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Finance glossary

Tax return fraud: what it is and how to avoid it

Shanna Hall
5 Min

Definition: what is tax return fraud?

In the US, businesses and individuals are required to file taxes every year. If a business entity or individual lies, omits information, or falsifies any financial data on their tax return in an attempt to get out of paying taxes or inflate their tax refund, they are committing tax return fraud.

A fraudulent tax return can materialize in a number of ways, but at the end of the day, committing tax fraud is a major offense. Punishable by jail time, fines, and other penalties, tax refund fraud damages government infrastructure, overextends the Internal Revenue Service (IRS) resources, and pushes tax liabilities to other citizens. In 2022, the IRS launched more than 2,500 criminal investigations and achieved a 90.6% conviction rate in the cases that were prosecuted.

Although submitting a false tax return can seem like a quick way to save some cash, tax return fraud should be avoided at all costs. The best practice for individuals and businesses alike is to be as honest and transparent as possible when filing taxes.

Technicalities: when is tax fraud considered fraud?

So, if you accidentally omit a small revenue stream or put the incorrect number for a deduction, are you committing tax fraud? Not necessarily. The IRS defines tax fraud as an “intentional wrongdoing, on the part of the taxpayer, with the specific purpose of evading a tax known or believed to be owed.” A few key tells of individual tax fraud are:

  • Intentional failure to file an income tax return
  • Intentional failure to pay tax debt
  • The preparation and filing of false income tax returns
  • Failure to report all income within the fiscal year
  • Inflating deductions or tax credits to reduce tax liabilities

On the business side, tax return fraud might consist of one or more of the following:

  • Failure to withhold federal income taxes from employee paychecks
  • Not reporting or paying withheld payroll taxes
  • Omitting cash payments made to staff members
  • Deflating asset values or revenue numbers to reduce tax liabilities

Though less common, tax identity theft is another form of tax return fraud. If a bad actor steals the identity of another person and uses their information to file false tax returns, that is considered tax fraud, no questions asked.

Assigning responsibility: simple negligence or fraud?

Tax return preparers can make mistakes when filing taxes, but even unintentional actions can have consequences. The IRS may impose a 20% penalty if a business or individual underpays taxes due to negligence. If the errors were an intentional attempt to skirt tax payments – AKA tax fraud — then the perpetrator could face legal ramifications and hefty fines.

Taking the time to ensure that all the information on your tax return is as accurate and correct as possible will always pay off. Trust us, navigating IRS investigations and correcting tax documents is a much bigger headache than combing through expense receipts and ensuring your tax return captures all necessary financial information.

Catch me if you can: how the IRS identifies tax fraud

The IRS takes tax fraud very seriously, and today, it has a number of tools available to help identify and catch tax-related crimes. Using detailed data analytics tools, social media insights, and information from whistleblowers, the IRS has developed a robust method of monitoring every suspicious tax return.

Data analysis

When you submit an individual tax return, the IRS uses an Information Returns Processing (IRP) System to check the data on your tax return against the information submitted by your employer. W-2s, 1099s, and Schedule K-1s are all verified within this system. Now, the IRS can even track credit card transactions and other electronic transactions. 

Social media

If you have any public social media accounts, the IRS can easily look at what you’re posting to assess whether or not fraudulent tax returns are in play. If you write off a business expense for a car you purchased, yet you reveal on social media that it’s a new car for your family, that will raise some alarm bells.

It’s unclear whether the IRS uses information from private social media accounts or e-mails stored on third-party servers when conducting their investigations, but with the rate of technological advancement, both of these considerations are plausible.

Whistleblowers

Not everyone is going to guard your secrets; a whistleblower in your network might be the very reason that the IRS is alerted of false income tax returns or other fraudulent tax refunds. A disgruntled employee seeking revenge, a jealous ex-partner, or even a colleague can report tax fraud. In certain cases, the IRS pays a reward of up to 30% of the tax recovery amount to whistleblowers.

Penalties: consequences of tax fraud

As with any crime, the punishment varies depending on the severity of each case. In milder cases, the IRS may order the offender to pay outstanding taxes owed, along with a penalty fee. If you were investigated and lied to auditors or doubled down on concealing income or falsifying expenses, that’s when the IRS will likely seek criminal charges. Depending on the amount owed and whether or not you’re cooperative during the investigation will play a big role in the consequences you’ll face.

Stay away: how to avoid tax fraud

The best way to avoid tax fraud is to keep an airtight handle on your financial transactions. If you’re filing as an individual, a document management system and personal accounting software can make the filing process a breeze. For businesses, ensuring every transaction has an audit trail and employing financial software systems – like Eftsure’s payment solution – to digitize the financial picture is the best approach.

Remember: if you file in good faith, odds are the IRS will work with you to correct your filing if any errors are discovered.

In summary

  • Think twice before filing a fraudulent return. Being charged with tax fraud may feel easily avoidable, but if you’re knowingly falsifying financial information, the IRS has many tools at its disposal to uncover your deception.
  • There’s a difference between accidentally submitting a tax return with incorrect information and intentionally misleading the IRS, but even the most honest mistakes can lead to penalties and extra fines.
  • Keeping a clear tracking mechanism for financial transactions is one of the best ways to avoid tax fraud.

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