Failure to File vs. Tax Evasion: Where the Felony Line Is

There is a difference between not doing something and doing something to hide that you did not do it. Federal tax law draws that line sharply, and for non-filers it is the most important line in the Code.

The two statutes side by side

Both statutes require willfulness. In Cheek v. United States, 498 U.S. 192 (1991), the Supreme Court addressed the meaning of "willfully" in both sections and described it as a "voluntary, intentional violation of a known legal duty."

What turns a failure into an attempt

Section 7203 is about omission: not filing, not paying. Section 7201 is about an attempt "in any manner to evade or defeat" a tax. The word "attempt" implies action.

The IRS handbook on fraud in non-filer cases puts the connection plainly: "Willful failure to file a tax return is a misdemeanor pursuant to IRC 7203. In cases where an overt act of evasion occurred, willful failure to file may be elevated to a felony under IRC 7201" (IRM 25.1.7.1.2).

The key phrase is "overt act." Simply not filing, even willfully, is the misdemeanor. Not filing plus something done to conceal income or defeat the tax is where the felony begins.

What overt acts tend to look like

The IRS's fraud indicators for non-filers, in IRM 25.1.7.2, give a good sense of the conduct that moves a case toward evasion. Indicators involving action, as opposed to inaction, include:

• Attempts to conceal income or assets
• Filing false documents, including false returns with the IRS or with third parties
• Providing incomplete or misleading information to a return preparer
• Payment of expenses in cash when cash payment is unusual, and cashing rather than depositing business receipts
• Offering implausible or inconsistent explanations

The fraud development procedures in IRM 25.1.7.4 show what investigators pursue: income verification through FinCEN data, third-party records, and copies of checks issued to the taxpayer; establishing cash on hand; and checking public records for assets, including when they were acquired and what was paid, to determine whether the taxpayer could have paid the taxes when due.

The common thread is concealment. Moving income through accounts in other names, titling assets in a relative's name, lying to IRS employees about income or assets, and creating false records are the kinds of conduct that give a failure-to-file case a felony shape.

The third statute: false returns

Non-filers who decide to fix things sometimes create a new problem by filing returns that are not accurate. IRC 7206(1) makes it a felony to willfully make and subscribe any return or other document verified under penalties of perjury that the person "does not believe to be true and correct as to every material matter." The penalty stated in the section is a fine of not more than $100,000 ($500,000 for a corporation), imprisonment of not more than three years, or both, plus costs of prosecution. The limitations period is six years under IRC 6531(5).

The lesson is simple. A late return must be an accurate return. Leaving off income the IRS does not know about, or inventing expenses because the records are gone, takes a person who may have had only misdemeanor exposure, or none, and hands them a felony.

The civil parallels

The criminal line has civil echoes. The regular failure-to-file penalty under IRC 6651(a)(1) is 5 percent per month, up to 25 percent. The fraudulent failure-to-file penalty under IRC 6651(f) is 15 percent per month, up to 75 percent. And the civil fraud penalty under IRC 6663 can apply to fraudulent underpayments on returns that are eventually filed. The IRS's handbook says both fraud penalties can be considered when the failure to file and the later return are both fraudulent, though it cautions that courts are unlikely to sustain both without compelling facts (IRM 25.1.7.6).

In Tax Court, the IRS bears the burden of proving fraud, under IRC 7454(a), and must do so by clear and convincing evidence under Tax Court Rule 142(b). See the fraudulent failure-to-file penalty.

A few hypothetical contrasts

Consider three hypothetical people, each of whom failed to file for the same four years.

The first was self-employed, deposited everything in one bank account in her own name, and simply stopped filing after a divorce. She did nothing to hide anything. Her problem is a filing problem, with civil penalties and interest.

The second did the same, but when a Revenue Officer asked about income, he said he had none, even though his deposits told a different story. That false statement is the kind of conduct the IRS lists among fraud indicators, and it is exactly the sort of affirmative act that can change how a case is viewed.

The third routed her business receipts into an account opened in a relative's name after she stopped filing. Concealing income or assets is at the top of the IRS's fraud indicator list.

The four unfiled years are identical. The exposure is not. What changed it was conduct, not the calendar.

The burden is on the government

In a criminal case, the government must prove every element, including willfulness, beyond a reasonable doubt. Cheek makes clear that willfulness requires proof of a known legal duty that was voluntarily and intentionally violated. For a felony evasion charge, the government must also show an affirmative attempt to evade or defeat the tax. Those are serious burdens. They are also burdens that a person's own words and later actions can help the government carry, which is why the advice in this guide is so consistent: stop, get counsel, and do not create new facts.

Why the distinction matters for decisions you make now

Most non-filers have done nothing but not file. If that describes you, the most important thing you can do is avoid creating new facts. The overt acts that matter are often acts people take after they realize they have a problem: moving money, retitling property, telling the IRS a story that is not true, or filing a quick return that leaves things out.

If something on the indicator list already describes your situation, the path forward is still filing, but the order and manner of filing become legal decisions. The IRS examination manual tells examiners who see fraud indicators to stop soliciting returns and to bring in a fraud enforcement advisor (IRM 4.12.1.7.1). By the time that happens, the best time to plan has passed.

A short self-check

• Did I simply stop filing, or did I also take steps to hide income or assets?
• Have I made any statements to the IRS, a lender, or anyone else that conflict with the truth about my income?
• Have I moved assets into other people's names since I stopped filing?
• Did I give my preparer complete information for every year I did file?
• Am I prepared to file returns that report everything, including income the IRS may not know about?

If any answer worries you, talk to a tax attorney before you talk to the IRS.