How to Calculate the Tax Loss from Evasion

Tax evasion is a big problem that costs the government and taxpayers billions of dollars every year. While some people intentionally try to avoid paying taxes illegally, others accidentally under-report income or over-claim deductions without realizing it. Regardless of intent, it’s important to understand how the IRS calculates the tax loss from evasion so you can avoid penalties and legal issues.

What is Tax Evasion?

Tax evasion refers to illegally avoiding paying taxes by under-reporting income, overstating deductions, failing to file returns, and other methods. Intentional evasion is a federal crime with penalties including fines and even jail time. But even accidental underpayment can result in back taxes, interest, and penalties if not corrected.

How the IRS Calculates Tax Loss

When the IRS suspects tax evasion, they investigate to determine the correct tax liability. They compare what was reported on tax returns to the taxpayer’s true income and deductions. The difference between what should have been paid and what was actually paid is considered the tax loss. Calculating this tax loss is key for both the IRS and taxpayer.

1. Calculate Total True Tax Liability

First, the IRS calculates the person’s total true tax liability for each year. This is the tax that should have been paid based on their actual income, deductions, credits, etc. The IRS can use information like bank records, business records, and interviews to determine the taxpayer’s true taxable income and liability.

2. Subtract Tax Actually Paid

Next, the IRS subtracts the amount of tax actually paid for each year, based on the filed tax returns. This includes any payments made, credits claimed, and withholding.

3. The Difference is the Tax Loss

The difference between the true tax liability and the tax actually paid is considered the tax loss – or the amount of tax evaded. This tax loss forms the basis for civil penalties and even criminal prosecution in tax evasion cases.

For example:

• John’s true taxable income for 2020 was $100,000
• Based on that, his total true tax liability was $18,000
• On his tax return, John only reported $80,000 in income
• So he only paid $14,000 based on the lower income
• The tax loss would be $18,000 (true liability) – $14,000 (paid) = $4,000

So in this case, the tax loss from John’s evasion would be $4,000.

Civil vs. Criminal Tax Loss

The IRS makes a distinction between civil and criminal tax loss. This is important, because criminal prosecution requires proving intent and meeting a higher tax loss threshold.

Civil Tax Loss

The civil tax loss is the amount of tax underpaid, whether accidentally or intentionally. This determines the amount of back taxes, interest, and civil penalties a taxpayer may owe in an audit.

Criminal Tax Loss

The criminal tax loss is the amount the IRS can prove was intentionally evaded. This requires establishing willful intent and meeting certain dollar thresholds. For example, tax evasion over $10,000 within a year may trigger criminal charges.[1]

How Tax Loss Affects Penalties

In civil audits, the amount of tax loss correlates to the size of accuracy and negligence penalties. In criminal cases, it determines whether charges are pursued and impacts sentencing.

Civil Penalties

In a civil audit, higher tax loss can result in larger penalties, such as:

• 20% accuracy penalty on underpayments
• 25% late filing penalty on unfiled returns
• 75% civil fraud penalty on evaded taxes

So a higher tax loss means potentially higher penalties.

Criminal Prosecution

For criminal charges, there are dollar thresholds that must be met to prosecute tax evasion, such as:

• Felony charges usually require tax loss over $10,000[1]
• Tax loss over $100,000 can increase sentences[1]

So a higher tax loss means more likely and more severe criminal prosecution.

How Taxpayers Can Calculate Tax Loss

Taxpayers who discover they underpaid taxes should calculate their own civil tax loss to understand their exposure and options. This involves:

1. Reconstructing their true taxable income for unreported years
2. Recalculating the tax owed based on the true income
3. Subtracting taxes already paid per returns
4. The difference is the civil tax loss

Taxpayers can then use IRS programs like voluntary disclosure to correct mistakes before an audit. Accurately calculating tax loss is key in these programs.

Strategies to Avoid Tax Evasion Issues

Some tips to avoid tax evasion and related penalties include:

• Carefully report all income earned each year
• Keep detailed records to document income and deductions
• Review returns carefully before filing
• Consult a tax professional if unsure about complicated tax situations
• Use IRS programs like voluntary disclosure to correct any mistakes as early as possible

Taking these preventative steps can help avoid or mitigate tax loss and any related penalties down the road.

The Bottom Line

Calculating tax loss is important for both the IRS and taxpayers in evasion cases. For the IRS, it determines penalties and prosecution. For taxpayers, it provides insight into their exposure and options. By understanding how the IRS calculates tax loss, taxpayers can be better prepared and possibly correct issues before an audit.

Some key points to remember:

• Tax loss is the difference between true liability and taxes actually paid
• Higher civil tax loss can increase penalties owed
• Criminal prosecution often requires a tax loss over certain dollar thresholds
• Taxpayers can calculate their own civil tax loss to understand their situation
• Strategies like voluntary disclosure can help correct issues early

Taking steps to accurately report income and deductions is key to avoiding tax loss issues altogether.

References

[1] IRS Criminal Investigation Division – How Criminal Investigations Are Initiated