The tax code, 26 United States Code section 7201, provides:
To prove a violation of the statute, the prosecutor must show (1) the existence of a tax deficiency (an unpaid federal tax), (2) an affirmative act constituting an evasion or attempted evasion of either the assessment or payment of that tax, and (3) willfulness (connoting the voluntary, intentional violation of a known legal duty).
A genuine, good faith belief that one is not violating the Federal tax law based on a misunderstanding caused by the complexity of the tax law is a defense to a charge of "willfulness", even though that belief is irrational or unreasonable. A belief that the Federal income tax is invalid or unconstitutional is not a misunderstanding caused by the complexity of the tax law, and is not a defense to a charge of "willfulness", even if that belief is genuine and is held in good faith.
The Internal Revenue Service (IRS) 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. 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.
The willful failures to report tips, income from side-jobs, other cash receipts, and barter income items are examples of illegal cheating. Similarly, those persons who are self-employed (or who run small businesses) evade the assessment or payment of taxes if they intentionally fail to report income. One study suggested that the fact that sharing economy firms like Airbnb, Lyft, and Etsy do not file 1099-K forms when participants earn less than $20,000 and have fewer than 200 transactions, results in significant unreported income.
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.
Jurisdictions which allow for limiting taxation, known as tax havens, may be used for both legally avoiding taxes and illegally evading taxes. In 2010, the Foreign Account Tax Compliance Act was passed to better enforce taxation in foreign jurisdictions.
U.S. citizens are required to report unlawful gains as income when filing annual tax returns (see e.g., James v. United States) although such income is typically not reported. Suspected lawbreakers, most famously Al Capone, have been successfully prosecuted for tax evasion when there was insufficient evidence to try them for their non-tax related crimes. Reporting illegal income as earned legitimately may be illegal money laundering.
In the United States, the IRS estimate of the 2001 tax gap was $345 billion. For 2006, the tax gap is estimated to be $450 billion.
A more recent study estimates the 2008 tax gap in the range of $450 to $500 billion, and unreported income to be approximately $2 trillion. Thus, 18 to 19 percent of total reportable income is not properly reported to the IRS.
Beginning in 1963 and continuing every 3 years until 1988, the IRS analyzed 45,000 to 55,000 randomly selected households for a detailed audit as part of the Taxpayer Compliance Measurement Program (TCMP) in an attempt to measure unreported income and the "tax gap". The program was discontinued in part due to its intrusiveness, but its estimates continued to be used as assumptions. In 2001, a modified random-sampling initiative called the National Research Program was used to sample 46,000 individual taxpayers and the IRS released updated estimates of the tax gap in 2005 and 2006. However, critics 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
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 (over $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. However, the Discriminant Index Function (DIF) system did not provide examiners with specific problematic variables or reasons for the high score and so each filing had to be manually examined by an auditor.
The IRS may carry out investigations to determine the correctness of any tax return and collect necessary income tax, including requiring the taxpayer to provide specific information such as books, records, and papers. The IRS whistleblower award program 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 crimes. The IRS can only impose monetary penalties and require payment of proper tax due. The IRS performs audits on suspicion of noncompliance but has also historically performed randomly selected audits to estimate total noncompliance; the former audits have much higher chance of noncompliance.
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. The cash method was approved in 1989 in United States v. Hogan.
First approved by the Eighth Circuit in 1935 in Gleckman v. United States, 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.
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. 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 Tax Relief and Health Care Act of 2006 created the IRS Whistleblower Office, 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.
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. Under this program, a taxpayer may file a lawsuit in court if he or she does not receive a deserved award.
The IRS publishes the number of civil and criminal penalties in the IRS Data Book (IRS Publication 55B) and makes these available online. Table 17 shows tabulated data on civil penalties and Table 18 shows data on criminal investigations. In 2012, the IRS assessed civil penalties in 37,910,493 cases and 4,994,926 abatements. In 2012, the IRS initiated 5,125 investigations; of 3,701 which were referred to prosecution, 2,634 resulted in conviction. The agency also highlights current investigations on its website by various categories, including abusive returns, tax schemes, corporate fraud, money laundering, and various other categories.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 syphilis.
1933: Gangster Dutch Schultz was indicted for tax evasion. Rather than face the charges, he went into hiding.
U.S. President Harry Truman pardoned George Caldwell, George Berham Parr, 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) was 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.
1972: 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) was 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 was 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) pleaded guilty to tax evasion while operating an offshore bank.
1986: Harry Claiborne, Federal District court Judge from Nevada, was impeached by the House and convicted by the Senate on two counts of tax evasion. He served over a year in prison.
1991: Harry Mohney, founder of the Déjà Vu strip club chain, began 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 Chicago alderman Fred Roti, was 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, pleaded guilty to mail fraud and tax evasion. He is sentenced to 21 months in prison.
1996: Heidi Fleiss was 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.
2001: U.S. President Bill Clinton pardoned 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) was 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", was shut down after convictions for tax fraud and tax evasion.
2005: Duke Cunningham (R-CA) pleaded 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.
2006: Jack Abramoff, lobbyist, was found guilty of conspiracy, tax evasion and corruption of public officials in three different courts in a wide-ranging investigation. Now serving 70 months and fined $24.7 million
2008: Charles Rangel (D-NY) failed to report $75,000 income from the rental of his villa in Punta Cana in the Dominican Republic and was forced to pay $11,000 in back taxes. The House of Representatives voted 333–79 to censure Rangel. It had been 27 years since the last such measure and Rangel was only the 23rd House member to be censured.
2008: Senator Ted Stevens (R-AK) was 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.
2013: Big Four accounting firm Ernst & Young agreed to pay federal prosecutors $123 million to settle criminal tax avoidance charges stemming from $2 billion in unpaid taxes from about 200 wealthy individuals advised by four Ernst & Young senior partners between 1999 and 2004.