the government.
However, simply refusing to pay taxes, even though one has the money needed to pay the tax, without affirmative acts to evade, does not establish grounds for an evasion of payment charge.
Examples of affirmative acts of evasion of payment include:
- placing assets in the names of others,
- using bank account(s) in the name of others,
- opening/using bank accounts with false identifying information such as social security number, place of birth, and/or date of birth,
- dealing only in currency,
- maintaining a “cash lifestyle”-no credit cards, no assets, and no bank accounts;
- not maintain business accounts or records,
- using other’s credit cards,
- directing one’s income to be paid to others,
- directing one’s debts to be paid by others,
- signing and submitting false financial statements to the IRS,
- placing precious metals, gems, jewelry, and currency in safety deposit boxes under a false name, and
- removing currency from the United States and laundering it through foreign bank account.
Additional Tax Due and Owing
The second element the government must prove is a tax deficiency. A tax deficiency arises on the date that the return is due, if an individual fails to file a tax return and the government can show a tax liability. A deficiency is the amount by which the tax imposed by statute exceeds the sum of the amount of tax shown on the return, plus the amount of any previously assessed deficiency, minus any payment/credit previously collected.
If the government cannot prove a tax deficiency, they cannot prove a tax evasion case.
The tax deficiency element, which must be established in all § 7201 cases, is easier proved in an evasion of payment case since filing of the return is a self-assessment of the tax. However, an assessment of tax is not necessary; the tax obligation arises by operation of law.
It should be noted that the government is not required to address a tax liability civilly or administratively prior to causing the filing of criminal charges of evasion of payment of tax.
Unit of Prosecution
Federal income taxes are paid on a yearly basis, therefore, most evasion of assessment cases charge each year as a separate offense.
Evasion of payment cases typically involve single or multiple acts that demonstrate a pattern of conduct fashioned to evade the payment of taxes over several years. Therefore, the government may charge one count of attempting to evade tax due and owing for multiple years.
Substantial Tax Deficiency
The government does not have to provide or prove the exact amount of the tax due and owing in a tax evasion case. It is sufficient for the government to prove that an individual attempted to evade any income tax, whether substantial or insubstantial.
Unreported Income
To determine unreported income, the government must follow the same method of accounting used by the individual. Similarly, a depreciation method utilized by an individual during the years in question, cannot then be changed to another depreciation method to support their defense.
To prove unreported income, the government will utilize one or more of the following methods:
- The specific items method includes direct evidence of income received by an individual in a given year, which can include records and/or testimony by third parties as to money paid to the individual for goods or services.
- The net worth method is indirect proof of income through measurement of increases in the wealth of an individual and comparing the results with reported income.
- The expenditures method is indirect proof that focuses on the expenditures made by an individual. This method is applicable for an individual who does not purchase assets, such as stocks and real estate, but spends money on expendable items, such as travel, entertainment, food, drink, hobbies, et cetera.
- The cash method is indirect proof through which a comparison is made of an individual’s cash expenditures with their known cash sources, including cash on hand, for each tax period. If the expenditures exceed cash sources, the excess is alleged to be unreported income.
- Finally, the bank deposits method is indirect proof through reconstruction of income through an analysis of bank deposits by an individual who makes regular and periodic deposits to bank accounts.
Loss Carry Back
A loss carryback is an acceptable accounting technique, through which a company applies net operating losses to a preceding year’s income in order to reduce tax liabilities present in that preceding year; however, it is not a defense for a falsely filed tax return. Each year is treated as its own unit; therefore, any adjustment from a loss in a subsequent year does not change any fraud committed in an earlier year.
Sources of Income
Due to the illegality of the action from which the funds were received, individuals customarily avoid reporting income, and thus avoid payment of tax, from sources such as:
- embezzlement,
- extortion,
- fraud,
- kickbacks,
- bribery, and
- narcotics trafficking.
Willfulness
Willfulness is the third element that the government must prove in a tax evasion case. In the context of tax evasion cases, willfulness means that the defendant knew what the law required, and voluntarily and intentionally violated the law.
Some examples of willful intent, in tax evasion cases, are apparent in their design to deceive or disguise:
- providing a tax return preparer with false or incomplete information to prepare an income tax return,
- a pattern of underreporting income,
- hiding or destroying books and/or records, utilizing false documents, and
- false statements to agents.
Others examples of willful intent are less apparent, but can nonetheless support the element of willfulness:
- placing property or a business in the name of another,
- extensive use of currency or cashier’s checks,
- cashing checks and depositing currency in an out-of-state bank,
- an individual’s stand on the reporting and payment of taxes, and
- the educational background and experience an individual.
Venue
The venue, for purposes of § 7201, will occur in any district in which an affirmative act of the alleged offense occurred.
Statute of Limitations
The statute of limitations for a § 7201 prosecution is six years. While there is significant discussion as to when the period of limitations starts, a good measure is from the date of the last action taken in furtherance of the alleged offense, the result of which is a tax deficiency.