Investigators from the IRS announced fraud charges against several Chicago residents on Monday, April 10, just a week before the filing deadline for federal income taxes. Why do some tax-cheats go to prison, while others just have to pay a fine?
Because not all cases of fraud go to criminal court. The government doesn’t have the time or money to launch criminal investigations into everyone it thinks has committed fraud, so investigators choose only the clearest—and, in many cases, the most high-profile—examples as their targets. The government only pursues criminal charges against a few thousand people every year. Civil tax proceedings are much more common, but they never result in prison sentences.
To prove that you’re a criminal tax fraud, the government has to show beyond a reasonable doubt that you “willfully” disregarded the tax code—that you knew exactly what you were doing when you underpaid your taxes. * This sort of argument can be tricky for Justice Department lawyers, especially when they’re trying to prosecute zealous “tax protesters” who believe (or claim to believe) that they don’t owe any taxes at all.
Commercial airline pilot and longtime tax-evader John Cheek pushed this issue as far as it would go in 1991. Cheek defended himself against tax-fraud charges with the argument that his crime couldn’t have been willful since he held a sincere conviction that he wasn’t breaking the law. The judge responded by telling a befuddled lower-court jury that “an honest but unreasonable belief is not a defense,” and Cheek was found guilty.
The Supreme Court disagreed, ruling that it’s not for judges to decide whether someone’s belief is “reasonable.” The jury has to figure out if the defendant truly believes he’s breaking the law, even if that belief is utterly ridiculous.
How might government lawyers prove what a tax-cheat truly believes? They can start by looking through his tax records for any sign that he knew his legal obligations. Had he filed returns in previous years? Did he make an effort to hide his income from the government?
Even if a tax-cheat escapes criminal prosecution, he could still face an audit and civil charges. In this case, the IRS would ask him to pay back-taxes plus interest. He could also get slapped with a penalty, depending on the nature of the misdeed. Once again, this depends on his intentions: The government will assess a 75 percent penalty if it can prove willful fraud before a tax judge. (In tax court, the government faces a more relaxed civil standard of proof).
The IRS deals out lesser penalties as well. You can get hit with a 20 percent “negligence” penalty if you didn’t even try to follow the rules, or if you recklessly disregarded them. (The “my-tax-preparer-did-it” defense turns up again and again in response to these charges.) If enough money is at stake, the government doesn’t even need to prove negligence: A nearly automatic 20 percent penalty applies to any “substantial underreporting” of your tax liability—i.e., if you underreport what you owe by more than $5,000.
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Explainer thanks Jack Townsend of Townsend and Jones, L.L.P.
* Correction, April 13, 2006: This piece originally described the standard of proof for a criminal trial as “beyond the shadow of a doubt.” The correct phrase is “beyond a reasonable doubt.” Click here to return to the corrected sentence.