Tax evasion

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Tax evasion is the general term for efforts by individuals, corporations, trusts and other entities to evade taxes by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability, and includes, in particular, dishonest tax reporting (such as declaring less income, profits or gains than actually earned; or overstating deductions).

Tax evasion is an activity commonly associated with the underground economy and one measure of the extent of tax evasion the amount of unreported income, namely the difference between the amount of income that should legally be reported to the tax authorities and the actual amount reported. In the 1970s and 80's, The IRS undertook the Taxpayer Compliance Measurement Program (TCMP) in an attempt to measure unreported income and the tax gap. The tax gap is the difference between the amount of tax legally owed and the amount actually collected by the government. The TCMP program was believed to produce the most reliable information about noncompliance,^[1] but these "audits from hell" were deemed to be overly intrusive and were discontinued in 1988. The National Research Program was undertaken in the 1990s as a less intrusive means of measuring noncompliance and was described as "the most careful and comprehensive estimates of the extent and nature of tax noncompliance anywhere in the world"^[2] However, critics^[3] point out numerous problems with the tax gap measure. The IRS direct audit measures of noncompliance are augmented by indirect measurement methods, most prominently currency ratio models^[4]

Tax avoidance, on the other hand, is the legal utilization of the tax regime to one's own advantage, to reduce the amount of tax that is payable by means that are within the law. Both tax evasion and avoidance can be viewed as forms of tax noncompliance, as they describe a range of activities that are unfavorable to a state's tax system.^[5]

In 1968, Nobel laureate economist Gary Becker first theorized the economics of crime,^[6] on the basis of which Allingham and Sandmo produced in 1972 an economic model of tax evasion. It deals with the evasion of income tax, the main source of tax revenue in the developed countries. According to them, the level of evasion of income tax depends on the level of punishment provided by law.^[7] The literature's theoretical models are elegant in their effort to identify the variables likely to affect non-compliant behaviors, however, alternative specifications yield conflicting results concerning both the signs and magnitudes of variables believed to affect tax evasion. As such, empirical work is required to resolve the theoretical ambiguities. Income tax evasion appears to be positively influenced by the tax rate, the unemployment rate, the level of income and dissatisfaction with government.^[8] The U.S. Tax Reform Act of 1986 appears to have reduced tax evasion in the U.S.

Customs duties are an important source of revenue in the developing countries. The importers purport to evade customs duty by (a) under-invoicing and (b) misdeclaration of quantity and product-description. When there is ad valorem import duty, the tax base is reduced through underinvoicing. Misdeclaration of quantity is more relevant for products with specific duty. Production description is changed match an H. S. Code commensurate with a lower rate of duty.^[9]

This section needs expansion. You can help by adding to it. (June 2008)

Smuggling is importation or exportation of foreign products through unauthorized route. Smuggling is resorted to for total evasion of leviable customs duties as well as for importation of contraband items. A smuggler does not have to pay any customs duty since the products are not routed through an authorized or notified Customs port and therefore, not subjected to declaration and payment of duties and taxes.^[9]

During the later half of the twentieth century, value added tax (VAT) has emerged as a modern form of consumption tax through the world, with the notable exception of the United States. Producers who collect VAT from the consumers may evade tax by under-reporting the amount of sales.^[10] The US has no broad-based consumption tax at the federal level, and no state currently collects VAT; the overwhelming majority of states instead collect sales taxes. Canada uses both a VAT at the federal level (the Goods and Services Tax) and sales taxes at the provincial level; some provinces have a single tax combining both forms.

In addition, most jurisdictions which levy a VAT or sales tax also legally require their residents to report and pay the tax on items purchased in another jurisdiction. This means that those consumers who purchase something in a lower-taxed or untaxed jurisdiction with the intention of avoiding VAT or sales tax in their home jurisdiction are in fact breaking the law in most cases. Such evasion is, especially, prevalent in federal states like the Nigeria, US and Canada where sub-national jurisdictions have the constitutional power to charge varying rates of VAT or sales tax. In Nigeria for example, some local states enforce VAT on each goods sold by trader. The price must be clearly stated and the VAT distinct from the price of the good purchased. Any act by the trader contrary to this (like including VAT in the price of the goods) is punishable as attempting to syphoning the VAT.

