Tax Avoidance vs. Tax Evasion: What every tax director needs to know about criminal tax fraud.

• Author: Abney, George
• Position: FEATURE

Reducing tax liability is a top priority for every corporate tax department. But that priority must be tempered by tax compliance obligations. Increasingly complex business relationships and transactions--often accompanied by increasingly complex tax planning--can leave even the most sophisticated tax practitioners wondering how the Internal Revenue Service will react to a claimed tax position. Will the IRS challenge the position? And, if it does, will the IRS pursue a civil audit seeking back taxes and potential monetary penalties? Or will the IRS pursue a criminal investigation and seek to impose criminal sanctions against the company or related individuals? Criminal prosecutions, even those resulting in acquittal, can destroy the reputations of companies and the lives of individuals involved. Thus, when evaluating, implementing, or defending a transaction and its tax consequences, tax professionals must take care to avoid conduct that the IRS may view as suspect. This article provides insights into how the IRS evaluates transactions for criminal potential and provides practical tips for avoiding criminal scrutiny.

Avoidance or Evasion?

Tax avoidance is perfectly fine. As the U.S. Supreme Court said more than eighty years ago, "[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted." (1) Tax evasion, however, is quite different. Section 7201 of the Internal Revenue Code provides significant criminal sanctions--including up to five years in prison--for felony tax evasion. (2) Tax evasion, as well as other criminal tax offenses, requires the government to prove that a taxpayer intentionally violated a known legal duty. (3) Accordingly, a taxpayer's mistake about what the tax law requires will not support a criminal conviction. And a taxpayer's belief that his or her tax position was legitimate should negate criminal intent.

So, it's easy, right? If you believe your tax position is consistent with the law, then you should face only civil sanctions. If, however, you know your tax position violates the law, then you may face criminal sanctions. But is it really that simple? The one thing all tax practitioners can agree upon is that tax law is not always clear. And if the law regarding a certain tax position is not clear, how could the IRS ever prove--as required for a criminal prosecution--that a taxpayer knew what the law required and intentionally violated the law?

Although every case is different, when evaluating whether a taxpayer should face criminal sanctions the IRS typically looks closely at the taxpayer's intent before, during, and after the tax benefit was claimed. And the IRS typically does not limit its review of intent to the sole question of whether the taxpayer actually believed the claimed tax position was correct. Rather, in almost all cases, the IRS evaluates the taxpayer's intent regarding all of the various transactions and activities surrounding the claimed tax position.

Increasingly complex business relationships and transactions-often accompanied by increasingly complex tax planning-can leave even the most sophisticated tax practitioners wondering how the Internal Revenue Service will react to a claimed tax position.

Seemingly Inconsistent Treatment?

The IRS' evaluation of intent beyond the mere question of the legality of the claimed tax position can lead to seemingly inconsistent treatment--two separate but similarly situated taxpayers might engage in the same transactions...