Representation before the IRS · Related Issues

Tax avoidance vs. tax evasion

Tax avoidance is arranging one’s affairs so that the law imposes less tax. It is lawful, and it is most of what a practitioner is paid to do. Tax evasion is a felony. What separates them is not the amount saved, not how aggressive the position looks, and not whether the IRS ultimately disallows it. It is willfulness and, for the principal offence, an affirmative act. A representative who cannot state that distinction precisely cannot advise safely on either side of it.

The rule

The principal offence. “Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof” is guilty of a felony (IRC § 7201). See the figures table for the stated penalties.

Three things follow. It covers evasion of assessment and of payment — hiding assets from a collection officer is § 7201 conduct just as understating income is. It requires an attempt, which is why the offence needs an affirmative act rather than mere omission. And it requires willfulness.

The failure offence. Willful failure to pay estimated tax or tax, to make a return, to keep records, or to supply information at the required time is a misdemeanor (IRC § 7203) — see the figures table. This catches the taxpayer who simply does not file. A willful violation of § 6050I, the cash-transaction reporting rule, converts it to a felony with five years.

The false-document offences. IRC § 7206 makes it a felony to willfully make and subscribe any return or document verified under penalties of perjury “which he does not believe to be true and correct as to every material matter” (§ 7206(1)), and separately to willfully aid or assist in, procure, counsel or advise the preparation of a return, affidavit, claim or other document that “is fraudulent or is false as to any material matter” (§ 7206(2)).

Read § 7206(2) carefully: it applies “whether or not such falsity or fraud is with the knowledge or consent of the person authorized or required to present” the document. A preparer commits it even where the client is innocent. That is the provision that puts a practitioner’s own liberty in issue.

Fines are larger than the Code says. See the figures table (18 U.S.C. § 3571).

The civil counterpart. Where any part of an underpayment is due to fraud, a penalty is added on the portion attributable to fraud — see the figures table (IRC § 6663). The burden allocation matters: once the Secretary establishes that any portion is attributable to fraud, the entire underpayment is treated as fraudulent except so much as the taxpayer shows, by a preponderance of the evidence, is not. On a joint return the penalty does not reach a spouse unless part of the underpayment is due to that spouse’s fraud (IRC § 6663(c)).

Obstruction. Corruptly, or by force or threats of force, endeavouring to intimidate or impede an officer acting officially, or in any other way corruptly obstructing “the due administration of this title,” carries up to three years (IRC § 7212(a)). Forcibly rescuing seized property is separately punishable (IRC § 7212(b)).

Current figures

How it works in practice

Avoidance is not a grudging concession — it is the design of the Code. Deducting mortgage interest, claiming a credit Congress enacted, contributing to a retirement plan, choosing an entity form, timing a disposition: each reduces tax because the statute says so. Using them is not a step towards evasion, and treating every planning question as sitting near a line does the client a disservice.

The line is willfulness, and willfulness is a state of mind about a known duty. Not carelessness, not a wrong answer, not an aggressive reading that loses. A taxpayer who reports a position that the IRS disallows has not evaded anything. A taxpayer who knows income is taxable and conceals it has.

Section 7201 needs an act; § 7203 does not. That is the cleanest structural distinction here. Failing to file is a § 7203 misdemeanor. Failing to file and keeping income in a nominee account, dealing in currency to avoid a paper trail, or lying to a revenue officer supplies the affirmative act that makes it § 7201. The same non-filing supports either charge depending on what else was done.

Evasion of payment is a real and separate branch. Section 7201 reaches evading the tax “or the payment thereof.” Transferring assets ahead of a levy, or concealing them from a collection officer, is evasion even where the return was correct and the liability fully reported.

Section 7206(2) is the practitioner’s exposure, and it does not require a guilty client. Aiding or assisting in the preparation of a materially false document is an offence “whether or not” the taxpayer knew. A preparer who inserts figures known to be false is exposed even if the client is a victim. It is the criminal analogue of the Circular 230 and § 6694 duties, and it is why “the client told me to” is not an answer.

“Material” does the work in § 7206. The declaration offence requires disbelief in truth “as to every material matter”; the aiding offence requires falsity “as to any material matter.” A trivial misdescription is not the offence; a misstatement that affects the tax, or hides a fact the IRS needs to test the return, is.

Know that the Code’s fine figures understate the exposure. The individual felony figure printed in §§ 7201 and 7206 is superseded upward by 18 U.S.C. § 3571 — see the figures table. The Code figure is a floor, not the ceiling, unless the offence statute exempts itself by specific reference, which these do not.

