Can You Go to Jail for a Tax Audit? Criminal vs Civil Tax Investigations

Civil Audits: Tax, Interest and Penalties

An audit examines whether a return is correct. Honest mistakes and careless errors are civil matters. The consequences can include additional tax, interest and civil penalties, such as the 20% accuracy-related penalty under section 6662.

If part of an underpayment is due to fraud, a civil fraud penalty of 75% of that portion can apply under section 6663. Under section 7454(a), in any proceeding involving whether a taxpayer committed fraud with intent to evade tax, the burden of proof is on the IRS. A civil fraud determination remains civil: it results in a penalty, not a criminal conviction.

The Main Criminal Tax Offenses

• Tax evasion (section 7201). A willful attempt in any manner to evade or defeat any tax or its payment is a felony punishable by up to five years in prison and a fine of up to $100,000 ($500,000 for a corporation), plus the costs of prosecution. Under the general federal fine statute, 18 U.S.C. 3571, the maximum fine for a felony can be higher, up to $250,000 for an individual or an alternative amount based on twice the gross gain or loss.
• Willful failure to file, pay, keep records or supply information (section 7203). A misdemeanor punishable by up to one year in prison and a fine of up to $25,000 ($100,000 for a corporation).
• False return (section 7206(1)). Willfully signing a return under penalties of perjury that the person does not believe to be true and correct as to every material matter is a felony punishable by up to three years in prison and a fine of up to $100,000 ($500,000 for a corporation).
• Structuring (31 U.S.C. 5324). Breaking up cash transactions to evade currency transaction reporting requirements is a separate federal crime punishable by up to five years in prison.

Under section 6531, the general limitations period for criminal tax offenses is three years, but it is six years for many common offenses, including tax evasion, willful failure to file a return or pay tax, and filing a false return.

Willfulness: The Dividing Line

What separates a civil tax problem from a crime is willfulness. In Cheek v. United States, 498 U.S. 192 (1991), the Supreme Court described willfulness as the voluntary, intentional violation of a known legal duty. The Court held that a good-faith misunderstanding of the law negates willfulness even if the belief is not objectively reasonable, but that a defendant’s view that the tax laws are invalid is not a defense.

For evasion, the Supreme Court in Sansone v. United States, 380 U.S. 343 (1965), identified the elements as willfulness, the existence of a tax deficiency, and an affirmative act constituting an evasion or attempted evasion. In Spies v. United States, 317 U.S. 492 (1943), the Court gave examples of conduct from which a willful attempt may be inferred, including keeping a double set of books, making false entries or false invoices, destroying records, concealing assets or covering up sources of income, and handling one’s affairs to avoid making the records usual in such transactions.

How Criminal Investigations Begin

IRS Criminal Investigation (CI) investigates potential violations of the Internal Revenue Code, the Bank Secrecy Act and money laundering statutes. According to the IRS, investigations can begin with information from within the IRS when a revenue agent, revenue officer or investigative analyst detects possible fraud, and with information from the public, other law enforcement agencies and U.S. Attorneys’ offices. Cases pass through more than one level of CI review before a subject criminal investigation is opened, and in a tax case a prosecution recommendation is forwarded to the Department of Justice Tax Division.

CI special agents are federal law enforcement officers. The IRS notes that criminal investigators may visit a home or business unannounced while conducting an investigation, and that they will not demand any sort of payment.

Rights and Practical Considerations

• Self-incrimination. The Fifth Amendment protects against compelled self-incrimination. Statements made to IRS employees, in an audit or an interview, can be used as evidence.
• Privilege. The attorney-client privilege protects confidential communications with a lawyer made to obtain legal advice. The separate privilege for federally authorized tax practitioners, such as CPAs and enrolled agents, under section 7525 is limited to noncriminal tax matters before the IRS and noncriminal tax proceedings in federal court. It does not apply in criminal matters.
• Records and statements. Altering or destroying records, or giving false information to investigators, can create separate criminal exposure.
• Voluntary disclosure. The IRS Criminal Investigation Voluntary Disclosure Practice is designed for taxpayers who willfully failed to comply with tax obligations and want to resolve them before facing potential criminal prosecution. The process begins with Form 14457, and the IRS states that the practice does not apply to taxpayers with illegal-source income.

The Bottom Line

Audits are civil, and disputes over deductions, documentation or honest mistakes are resolved with tax, interest and civil penalties. Criminal prosecution requires proof beyond a reasonable doubt of willful conduct, such as concealing income or falsifying records. Contact from a special agent is the clearest sign that a matter has moved into the criminal arena.