Borders between tax districts in the same nation usually lack the resources to enforce tax collection on goods carried in private vehicles from one district to another, so states only pursue sales and use tax collection on high-value items such as cars.^[11]

The level of evasion depends on a number of factors, one of them being fiscal equation. People's tendency to evade income tax declines when the return for due payment of taxes is not obvious^{[citation needed]}. Evasion also depends on the efficiency of the tax administration. Corruption by the tax officials often render control of evasion difficult. Tax administrations resort to various means for plugging in scope of evasion and increasing the level of enforcement. These include, among others, privatization of tax enforcement,^[12] tax farming,^[13] and institution of Pre-Shipment Inspection (PSI) agencies.^[14] In 2011, HMRC stated that it would continue to crack down on tax evasion, with a goal of collecting £18 billion in revenue before 2015.^[15] A voluntary amnesty program HMRC began in 2010 that targeted middle-class professionals raised £500 million.^[16]

Corrupt tax officials cooperate with the tax payers who intend to evade taxes. When they detect an instance of evasion, they refrain from reporting in return for illegal gratification or bribe. Corruption by tax officials is a serious problem for the tax administration in a huge number of underdeveloped and southern European countries.^{[citation needed]}

This article contains weasel words: vague phrasing that often accompanies biased or unverifiable information. Such statements should be clarified or removed. (October 2009)

Tax evasion is a crime in almost all developed countries and subjects the guilty party to fines and/or imprisonment. In Switzerland, many acts that would amount to criminal tax evasion in other countries are treated as civil matters. Even dishonestly misreporting income in a tax return is not necessarily considered a crime. Such matters are dealt with in the Swiss tax courts, not the criminal courts. However, even in Switzerland, some fraudulent tax conduct is criminal, for example, deliberate falsification of records. Moreover, civil tax transgressions may give rise to penalties. So the difference between Switzerland and other countries, while significant, is limited. It is often considered that extent of evasion depends on the severity of punishment for evasion. Normally, the higher the evaded amount, the higher the degree of punishment.

Professor Christopher Hood first^{[citation needed]} suggested privatization of tax enforcement for overcoming limitations of government tax administration in controlling tax evasion.^[17] Some governments have resorted to privatization of tax enforcement to enhance efficiency of the tax system. The assumption is that leakage of revenue will lower under a privatized regime. In Bangladesh, part of customs administration was privatized in as early as 1991.^[18]

Abuse by private tax collectors (see tax farming below) has led to revolutionary overthrow of governments which have outsourced tax administration.

Tax farming is an old means of collection of revenue when it is difficult to determine the leviable amount taxes with certainty. Governments lease out the collection system to a private entity for a fixed amount, who then collects the revenue and shoulders the risk of attempts at evasion by the taxpayers. It has been suggested that tax farming may be a solution to the problem of tax evasion seen in developing countries.^[19]

This section needs expansion. You can help by adding to it. (June 2008)

Governments have historically turned to tax farming for quick cash. A "tax farmer" buys a "franchise" by making pre-payment to the government. The "tax-farmer," then invested with the authority of the government, goes into the "farm" and begins extracting "taxes" from citizens. This is a system destined to be abusive as the "tax-farmers" seek back their investment, plus profit, and are themselves unrestrained by "politics." Abuses by "tax farmers" (together with a tax system that exempted the aristocracy) were a primary reason for the French Revolution that toppled Louis XVI.

Pre-shipment Agencies like SGS, Cotecna etc. are employed to prevent evasion of customs duty through under-invoicing and misdeclaration. However, in the recent times, allegations have been lodged that PSI agencies have actively cooperated with the importers in evading customs duties. Authority in Bangladesh has found Cotecna, a PSI agency of Swiss origin, guilty of complicity with the importers for evasion of customs duties on a huge scale.^[20] The same company Cotecna was implicated for bribing Pakistan's prime minister Benazir Bhutto for securing contract for importation by Pakistani importers. She and her husband were sentenced both in Pakistan and Switzerland.^[21]

Under the federal law of the United States of America, tax evasion or tax fraud, is the purposeful illegal attempt of a taxpayer to evade payment of a tax imposed by the federal government. Conviction of tax evasion may result in fines and imprisonment.^[22]

The Internal Revenue Service has identified small business and sole proprietorship employees as the largest contributors to the tax gap between what Americans owe in federal taxes and what the federal government receives. Rather than W-2 wage earners^{[clarification needed]} and corporations, small business and sole proprietorship employees contribute to the tax gap because there are few ways for the government to know about skimming or non-reporting of income without mounting more significant investigations. When tips, side-jobs, cash receipts and barter income is not reported it is illegal cheating because no tax is paid by individuals. Similarly, those who are self-employed or run small businesses may not declare income and evade the payment of taxes.

