The Ultimate Guide to the Federal Tax Evasion Statute
Tax evasion is a serious federal crime. Individuals convicted of violating the federal tax evasion statute can face fines and prison time, while corporate tax evaders can face fines far in excess of those imposed for individuals. Due to its breadth, the federal tax evasion statute covers nearly all forms of unlawful tax avoidance—with the major caveat being the statute’s requirement for a “willful” state of mind.
The three primary federal authorities that are responsible for enforcing 26 U.S.C. Section 7201 are the U.S. Department of Justice (DOJ), the Federal Bureau of Investigation (FBI), and Internal Revenue Service Criminal Investigation (IRS CI). While each of these federal authorities can (and does) investigate tax evasion independently, they often work in tandem to pursue charges for tax evasion and other white-collar crimes.
In this Ultimate Guide to the Federal Tax Evasion Statute, we cover everything that taxpayers and their defense counsel need to know about defending against charges under 26 U.S.C. Section 7201. After examining the elements of a federal tax evasion charge, we cover some of the more-common allegations in federal tax evasion investigations, and then we discuss some of the defenses that targets and defendants may have available.
The Federal Tax Evasion Statute (26 U.S.C. Section 7201): An Overview
The Internal Revenue Code (IRC) is extraordinarily complex; and, as we discuss in detail below, criminal tax evasion allegations can take numerous different forms. Yet, the federal tax evasion statute is among the simplest criminal statutes in the federal code. The federal tax evasion statute (26 U.S.C. Section 7201) states in full:
“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.”
If we look at this closely, we can see that the crime of federal tax evasion is defined with just 19 words: “willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof.” Even so, there is a lot we need to unpack in order to understand what constitutes criminal tax evasion—and what doesn’t. Let’s take a closer look at the elements of the offense:
- “Willfully” – As we noted in the introduction, the federal tax evasion statute requires evidence that a taxpayer acted “willfully” to evade or defeat tax. While unintentional underreporting and underpayment can trigger liability for back taxes, interest, and civil penalties, they do not justify criminal prosecution. Crucially, federal courts have held that “[a] mere act of willful omission” is not enough. Instead federal prosecutors must prove “an affirmative act for the purpose of attempting to evade or defeat the assessment of a tax.”
- “attempts in any manner” – A taxpayer does not need to actually evade or defeat any tax in order to be found guilty under 26 U.S.C. Section 7201. The federal tax evasion statute treats all “attempts” to evade or defeat tax equally—regardless of their success. In other words, even if a willful attempt to underreport a taxpayer’s liability does not ultimately result in a failure to pay tax (i.e., if the attempt triggers an intervening audit or investigation), the taxpayer can still face criminal prosecution.
- “to evade or defeat any tax . . .” – To prove tax evasion, the government must establish that a taxpayer, “engaged in some affirmative conduct for the purpose of misleading the IRS or concealing tax liability or assets.” This is a very broad definition of “evasion,” and, again, it allows for prosecution in a wide range of scenarios. This clause also makes clear that 26 U.S.C. Section 7201 applies to attempts to evade “any” tax—including income tax, employment tax, and estate tax among others.
The second half of 26 U.S.C. Section 7201 establishes the criminal penalties for federal tax evasion. If convicted under the statute, individuals can face up to a $100,000 fine and five years of federal imprisonment for each count of tax evasion, while corporations can face fines of up to $500,000.
Common Allegations in Federal Tax Evasion Investigations
While tax evasion is a singular crime under 26 U.S.C. Section 7201, the DOJ can pursue charges against both individual and corporate taxpayers for a broad array of alleged tax avoidance schemes. The federal government draws a hard line between tax planning and criminal tax avoidance, and taxpayers must walk this line carefully to lawfully minimize their federal tax liability.
So, when do taxpayers cross the line? Here are some examples of common allegations in federal tax evasion investigations:
Willfully Failing to Report and/or Pay Income Tax
Many federal tax evasion cases simply focus on a taxpayer’s failure to report and/or pay the tax they owe. These cases commonly involve both ordinary income tax and the tax owed on capital gains. In civil enforcement matters, failure to report and failure to pay are treated as two separate violations. However, there is no such distinction under the federal tax evasion statute.