The civil fraud penalty has an all-or-nothing default. Establish fraud as to any part of the underpayment and the whole underpayment is treated as fraudulent unless the taxpayer disproves it, by a preponderance, item by item. That default is why the civil fraud penalty is so much larger than the arithmetic of the fraudulent item alone suggests, and why the taxpayer’s evidentiary work is on the non-fraudulent remainder.

How this has changed

The Code’s fine amounts have not moved since 1982, and that is why they mislead. Public Law 97-248 raised the § 7201 figures tenfold and made parallel changes to §§ 7203, 7206 and 7207, effective for offences committed after 3 September 1982. Nothing has changed since. The operative ceilings come from the general fine structure in 18 U.S.C. § 3571, added in 1984, which applies the greater of the offence-statute figure or the general felony maximum. Study material quoting the Code figures alone is quoting a 1982 number.

Section 7203 acquired a felony branch. The § 6050I cross-reference — willful violation of the cash-transaction reporting rule — was added in 1988 and amended in 1990 to substitute “felony” for “misdemeanor” as well as five years for one. A blanket statement that § 7203 is always a misdemeanor is wrong.

The civil fraud penalty is a 1989 provision. Section 6663 was added by the Omnibus Budget Reconciliation Act of 1989, applying to returns due after 31 December 1989. It replaced the older combined fraud addition, and it brought with it the burden structure now in § 6663(b) — establish fraud as to part, and the whole underpayment is treated as fraudulent subject to the taxpayer’s rebuttal.

Section 7212(a)‘s “omnibus clause” has been narrowed by the courts. The words “in any other way corruptly … obstructs or impedes … the due administration of this title” were once read very broadly; the current reading requires a nexus to a particular administrative proceeding pending or reasonably foreseeable. This page states only what the statute says — the judicial gloss is noted so the clause is not read as unlimited.

Exam focus

Know that avoidance is lawful and is what the deduction, credit and timing provisions of the Code are for, and that the distinction from evasion is willfulness, not the amount at stake.

Know that IRC § 7201 is a felony requiring a willful attempt, that it reaches evasion of assessment or payment, and that it carries up to 5 years.

Know that IRC § 7203 is a misdemeanor for willful failure to file, pay, keep records or supply information, carrying up to 1 year — with a felony branch for willful § 6050I violations.

Know that IRC § 7206(1) covers signing a document under penalties of perjury not believed true as to every material matter, and § 7206(2) covers aiding or assisting in a materially false document whether or not the taxpayer knew — both felonies, up to 3 years.

Know the civil fraud penalty rate and its burden rule under IRC § 6663(b), and that on a joint return it reaches only the spouse whose fraud it was.

Know that the fine amounts printed in the Code are superseded upward by 18 U.S.C. § 3571.

Check yourself

1. Which of the following is tax evasion rather than tax avoidance? (A) Deducting mortgage interest on a qualified residence (B) Contributing to a retirement plan to reduce current income (C) Claiming a credit the taxpayer qualifies for (D) Omitting cash receipts from a business from the return Answer: D. The first three are the Code operating as written; omitting known income is willful understatement.

2. A taxpayer willfully fails to file for three years but takes no steps to conceal anything. Which section fits? (A) IRC § 7201, felony evasion (B) IRC § 7203, misdemeanor failure to file (C) IRC § 7206(1) (D) IRC § 7212(a) Answer: B. Section 7201 requires a willful attempt — an affirmative act — beyond the omission itself.

3. A preparer knowingly inserts fabricated deductions supplied by a client who is unaware they are fabricated. Is the preparer exposed under IRC § 7206(2)? (A) No — the taxpayer must be complicit (B) No — only the signer is liable (C) Yes — it applies whether or not the falsity is with the taxpayer’s knowledge or consent (D) Only if the tax understated exceeds $5,000 Answer: C. The statute says so in terms, and the offence is a felony.

4. The IRS establishes that part of an underpayment is due to fraud. How much is subject to the IRC § 6663 penalty? (A) Only the portion proved fraudulent (B) The entire underpayment, unless the taxpayer shows by a preponderance which portion is not attributable to fraud (C) Half the underpayment (D) None, absent a criminal conviction Answer: B. IRC § 6663(b) reverses the default once any portion is established.

5. A taxpayer whose returns are all accurate conceals assets from a revenue officer to defeat collection. What is the exposure? (A) None — the returns were correct (B) A civil penalty only (C) IRC § 7201, which reaches evasion of the payment of tax as well as its assessment (D) IRC § 7203 only Answer: C. Concealment aimed at defeating payment is the affirmative act, and IRC § 7212(a) may also be in play.