The IRS has developed several methods of proof of income tax evasion in an effort to decrease the tax gap. These investigations can be carried out to determine the correctness of any tax return, make a return where none has been made, determine the liability of any person for any income tax or collect any income tax.^[23] The IRS has the authority to summons the taxpayer to provide particular information for purposes of investigating and ascertaining the correctness of the tax return.^[24] The information requested may include books, records, papers and any other data which may be relevant to the investigation.^[25] However, the IRS investigator must follow all proper administrative steps in obtaining the information. The IRS tax informant (whistleblower) award was created to assist the IRS in obtaining necessary information. While these investigations can lead to criminal prosecution, the IRS itself has no power to prosecute tax evasion crimes. The IRS can only impose penalties and require payment of proper tax due.

In Forensic Analytics, Mark Nigrini summarized the method used by the IRS in the 1980s, 1990s, and the early part of the 2000s for selecting tax returns for audit. The IRS selection system involved a process called discriminant analysis and a special audit process called the Taxpayer Compliance Measurement Program (TCMP) of about 50,000 individual tax returns every three years. The goals of the TCMP were to provide the IRS with an estimate of the level of noncompliance, the noncompliance trend, and the characteristics of delinquent returns. The results were used to improve IRS efficiency and effectiveness in numerous areas, including the selection of returns for audit and general tax administration policy and systems. After the TCMP audits, the IRS focused on two groups of taxpayers: those with just a small change in the balance due, and those with a large ($400+) change in the balance due. Taxpayers were further partitioned into "nonbusiness" and "business" groups and each group was divided into five classes based on total positive income. Using line items from the auditor's checksheet, discriminant analysis, and a scoring mechanism, each return was awarded a score, known as a "Z-score." Higher Z-scores were associated by IRS personnel with a higher risk of tax evasion. This scoring method was not without its problems. First, the Discriminant Index Function (DIF) system did not provide examiners with specific problematic variables or reasons for the high score. A manual examination at the level of each IRS district office determined whether the return would be audited, and the extent of the audit. Second, the method was expensive both in terms of IRS resources and in terms of inconvenience to the "chosen" 50,000 taxpayers. Using the process, IRS personnel did achieve stated goals in that the DIF model predicted taxpayer type (evasion or no evasion) better than the classification accuracy that would be achieved by chance alone (random selection). The IRS now has a National Research Program in place; from time to time the IRS releases information about this program.^[26]

In the United States, the IRS estimate of the 2001 tax gap was $345 billion.^[27] For 2006, the tax gap is estimated to be $450 billion.^[28] A more recent study^[29] estimates the 2008 tax gap in the range of $450–$500 billion, and unreported income to be approximately $2 trillion. Thus, 18-19 percent of total reportable income is not properly reported to the IRS. The typical tax evader in the United States is a male under the age of 50 in the highest tax bracket and with a complicated return, and the most common means of tax evasion is overstatement of charitable contributions, particularly church donations.^[30]

In the United States, persons subject to the Internal Revenue Code who earn income by illegal means (gambling, theft, drug trafficking etc.) are required to report unlawful gains as income when filing annual tax returns (see e.g., James v. United States^[31]), but they often do not do so. Suspected lawbreakers, most famously Al Capone, have therefore been successfully prosecuted for tax evasion when there was insufficient evidence to try them for their non-tax related crimes. The United States Supreme Court has ruled that a simple declaration of income does not violate an individual's right to remain silent,^[32] although the privilege may apply to the source of the income if claimed.^[33] Those who attempt to report illegal income as coming from a legitimate source could be charged with money laundering. By contrast, in the UK law enforcement agencies do not generally have access to tax returns and so illegal earnings can supposedly be safely declared^{[citation needed]} but in practice those carrying on criminal activities generally prefer not to do so, and so can sometimes be prosecuted for tax evasion rather than for other crimes^{[citation needed]}. Soviet spy Aldrich Ames, who had earned more than $2 million cash for his espionage, was also charged with tax evasion as none of the Soviet money was reported on his tax returns. Ames attempted to have the tax evasion charge dismissed on the grounds his espionage profits were illegal, but the charges stood.

