Criminal Issues- Unfiled Tax Returns / Tax Fraud

August 1, 2022 | Tax Audits

Usually, the most panicked and upset clients call me and when they have not filed their tax returns in many years, and are extremely worried that by this inaction they will be arrested, or worse thrown in prison. Evading tax is a crime, but usually not failing to file a tax return. Therefore, criminal issues- unfiled tax returns is not a common occurrence. Occasionally, clients are audited for non-tax problems ( for example workman’s payment insurance, highway permits) by the IRS or State of New York, and the auditor makes the discovery that the taxpayer has not filed their income tax returns in a long time. This “great” discovery causes a lot of angst to the taxpayer, but usually the IRS and the States are not quick to press charges if the tax returns are filed quickly (see list below of action steps needed). Typically, you only have a criminal tax problem is you intentionally do not pay the right amount of taxes, so usually they issue is manageable. Therefore, non filing typically does not cause the same level of problems are actively avoiding paying taxes, and your almost never going to jail. Please keep in mind, in New York State it is actually a felony to not file your income tax returns for at least three years in a row where you owe taxes for each of those years. It is not often that NYS Tax uses this law to charge a taxpayer with a crime, but I have seen it applied in hundreds of cases, so it is not overly rare that they do.

The IRS and NYS tax auditors normally take the approach of creating their own estimated version of the income tax return you failed to file (called a substitute tax return), and charging the taxes owed based upon their computation based on limited information. Please keep in mind they have no incentive to lower your tax bill, so their work is suspect. The crucial point is that the substitute tax returns tends to overstate the tax debt amount, since they give you no deductions and use  the highest possible tax rate. As they say, you never get something good for nothing.

The very long standing IRS’s voluntary disclosure policy applies to a taxpayer who: 1) Informs the IRS or NYS that they failed to file a tax return, 2) You make the disclosure prior to being notified by the tax authorities, or before you are under criminal investigation for failing to pay the right amount of taxes, 3) File the correct income tax come returns, and cooperate with the tax authorities (NYS and IRS) in ascertaining their correct income tax liability, and 4) Make full payment of the amount of the sales or income taxes due, or if are unable to make payment in full, to create a monthly tax payment plan for the tax balance owed.

Criminal Issues- Unfiled Tax Returns – Is tax fraud a Felony?

If you follow these steps, the issue of non filing can become manageable, and you will take the first step of getting the issue behind you. In the case of New York State, they also have a voluntary disclosure process where they waive penalties for not filing or paying the taxes on time, so that is also a good reason to use their program. Therefore, to the question, Is tax fraud a felony?  Evading tax is a matter of degree, and when only small amounts are owed, it can be corrected and a fine paid.

Interest Charges for Restitution

A recent Internal Revenue Service Office of Chief Counsel memorandum (CCA 201725026) provides guidance on whether the IRS can charge interest on court ordered restitution payments related to Title 18 criminal tax cases. As background, typically when a court orders restitution in a criminal tax case, it is often for an amount equal to the taxes not paid by the defendant due to their conduct. Before Congressional FETI ACT of 2010, the restitution was not viewed as a “tax” under the income tax rules. This act changed that.

The three main issues addressed in this memorandum are:

  1. Whether the court-ordered restitution incurs interest under Title 26 (Internal Revenue Code)
  2. When does the interest begin to accrue on the obligation
  3. Whether the assessment of interest is barred by the prohibition on over compensation of the government

Interest on Ordered Restitution for Criminal Tax Cases

Under IRC section 6201(a)(4), the IRS shall assess and collect the amount of restitution under an order pursuant to Title 18, section 3663A. Therefore, if restitution is ordered by the court to compensate the IRS as a victim for the failure to pay taxes imposed by Title 26, then the restitution will be viewed as a tax, and be subject to the interest rules when the tax is not paid when it was due.

Under IRC section 6601(a), it provides that if any amount of tax imposed by Title 26 is not paid on or before the last day prescribed for payment, interest on such amount at the current under payment rate established under IRC section 6621 shall be paid for the period from such date incurred to such date paid. As an example, if the restitution amount related to unpaid taxes for the 2014 tax year the taxes were originally owed and due April 15, 2015. The interest would be charged from April 15, 2015 until it is paid. In the recent past (the last 5 years or so), that interest rate has hovered around 4-5% per year. Of note, the IRS ignores other code sections that would impose a separate penalty for not paying the “taxes” owed on time. That rate is typically one-half of one percent per month. Since the restitution is related to the computed tax loss suffered by the IRS, and the restitution is not a penalty in itself, it is a bit perplexing why the IRS would not charge a failure to pay penalty in addition to the interest charge they normally do in civil underpayment case, if the restitution amount is now a “tax”.

In conclusion, interest on Court Ordered Restitution for Criminal Tax Cases creates a situation where a US Federal Court sentences a defendant to pay restitution upon conviction of certain criminal tax cases, the IRS can separately charge interest on the underlying tax that relates to the restitution award. Whether the tax assessment is barred by the prohibition on over-compensating the government depends on the facts of each case. When a plea agreement is entered into, the defendant needs to determine the amount he or she is willing to spend to settle the matter. Knowing that interest is being charged by the IRS in these cases, the defendant should factor that amount into  account the interest charge when determining the restitution amount they are willing to pay. Therefore, it is unlikely that a court would find an over compensation issue in these cases.

Why an Attorney is Helpful

While there’s no way for an individual to completely avoid paying taxes (taxes Fraud), there are ways to cut and reduce the amount of taxes an individual owes. By being proactive and engaging in tax planning, an individual can often reduce his or her tax liabilities substantially. It’s important to note, however, that there are creative strategies that can be employed to reduce the amount of taxes one pays and then there are those that are questionable or outright illegal and you could face IRS criminal charges for evading tax.

Simply failing to file and/or pay one’s taxes is never a good idea. Not only is an individual likely to accrue costly fees and penalties, but he or she may also face criminal charges related to tax evasion. Additionally, it’s never a good idea to file or submit tax-related documents that contain false or doctored figures. Again, an individual who under- reports the amount of income or overestimates deductions will incur costly fines and penalties and may face charges of tax fraud.

IRS criminal charges

In cases where an individual learns that he or she is being investigated or audited by the Internal Revenue Service, it’s wise to contact an attorney. It’s especially important to retain a strong legal advocate and representative if an individual is concerned that an IRS audit or investigation may result in the discovery of questionable or illegal tax-avoidance activities.

The IRS takes matters related to possible acts of tax fraud and evasion very seriously and individuals who are convicted of criminal tax charges often pay dearly—both financially and personally. From punitive financial penalties to lengthy prison sentences, the IRS aims to make examples of individuals who the agency believes are attempting to avoid paying taxes.

Residents in New York who have questions or concerns about their current or past tax-planning strategies can obtain sound legal advice and guidance from an attorney at Timothy S. Hart Law Group. Our attorneys are well-versed in all tax matters and routinely help individuals who are facing IRS audits, fines, liens, levies and criminal charges.

Attorney Timothy Hart

Timothy S Hart, the founding partner of the tax law firm of Timothy S. Hart Law Group, P.C. is both a New York Tax Lawyer & Certified Public Accountant. His area of expertise includes innovative solutions to solve your Internal Revenue Service and New York State tax problems, including tax settlements through the Federal and New York State offer in compromise programs, filing unfiled tax returns, voluntary disclosures, tax audits, and criminal investigations. [ Attorney Bio ]