Jail?? Isn't that just a tiny bit harsh? I'm not a criminal, am I? 😨
⚡News flash⚡: Tax fraud is a criminal offense in the United States punishable by penalties and even imprisonment. If you did not commit tax fraud, then you have nothing to worry about. 😊
How about the failure to file a tax return? Is that considered tax fraud? 🤔 I'm glad you asked. 🙃
Let me start by clarifying that I am not a lawyer; I am an accountant, yet I have lost count of the number of times I have been asked this question in the last decade. 🤷♂️
There are a few key concepts that I would like to simplify for you:
Tax Fraud
Tax Evasion
Tax Avoidance
Tax fraud and tax evasion each have their unique specifications, but we are keeping this simple, right? Right. So let's just say they are both illegal, and they both involve willful intent to evade taxes that the taxpayer owes.
Tax AVOIDANCE is legal. Let's focus on that. ✔
The IRS describes tax avoidance on their website as follows:
"Avoidance of tax is not a criminal offense. Taxpayers have the right to reduce, avoid, or minimize their taxes by legitimate means. One who avoids tax does not conceal or misrepresent but shapes and preplans events to reduce or eliminate tax liability within the parameters of the law".
In short, tax avoidance is essentially the act of legitimate tax planning.
Here is an example of legitimate tax planning: As you may know, there are several different types of legal entities in the United States, such as a corporation, sole proprietorship, and partnership, to name a few. It is legitimate for a taxpayer to form a certain entity (for business/ investments) with the deliberate intent of owing fewer taxes at the end of the year, as a direct result of the entity choice. Of course, the entity chosen must also make sense from an economic standpoint.
Guess what else is legal? Not filing a tax return IF you are not required to file a tax return. Yes, there are scenarios where one does not have to file a tax return.
Examples include:
A US citizen who earned less than the annual threshold in a given year. (This depends on filing status and employment type, among other things)
A non-US citizen with certain US activity and US taxes were properly withheld. (Does not apply to ALL types of US activity)
A Limited Liability Company which was classified as a partnership that did not have any activity (income, expenses, assets, etc) at all during the tax year. (As opposed to a corporation that must file each year even if there was no activity at all)
We are now getting closer to answering our initial question: Can I go to jail for not filing a tax return?
Having just learned that there are scenarios where a tax return is not even required, our question is narrowed down to the case where a tax return is required but not filed, meaning it falls into the category of tax fraud.
At this point, it is critical to differentiate between someone who willfully (knowingly and purposely) refrains from filing and someone who is non-willful. This distinction will dictate the type of punishment that may await.
As you may have guessed, willfully refraining from filing a tax return is tax fraud. Punishments for violators include fines, penalties, interest, and yes, even imprisonment, depending on the severity of the violation (amount of taxes owed, repeated violation, sophisticated tax evasion, etc).
Non-willfully not filing a tax return is a whole different ballgame. ⚾ People make honest mistakes sometimes, and the IRS understands that.
If you honestly were not aware of your filing obligations and you were also not expected to be aware of them (due to professional background, geographical location, etc), then chances are you are not going to jail, provided that you can prove your intentions and your circumstances. There is, however, a good chance you will be slapped with a significant penalty, especially if you owe taxes.
Naturally, the punishment will be significantly less severe if you approach the IRS before they "catch" you.
The good news for non-willful violators is that the IRS wants to help you get back into compliance and offers various amnesty programs that can significantly reduce or eliminate the penalties. The IRS will not be willing to waive the actual taxes owed plus interest, which makes sense.
What happens if the IRS does come to me first and sends me a penalty notice? Is there anything I can do to abate the penalty?
It is common for the IRS to send penalty notices to taxpayers who filed late. Penalties on individual tax returns are often a percentage based on the taxes owed. However, penalties on informational returns, where taxes are not relevant, are often very high. I'm talking about tens of thousands of dollars for each violation!
Examples of common informational returns include:
FinCEN Form 114, better known as the FBAR, the annual requirement for US citizens to report any and all financial accounts (bank accounts, investment accounts, etc) located outside the United States if the aggregate total in all accounts exceeds the equivalent of $10,000 at any given time during the year. (This is not an IRS form, but the IRS does have a similar form called Form 8938 with much higher thresholds)
IRS Forms 5471 and 5472 which involve fun topics like foreign companies owned by US citizens, and US companies owned by foreigners.
In cases like these, the IRS will often require proof of "Reasonable Cause" when requesting a penalty abatement. The classic example of reasonable cause involves serious illness or death which prevented the timely filing of a return.
Proving non-willfulness and reasonable cause according to IRS standards can be tricky. That is the reason your accountant will likely refer you to a specialist tax attorney to obtain the most favorable outcome so you do NOT end up in jail!
This article provides general information in simplified terms and should not be confused for personal tax advice. Each specific case must be analyzed separately by consulting a professional tax advisor.
Note: A version of this article was published on keepertax.com in August 2020