Under the net worth and cash expenditure methods of proof, the IRS performs year-by-year-by-year comparisons of net worth and cash expenditures to identify under reporting of net worth. While the net worth method and the cash accrual method may be used separately, they are often used in conjunction with one another. Under the net worth method, the IRS chooses a year to determine the taxpayer's opening net worth at year’s end. This provides a snapshot of the taxpayer's net worth at a particular point in time. The snapshot includes the taxpayer’s cash on hand, bank accounts, brokerage (stocks and bonds), house, cars, beach house, jewelry, furs and other similar items. Generally the IRS learns about these items through very thorough and in-depth investigations, sometimes casing the suspected fraudulent taxpayer. In addition, the IRS also assesses the taxpayer’s liabilities. Liabilities include expenses such as the taxpayer’s mortgage, car loans, credit card debts, student loans, and personal loans. The opening net worth is the most critical point at which the IRS must assess the taxpayer's assets and liabilities. Otherwise, the net worth comparison will be inaccurate.

The IRS then evaluates new debts and liabilities accumulated in the next year, and assesses the taxpayer’s new net worth at the next year’s end. In addition, the IRS reviews the taxpayer’s cash expenditures throughout the tax year. The IRS then compares the increase in net worth and the cash expenditures with the reported taxable income over time in order to determine the legitimacy of the taxpayer’s reported income.

The net worth method was first used in the case of Capone v. United States.^[34] The cash method was approved in 1989 in United States v. Hogan.^[35]

First approved by the Eighth Circuit in 1935 in Gleckman v. United States,^[36] the bank deposit cash expenditure method identifies tax evasion through review of the taxpayer’s bank deposits. This method of investigation primarily focuses on whether the taxpayer’s total bank deposits throughout the year are equal to the taxpayer’s reported income. This method is most appropriate when the majority of the taxpayer’s income is deposited in the bank and most expenses are paid by check.^[37] This method is most commonly used for surveillance of tipped employees and is combined with statistical analysis to determine what a tipped employees actual wages are. Information gathered through this method is most successful when the credibility of tipped employees can be destroyed. This method is used less frequently now for tipped employees because the IRS negotiates with hotels or casinos, the largest employers of tipped employees, to identify a tip estimate. If the tipped employee reports the minimal amount agreed upon, he is not questioned by the IRS. However, it is recommended for corroborating other methods of proof.^[38] Given the uncertainty of this method, this method likely could not be used in criminal prosecutions where the guilt must be found beyond a reasonable doubt.

In addition to the methods of proof the IRS has developed, the IRS has recently adopted a program which allows anonymous whistle blowers to receive 15 to 30 percent of any recovery by the IRS which comes to at least $2 million including all penalties, interests and any other monies collected from the government. The whistle blower program seeks information based on evidence and analysis which can provide a solid basis for further investigation rather than speculation and hearsay.^[39] The program is designed to provide incentive to ordinary citizens to inform on tax cheats. The program provides far greater incentives for whistle blowers than previous programs because under prior programs the government was not required to compensate whistleblowers.^[40] Under this program, a taxpayer may file in court if they are not issued a deserved award.^[39]

