Mistake or fraud? Understanding federal and Massachusetts tax laws

Making an honest mistake when filing a tax return typically is not a crime, though it does have consequences.

Every year, people in Massachusetts are required to file both a state and a federal income tax return. There are a number of cases in which taxpayers make errors that result either in a "deficiency" in tax due, or an overpayment. Many people understandably worry that missteps could land them in hot water. Fortunately, there are ways the IRS differentiates between a criminal act and an honest mistake.

What is considered tax fraud?

Federal and state laws define tax fraud as the following willful acts:

  • Failing to pay taxes
  • Failing to file a return
  • Failing to report income
  • Filing a false return or making false claims

The operative word here is "willful." In other words, a person who commits an error or omission on the tax return must be seen to have done so knowingly in order to be charged with "fraud." Fraudulent intent is a finding on the basis of evidence. It is a "divisible" concept - fraud of a civil nature and fraud of a criminal nature are included in the term. The latter is usually defined by a level of deceit that is beyond doubt. The former, not so much.

Fortunately, the IRS is understanding of how complicated it can be to file taxes based on the complex code. Agents reviewing errors look for common signs of fraud, such as falsified documents or keeping two sets of books. If these symptoms are absent, the IRS typically assumes the act was a mistake.

What are the penalties for fraud?

The IRS does not take tax crimes lightly. Simply failing to file a return could result in up to one year in prison. Evading tax could result in up to five years in prison and as much as $250,000 in fines for an individual or $500,000 for a business. Again, these are punishable crimes when the person committed the error willfully and not by mistake.

In Massachusetts, the penalties include up to five years in prison and a $100,000 fine in addition to the possibility of paying restitution. The sentencing depends on the nature of the crime.

Can I be punished for a mistake?

Yes. Just because the error was an honest one does not mean the IRS simply lets it go. In fact, the IRS can penalize taxpayers through a number of methods. For example, someone who files a return late could owe an additional 5 percent of the due taxes for each month it is late, up to 25 percent. Making a mistake could result in a 20 percent penalty on the underpayment. Failing to pay the total amount due could mean owing one-half of 1 percent of the owed amount each month until the bill is satisfied.

A criminal tax investigation is a serious matter, even when the person accused of the act has not done anything wrong. There are severe consequences at stake. Anyone who has concerns about this issue should speak with a competent, experienced tax attorney in Massachusetts.