Willfully Failing to Collect, Remit, or Pay Employment Taxes
Companies can also face criminal prosecution under 26 U.S.C. Section 7201 for failing to collect, remit, or pay employment taxes. In some cases, companies’ personnel can face individual criminal responsibility for trust fund tax violations as well (i.e., violations involving the employee’s share of FICA taxes). Here, too, while civil enforcement matters will address income tax and employment tax violations separately, both types of violations can trigger the same criminal charges and consequences.
Utilizing Abusive Tax Avoidance Schemes
The IRS refers to tax planning strategies that cross the line as “abusive tax avoidance schemes.” Recently, the IRS has identified several abusive tax avoidance schemes as being among the agency’s top law enforcement priorities. Some examples include:
- Abusive Foreign and Domestic Trusts – Abusive trust arrangements that taxpayers use to attempt to illegally avoid paying federal taxes can take a variety of different forms. The IRS is paying particular attention to business trusts, equipment trusts, family trusts, charitable trusts, and asset protection trusts, among others.
- Micro-Captive Insurance Arrangements – As the IRS explains, “a micro-captive is an insurance company whose owners elect to be taxed on the captive’s investment income only . . . [and a]busive micro-captives involve schemes that lack many of the attributes of legitimate insurance.” Excessive premiums that do not reflect arm’s length pricing are often considered a red flag for tax evasion.
- Syndicated Conservation Easements – A syndicated conservation easement is a type of abusive tax avoidance scheme “that purport[s] to give an investor the opportunity to claim charitable contribution deductions and corresponding tax savings that significantly exceed the amount the investor invested.” As the IRS goes on to explain, these schemes often generate substantial fees for promoters while “attempt[ing] to game the tax system with grossly inflated tax deductions.”
Failing to Disclose Foreign Assets and/or Income Sources
Combating offshore tax evasion is another top IRS enforcement priority. Along with the federal tax evasion statute, the Bank Secrecy Act (BSA) and Foreign Account Tax Compliance Act (FATCA) impose substantial penalties for reporting violations and other forms of non-compliance. Taxpayers accused of using offshore accounts and entities to evade U.S. tax liability can face scrutiny both domestically and abroad, as IRS CI works with the other international Joint Chiefs of Global Tax Enforcement to combat tax evasion on a global scale.
Potential Defenses to Tax Evasion Charges under 26 U.S.C. Section 7201
As with all types of federal white-collar crimes, there are several potential defenses to tax evasion charges under 26 U.S.C. Section 7201. These include defenses based on the statutory language, judicial interpretations of the federal tax evasion statute, and the constitutional protections that apply during federal investigations and prosecutions. Some examples are:
- Inadequate evidence of willfulness
- Good-faith tax planning based on the advice of counsel (which also goes to willfulness)
- Inadequate evidence of an “affirmative act” in furtherance of an attempt to evade or defeat tax
- Compliance with the Internal Revenue Code (many federal tax audits and investigations target taxpayers that have complied with the law)
- Unconstitutional searches and seizures, withholding exculpatory evidence during prosecution, and other violations of targets’ and defendants’ constitutional rights
Again, these are just examples. Successfully defending against tax evasion charges under 26 U.S.C. Section 7201 requires a comprehensive understanding of both the relevant facts and the relevant law. To protect themselves, taxpayers targeted in federal tax evasion investigations should engage experienced defense counsel as soon as possible.
Contact the Federal White-Collar Defense Attorneys at Oberheiden P.C.
At Oberheiden P.C., we provide experienced legal representation for individuals and companies facing criminal tax evasion allegations under 26 U.S.C. Section 7201. To discuss your case with an experienced federal white-collar defense attorney in confidence, call 888-680-1745 or tell us how we can reach you online now.
Dr. Nick Oberheiden, founder of Oberheiden P.C., focuses his litigation practice on white-collar criminal defense, government investigations, SEC & FCPA enforcement, and commercial litigation.