IRS Tax Definitions of Negligence Vs. Fraud

An IRS audit is mainly carried out on taxpayers who are suspected to have understated their taxes in a given tax season. The IRS has up to 3 years to initiate an audit on a given taxpayer. If the taxpayer has understated their incomes by at least 25% in a given tax year, the IRS's time limit is extended to 6 years. For taxpayers who were involved in fraud or for taxpayers who did not file a tax return in a given year, the IRS can audit them indefinitely with no time limitation. There are two tax crimes that an IRS auditor investigates when auditing a taxpayer. These are considered tax negligence and tax fraud.

Tax Negligence

Tax negligence ranges from a simple erroneous entry on tax forms to frivolous tax filing. The IRS considers understated or overstated incomes, undisclosed incomes, erroneous deductions or credit claims, and other mistakes committed on tax returns as negligence (if the taxpayer made the error unknowingly). However, for some of the gray areas, the IRS can not really pinpoint whether it is willful or erroneous, and substantiating it may be difficult. Therefore, the IRS categorizes most of their tax-error findings as "negligence."

What is Tax Fraud?

Tax fraud, on the other hand, is a willful attempt by a taxpayer to cheat on their tax returns so as to avoid paying their due taxes. This includes businesses having two sets of accounts for fraud purposes, taxpayers intentionally overstating donations and other tax deductions and credits, intentional non-remittance of taxes for incomes (such as foreign incomes), and forging of receipts and other payment documentation. To identify tax cheats, the IRS auditors and reviewers will closely scrutinize areas and taxpayer groups that are prone to tax fraud.

Statistics on Tax Crimes

The IRS estimates that about 17% of taxpayers cheat on their returns, denying the IRS billions of dollars in due taxes. Of these taxpayers, 75% of them are individual taxpayers and the majority of the rest are corporate organizations. Individual taxpayers will normally understate or not include earned incomes or make fictitious claims. The most common culprits are service industry workers and businesses that are cash-intensive. Doctors, lawyers, IT consultants, and handy workers are some of the examples of service industry workers known to commonly cheat on their returns. This is mainly due to the low audit trail, especially in cash receipts. Waitresses and bartenders, for example, are known to understate tips by 84% on average. Corporations normally cheat on their taxes by understating or not remitting payroll taxes, making fictitious business expense claims, and understating their corporate taxes.

However, according to a recent report by a leading government watchdog organization, there were only 2,472 taxpayers who were convicted for tax crimes. This accounted for about 0.002% of the taxpayers who filed returns. The number of those convicted has also been reducing over the years, according to the same report.

Implications of Negligence and Fraud

There are various consequences of tax fraud and tax negligence. For outright tax fraud, the civil penalty is a 75% charge on the taxes due and the IRS may also pursue criminal charges on the offender. For errors made through negligence, the IRS charges a civil penalty of 20% of due taxes, including any interests that have accrued.