Tax Negligence vs. Tax Fraud
April 14, 2023
Tax Negligence vs. Tax Fraud

Tax season is quite notably one of the most dreaded times of the year for individuals and small business owners alike. The entire process of filing – before, during, and after – is enough to send even the most composed taxpayer into a frenzy.


It is only natural, therefore, that errors can and will be made.  However, this is no excuse for carelessness and small business owners must pay extra attention during the tax planning process. A simple but serious blunder could be the difference between being screened for tax negligence versus tax fraud.


Unfortunately, most people do not know the difference between negligence and fraud when they are filing their taxes. Most individuals are only familiar with the fact that if they do not pay their taxes, there will be consequences.


This article will go into detail about both to inform business owners and individuals and raise awareness.


Tax Negligence 


An IRS auditor considers the intentions behind an error in order to pass the judgment that a taxpayer was negligent.  In simple terms, negligence is the act of making a careless mistake while filing taxes that incurred a miscalculation or glitch.  


If an individual or business owner underpays or reports their taxes inadequately, they could be liable for an extra 20 percent of their bill added to their tax debt. This penalty is considerably higher if there is suspicion of fraud.


Some examples of tax negligence include, but are not limited to:

  • Excluding income from your tax return that was shown in a record, such as earnings reported on Form 1099,
  • Not keeping appropriate records to confirm that you qualify for the deductions or credits that you have claimed, and
  • Not checking the accuracy of a credit or deduction that seems unlikely or highly impossible.


To better understand tax negligence, examine the below case study.


John has international clients at his real estate agency. As a result, he has foreign bank accounts and a foreign pension plan. When he was doing his taxes this year, he did not include the foreign pension plan, because he did not know that it would be considered an account.


Therefore, John had to revise the documents that he filed. His mistake was an oversight and he committed tax negligence. John could have further avoided paying the penalty if he could prove that he acted reasonably and in good faith.


This is the first illustration of the disparity between negligence versus fraud. 


Tax Fraud


The IRS deems fraud as the willful act of not complying with tax law. 


Auditors are trained to look out for red flags, that is, actions or mistakes that have no innocent explanation. If it can be proven that an individual or business owner’s actions were intentionally made to deceive the IRS, then it is considered tax fraud.


Below are common examples of fraudulent tax acts:

  • Creating the existence of a spouse or dependent
  • Providing false information about identity 
  • Keeping two different sets of books or having multiple financial records


There can be severe repercussions if an auditor determines that a business owner or individual has committed tax fraud.  In addition to paying a penalty of 75 percent of their tax obligation, a person could have to pay exorbitant fines or even face time in prison.  


To better understand tax fraud, let us explore once more the case study from the previous section.


John has foreign accounts, including his foreign pension plan.  He is fully aware that he is required to report the pension plan since it is considered an account.  However, John deliberately does not report the pension plan because he believes he will not get caught.


This is a clear example of tax fraud versus negligence above, since in this case, John is willfully circumventing tax law. 


So what happens next?


The distinction between tax negligence and tax fraud can be disputed, as the line between the two can be unclear at times.  However, the intention behind the actions is what IRS auditors look for. This can be resolved with the presentation of accurate records. If you or your business does not maintain proper records, then an auditor could suspect tax fraud.


If a business owner or individual is ever speculated of tax fraud – that is they have received a notice from the IRS to state this – then they should consult a tax attorney.  It is best to rule out the idea of tax fraud with the IRS. Although some people avoid jail time, they still have to pay a significant amount in fines which can be disastrous financially, especially for a business.


Mistakes happen and auditors are conscious of this fact.  Unfortunately, some mistakes can be costly, as in the example of tax negligence. If you are unable to demonstrate that your actions were reasonable, then you may have to pay the penalty for negligence.


20 percent may not be as steep as 75 percent, but it is still a costly mistake. Honesty and accuracy is the best route when doing your taxes, and the cheaper one as well.


For assistance with your tax planning process, contact us below.

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