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• 1932-1939: Al Capone served seven years of an 11-year sentence in federal prison on Alcatraz Island for tax evasion. He was let out of jail early while suffering with the advanced stages of Syphillus.
• 1933: Gangster Dutch Schultz is indicted for tax evasion. Rather than face the charges, he went into hiding.
• U.S. President Harry Truman pardons George Caldwell and Seymour Weiss for income tax evasion.
• 1963: Joe Conforte, a brothel owner, serves two and a half years in prison, convicted for the crime of income tax evasion.
• 1971: Martin B. McKneally (R-NY) is placed on one-year probation and fined $5,000 for failing to file income tax return. He had not paid taxes for many years prior.
• Cornelius Gallagher (D-NJ) pleaded guilty to tax evasion, and served two years in prison.
• 1974: Otto Kerner, Jr. (D) Resigned as a judge of the Federal Seventh Circuit Court District after conviction for bribery, mail fraud and tax evasion while Governor of Illinois. He was sentenced to 3 years in prison and fined $50,000.
• 1982: Frederick W. Richmond (D-NY) is convicted of tax evasion and possession of marijuana. Served 9 months
• 1985: Joseph Alioto, a lawyer, confesses that he paid no income taxes during the years he served as Mayor of San Francisco.
• 1985–1986: Iran-Contra Affair - Thomas G. Clines is convicted of four counts of tax-related offenses for failing to report income from the operations.
• 1987: Robert Bernard Anderson (R) former United States Secretary of Treasury (1957–1961) pled guilty to tax evasion while operating an offshore bank.
• Harry Claiborne, Federal District court Judge from Nevada, is impeached by the House and convicted by the Senate on two counts of tax evasion. He served over one year in prison.
• 1990: IRS handed country musician Willie Nelson a bill for $16.7 million in back taxes and seized most of his assets to help pay the charges. He sued accounting firm Price Waterhouse, contending that they put him into tax shelters that were later disallowed. The lawsuit was settled for an undisclosed amount. His debts were paid by 1993.
• 1991: Harry Mohney, founder of the Déjà Vu strip club chain, begins to serve three years in prison for tax evasion.
• "Matty the Horse" Ianniello (Mafia) was sent to prison for income tax evasion.
• 1992: Catalina Vasquez Villalpando (R), Treasurer of the United States, pleads guilty to obstruction of justice and tax evasion.
• 1993: Sam Roti, nephew of alderman Fred Roti, is indicted on Federal tax charges, which were later dropped.
• Nicolas Castronuovo is the owner of the Florida pizza parlor where Senator Robert Torricelli was caught on an FBI wiretap soliciting contributions in 1996. Nicolas Castronuovo and his grandson Nicholas Melone later pleaded guilty to evading the government of $100,000 in taxes.
• 1995: Webster Hubbell, (D) Associate Attorney General, pleads guilty to mail fraud and tax evasion. He is sentenced to 21 months in prison.
• 1996: Heidi Fleiss is convicted of federal charges of tax evasion and sentenced to 7 years in prison. After two months she was released to a halfway house, with 370 hours of community service.
• U.S. President Bill Clinton pardons Marc Rich and Pincus Green, indicted by U.S. Attorney on charges of tax evasion and illegal trading with Iran. President Clinton also pardons Edward Downe, Jr. for wire fraud, filing false income tax returns,, and securities fraud.
• 2002: James Traficant (D-OH) is convicted of ten felony counts including bribery, racketeering and tax evasion and sentenced to 8 years in prison.
• 2002: The Christian Patriot Association, an "ultra-right-wing group", is shut down after convictions for tax fraud and tax evasion.
• 2005: Duke Cunningham (R-CA) pleads guilty to charges of conspiracy to commit bribery, mail fraud, wire fraud and tax evasion in what came to be called the Cunningham scandal. He is sentenced to over eight years.
• 2008: Actor Wesley Snipes is sentenced to 3 years in jail for tax evasion.
• 2008: Charles Rangel (D-NY) failed to report $75,000 income from the rental of his villa in Punta Cana, Dominican Republic and was forced to pay $11,000 in back taxes.
• 2008: Senator Ted Stevens (R-AK) is convicted on 7 counts of bribery and tax evasion just prior to the election. He continued his run for re-election, but lost. However, prior to sentencing, the indictment was dismissed—effectively vacating the conviction—when a Justice Department probe found evidence of gross prosecutorial misconduct.
• Jack Abramoff, lobbyist, is found guilty of conspiracy, tax evasion and corruption of public officials in three different courts in a wide ranging investigation. Currently serving 70 months and fined $24.7 million
• Jared Carpenter, Counsel of Republicans for Environmental Advocacy, pled guilty to income tax evasion, and received 45 days, plus 4 years probation.

• Tax amnesty
• Tax avoidance
• Tax noncompliance

• Tax Evasion and Fraud collected news and commentary at The Economist
• Tax Evasion collected news and commentary at The New York Times
• Template:WSJtopic

United States

• US Justice Dept press release on Jeffrey Chernick, UBS tax evader
• US Justice Tax Division and its enforcement efforts